Tax on unblended fuels may add to uncertainties in ethanol blending policy

Finance Minister Nirmala Sitharaman hardly mentioned fossil fuels in her shortest Budget speech, perhaps a reflection of India’s quest for a clean energy future. The little that was said was a tax on unblended fuels. It was the last item in the speech.

“Blending of fuel is a priority of this government. To encourage the efforts for blending of fuel, unblended fuel shall attract an additional differential excise duty of Rs 2 per litre from the 1st day of October 2022”. The statement was as opaque as it was transparent. Will a mug of ethanol mixed with petrol count as blended, will 5 per cent constitute a blend, or will the government publish a rule book?

The government said that the levy was not a tax; it was a penalty, or, one could say an effort to use the stick to promote the use of biofuels.

Given the problems that Indian oil marketing companies are facing with blending and distributing ethanol — under aggressive deadlines set by the government — a penalty was the last thing they expected from this Budget. They have eight months to come up with a plan to sell biofuel-laced petrol and diesel, or start paying the new tax.

At first glance, introducing a new excise tax contradicts a 15 per cent drop in excise collections in the 2022-23 Budget. Excise receipts, comprising mainly taxes on motor fuels, are estimated at Rs 3.94 trillion, 1 per cent higher than a year earlier. Excise receipts are budgeted down by Rs 590 billion for the next fiscal. But the decline is misstated because the government cut excise duties on diesel and petrol last November by Rs 10 and Rs 5 a litre, respectively, which Nomura pegged at a loss of Rs 450 billion in revenues for the rest of the fiscal, or, Rs 1 trillion on an annualised basis. That implies that, given no change in volumes, India should have redu­ced excise receipt estimates by Rs 1 trillion. Instead, the drop is lower, which means the government expects to soak up higher receipts from duties on motor fuels.

Private sector oil companies, which control around 13 per cent of the fuels market and sell only un­blended grades, run the risk of losing market share or making lower margins if they continue selling unblended fuel. State oil companies Indian Oil, Bharat Petroleum and Hindu­s­tan Petroleum are better placed.

Now, if the biofuel business were profitable and easy, BP-Reliance, Shell and Rosneft-run Nayara would not be waiting for a penalty to start selling blended varieties. But ethanol blending is a complex business, at least in India, unlike, say, in Brazil or the US. It’s not as simple as adding additives to fuels and positioning the mix as a premium grade.

Diesel is the country’s most cons­u­med fuel. There is a 5 per cent mandate to mix biodiesel with diesel but there is hardly any blended diesel available, a top IOC official says. Less than 1 per cent of the diesel sold in the country is blended, reckons a top BPCL official. Both officials do not see any substantive pick-up in diesel blending by October because of a lack of availability of materials. Oil companies procured 106 million litres of biodiesel in 2019-20, a sliver of around 100 trillion litres in diesel sales that year. Biodiesel is produced primarily from imported palm ste­ar­in oil. Efforts to substitute imports with domestically procured used cook­ing oil has not made much progress.

Unlike biodiesel, which has no political basis, ethanol has fared much better because of its potential gains to politicians. Over 8 per cent of ethanol, typically derived from molasses and sugarcane, is blended with petrol but is available mainly in the sugar-producing states of Uttar Pradesh, Maharashtra and Karnataka. The blending ratios fluctuate wildly across states with some like Rajasthan and Madhya Pradesh having a ratio of less than 4 per cent. The Northeastern states use only unblended fuels.

Ethanol continues to be scarce despite an 11 per cent blending projection in the December 2021-November 2022 ethanol blending year (EBY) by the Indian Sugar Mills Association, based on 9.5 billion litres of ethanol supplies sought by state oil companies. The target is overly ambitious considering refiners received only 2.96 billion litres of ethanol in the previous EBY. Crisil’s Head of Research Hetal Gandhi ex­pects India to achieve only 14-15 per cent blending by 2025, and it will be concentrated in sugar producing areas. Ethanol-blended petrol needs to be available across states for uniform blending, without which outlets in a region may face differential tax rates, Gandhi says.

Administered pricing of ethanol partly defeats the very purpose of fuel price reforms. Rates are set by the government, with an eye on the sugarcane belt, and increased year-on-year. Oil companies lose a fifth of pricing power while selling 20 per cent blended petrol. When crude fell to $20 a barrel last year, refiners lost money in blending because ethanol rates, currently at Rs 46.66-Rs 63.45 a litre, excluding tax and transport, were much higher. After adjusting for ethanol's lower calorific value, blending is viable only when crude stays over $60 per barrel.

Then we have the spectre of double taxation. Ethanol is under the goods and services tax (GST), while petrol is under excise. The government slaps duties on the entire volume of petrol sold and charges 5 per cent GST on the volume of ethanol blended, an industry official says.

Logistical and storage issues are other concerns. Oil companies transport ethanol in a 100-150 km radius, and blend it at depots before sending the fuel in dedicated trucks to gas stations, says R Ramachandran, former refining director, BPCL. Ethanol demands a dedicated transport and storage system because of a risk of water or moisture contamination, he adds, something that India does not possess. Dealers cannot have multiple storage and dispensing facilities to sell both unblended and blended fuels, says an official from a private sector refiner.

The entire biofuel programme, catering primarily to a powerful sugar and farm lobby, is poised to end with motorists consuming the exc­e­sses of a sugarcane industry, and subsidising a farm lobby. Foreign exchange savings at $1.3 billion from using ethanol are minuscule compared to $650 billion in reserves. The government is offering huge incentives to double ethanol distillation capacity, which is supposed to cut hydrocarbon and carbon monoxide emissions by 30-50 per cent. But engines must be modified to accept blends with over 15 per cent ethanol. Automakers, already faced with BSVI, CNG and LPG fuels, and the prospect of EVs, are reluctant to spend more to cater to another fuel source.

An official from a private sector oil company asks who will pay the penalty if the distiller does not deliver. It’s naive to expect the sugar belt to pay a fine for failed deliveries; it’s equally naive to expect oil companies to absorb the duty. Finally, it’s the motorist who will pay the penalty, double taxes and whatever else gets blended in-between.