Oil Pool Deficit Blues
The adoption of a pro-consumerist stance by the Left parties in settling the oil pool deficit is a landmark event which has gone largely unnoticed. Their proposals seem to be driven by two crucial principles relating to public accountability and governance.
One, revenue generation by the government must be transparent. Non-tax funds received, for example, as accretions to the oil development fund or surpluses in the oil pool, must be used only for the purpose intended in the authorising legislation. This was clearly not done. Disbursements from the oil development fund are barely 3 per cent of accretions. Similarly, withdrawal of surpluses from the oil pool without the facility of automatic plough back to cover deficits defeats the rationale behind creation of the pool.
Two, a certainly administered, cost plus pricing system is not in the interest of either the consumers or economic efficiency. Cross-subsidisation through a pool controlled by the government breeds administrative ennui. This ultimately reflects in passive pass-through of costs to consumers without adequate attention to improving the efficiency of expenditure. The cost plus approach is inflationary and subverts macroeconomic stability.
These are healthy principles and need to be reaffirmed. This is why it is cynical to be dismissive of the reported initiatives under the Arjun Sengupta Committee. Yes, these are mainly accounting adjustments improving the balance sheet of oil companies by transferring assets from the current to the capital accounts. The recommendations, if indeed they exist, to convert the oil pool deficit into sovereign interest paying debt held by the oil companies are important not because of the financial ingenuity they display but because of the principle they establish that non-tax revenue cannot be a source for financing revenue expenditure.
The second area of virtual consensus seems to be the need to liberalise the administered pricing mechanism (APM) and introduce competitive pressures into the domestic petrogoods market. The oil industry in general feels that dismantling the APM will benefit them. This is strangely in contradiction with facts. Once retail prices are freed, producer margins can not be protected. International refining margins are under pressure and refining capacity is surplus. Contrarily, Indian refiners are the most cash rich entities. Their financial viability can be traced to the 12 per cent assured rate of return they enjoy on net worth. Continued good times, outside the APM, seem possible only if protection from foreign competition, through prohibitive import tariffs, continues.
It seems the refiners are in tandem with the government, which is, supposedly, thinking of sharing this bonanza through a windfall tax. Where is the windfall likely to come from? Refining capacity is expected to nearly double over the next two plan periods. If protected by import tariffs on petrogoods, the high costs of these new refineries will determine the sale price of petroproducts. Fully depreciated existing refiners will naturally enjoy a cost advantage which the government wants to tax. The unstated assumption behind this is the possibility of a real increase in the average consumer price of petroproducts once the APM is dissolved.
Why should consumers then favour dismantling the APM and liberalising distribution? There are considerable cost efficiencies to be gained through liberalisation. The resultant corporate surpluses can cross-subsidise basic products like kerosene or diesel. A considerable portion of the profits of international oil companies is earned in distribution and marketing and not in refining. There is an entire consumer segment in India which is ready to absorb currently unavailable value added services associated with petroproducts. This is a wholly under-developed and over-controlled market which will blossom once controls go. This will boost oil company profits, but how will it help consumers of low value added petroproducts? If APM is completely abolished, no levers will exist to divert a part of this incremental surplus to contain the prices for select consumer groups, deserving of subsidisation. To make the reform process painless, the government will then need to implicitly provide for subsidy. Nobody
seriously believes it can. What it can do, however, is to remove price control selectively while fully liberalising distribution and marketing. Rationed quantities of kerosene for the poor and diesel for marginal farmers in unelectrified areas, supplied at subsidised rates, will be the social responsibility oil companies will need to bear to enjoy the fruits of liberalisation.
The proposal currently being considered of imposing a windfall tax probably has the same intention. Where it fails to convince, as a viable alternative, is the faulty assumptions on which it is based. The key, and largely misplaced, assumption behind the existence of a windfall is continued market failure. The government feels that post-APM, consumer prices will be dictated by the highest cost domestic refinery working on a similar rate of return as an old fully depreciated refinery. The fact is, this can happen only with tacit government support via prohibitive import tariffs on petrogoods. If tariffs are rationalised, foreign competition will pare refining profits to the bone thereby constraining price increases. Why will new refining capacity then come up? It is possible that it will not. Is this a matter of concern?
Why do we need accretions to refining capacity in India? Our refining capacity of around 70 m.t is nearly double of the medium term production forecast for crude of around 44 m.t per year. Refining is a capital-intensive business where the capital cost is a significant factor in profitability. These are areas where India does not have a comparative advantage. The average cost of foreign capital for an Indian private refiner will be at least 1 to 2 percentage points higher than for a refiner in West Asia or Singapore. The domestic capital cost differential will be even higher. Is the energy security premium differential between crude and petroproduct import really higher than the capital cost differential? If it is not, how does one justify capital outlays on an industry which has low value addition, low employment generation per rupee of investment with significant adverse environmental impacts to boot?
Is it not more cost-effective to import our petroproduct needs beyond what is available from existing refining capacity? If this is done and if import tariffs are kept at reasonable levels, there will be no windfall profit to tax and whatever benefits accrue from competition will be passed to consumers. The implicit problem, of course, is that liberalisation will have an adverse impact on subsidised consumers. It is strange, therefore, that the public debate on the equity impacts of oil price increase has receded and has been replaced by a debate on the merits of one or the other accounting method for adjusting overdues.
The poor have not vanished. The problem of insulating them from kerosene price increases remains. The adverse environmental consequences of subsidising diesel are just as stark. The implicit disincentives for adoption of environmentally sound renewable technology, even in remote areas, arising from the availability of a cheap hydrocarbons still exist. These are the areas which need public attention, now that we have an accounting framework for protecting IOCs financial image.
(The author is Senior Fellow, Tata Energy Research Institute)