Oil Subsidies


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Oil Subsidies

  1. 1. CASE OF OIL SUBSIDIES Are we stealing from future generations? TEAM C-Town Sleuths Praveen Kumar S Arun Prasad R Ghouse Mohideen S Srikanth BG
  2. 2. • India – 4th largest consumer / 4th largest importer of Crude oil • Oil and gas sector in India -accounts for 15 % of country’s GDP • 79% of crude demand imported • 1.6 lakh cr subsidy burden shared by Government & Upstream companies • Revenue from Oil & Gas sector to the Government: Rs 2.25 Lakh Cr • Trade Parity Pricing(TPP) (80:20) with Arab Gulf Price as the FOB Price reference. • Petrol prices decontrolled in 2010; Diesel price - partially deregulated. • Prices of Diesel, PDS Kerosene and Domestic LPG determined by Govt. • Fiscal subsidy provided on PDS Kerosene and LPG • Consumption subsidy is employed and subsidy is shared by Government, OMCs, PSU upstream and midstream companies • Average Crude Oil Price(Indian Basket as on Oct 16th 2013) : $ 108.71(6663 rupees) per barrel • Crude oil prices showed a steep increase during 2008 causing subsidies to jump to 2% of the total GDP Oil And Gas Industry Scenario: India Current scenario Impact of Subsidy Need for oil subsidy Recommendations Appendix
  3. 3. • The difference between the total cost price and the retail price is borne either as • Subsidy- the government subsidizes the OMC , the part of the price difference upfront (only for PDS Kerosene and LPG Cylinder and not for diesel) or • under-recovery- only a minor part of the difference is compensated as subsidy. The rest of the price difference burden is borne by OMC companies in the short run, the majority of which is later compensated by Upstream Oil Companies and Governments. • For clearer idea on subsidy and under recoveries look at the below formulae Total Cost- Retail Price-subsidy= Under-recovery (For Kerosene and LPG) Total Cost- Retail Price= Under-recovery (For Diesel) • Government compensates the under-recovery through • Oil bonds(Off-budget) • Direct Cash assistance(On-budget) • Following are the statistics for FY’13 (in crores) • Taxes on Crude oil is a major source of revenue • Central Government • Excise • Custom • Tax revenues are higher than subsidy • Tax alone constitutes 32% of diesel price • Central Government has taken steps to streamline And reduce taxes • Intended Benefits of Subsidies: • Poor and Lower-middle Income house-holds for their basic needs such as lighting, cooking and farming purposes • To lessen the inflationary pressures caused due to Crude oil price increases • However the richer few are the major consumers of subsidies and the intended beneficiaries (under 10% of the subsidized LPG and 2% of the PDS kerosene are consumes d by the intended beneficiaries • However removing the subsidies would hit the lower-middle class and poor harder than the rich due to the lowering of real-income Government Subsidy Under-recoveries borne by Government and Oil companies Diesel NA 92061 PDS Kerosene 741 29410 LPG Cylinders 1989 39558 Under recovery as a % of total GDP spiked to 2% briefly in the year FY08-09. For the Fy’13 it is about 1.6%. Current scenario Impact of Subsidy Recommendations Appendix Oil And Gas Industry Scenario: India Bearing the burden Of Under-recovery and Subsidy Taxation and Subsidy Beneficiaries of Subsidies • State Government • Sales tax
  4. 4. Oil subsidy – Pros and Cons • Resulting in mounting fiscal deficit (~2% of GDP) Source: PPAC (2011b) and PPAC (2011c) • Can crowd out growth enhancing public spending. Subsidies are substantially higher than critical social spending in many countries Source: International Energy Agency; World Bank • Subsidies discourage investment in energy sector since they can result in outright losses making it difficult to expand production • Subsidies diminish competitiveness of private sector in the long term since there are no incentives for investment in R&D of alternate tech • Subsidies create incentives for smuggling • Subsidies lead to over consumption of energy products which can have effects on global energy demand and prices. This leads to negative effects on environment as well • Subsidies are inequitable because they mostly benefit upper-income groups. Avg per capita welfare impact for the bottom 2 income deciles is Rs 20 vs Rs 120 on top 2 deciles Current scenario Impact of Subsidy Recommendations Appendix • Subsidies protect consumers from international price volatility and provides energy access to citizens, especially the poor • Out of India’s 1.2b people, atleast one-fourth live below poverty line. Energy access plays a very important role in the development of this segment Increased Affordability Greater access to basic amenities Source: PPAC (Jan 16, 2012) Source: NSSO (2010) • Subsidies help to counter inflation. Oil prices are highly unstable and have spill-over effects to other commodities. Subsidies help in smoothing out the fluctuations • Every 10% increase in crude prices results in 1% increase WPI index • Subsidies promote the growth of energy-intensive industries • Affordability of commodities would go down without subsidies
  5. 5. Current scenario Impact of Subsidy Recommendations Appendix Impact of subsidy on upstream oil companies and economy Source: PPAC (2011a) Issuance of Oil Bonds • Did not prove to be the commercial panacea as hoped due to saturated bond markets and Non-SLR status of the bonds • Following the budget announcement in 2009–2010, oil bonds were stopped and partial cash assistance from the government replaced them • But compensation varies and is provided on “as per need” basis Equitable Burden Sharing Mechanism (EBSM) • Upstream public oil companies (ONGC, OIL) would shoulder one-third of the burden of under-recoveries Source: OIL (2011) • Under-recoveries have risen at an exponential rate while Govt has cut petroleum product taxation • According to S&P, India’s fiscal debt entirely unsustainable in the medium term • Possible downgrade of India’s sovereign credit from BBB- to junk status which will put upward pressure on govt paper interest rates • Rising expenditure obligations and falling revenues have eroded the net ability of the petroleum sector to fund current pricing • Affects the willingness and ability of companies to invest in additional technology or, in fact, even to conduct productive long-term planning. • For example, in the 11th five-year Plan, OIL had invested only Rs 9,322 crore, against the outlay of Rs 13,439 crore. Rising Under-Recoveries… Regulatory Response Increasing burden on upstream companies… …and fiscal and macroeconomic instability Leading to reduced investments… Coupled with rising costs…
  6. 6. Fixed Charge from Diesel Cars Owners Diesel Source: Hindustan Petroleum Fuel cards Promote Use of Efficient transport system Remove Political influence Short Term Implementations Long Term Implementations 14.2 Kg LPG Cylinder(Oct. 2013) original price – Rs.966 ; Retail Price – Rs.410.50 Subsidy amount - Rs.555.50 Create a independent body in Oil & Gas sector responsible for pricing mechanism and de-politicise pricing of petroleum products. Ministry of Oil and Gas will not be responsible for pricing Reduce Diesel consumption by incentivizing car, diesel manufacturers to make fuel efficient vehicles Strengthen and Promote Use of Public Transport system Charge a cess on Diesel Cars.Collect it along with annual insurance premium from car owners. Cess amount charged could depend on vehicle category, average diesel consumption by cars in a year. Revenue by charging Rs 5 per unit of diesel will reduce burden by Rs 32 bn Employee Dual pricing by subsidizing only Trucks and market price for passenger vehicles. Issue Fuel Cards to Trucks and at the time of their purchase when they swipe their card it linked to back-end ADHAAR network. Subsidy for fuel is transferred to bank account of intended beneficiary at the end of the month. Major Issue : Development of black market. Reducing Taxation Medium Term Implementations Current scenario Impact of Subsidy Recommendations Appendix Liberalize Diesel Pricing in Long run Employed a phased approach to reduce the subsidies of the order of Rs1/per unit. Fixed Charge for diesel generators/ pump sets Charge a one time diesel cess for purchase of diesel generators at the time purchase. Calculate average lifetime use of diesel by generators / pump sets and load that charge at the time of its purchase. Tax revenues higher than subsidies. Wide variation in prices of Petrol and Diesel across states ( Variation in State Taxes) By reducing or streamlining taxation we would be able to reduce under-recovery and liberalise our pricing. Diesel constitutes more than 30% of the subsidy amount. Apart from trucks and public transport vehicles, only cars which are owned by people belonging to higher strata’s who does not need subsidy Why reduce subsidy for Diesel?
  7. 7. Price Hike Liquefied Petroleum Gas Decrease Under-recovery from Rs 550/ per unit Targeted subsidy Benefits Reduces LPG Under- recovery by more than 40% Support only BPL households Income Based Price Differentiation Benefits Assessment Studies & Expand scope of pilot projects Benefits Will help in designing future policys Reduces Under- recovery Short Term Implementations Medium Term Implementations Long Term Implementations Consumers need to purchase at an unsubsidized price set around Rs. 930 for a 14.2 kg cylinder Government has implemented a cap of maximum 9 LPG cylinders per year to households. Expect to save INR 30-70b in under recoveries Direct transfer of cash subsidy through Aadhaar Scheme to end customer’s bank account. Pilot Project already implemented. How??? 14.2 Kg LPG Cylinder(Oct. 2013) original price – Rs.966 ; Retail Price – Rs.410.50 Subsidy amount - Rs.555.50 Current Measures by Government Carry out studies to assess the actual usage of LPG per household per month. Extend Aadhaar Cash Transfer to all districts Variable Subsidy based on Household income or MPCE. Eliminate Subsidy for top quintile of household based on income Urban Areas: Gradually phase out LPG and restrict subsidy only to lower quintile population using MCPE. Implement a gradual increase in LPG prices Identify Bogus connection Identify bogus connections through Aadhaar card and eliminate it Rural Areas: Increase rural penetration of LPG connections through new distributors. Roll out subsidy only to BPL card holders. Explore possibility of reducing of LPG subsidy through introduction of advance combustion stoves using solid biomass as cooking and heating fuel How??? Collect more information regarding households through National survey and also identify various surrogate methods to identify household spending and earning capacity. Current scenario Impact of Subsidy Recommendations Appendix
  8. 8. Migration to paperless technologies Kerosene Source: Petroleum Economics Limited Real time data for better Inventory Management & forecasting Reduction of black market selling of kerosene by Fair price shop owners Benefits Reduction of bogus ration cards Mandating adoption of any one of the bank account linked technologies at all State run Fair price shops Selling kerosene at Market price Subsidy amount transferred to the bank account of the consumer every quarter Government has more funds which can used in income generating activities Reduction of Kerosene consumption Barcode Aadhar linked biometric system Smart card Selling at Market Price Benefits Removing non performing accounts Benefits Three months of non-usage removes the consumer’s eligibility for kerosene Better forecasting Reduction of bogus ration cards Why need subsidy for kerosene? Short Term Implementations Medium Term Implementations Long Term Implementations URBAN Areas: Migrating current kerosene urban households(8%) to alternate more efficient fuelsKerosene consumed by most of the lower strata people in urban & rural areas– Subsidy essential & reduce consumption Difficult to establish a commercially viable LPG distribution network in rural areas Fuel available at low cost for lower strata people and the option to buy in loose quantities How??? • Levying the initial fixed costs for setting up LPG to kerosene eligible consumers. • 5 kg LPG cylinders exclusively for urban people who are currently eligible for kerosene • Introducing Kerosene in small bottles of 1, 2, 5 litres Allocating more budget and speeding up of rural electrification projects Introducing Kerosene in small bottles of 1, 2, 5 litres Market price – Rs.65/ltr;Subsidized price ~ Rs.13.5/ltr. Rural : Cooking :1.3% Lighting: 39% Urban: Cooking :8% Lighting – 5.1% RURAL Areas: Reducing the consumption of kerosene used for lighting purposes How??? Current scenario Impact of Subsidy Recommendations Appendix
  9. 9. Some Examples from other Emerging countries Brazil:(Successful) • Garnered political support by educating the masses regarding the benefits of de-regulation of prices • Phased approach while liberalizing the products. First liberalizing politically easier, then gradually moving to other products Sustainability measures: • Introduced Gas-vouchers to assist poor people to buy LPG cylinders • Introduced a conditional cash transfer programme Bolsa Escola Challenges faced: • A short spike in inflation after every subsidy reform. • Large currency depreciation and the failure to rapidly adjust fuel prices led to a brief subsidy regime for diesel during 1999 Indonesia:(Mostly Unsuccessful) • Cut subsidies in the wake of Asian financial crisis during 1997 • Series of Price increases between 1999-2003 Both of these measures were rolled back owing to Public Opposition Reduction in Petrol subsidy • Encouraging the use of LPG, which is lesser subsidized, rather than Kerosene, citing environment concerns. Sustainability measures: • Subsidies for rice • Increase in public spending on Health, Education and social welfare • Cash transfers • Conversion of households from kerosene to LPG South Africa (Successful) • Automatic pricing mechanism to bring the prices to trade-parity levels and encourage private sector participation • Equalization fund to smoothen the price fluctuations (1977-2004) which Ran out of funds during 1993 and government raises the fuel prices to finance the deficit caused wide opposition from public • Establishment of Central energy fund in the year 1977 to determine the prices depending on the international crude oil prices and the same was communicated to the public. • No sustainability measures was adopted to counter price fluctuations Some lessons from other countries • Phased approach to minimize the resistance from public (Brazil) • Sustainability measures can help in reducing the public resistance (Brazil and Indonesia • Automatic pricing mechanisms work if the price determination is credible and transparent (SA) • Garnering public support before any reforms is necessary for the reform's success (SA and Brazil) • De-regulation reforms do not work in worse macro-economic conditions ( Indonesia- Asian Crisis) • Economic instability can lead to resurgence of subsidies (South Africa) Current scenario Impact of Subsidy Recommendations Appendix
  10. 10. Description Value 1 Total Diesel Consumption 81.42 2 Diesel Volume for Bulk Users 14.66 3 Diesel Volume for Non Bulk User 66.76 4 Current Under Recovery 10.54 5 Subsidy bill for Non bulk users 703.65 6 Incremental Revenue for 1 Re hike 66.76 7 Remaining subsidy to be covered 636.89 8 Initial Government share of subsidy(60%) 422.19 9 New Government share of subsidy after hike (60%) 382.13 10 Reduction in fiscal burden for Govt. due to 1 Re price hike 40.06 11 As a Percentage of Diesel Subsidy 9% Current scenario Impact of Subsidy Recommendations Appendix Description Value 1 Total PDS Kerosene Consumption 9.2 bn ltr 4 Current Under Recovery 39.14 5 Subsidy Bill 360.088 6 Incremental Revenue in 1 Re hike in PDS Kerosene 9.2 7 Remaining Subsidy to be covered 350.888 8 Initial Government share of subsidy(60%) 216.0528 9 New Government share of subsidy after hike (60%) 210.5328 10 Reduction in fiscal burden for Govt due to 1 Re price hike 5.52 11 As a Percentage of Kerosene Subsidy 3% Reduction in Diesel burden by Rs 40.06 bn for Re 1 hike in diesel price. Reduction in Kerosene burden by Rs 5.52 bn for Re 1 hike in Kerosene price. Kerosene Diesel Sensitivity Analysis