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. • 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. • 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. 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. 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. 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. 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. 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. 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. 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