Pricing and Subsidy Reform for the Petroleum Sector Presentation at Seminar on “Impact of Rising Oil Prices and Possible Solutions” 10 th May 2005 at the India Habit Centre Indian Institute of Management Ahmedabad Sebastian Morris

IIMA Current Tax Situation Not ‘value added tax’ so all the distortions of excise duties –Tax on tax –Difficult to estimate tax burden –Production /integration affected Exports hurt Tradables goods production hurt One of the reasons for hollowing of Indian Mfg. Centre state tax base problem; opportunistic taxation possible Open ended subsidies; High growth of LPG

IIMA Distortions of Differential Pricing First order –Implicit cross subsidies –Dead-weight losses Second order –Input choices affected –Demand shifts; interfuel substitution Third Order Distortions –Governance –Adulteration; diversion –Corrupt society –Policy /Investments affected

IIMA The Chain of Distortions Excessive consumption, underconsumption and inefficient consumption Applications that are not the comparative advantage (of application) of the fuel in question Higher growth in the consumption; interfuel substitution Such shifts result in ‘revenue loss’

IIMA ‘Option’ to mop up such potential losses limited Excess naphtha has an arbitrage possibility when diverted. Similarly kerosene diesel – large revenue loss The Problem of substitution with NG Adulteration privately profitable but social loss: –(1) environmental quality losses

IIMA –(2) the wasted efficiencies –(3) lower engine life –(4) higher cost of maintenance –(5) higher monitoring and organizational and such other costs that are borne in fighting adulteration itself. Environmentalists Delhi and Gas; Policy response to distortion Innovativeness in response to distorted demands. Open ended subsidies when price based; high growth inevitable.

IIMA Dealerships a prized opportunity and politicized. Revenue max criteria may be bypassed. MS a case in point? Entrenchment of corruption Raises monitoring cost Oil company valuations are affected Basis for micro-intervention Commercialisation, commercial behaviour difficult; privatisation impossible

IIMA Life Cycle Costs of Subsidising LPG Per Consumer (Rs per consumer) Assumed subsidy per cylinder Interest rate of government 8.5% % Source: Morris, S. and Ajay Pandey (2005) “Petrofed LPG Subsidy

IIMA Kerosene and LPG Consumption and Leakages (‘000 tonnes) Aggregate Supplies of PDS/ Officially reported consumption Aggregate Household Consumption of PDS Kerosene /LPG from Consumer Expenditure Reports LeakageLeakage as % of supplies (Kerosene)* % % (LPG)** Negl (LPG)** Negl *Table 13; **Table 17 of Gangopadhyay, Subashis; Bharat Ramaswami and Wilma Wadhwa (2004)

IIMA Tax reform of sector Tax reform of the sector CENVAT and VAT merged into one for the energy (oil and natural gas) sector – most preferable Deduction of tax paid on inputs for petroleum and energy industry Revenue neutral rate to be arrived Pricing freedom to oil-cos Advalorem tax at two rates at best converging to single rate; and tax credit on inputs (Central and state)

IIMA States get share based on consumption data of oil companies; some non-linearity to take care of the interest of poor states Zero vatting of all exports starts on day 1 Countervailing duty on imports Uniform import duty rate rate (10%) for crude and refinery products; then effective protection is still positive and sufficientfor refining

IIMA Subsidy Reform Removal of all price based subsidies Direct subsidies for kerosene –15 litres per BPL family per month of kerosene at subsidised prices. –Identification based on BPL List –Identification separation from issuance; chip cards etc –No PDS; coupons issuance –Tradability possibility; introduced graduall

IIMA Removal of LPG subsidy –No argument here; not a practical merit good –Large scale kerosene subsidy prevents LPG usage –Limited subsidy to BPL families; through direct subsidy (coupons / chip cards) Removal of user based price differences in diesel and other fuels ATF, bunker fuels zero vatted Tax rate convergence plan for natural gas

IIMA Direct Coupon Based Subsidy for LPG BPL card holder families may be given coupons by the LPG marketing companies every year which would entitle them to buy up to 8 cylinders/ year by paying a subsidized price and a coupon. The coupons could be collected by the dealer and presented to the company for collection.

IIMA The subsidy administration in terms of printing of, issue of, accounting of and collection of coupons would have to be in the control the company and be supported by an effective and efficient organizational setup. As there would be risk of proliferation of non-deserving consumers or multiple connection, there would be a need for centralized oversight on new connections under this category.

IIMA ASSUMPTIONS Gross subsidy per cylinder (November 2004) (as reported in study) Rs. 195 Likely Gross subsidy after hike of price by Rs.20 Rs. 180 Net Subsidy per cylinder (November 2004) (as reported in study) Rs. 105 Likely net subsidy after price hike Rs. 85 Sales ( ) around 628 million packed cylinders Growth (last 3 years)around 11-12% Net Subsidy ( ) assuming November subsidy level (post Rs.20 hike) through out the year[1] is..Rs.5925 crore[1] [1] Upward biased estimate as the crude /LPG prices were higher around October/November Potential Annual “Savings” An estimate

IIMA SAVINGS ENVISAGED IN THE PROPOSALS[1][1] 1. Elimination of net subsidy Rs crore 2. Restricting subsidy to BPL families Rs 4740 crore or more Assumptions made: Maximum 20% consumers belong to BPL category Average consumption of BPL family is same as that of remaining customers. [1][1] Annual Savings at sales and subsidy levels for each of the options brought out in the study

IIMA 3. Restricting subsidy to 6 cylinders per year: Rs.1955 crore Assumptions made: The average consumption in has increased to 9 cylinders per connection from 8.13 cylinders in At 8.13 cylinders per connections, the savings would be lower at 1552 crores.

IIMA Appendices

IIMA Cost of Using LPG and Kerosene FuelPriceStove efficiency Rs/MJEquivalent quantity Rs /month LPGRs 241/cyl* 55% kg241 LPGRs 469/cyl 55% kg469 kerosene1Rs 9/lit* 40% liter188 kerosene, high pressure2 Rs 9/lit* 45% liter167 KeroseneRs 16.54/lit 40% liter345 kerosene, high pressure Rs 16.54/lit 45% liter307 *Subsidized price in New Delhi as of February 2003; Rs per month per household for purchasing the quantity indicated under “Equivalent quantity” Source Table 2.2 of Chapter 2 “Kerosene and LPG Markets in India”, (

IIMA Monthly Per Capita Consumption of LPG – All Households (kgs), c.2000 All HouseholdsLPG Using households Expenditure Decile* RuralUrbanRuralUrban All Source: Table 15, ibid.

IIMA Policy Uncertainity; Price Difference Outdated Diesel Engine technology Delhi Government’s Resistance Oil Cos. See Uncertainity Few Conversions Arbitrage Opportunity Few Retail Outlets for Gas Adulteration Dealer Selection Board’s Vested Interest Resistance to CNG Environmental Lobby Favour CNG Pollution Unabated High Policing Cost; Low Punitive Measures Chain of Price Distortions: The Case of CNG in Delhi