Sunday, December 11, 2011

Reforms in Pricing Petroleum Products is the need of the hour

Reforms in Pricing Petroleum Products is the need of the hour

The pricing of petroleum products India has several anomalies that warrant urgent reforms to address the unintended adverse effects on persistently high inflation, high energy costs for the industry as well as improve the health of the petroleum sector. The key problems are the ‘ad valorem’ basis for various taxes levied by central and state governments, the high incidence of overall taxes on petroleum products and high government interference in day-to-day pricing thereby eroding the health of the oil companies.

‘Ad valorem’ tax basis adds to contagion effect
The taxes on petroleum products are largely “ad valorem” taxes – i.e. tax is based on the value of the product such as 27% VAT on Petrol and 21.43% on Diesel by Tamilnadu Government. Thus, when the price of diesel is revised by Rs. 1 by the oil marketing companies, VAT on diesel gets revised upwards automatically.  Similarly, customs duty on imports, road development cess, etc. are also levied on ad valorem basis. This results in a cascading effect on any increase in the basic price, thereby fuelling inflation. A better, and more transparent, way of taxation is specific duty i.e. say VAT of Rs. 14 per litre. This way, any revision of this rate is the responsibility of the respective state government, and they can no longer get a free ride based on the oil companies’ price revisions.

High incidence of taxes on petroleum products
The two main petroleum products viz. Petrol and Diesel suffer from high incidence of overall taxes.  A barrel of crude (~160 litres of crude) produces approximately 150 litres of diesel/petrol/ATF equivalent (this is a broad generalization as it depends on quality of crude, efficiency of refinery etc., but it is a reasonable assumption based on expert opinion). At $100 per barrel of oil, and additional $12 towards cost of refining, transportation of crude and finished goods, the final ‘price at the fuelling station’ without any taxes will be Rs. 38 per litre (112x51/150) for both diesel and petrol.  Against this, the selling price of Rs. 44 for diesel and Rs. 67 for petrol implies total tax incidence of 16% and 76% respectively. 
One key observation to note here is, shorn of taxes at various levels, diesel is not subsidised at current rates; it may earn lesser tax revenue to the government compared to petrol or ATF, but calling it “subsidised” is a travesty.  While taxation on petroleum products is a public policy debate, and altering this may have serious implications on fiscal health of state and central governments, fixing the taxes at specific rates at current levels could, over a period of time, reduce the impact of taxation as the basic price increases gradually.

Minimal Government Interference
Reforming the petroleum sector by allowing free pricing of petroleum products by oil companies based on international prices, and achieving social objectives such as subsidizing Kerosene or LPG through transparent specific duty on Petrol, ATF and Diesel would significantly improve the health of the Petroleum sector.  The Government can adopt a stance similar to RBI’s stated policy on forex rates – intervention only to prevent excess volatility but not in any directional movement – for petroleum product pricing, minimising political fall out of price revisions.

N. Muthuraman is ex-Director Ratings, CRISIL and Co-founder of RiverBridge Investment Advisors Pvt. Ltd., a boutique financial advisory firm.

This is the blog of the Print Version published in Business Line dated 12th Dec 2011 

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