To understand the plight of the oil sector, one needs to take a closer look at the reform efforts there. The first stage of oil reform was supposed to start from 1 April 2002 —the date on which the government promised to abolish administrated pricing mechanism (APM) and allow oil companies to decide retail prices based on market dynamics.
However, the government did not allow oil marketing companies (OMCs) to do this till 2007 due to the jump in international crude prices. OMCs reported heavy losses during this period because they were forced to buy crude at higher prices, refine it and sell finished products at lower prices. While the government reimbursed a part of this loss to PSU OMCs in the form of subsidies, the same was denied to private sector companies.
Oil marketing became unviable for the private sector and most retail outlets started by companies like Reliance Petroleum, Essar Oil, etc were forced to shut shop. Upstream PSUs like ONGC, Oil India, etc also suffered as these had to bear a part of the subsidy.
Since then, successive governments have decided fuel prices, though theoretically the right lies with oil companies. The fact that prices are not fixed by individual OMCs, but by all PSU companies together demonstrates the lack of competition in the sector. The government’s ‘back seat driving’ was on display when OMCs did not hike fuel prices for 14 days before the Gujarat elections in 2017 and 19 days before the Karnataka elections in 2018.
Ad hoc increase in duties is another problem plaguing the sector. While customs, cess and excise duty hikes are levied by the central government, state governments impose value added tax (VAT). Much of this happens when international crude oil prices fall and is aimed at denying the benefit of lower prices to consumers. The recent Rs 10 increase in price of petrol and Rs 13 for diesel followed a crash in international crude oil prices. The Brent variety of crude oil is now trading close to $31 a barrel, compared to $66 on 31 December.
Since the Centre had already increased duties by Rs 3 each on petrol and diesel in March, the total hikes in 2020 till now works out to Rs 13 for petrol and Rs 16 for diesel. A duty increase of this magnitude and then not allowing OMCs to pass it on to consumers bode ill for the oil sector, because it will be forced to absorb the hit. This negative impact will be short term if international crude prices remain at low levels, because OMCs will not reduce prices.
The government’s actions raise serious questions about its intent to carry out oil price reforms for which it restricted additional investment in the sector. Had oil reforms happened as planned in April 2002 and oil pumps of Reliance and Essar were not forced to shut, the Indian oil market would have looked very different.
The government’s action also raises corporate governance concerns. Why should retail investors of listed OMCs pay the price? Incidentally, the government has not imposed similar duties on upstream oil companies in recent years.
The negative impact on the broader economy will be severe. This is because state governments are also increasing VAT regularly. For example, petrol and diesel prices in Delhi increased by Rs 1.67 and Rs 7.10 respectively after the Delhi government hiked VAT on fuel. India charges the maximum tax on petrol and diesel and this makes oil consuming sectors less competitive compared to other countries. These are forced to pay more even as competitors in other countries get the same fuel for less. This will make the Indian companies vulnerable. They could lose export orders to other countries or face cheaper imports from other countries.
As of now, OMCs are only allowed to freely change prices of aviation fuel and non-subsidised portion of LPG and kerosene. Since OMCs keep on reducing the prices of aviation fuel with the reduction in crude oil rates, aviation fuel price is now at one-third of petrol price. Compared to petrol and diesel, even non subsidised kerosene is cheaper by 42% and 35% respectively. In addition to creating under-recoveries for oil companies, large distortion in prices of petroleum products will also results in misuse— like adding kerosene to petrol or diesel and the resulting pollution.
Bringing all petroleum products under GST is the only protection against the regular tantrums by central and state governments. The main advantage of GST is that it will put an end to the ad hoc increase in taxes as is happening now.
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