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Subsidies: A bane for oil companies

Feb 23, 2004

The announcements by the Finance Minister in the 'Vote on Account Session' regarding subsidies on LPG (liquefied petroleum gas) and SKO (superior kerosene oil) shall not go down well with oil companies. The Finance Minister has slashed subsidies from the Budget estimates of Rs 81.1 bn in the current fiscal to Rs 35.6 bn in the next fiscal. Consider how the subsidy actually works. The retail price of LPG is Rs 250 per cylinder. But the actual cost for oil marketing companies like BPCL, HPCL and GAIL is Rs 401 per cylinder. This means that the difference between the retail price and actual cost has to be borne by someone. Currently, the GOI chips in with just Rs 45.2/cylinder of LPG and the rest (Rs 106/cylinder) is borne by oil marketing companies, including GAIL and ONGC. The same is the case for kerosene. While the government's share is Rs 1.6/litre, oil-marketing companies take a hit to the tune of Rs 3/litre.

The interim budget has thereby cut the government's share of subsidy on LPG to Rs 22.58/cylinder and Rs 0.81per/litre of kerosene. This means that oil companies shall now have to bear a hit of upto Rs 128.59/cylinder of LPG and Rs 3.82/litre of kerosene. Historically, oil companies have been using the cross subsidy mechanism whereby, subsidies on LPG and SKO were met against the higher prices on petrol. The recent move shall have an adverse impact on the bottomline of the oil companies mainly ONGC, IOC, BPCL, HPCL and GAIL. However, the actual burden would depend on factors such as international prices of crude, growth in domestic production and tax structure.

Looking at the table below, it becomes quite clear as to how the GOI has been slowly and steadily reducing its subsidy bill on LPG and SKO.

Government: Hands-off...
Year Subsidies
(Rs) LPG/cylinder Kerosene/litre
2002-03 67.75 2.45
2003-04 45.17 1.63
2004-05 22.85 0.81
Source: Oil companies

With elections round the corner, these companies are not in a position to pass on the subsidy burden to the consumers. As a result, one is likely to see a negative impact on operating margins of oil marketing companies in the coming quarters. However, we feel, post-elections, the prices of LPG and kerosene are likely to increase and relieve some pressure on the oil companies.

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