Clarity on parity

Measure the cost of subsidised fuel properly

It has been reported in this newspaper that a committee headed by Kirit Parikh may recommend that export parity pricing should not be the basis of measuring the extent of under-recoveries on petroleum products. The formal submission of the report is still weeks away. Still, the pricing formula would have both fiscal and commercial implications. Essentially, the quantum of transfer from the government to the oil marketing companies (OMCs) to compensate them for certain petroleum products being sold below their cost of production depends on the formula. If "import parity" pricing is used, the extent of the under-recovery would be measured as the difference between the full cost of delivering the product to the retailer and the price at which it is sold. On the other hand, in an "export parity" formula, the opportunity cost would be measured by the foregone revenue in the event that the company exported the product, that is the prevailing world price for the specific product. The former captures all transport costs and domestic taxes; the latter is simply a global benchmark, which varies on a daily basis. 

From the fiscal perspective, the use of export parity reduces the extent of under-recovery, because the global price is obviously below the fully costed domestic price. But what is good for the government is not necessarily good for the OMCs. In this case, they have to absorb the residual impact of transportation costs and taxes. In effect, this is a tax on the private shareholders of the OMCs. The petroleum ministry, which is representing the companies' interests in the debate, obviously prefers the use of import parity - and so should the OMCs' shareholders. The current formula is a compromise: 80 per cent weight is given to the import parity price and 20 per cent to the export parity price. Clearly, this is neither here nor there, and a change is probably going to be an improvement. The question is: in which direction?

Two factors need to be considered here. One, public sector OMCs do not export the products concerned and presumably would not be allowed to. In contrast, private sector refiners, who are not entitled to the under-recovery reimbursement, are realising large gains in rupee terms from their exports, having no incentive to sell domestically. Two, from the fiscal standpoint, the government as a significant shareholder in the OMCs needs to take a holistic view of the financial implications of each formula. Even if import parity is to cost more, at least some of the excess will be offset by higher dividend payouts and equity valuations. The first factor implies that export parity pricing would be entirely notional; it only has relevance if the OMCs are actually allowed to export freely, enabling them to decide between exports and domestic sales on purely commercial considerations. If they cannot do this, they should be compensated for the full cost of domestic business. The second factor reinforces this argument. If it hasn't done so already, the committee should make an assessment of the net cost to the government of import parity pricing. If the government is serious about reducing its subsidy bill, it first needs to measure the subsidies correctly.