Down the oily slope

Jan 31, 2012, 07:41 IST | Sushant Singh

Government subsidies are bad only as long as they are being provided to others.

Government subsidies are bad only as long as they are being provided to others. How else would you explain our total silence on the hefty government subsidy provided to cooking gas, diesel and kerosene? Government subsidies each LPG cylinder by Rs 350 and every litre of diesel by Rs 13. Kerosene gets subsidised by Rs 29 per litre.

The total subsidy bill for petroleum products is expected to reach Rs 144,000 crore this year. To put this in perspective, India's defence budget this year is Rs 164,000 crore. Moreover, the central government will collect only Rs 86,000 crore in excise and taxes on importing and selling these products.

Slippery assessments: By reducing the cash surplus of oil companies 
through subsidies, the government has restricted their ability to explore 
domestic fields and acquisitions overseas

This subsidy bill can come down only in two ways. First, if the international prices of crude oil fall to a level --around $45 per barrel -- where the current retail prices do not warrant any subsidy. India imports 80 percent of its crude oil requirement. The price of Indian basket of crude oil on the world market increased from $36 per barrel in May 2004 to $132.5 in July 2008, and is currently at around $110 per barrel. 

The real driver of high oil prices is geopolitics. Evidently, the biggest risk to oil supplies is the uncertainty in the Persian Gulf and the Middle East. Moreover, other oil producers like Iraq, Libya, Nigeria, Venezuela and Russia are facing domestic unrest. 

More importantly however, the world's biggest crude oil producers now need to sell oil at a higher price to balance their own budgets. Russia, with few other sources of revenue, now needs oil prices at $110 per barrel to manage its finances. With its latest bout of social spending, Saudi Arabia needs crude oil to sell at around $80 per barrel just to balance its budgets. 

The numbers are similarly high for Iraq, Algeria, Qatar and Oman. Only a decade ago, Saudi Arabia was able to balance its budget with oil prices at $25 per barrel. Because it is in these countries' interest to keep prices high, any hope of reducing the fuel subsidy bill due to lower crude prices in the international market will remain unfulfilled.

The second way to reduce the subsidy bill is to substantially increase the retail price of diesel, LPG and kerosene. Recently in Nigeria, one of the world's largest crude oil producers, President Goodluck Jonathan had to rollback his decision to slash fuel subsidies. Similarly in India, a sudden and sharp price increase is politically unfeasible. Increase in diesel prices has implications for headline inflation, which has started coming down only recently. Despite it being used to adulterate diesel and being smuggled to neighbouring countries, kerosene is a so-called poor man's consumption item. The NAC will thus veto any increase in kerosene prices. Any increase in LPG prices will be resented by the vocal middle class. 

Had retail price changes been incremental over the years, it would have resulted in bearable cost-increase shocks. With the backlog of repressed price increase accumulating over time, a true price increase today is completely out of question. 

But the consequences of continuing with the status quo are devastating. The ballooning subsidy bill has put stress on government's finances. By reducing the cash surplus of oil companies, it has restricted their ability for exploration of domestic fields and acquisitions overseas. Since only public sector companies are provided financial support by the government, private sector companies have withdrawn from oil marketing. 

This has reduced competition in oil marketing. Subsidised oil prices also prevent consumers from economising on use of petroleum products. With oil prices remaining low and personal incomes rising, the demand for petroleum products has recorded double digit growth -- higher than our GDP growth rate. 

With the international crude prices remaining high, government will have to discard its present policies. Petroleum ministry has suggested a stiff excise duty on diesel cars to correct the imbalance in consumption caused by subsidised diesel prices. A transparent and effective distribution system for kerosene and LPG must be ensured through the UIDAI-Aadhar framework. Eventually, there is no alternative but to pass global prices of petroleum products to domestic consumers.

Sushant K Singh is Fellow for National Security at the Takshashila Institution and editor of Pragati-The Indian National Interest Review

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