Petroleum pricing quagmire

It's futile to insulate domestic consumers from international prices

The government of India decided to dismantle the administered pricing mechanism (APM) for petroleum products in 2002. According to the government notification issued then, from April 1, 2002, the pricing of petrol and diesel was freed, and the subsidy on domestic liquefied petroleum gas (LPG) and kerosene (through the public distribution system, or PDS) was to be phased out over three to five years.

It is an irony that even after so many years of this, fuel prices in the country are yet to be market-determined. Before we come to the issues, a brief history of this decision and its implementation may be in order. Also, let’s focus only on petrol and diesel to keep it simple.

Petroleum products’ pricing is a sensitive matter, with social and political implications, not only in developing countries like India, but even in developed nations in the West. One of the reasons why the government then could muster the courage to take the APM dismantling decision was the extraordinarily low international oil prices in the aftermath of the 9/11 attacks in the US. The prices had crashed and Brent crude oil could barely move up to $20-21 a barrel by February 2002 at the time of taking this decision.

The domestic retail marketing of petroleum products at that time was handled entirely by public sector undertakings (PSUs) — not that the situation has changed much even now after two decades — still more than 90 per cent of the market share is with the PSUs. This effectively left the government in control of managing the transition from the APM regime to the post-APM regime.

Illustration: Ajay Mohanty

It was agreed between the government and the PSUs at the time of APM dismantling that the latter would revise every fortnight the retail prices of petrol and diesel on the basis of international prices. The oil PSUs also informally kept the government informed while revising the prices. This arrangement worked reasonably well for two years or so in the absence of any international price shock. However, this neither resulted in any competition, nor increased the operational efficiency. Barriers to entry for new players in the retail marketing of petroleum products dissuaded the private sector from entering the fray in any meaningful manner.

Post-APM dismantling, the cost-plus pricing mechanism gave way to import parity pricing. The absence of competition and many normative factors being taken into account while computing the import parity price made many people wonder whether the APM had actually been dismantled.

Somewhere in 2004, the government again formally got into deciding the pricing of petrol and diesel. From then on, petrol and diesel pricing in the country has been a muddled story. Different governments at different times announced free market pricing, but haven’t been able to carry it through. The pricing of petrol was decontrolled in 2010, according to a government communication, and that of diesel in 2014. However, the continued dominance of PSU oil-marketing companies (OMCs) implied that the government could intervene in pricing as and when it thought appropriate.

The taxation of petroleum is another issue. Considering the highly price-inelastic nature of demand for petroleum products like petrol and diesel, they become the natural potential candidates for high taxation by the government. As an illustration, the percentage of total tax (central government and state government taxes combined) in the retail price of petrol and diesel in Mumbai during 2002 was as high as 60 per cent and 38 per cent, respectively. This share was around 42 per cent and 37 per cent in May 2022.

During 2021-22, indirect tax collection by the government of India from petroleum was Rs 4.3 trillion, about 33 per cent of the total indirect tax collection. Similarly, the states’ dependence on value-added tax (VAT) collection on petroleum products to meet their revenue requirements was quite high. For instance, in Maharashtra, VAT collection from petroleum products was over 18 per cent of the state’s tax revenue during 2021-22. In Madhya Pradesh, this figure was around 22 per cent.

India imports around 85 per cent of its crude oil requirement. Such a magnitude of import dependence, combined with high price volatility, would obviously make any government intervene in domestic pricing. Add to this the undue dependence of the governments on petroleum taxation for meeting their revenue requirements and you get a recipe for chaos.

Three things need to be done. First, the OMCs must be allowed to pass on the impact of international price movements to consumers of petrol and diesel. Notwithstanding any political compulsions, considering the level of our import dependency, it is futile to aim at insulating the domestic consumers from international prices. It is absolutely wrong to ask the OMCs to absorb under-recoveries. The commercials of oil companies, which are listed on stock exchanges, should not be interfered with.

Second, the governments should reduce their dependence on petroleum taxation in meeting their revenue requirements. Petroleum should be transparently taxed, with each element of taxation by the central government and the state government concerned clearly brought out in the public domain. The build-up of the retail prices of petrol and diesel at all the state capitals, giving the granular details of refinery gate/import parity price and all types of taxes, may be hosted on the website of the Ministry of Petroleum and Natural Gas and updated on a quarterly basis.

While it may be early to bring in petroleum under goods and services tax, the central and state governments should come to an agreement on the maximum amount of tax they could impose on petroleum. The central government has to take the lead in this regard and set an example for the state governments as the latter are comparatively constrained in terms of fiscal space.

Third, and most importantly, all efforts need to be made to facilitate the formation of a sizeable market share of the private sector in the retail marketing of petroleum products. The privatisation of one of the PSU OMCs is the only way to achieve this quickly. The privatisation of Bharat Petroleum Corporation Ltd (BPCL), which the government has been planning for over two years, must be expedited. An opportunity was lost in the recent past when the international oil prices were comparatively benign and the stock market was booming. The capital receipts of the government on account of such divestment are only one part of the story and should not be the only consideration. 
 

Once BPCL, with about a 24 per cent share in the marketing of petroleum products, is privatised, it would change the whole oil-marketing scenario in the country. The PSUs’ dominance would end, and that will be the beginning of competition and the end of government influence over commodity pricing. In fact, that would be the true beginning of dismantling of the APM, a decision taken by the government two decades ago!

The writer is a retired IAS officer and former chairman, Sebi