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All Obfuscating Petro Pricing Policy in India:
Story of a Mare's Next?
|by Dipankar Dasgupta|
Jointly written with Tushar Kanti Chatterjee (Project & Management Consultant to SK Birla Group)
Oil refineries, being multi-product firms in the classical sense, cannot employ a straight forward cost plus mark-up procedure for computing the prices of their final products. Different quantities of petrol, diesel, kerosene, LPG, as well as other final products are simultaneously produced from a given volume of crude oil and it is not obvious what the crude input content of each product is. Reading between the lines of the Rangarajan Committee and the Parikh Committee reports on oil pricing in India, it is obvious that both were clearly aware of this deep rooted theoretical issue. The Parikh Committee’s recommendation that international oil prices should ultimately guide price fixation in India may have been partly motivated by this factor, though it justified its recommendations instead with reference to the unsustainable fiscal deficit of the Central Government. The prices of petrol, diesel, kerosene and LPG, the four most sensitive of oil products in India, have mostly been administered by the government. Since these prices rarely sync with international prices, the administered prices of some of the products fall short of world market prices while those of others exceed them and, according to the government and public sector oil companies, these distortions lead to avoidable fiscal deficits for the government.
The Pricing Scheme
Our primary goal is to adopt a cross-subsidized administered pricing scheme for petrol, diesel, kerosene and domestic LPG. The suggested prices and the motivations underlying them are described below.
Petrol is largely an item of final consumption. Its price has little impact on inflation through forward linkages. Also, it is mostly consumed by the relatively affluent sections and need not be subsidized. Thus, the price of petrol is fixed higher than the average 2011-12 international price (viz. Rs.35.39 per liter) at Rs. 60 per liter, which still falls short of the 2011-12 average petrol price of Rs. 64.43 in India.
According to the Parikh Committee, the approximate consumption pattern of diesel in India was: Railways -- 6 per cent; trucks --37 per cent; buses -- 13 per cent; taxis -- 8 per cent; agriculture -- 12 per cent; industry --10 per cent; power generation -- 8 per cent; and private cars -- 6 per cent. Thus, the diesel consumption for railways, trucks, buses, taxies and agriculture accounts for about 76 per cent of the total consumption, while that for industry, power generation and private cars constitutes the balance of 24 per cent. In other words, 76 per cent of the diesel consumed is critical in nature and needs to be subsidized. With this consideration in mind, we suggest a diesel price for critical use to be Rs.35 per liter. For the remaining 24 per cent of diesel use, the price is chosen to be Rs. 60 per liter, which matches the suggested price for petrol. (The Parikh Committee report was submitted in Feb, 2010. Consequently, the consumption pattern assumed here may have changed since then. In particular, it is almost certain that diesel use for privately owned cars has shot up.)
Estimates suggest that 35 per cent or more of PDS kerosene is diverted to take advantage of higher market prices. A single price in the market must therefore prevail as in the case of diesel. We suggest this price to be Rs. 40 per liter. The subsidized price of PDS kerosene will be Rs.13.70 per liter for 65 per cent of total kerosene consumption. As with diesel, ration shops could sell it at a uniform price of Rs.40 per liter. The Ration/BPL card holders would need to open bank accounts in nearby nationalized banks. Under this arrangement, they would receive bank transfers of Rs. (40 – 13.7) = Rs.26.30 per liter of kerosene purchased every month. In the absence of branches within a 3 km radius, the Panchayat would be assigned the responsibility of distributing cash subsidy to the villagers and submit the accounts to concerned authority. This should reduce some, though not all, malpractice and lower PDS Kerosene purchase to one third of the observed levels.
The Parikh Committee observes that rural households use 6 to 9 cylinders per year (since they also use wood as an alternate fuel), whereas urban and semi-urban households use 9 to 20 cylinders per year, with lower income groups using PDS kerosene as substitute fuel for cooking.
Source for Consumption Pattern: Petroleum Planning and Analysis Cell
As the table shows, the total revenue that the 4 essential products would generate in 2011-12 under the suggested price scheme and unchanged consumption equals Rs. 5,14,746 cr.
The total crude oil cost of production of petrol, diesel, kerosene and LPG needs to be calculated prior to other costs of production. The total crude oil consumed by Indian refineries in 2011-12 was 209.74 million ton. This broke up into 171.73 million ton of imported crude and 38.01 million ton of domestically extracted crude oil. The total production of petro-products by Indian refineries was 203.99 million ton. Around 50.66 per cent of this total output, or 103.34 million ton consisted of petrol, diesel, kerosene and LPG for Indian consumption. Technology suggests that the same percentage of the total (imported plus domestically produced) Indian mix of crude, or 106.25 million ton (or 77,88,42,358 barrels), was needed to produce the petrol, diesel, kerosene and LPG for Indian consumption. The aggregate quantity of domestic crude produced (38.01 million ton) turns out to be 35.78 per cent of the above calculated total crude need. This leaves a balance of 106.25 million ton minus 38.01 million ton = 68.24 million ton of imports to bridge the shortfall of crude required for the four essential products. The latter equals 66.22 per cent of the total Indian mix of crude used up. The calculations are captured by Table 2.
Source for Production and Consumption Pattern: Petroleum Planning and Analysis Cell
Thus, the average price of a barrel of the Indian mix of crude should be calculated by attaching a weight of 64.22 per cent to the import price and 35.78 per cent to the indigenous price. This calculation is presented in Table 3.
Given that the quantity of Indian mix of crude used to satisfy the domestic need for the four products was 103.34 million ton or 77,88,42,358 barrels, the nominal value of this crude, using the price computed in Table 3, was Rs.3,91,101 cr. The balance amount of imported crude, i.e. (209.74 – 106.25) million ton = 103.49 million ton was used to produce items other than the 4 major products for domestic consumption considered so far. These consisted of Naphtha, ATF, LDO, Lubes, Furnace Oil, LSHS, Bitumen, Asphalt, and other exported petro-products.
Surplus Generated by Suggested Pricing Scheme
Under the adopted pricing scheme, the gross surplus realized from producing the 4 essential products is then Rs. 5,14,746 - Rs. 3,91,101 cr = Rs. 1,23,645 cr. This gross surplus would need to cover refinery expenses and margins, dealer commissions, VAT as well as Central taxes. As per the information available from the websites of the oil companies, these figures for the year 2011-12 were as follows:
The total expenses of the refineries were Rs. 48,520 cr. (These included power and fuel cost, employee cost, other manufacturing expenses, selling and administrative expenses and miscellaneous expenses.) Their interest and depreciation charges amounted to Rs.11,369 cr. Assuming as before that 50.66 per cent of the expenditure was incurred in producing the 4 sensitive products, their total production cost amounted to Rs.30,340 cr (approx).Refinery Margins:
The total margin of all 3 refineries was Rs.61,77 cr. Once again, applying the 50.66 per cent argument, the profit derived from the 4 products should have been Rs.3,129 cr (approx).
Based on dealers’ margin for the 4 products prevailing in the very recent past, the total margin turns out to be Rs.14,141 cr.
Besides item 6(c) in Table 4, the oil companies earn substantial profits from selling the other petro-products listed earlier, since these are sold at market driven prices. Also, In 2011-12, their net exports of the 4 products were worth Rs.1,45,886 cr. Thus, 6(c) provides a minimum bound on the profits of the oil companies. Similarly, since the Central Government will earn taxes from these other sources as well, item 10 in Table 4 too stands to be augmented to a larger figure.
As far as cost saving policies are concerned, it is important to note that a merger of the three PSU refineries will lead to a minimum saving of Rs.10,000 crs by cutting down on excess man-power, particularly at the executive level (to wit, IOC maintains a highly uncompetitive executive to workmen ratio of 1:1.35), as well as operating, capital and overhead expenditures. We expect another 5-10 per cent possible reduction in prices of these 4 products through this channel.
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10/09/2012 02:10 AM
10/09/2012 00:46 AM