WE FUEL AMAZING

case study Challenge

Case of Oil Subsidies:
Are we stealing from
future generations?

SEASON 2
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Foreword

Petroleum oil has been known to human civilization
for a long time. Oil, in the present, caters to a
large percentage of energy requirements in the
world. Its importance has greatly increased mainly
as transport fuel. The invention of the internal
combustion engine, the rise in commercial aviation,
and the importance of petroleum to industrial
organic chemistry, particularly the synthesis
of plastics, fertilizers, solvents, adhesives and
pesticides have actually boosted its consumption.
Oil consumption as a percentage of total energy
is as follows: Europe and Asia- 32%, Middle East
- up to 53%, South and Central America-44%,
Africa-41% and North America 40%.
In India 23% of total energy consumption was
through oil usage (2011).

In 2011, fossil-fuel consumption subsidies worldwide are estimated to have totalled US$
523 billion, US$ 111 billion higher than in 2010.

In particular, as subsidy policy is so politically sensitive, the pace and ambition of reform
efforts is often dictated by political realities and electoral cycles.

If the OMCs are not adequately funded against their under recoveries there is a genuine
risk that is analogous to the case of the state electricity boards, the high debt of the
OMCs could lead them into financial crisis. This in turn, could not only cause an oil supply
breakdown resulting in immense public hardship but also adversely impact the banking
system from where such debt is sourced.
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Subsidy
In India and elsewhere, oil subsidy has been
historically used and has always been a very
powerful tool for economic policy making and
re-allocation of resources. However, as subsidy
generally influences the short term life of a huge
section of common people subsidy has always
been at the centre of political interest. And
politically it is often extremely difficult to repeal an
already existing subsidy. Probably the only way
to build a case to abolish a subsidy is to show the
common people, with hard numbers, how their
lives would be much better if the amount spent on
subsidy is channelized otherwise.
Oil subsidies can be provided in the following
forms:
1. Direct Financial Transfers
2. Preferential tax treatment
3. Trade restrictions
4. Oil related services at discounted rates
5. Regulation of the energy sector
Subsidies for energy can be broadly classified
as producer subsidies or consumer subsidies.
Producer subsidies are provided to companies
to encourage investment and increase output.
Consumer subsidies, as the name implies, support
the consumption of energy, by lowering prices
at which energy products are sold. Govt. of India
currently exercises consumption subsidy.
Rationale behind Oil Subsidy
The idea behind lowering price of oil through
subsidy is to make energy in the form of oil
available to the common people, especially to
the poor. Such subsidy also aims to protect the
domestic consumers from unforeseen fluctuations
in the international market. Oil subsidy, therefore,
makes oil and hence energy in India more
affordable to the public.
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Moreover, oil prices in India have its spill over
effects. Most of the oil is used transportation of
goods and commodities. Market prices of different
commodities include their transportation cost or
‘freight’ charges for getting them delivered from
the source to the destination. So, increase in oil
prices would mean increase in freight charges and
hence increase in commodity prices. Also, products
and by-products of oil refineries are used in various
industries. If oil prices go up, the prices of the
products of these industries would also go up. All
these would lead to higher price levels and result
into inflation. So, from this perspective oil subsidy
is doing a great job of providing affordable fuel to
the needy and controlling the inflation.
But this is only one part of the story. Oil prices or
oil subsidy is interlinked with so many various other
national and international factors that this issue
cannot be analysed in isolation.
Nature of Oil Subsidy in India
LPG, PDS kerosene and diesel are sold to the
retailers at less than international market price.
Therefore there is a gap between the cost price
(including marketing cost) and the selling price.
The Govt. provides fiscal subsidy for LPG and
kerosene. But that fiscal subsidy is not enough
to bridge the gap between the cost price and
the selling price. Therefore in spite of the Govt.
providing fiscal subsidy there remains a gap
which is called under recovery. Under recovery is
generally calculated as the difference between
the cost price and the regulated price while
accounting for the fiscal subsidy. A large part of
the under-recovery is compensated by the Govt.
by cash assistance (in addition to fiscal subsidy)
and another big chunk is taken care of by financial
assistance from upstream National Oil Companies
(NOCs).The rest of it is borne by the Oil Marketing
Companies (OMCs).
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Cash assistance is allocated from the fiscal budget
and is accounted for as expenditure. The cash
assistance is paid on ex-facto basis i.e. after the
under-recoveries have incurred. Therefore the
OMCs often face crunch of investible funds in the
short run and they resort to raising loans.
The following figure shows how government’s
share in under-recoveries has changed from
2008-2011 (The cash assistance system was
started in 2008).
Consequences of subsidies
Fiscal deficit
Subsidies specifically impact the fiscal balances
of the country. The fiscal subsidy to the petroleum
companies in India in 2010–11 was INR 2,904
crore (US$637 million). In addition to the fiscal
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subsidy, the government also granted assistance
to the OMCs in the form of cash and oil bonds
to share the under-recovery burden. In 2010–11,
this assistance amounted to INR 41,000 crore
(US$8,995 million) (MoPNG, 2011).
In 2012 RBI stated:
“The centre has already exhausted its budgetary
provision for petroleum subsidies and has indicated
additional provisions (Rs. 300 billion) in the second
supplementary demand for grants presented in
November 2011. It is estimated that the higher
expenditure on petroleum subsidy could drive up
the fiscal deficit by around 0.8 percentage points
of GDP for 2011-2012.”
Black market
Subsidized domestic LPG and kerosene are
available at a much cheaper rate than other fuels
and hence it encourages the misuse for industrial
purposes and beyond the control of PDS. As per
one estimate, 40% of the PDS kerosene was
mixed with other fuel and was being used for
non-PDS and non-household purposes (NCAER
2005).
Impact on Public Sector Oil Companies
Under-recoveries are shared by both the upstream
and downstream companies. So, subsidies have
an impact on the petroleum sector as a whole.
Upstream oil companies, namely Oil and Natural
Gas Corporation Limited (ONGC) and Oil India
Limited (OIL), sell crude oil to downstream
refineries at discounted rates and the downstream
companies also bear a portion of the under-
recovery burden. In 2010–11, the burden borne by
upstream and downstream companies was INR
30,297 crore (US$6.65 billion) and INR 6,893
crore (US$1.51 billion), respectively. This not
only affects the cash flow and profitability of oil
companies adversely but also hinders the upstream
sector from investing in improving and expanding
their exploration and production operations.
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These upstream PSUs take up exploration and
production activities with some technological
partner who is capable of running the operations
on behalf of the PSUs. But exploration itself is
an activity with high financial risk and any party
involved in it needs to have huge investible
funds. Because the upstream companies share
a significant burden of the oil subsidy their
investible funds decrease and hence they cannot
aggressively pursue & execute E&P activities.
This ultimately results in less number of oilfields
being discovered and hence less number of oil
wells from which oil can be ultimately extracted. In
essence it decreases the domestic oil production
in India resulting in net increase of imported oil.
This not only reduces India’s energy sufficiency
but also depletes India’s forex reserves as crude
oil is always pegged in USD. It also affects Rupee
exchange rate as higher oil demand weakens
Rupee. Among the upstream companies, ONGC
bears the largest burden of the total subsidy
followed by OIL and Gas Authority of India Limited
(GAIL). See figure below:
It is important to note that the subsidy and cash
assistance is provided only to public sector
companies. Private companies are free to market
these products at competitive market prices.
But it does not make their lives any easier.
On the contrary, higher market prices make it
uncompetitive for private companies to retail these
products; therefore, while private participation
is increasing in the exploration, production and
refining of petroleum products, there is practically
no private participation in marketing these fuels
(petrol, diesel, LPG and kerosene).
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Do the poor really gain?
Liquefied petroleum gas(LPG)
In 2007–08 only around 8-9% of the rural
population consumed LPG as a primary fuel for
cooking, compared to 62% in urban areas (NSSO,
2010). Although LPG is subsidized to meet the
fuel requirements of the poor, in reality a larger
share of LPG is consumed by economically well-
off urban households (GoI, 2010b).According to
an earlier study by The Energy and Resources
Institute (TERI), 76% of the LPG subsidy goes to
urban areas and nearly 40% of the LPG subsidy is
enjoyed by the wealthiest 6.75% of the population
(Chawla et al., 2005).
Diesel
Almost 60% of the diesel consumed in India
was in the transport sector, of which 54% was
consumed by the road transport sector (GoI,
2010a).Within the road transport sector, the
consumption of subsidized diesel by private
vehicles has increased substantially; a trend that
is further exacerbated by the price difference
between petrol and diesel.
PDS kerosene
PDS kerosene was conceptualised and subsidised
to increase its accessibility to the poor. In rural
areas this fuel is used primarily for lighting
purposes—only 1.3% of rural households use it for
cooking (NSSO, 2010). However, in urban areas,
8% of the households use kerosene for cooking.
In 2007–08, 39% of rural and 5.1% of urban
households used kerosene as the primary fuel for
lighting.
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Opportunity cost, Environment and long Concluding thoughts

term energy security
Combustion of fossil fuel is one of the biggest
contributors to greenhouse gases and severely
pollute the air. Not only that, many of the by-
products of oil are also hazardous to environment.
Subsidy to oil incentives use or over-use of it. If oil
subsidy were abolished the same amount would
have been channelized to invention and discovery
in the fields of alternative energies. These
energies are generally cleaner, greener and more
sustainable, leading to long term energy security.
In fact their usage could prove to be cheaper after
initial investment and in that case it would not be
necessary for India to bear the huge burden of
oil subsidy. Rather, funds from the subsidy could
be utilised for further improvement of our living
standards.
Oil subsidy, although only a consumption subsidy,
creates a multitude of adverse consequences.
Some are immediate and some are a little far-
fetched. It impacts fiscal deficits, exchange rate,
and possibility of research on alternative energy
and overall living standard of our country. Moreover,
because of the over-usage, we may actually be
depriving our future generation. The amount
of oil that was supposed to be consumed over
generations is smoked up by one generation only
because for the time being it is artificially made
cheaper than the other forms of energy. Perhaps
it is time we stopped, looked back and pondered
over our own footprints which are getting larger,
deeper and darker with every passing year.

Questions

1. Who, in your opinion, benefit the most from the Oil Subsidy? Are they the
intended targets for which subsidy were conceived in the first place?
2. How does subsidy impact the upstream oil companies? Does it affect
India’s position as a net importer of oil?
3. If subsidy is abolished or reformed what sort of reform is required?
4. Are you for or against oil subsidy in today’s world? Why?
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Appendix
Global Oil Consumption over the Years

Year Consumption (Thousand barrels/day) Change

1980 59,928.84 NA
1981 58,013.31 -3.20 %
1982 56,722.96 -2.22 %
1983 56,002.25 -1.27 %
1984 57,064.08 1.90 %
1985 57,382.49 0.56 %
1986 58,996.11 2.81 %
1987 60,385.75 2.36 %
1988 62,269.80 3.12 %
1989 63,497.39 1.97 %
1990 63,875.13 0.59 %
1991 66,970.88 4.85 %
1992 67,136.27 0.25 %
1993 67,587.53 0.67 %
1994 68,927.09 1.98 %
1995 70,130.20 1.75 %
1996 71,712.41 2.26 %
1997 73,459.28 2.44 %
1998 74,109.43 0.89 %
1999 75,872.74 2.38 %
2000 76,779.14 1.19 %
2001 77,468.54 0.90 %
2002 78,163.60 0.90 %
2003 79,708.27 1.98 %
2004 82,564.87 3.58 %
2005 84,067.14 1.82 %
2006 85,132.05 1.27 %
2007 85,901.96 0.90 %
2008 84,463.22 -1.67 %
2009 84,756.56 0.35 %
2010 87,371.34 3.09 %
2011 87,356.29 -0.02 %
SEASON 2 ACE Case Study | 8

India’s Oil Production and Consumption

Indian Subsidies

Acknowledgement

oil subsidy - The Economic Times

www.indexmundi.com
www.iisd.org
www.teriin.org

References

IEA, World Energy Outlook 2012

IEA, Southeast Asia Energy Outlook 2013
GOI, Report Of The Committee On Roadmap For Fiscal Consolidation, September 2012
http://articles.economictimes.indiatimes.com/2013-08-26/news/41455220_1_hpcl-rs-indian-oil-corp-ioc
http://en.wikipedia.org/wiki/Energy_subsidies
http://economictimes.indiatimes.com/topic/oil-subsidy
http://www.business-standard.com/article/economy-policy/finmin-hopes-for-50-cut-in-oil-subsidy-in-
fy14-113052300894_1.html
http://online.wsj.com/article/SB10001424127887324463604579040611737389236.html
http://www.thehindubusinessline.com/features/oil-subsidies-politics-first-economics-last/article4458680.ece