A common refrain of the government, the oil companies, trade lobbies and even economists

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is that Indian con­sumers need to pay ma­r­ket prices aligned with int­e­­r­­national prices for fuel because subsidies are killing us.

The fact is Ind­ians pay among the highest prices for fuel in the world. In India petrol — which is not subsidised as its pricing is market based — costs an average of Rs 57 a litre, or $5.69 a gallon. In Pak­istan, heavily dep­endent as India on imports, they charge $4.

Subsidised diesel costs 82 US cents a litre in India. In the US, where diesel is not subsidised, it costs 84 cents. In the Philippines which imports all its crude, diesel sells at 84 cents.

It can be said with certainty that had it not been for the subsidy, diesel wou­ld have cost much more than in all the countries mentioned above.

The blame always goes to costly imports of crude (true, prices are high) and India’s own subsidies.

But all this still does not answer a valid question: why are Indians forced to pay so much more for fuel? The answer lies in just one factor — the greed of three sets of organisations. They are the oil companies the­mselves, the Union government (which milks the oil sector dry through a crippling tax structure), and states (that perforce have to tax fuel as they have very few other means of raising large resources). But more of that later.

First, let us look at the pet grouses of the oil companies and the Union government. Oil companies cry hoarse about having to suffer under -recoveries, which are unrecovered costs arising from below-market prices at which they sell.

How justified are they?

India’s domestic dem­and is around 3.4 million bar­rels per day, of which about 2.7 million barrels are imported. Current import prices are around $112 a barrel.

Though under-recoveries are always calculated at current prices, crude refined at any given point of time has been contracted sometime ago and should have cost less. Crude contracted today takes time to arrive and be refined. So, the calculation of under-recoveries itself on the basis of current prices is an accountant’s sleight.

Data also contradict oil companies’ claims of under-recoveries. One indication is their gross refining margins (GRM), which are among the highest in the world. Refining margin is the difference between crude price and the weighted average price at which the final products are sold. GRM for Indian companies in the first quarter of this financial year ranged from $4 to $7 a barrel. Integrated companies — IOCL, BPCL, HPCL — have higher margins because of product diversity. But even a stand-alone refiner like Chennai Petroleum had a refinery margin of $5.75 a barrel.

Now compare this with China, where diesel costs $1.04 a litre. According to the International Energy Agency, Chinese refining margin is a negative $2.73 a barrel. This implies they make a loss on every litre of products sold. Like India, China is also a net importer of crude, shipping in half its requirement of 9.6 million barrels a day.

In Europe, where final fuel prices are higher than in India, the margin was just 0.8 cents a barrel. In the US, the world’s biggest fuel consumer, the refinery margins are slightly better. Both in Europe and the US petroleum prices are fully deregulated and pricing is market driven. All this clearly points to the fact that fuel in India is overpriced.

Another pointer to the same fact is very high return on equity (RoE) in Indian oil companies. This ratio measures the return on shareholder funds. The average RoE in Indian refineries is over 13 per cent, less than British Petroleum’s 18 per cent. If indeed there were under-recoveries, the Indian refineries’ margins should have been negative and RoE non-existent. Clearly, petroleum refining and marketing is not a loss-making business in India, despite the claimed under-recoveries.

Oil companies that invest in new refineries adopt a pricing on the basis of 16 per cent RoE. This effectively means that if they still manage a 13 per cent RoE, they are pricing their products from even the old refineries on the basis of a predetermined 16 per cent ROE.

This is evident in the dividend payout of IOC, HPCL and BPCL which stood at Rs 3,287 crore in 2010-11, when their claimed under-recoveries were Rs 78,190 crore. No committee on petroleum pricing has ever questioned the high refining margins or high RoE. Not even the Rangarajan, the Chaturvedi and the Kirit Parikh committees.

Instead, they always harped on the subsidy drain on the government and the need to let the market prices, which, in plain words they won’t utter, is a synonym for higher prices. The government paid out Rs 42,000 crore as subsidy to oil companies in 2010-11. In addition, they also got Rs 25,000 crore as subsidy from crude producer ONGC. This is almost half the price of the Indian crude supplied. In other words, besides the subsidies in final products, the oil companies also got their ONGC crude supplies subsidised to the extent of 50 per cent. Similarly, two other public sector Indian hydrocarbon suppliers, OIL and GAIL paid them another Rs 3,000 crore and 2000 crore, respectively.

We have looked at what the government pays out as subsidies. Now let’s look at what it gets from them. In 2010-11, it got almost Rs 1,80,000 crore as taxes from the oil companies. The subsidy outgo (including that from ONGC) was just a fifth of this amount. The scale of the government’s huge profits (here taxes too should be seen as profits to it) from its investments in oil sector becomes absurdly usury.

Who, therefore, most benefits from the complex pricing and subsidy structure? The Union government, of course. And it is not willing to yield a bit on its profiteering to help the inflation-hit India.

All this points to the need for a rational tax structure for the oil industry. Instead, it wants to pass the onus of reducing fuel prices to the states, badgering them at every opportunity to cut local taxes on fuel. The states have stood their ground, refusing to give in. States tax petroleum products on ad valorem basis, ranging from 15 to 20 per cent, which clearly is linked to the original pricing — fixed by the oil companies and the government.

Plainly, the states cannot afford to sacrifice any of their fuel tax revenue. State tax on petroleum products is their biggest revenue earner, accounting for 35 to 40 per cent of their incomes. The pricing at the refiners’ end itself is under scrutiny; bringing into question the so-called under-recoveries. Former petroleum secretary SC Tripathi says: “Under-recovery is notional. The notional price is worked out on basis of landed parity price. In 2006, finance ministry said notional price should be based on export parity price.

Companies take a mean of the import and export prices.” Tripathi suggests oil subsidy be given at customer level and revised every quarter. This will lead to a competitive market for both government and private players. This benefits the consumer. But the government is not ready to heed this.

Chairman of Integrated Research and Action for Development and former member of planning commission Kirit Parikh, whose committee authored a report that called for a total switchover to market prices, also agrees that the issue of under- recoveries needs a review.

One form of cost padding is not to pass on full benefits of depreciation of plants to consumers. India has a refining capacity of 180 million tonnes. Half the capacity is so old that its has already fully depreciated. The benefit is somehow passed on to export markets – India exports a good deal of refined products to the US and even West Asia, the latter its main source of crude. But the same benefit of export parity price they are not willing (independently or under government pressure) to give to Indian consumers.

The BK Chaturvedi committee report in 2009 recommended a complete overhaul of the pricing mechanism. It was not acted upon. The committee had recommended: “Given the global context and India's refining capacity, a more appropriate pricing model for diesel and petrol will be trade parity price, which would be the weighted average of the import parity and export parity price in the ratio of 80:20.”

In an interview last week with FC, planning commission deputy chairman Montek Singh Ahluwalia said, “Energy prices have to be brought in line with the world. This is necessary to increase incentives for energy efficiency, but also to ensure that energy producers get the resources they need to invest and ensure supplies.”

Bringing down prices now, an industry expert confided, will hit the oil industry’s future investment plans. “These costs need to be amortised,” he said. Government resists change because it will receive less dividend and tax revenues from oil companies. Oil will, therefore, remain a cash cow for the government.