Cooling oil

The government's decision to lower import and excise duties on various petroleum products last week has not come a day too soon. It may leave some equity analysts and refineries unhappy""they will have to pencil in some reduction in profit margins""but keeping duties high when oil prices are on fire makes no economic sense.

The cuts will cost the oil refineries around Rs 3,500 crore in terms of reduced margins this year and the government about Rs 2,500 crore in forgone duty collections, but that's still a small price to pay for keeping inflation in check and reducing the economy-wide cost-push effects of soaring oil.

In fact, as this newspaper has been arguing, the protectionist duty structures have enabled both the government and refiners to collect easy money from consumers. The government earns around Rs 1,500 crore extra from each $1 rise in global oil prices through higher excise, customs, and corporate tax collections from oil companies.

Given the spike in global prices over the past few months, the government is a net gainer even after the duty cuts. As far as the Budget is concerned, both excise and import duty calculations assume much lower oil prices, and so there is no real danger here.

As for the oil refiners, since India doesn't import petroleum products (it imports only crude, by and large), any import protection they get through tariffs is like a net addition to the bottom line.

If one were to go by the figures put out by ONGC Chairman Subir Raha, the refining margins of Indian oil companies are around $3 per barrel higher than international levels. This means they can earn around Rs 11,000 crore extra on an annual basis at the current refining capacity. So, even after taking a Rs 3,500-crore hit from the duty cuts, they will still have a tidy sum left over in terms of excess margins.

Indeed, the numbers suggest that there may still be room for further duty cuts if oil prices breach the $50-mark""as some oil analysts are predicting due to the prospect of winter-stocking demand from countries in the northern hemisphere.

If there is to be another round of duty cuts, it may be a good idea to target crude imports this time. In any industry, it is the basic raw material that attracts the lowest levels of duty. But in the current scenario we have duties on LPG and kerosene being cut to 5 per cent while crude stays higher at 10 per cent.

In theory, this negative protection to kerosene and LPG should make refineries less eager to produce these mass consumption fuels. However, it is doubtful whether oil companies will actually attempt to do this, given that there is not much room for altering a refinery's product-mix in the short term. Such decisions tend to affect a whole stream of products.

Moreover, since kerosene and LPG are not being imported now, the negative protection argument is not strictly relevant in the current context.