Should the subsidy on kerosene and LPG stay?

DEABTE

HPCL

The issue of subsidy and regulated pricing always evokes diverse opinions. The reformists want market forces to determine prices and the consumerists feel appalled that the vulnerable sections of society are sought to be orphaned.

While I personally would echo the views of the reformists that economic reforms should usher in a better future for us, such views are utopian and we have to accept the stark reality of the economic condition of the weaker sections of our society.

Household incomes of a large section of the people need protection and in that list the consumption of kerosene and liquefied petroleum gas (LPG) must figure prominently. As a matter of fact, kerosene is used by disadvantaged people even for lighting purposes.

When we discuss subsidies, we need to get to the very root of the pricing system and the anomalies therein. The oil industry in India follows what is commonly known as import parity for its product pricing, although most of the finished product is manufactured locally.

About 70 per cent of the crude oil processed at refineries is imported and the rest procured locally either from onshore or offshore sources. Domestic exploration companies are now being paid import parity prices for their crude, despite many acreages being assigned to them locally.

The state gets only a meagre share of the full economic rent. Any effort to change this is countered by the argument that additional revenue flows to the companies are needed to support new investments by them for oil finds.

Experience has shown that this has not strictly happened. The rationale to adhere to import parity for pricing of finished products, therefore, requires review. No one seems to be eager to develop a local costing model.

Each barrel of crude produces several streams of finished product "" LPG and kerosene being two of them. LPG is a combination of propane and butane depending upon the refining yield. Some quantity of propane also comes out of gas pipeline fractionators.

Thus, the issue of fixing refinery transfer prices is crucial to the issue of working out the eventual subsidy. Apart from this, the marketing costs also contribute to the calculation of subsidy. A set of historical practices contribute to the marketing costs and it can be argued on behalf of consumers that they are unfairly set.

The distribution system, especially of kerosene, also leaves much to be desired. There are leakages in the open market because of the pricing differential between diesel and subsidised kerosene.

Several years ago, this was sought to be plugged by introducing retail of kerosene at the taluka level by setting up taluka kerosene depots where leakages could be more effectively controlled, but vested interests saw to the early demise of this idea.

The question of whether the eventual subsidy is to be paid through the budgetary process of the state or by the oil companies has gained unusual prominence, perhaps to highlight the so-called plight of the oil companies.

The state should not figure in the pricing equation if it has no control over the price and cost mechanism adopted by the oil industry. It should only set ceilings. Let the companies rework their costs. The issue is that of the government's interventionist role.

As a result, it is seen as the protector of the consumer and subsidies and this has become a highly emotive political issue. The fact that the government is an owner as well as a regulator is very often a constraining factor for any true implementation of pricing models.

It needs to be emphasised that consumers cannot and should not be left to the vagaries of market forces in an imperfect market condition where real competition is yet to pick up. The dynamic competitive pressures that we have seen in the telecom industry is a good lesson where real consumer prices evolved once competition was let loose.

Insiders in the oil industry know that cross-subsidisation is not an uncommon thing to gain market share or to dispose of surplus production that only benefits the industry and not necessarily the consumer.

Finally, the delivery mechanism that adds to the cost requires serious attention. Differential pricing of kerosene versus diesel and petrol should not be cited as arguments to increase kerosene prices or to reduce the "so-called" subsidy.

There are a host of other issues that need to be sorted out before we call the so-called subsidy to question. These include regulatory issues, inter alia facilities and pipeline access, tariff conditions, up-scaling to reduce delivery costs and so on. Till then, prices charged to the consumer need not be considered artificial pricing.

T N R Rao
Former Petroleum Secretary

"Any discussion on subsidies on petroleum products has to be in the overall context of energy pricing and equity, especially when energy prices are becoming market-determined.

Subsidisation as practised in this country, on both merit and non-merit goods, is inducing a large wastage of scarce resources and promoting inefficiency.

The cross-subsidisation of products, especially kerosene and LPG, has resulted in large-scale diversion to and cornering by non-targeted and affluent sections of the society, because of poor delivery mechanisms and with no effort to streamline and strengthen the public distribution system (PDS).

There is a wealth of data showing a clear urban bias and easy dispersion of the subsidies to the well-to-do even in rural areas.

Subsidies, in general, distort energy pricing and energy management, including supply and demand, making it difficult to effectively manage inter-related and frequently conflicting national objectives and to avoid macroeconomic costs of unjustified subsidies.

While there is no case for any type of subsidy on LPG, there is justification to provide some subsidy to the vulnerable sections of society, provided it is devised for practical implementation.

The laudable objective of regulatory subsidies on kerosene and LPG initially was to achieve certain socio-economic goals: to secure inter-fuel substitution by weaning away rural households from forest fuels "" an environmental consideration "" and induce the more affluent to go in for LPG and release, in turn, their consumption of kerosene to the poor and minimise the burden of high energy prices on low-income groups.

These were in addition to larger considerations varying from equity across households and across rural-urban areas to possible inflationary consequences and employment effects.

But unfortunately, the way subsidisation of kerosene and LPG is practised is, in effect, defeating these objectives. In the case of kerosene, no concerted effort is made to streamline PDS to improve the delivery mechanism to target groups and minimise leakages.

Wood, crop residues and animal dung constitute 90 per cent of the rural cooking fuel need. Kerosene supplied to them under the PDS, if it reaches them at all, is rarely sufficient for their lighting needs, while the requirement for cooking is five to six times more.

Women go long distances to collect these biofuels, and according to some surveys, spend as much as 20 personhours per household per month, reducing their earning capacity and putting unrelenting pressure on forests. Such rural households are even willing to pay the market price for it, if only it is made available.

It was in this context that parallel marketing was introduced. With increased supplies, the shadow price of kerosene also fell, bringing relief through availability on demand. No doubt a portion of it was diverted for adulteration, but that was not the only kerosene that was and is being diverted for that purpose.

The return stream of kerosene from LAB (Linear Alkyl Benzene) plants is being openly diverted for adulteration, in addition to the PDS kerosene. The recent ban on import by parallel marketers will not, therefore, reduce its diversion for adulteration, but will increase its scarcity and open market price for the rural poor.

Instead of improving governance in these areas of the PDS and diversion, recourse is taken to the easy option of banning free availability or price increase, affecting only the poor. The cost to the nation is enormous in terms of health and productivity loss of more than 70 per cent of the population.

The situation in LPG is even more tragic. Domestic LPG is universally subsidised. Industry studies have repeatedly shown its substantial diversion to commercial establishments, including five-star hotels, the automotive sector and so on, defeating the very purpose of subsidy.

Monopoly given to public sector units entails hidden costs of inefficiencies, resulting in ballooning subsidy bills. Worse, private investment, including foreign direct investment in LPG infrastructure and distribution, has been rendered non-performing assets.

Several states have schemes to further subsidise this to the weaker sections. It should be enough to confine the subsidies to such identified groups and withdraw it for domestic LPG altogether. This would bring in competition and reduce the ultimate price to the consumer and consequently the subsidy burden.