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The myth behind oil under recoveries

Jan 9, 2012

Petrol prices have been a matter of concern for common man since their deregulation in June 2010. Deregulation was an attempt to cut down the Government cash outflows on fuel subsidies. The prices have been hiked around 13 times since then, however, there is hardly a relief on the under recoveries front. While petrol prices were left unchanged this fortnight on account of approaching elections, one should not be surprised to see a steep hike once the imminent political pressure gets over.

With Government contributing huge amounts to under recoveries and subsidies, it may seem a little unfair to blame the Government for hiking end product prices when crude is trading high. However, a little analysis of the economics shows that under recoveries could be a fancy concept exploited by the Government to justify high fuel product prices.

While a common man perceives under recoveries as losses suffered by state run oil marketing companies, these losses are just 'notional 'and not actually incurred by the companies. This is because the Government uses import parity basis to calculate under recoveries. For example in case of diesel, the fixed selling price of the diesel is compared to the amount the companies would have paid had they imported the diesel (this will include international price of diesel, custom duties, transportation costs and marketing costs and margins). However, the price thus arrived has nothing to do with the actual cost of producing diesel which will be lesser (considering domestic over capacity in petroleum products refining markets). The way whole thing is projected makes one feel that the Government is making net losses in oil marketing business so as to keep the fuel prices affordable.

However, as we have illustrated below, the net beneficiary from the oil marketing business is the Government itself.

Sample this. Indian Oil Corporation (IOC), the largest player in oil refining and marketing space, paid excise duties to the extent of Rs 309 bn as compared to total Government grants/subsidies of Rs 243 bn towards fuel subsidies. The net effect of this was Government registering net inflows of Rs 66 bn from IOC. The whole hue and cry about subsidies and under recoveries looks ridiculous since this inflow is over and above the corporate tax rates paid by these Oil Marketing Companies.

(Rs bn) IOC BPCL* HPCL** TOTAL
  FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY11
Government Grants/Subsidies 168 243 59 100 63 97 289 441
Excise duties 261 309 99 124 80 97 440 530
Net inflow for the Government/Outflow for OMC 93 66 41 23 17 0 150 89
Company's Pre tax profits 150 101 28 28 24 26 202 156
Duties as a % of pre tax profits (over and above the Corporate tax rate) 62% 65% 147% 82% 70% 1% 74% 57%
*BPCL - Bharat Petroleum Corporation Ltd.; **HPCL - Hindustan Petroleum Corporation Ltd.;
Source: Equitymaster, Company data

To conclude, it's not under recoveries dragging down the viability of oil marketing business but the convoluted taxation and pricing policies formulated by the Government. If the Government rationalizes such taxes and even if it deregulates all the fuel products in a phased manner, chances are that increased competition from private sector will lead to oversupply and pricing war thus ensuring affordability of fuel products.

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5 Responses to "The myth behind oil under recoveries"

Upendra

Mar 30, 2012

Govt.May collect the tax for their project, But in Today's Scenario State government are not doing very big project all the projects are giving on BOT Basis and the additional Toll tax is recover from the people means that the people of India are paid Tax on Tax.My opinion is Tax structure must be unique there should not be double taxation policy.

Like (3)

JAIN

Jan 21, 2012

Tax collection from Petroleum product is easiest for center and state Govt. How much should be collected and how much is really get collected from other commodites and services is known and why it happens is also known. But govt is not able to improve tax collection from other sources that is why tax on petroleum product is rediculously high. Vat varies from 8% to 34%. Rather then crying for under recoveries govt to rationalise the tax. Incidently oil produes by ONGC ia at about 15 Dollar a baller as against about 90 Dollar a barrel international crude price.Difference is with Govt owned ONGC.

Like (2)

Ramanand

Jan 17, 2012

Its interesting @raj bhansali that you believe that excise duty receipts from oil sector is significant contribution to the government.
To be frank, I completely agree with you that government must get money from taxes to fund its projects and other expenses. If excise on petroleum products does the job, then so be it...completely agree with you there.
However, the counter argument doesn't hold water...why should govt administer the prices of petrol products. Today, reliance, essar, shell have practically wound up their business precisely because even after ostensibly 'freeing' up the petrol prices, following things happen:
1. Petroleum prices are changed by all state run corps in a co-ordinated manner
2. These changes are also precisely for the same amount for a city, and don't differ from pump to pump within it
3. If an increase is objected to by any strong political party, it may be rolled back
4. With the low prices, it is guaranteed to hit the OMCs balance sheets, which, since they are mostly state owned, will meekly agree to it
5. Private cos cannot take the hit since they are not doing social service, hence have to go out of business, thereby maintaining govt's monopoly in oil.

Like (1)

raj bhansali

Jan 11, 2012

To comment on your statement "The whole hue and cry about subsidies and under recoveries looks ridiculous since this inflow is over and above the corporate tax rates paid by these Oil Marketing Companies".

Please check your basics, what is portion of total receipts from oil sector is as percentage of government receipts. it significant if it stops who will fund government projects. How will growth happen. Also look at contribution of duties on petroleum products as % of total indirect taxes it is 50% approx. can we cut it. This is the fuss with under-recoveries unless India increases petroleum prices in a significant manner. or direct tax ambit becomes biggers and people becomes honest in paying direct and indirect tax. What will government do apart from taxing petroleum products where no tax evasion is possible

Like (2)

Anand

Jan 9, 2012

A bit confused about this - since we import a lot of our fuel, would we not pay international prices ?

Like (1)
  
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