Professional Documents
Culture Documents
Submited by Anit Datta Rabin Shrestha Rupesh K. Shrestha Sabin Panta On June 18th, 2011
Executive summary:
We examined the current pricing mechanism of different petroleum products of Nepal Oil Corporation on the basis of data provided in their website. We discover substantial deficit in tax revenue collection from NOC in comparison to the subsidy provided to them by the government. To address and minimize this deficit we have proposed two alternatives of price discrimination by segregation of end users of diesel in the transportation and non transportation sectors and household(domestic use for cooking purposes) and commercial sectors (mainly industrial uses). Our analysis shows substantial reduction in the subsidy after the price discrimination strategy is implemented based on segregation of groups. Key words: NOC, Price Discrimination, Oil, Subsidy
Background:
Nepal Oil Corporation (NOC) was established in January 1970 by the Government of Nepal as a state-owned trading company to deal with the import, transportation, storage and distribution of various petroleum products in the country. With its fuel depots and aviation fuel depots in various different parts of the country, it has a total storage capacity of 71,558 kilolitres (KL) (NOC, 2011). There are around 600 employees working in its headquarter in Kathmandu and various branch offices in different locations in the Nepal. Nepal is a land locked country bordering three sides by India and the northern part of snow fed Himalayas by Tibet/China. Nepal does not produce any petroleum products and depends totally on imports in the refined form, as it does not have any oil refinery. NOC is the sole organization responsible for the import and distribution of petroleum products through 1500 retail outlets throughout the country owned by the private sector (quote). Nepal is becoming more dependent on oil for meeting its energy requirement. The demand of petroleum products like MS, HSD, SKO, ATF and LPG1 is about 1.2 million ton (MT) per annum, with annual increase by 20% (NOC, 2011). Petroleum products constitute about 11% of total energy consumed in Nepal (NOC, 2011). The nearest port for importing petroleum products in Nepal is about 900 km far, which is Haldia (Kolkata), India. The transportation from nearest sea port to Nepal is the main constraint in the import of POL from a third country. All the petroleum products consumed in Nepal are procured and imported from India's, Indian Oil Corporation (IOC) under a 5 five-years' Contract Agreement signed on 31st March 2007. NOC procures petroleum products as per its requirement from IOC's six nearest refineries and depots situated in the eastern and northern part of India. The transportation from IOC locations to NOC depots and to retail outlets is done by tanker trucks. To meet the increasing demand, a MOU between IOC and NOC for construction of cross border Petroleum Product Pipeline from IOC's depot to NOC's depot in the central region is under way. (quote)
Current status:
Analyzing Analyses of the its financial reports show that, NOC operates at a heavy loss, which
1 MS (Motor Spirit, i.e. Petrol ); HSD (High Speed Diesel); SKO (Superior Kerosene Oil); ATF (Air Turbine Fuel); LPG (Liquefied Petroleum Gas)
increases with the increase in import and distribution. The most critical problem it faces is inadequacy of cash flow. The government does not allow NOC to adjust the upward price with increase in the international POL (stands for?) pricing. As a result, NOC, faces acute problem of managing cash flow especially when the price goes up in the international market and the government is unwilling to adjust price accordingly. However, it is not easy for the government to increase the prices as it entails not only economical reasoning, but also political considerations. The political considerations overshadowing economic justifications are the main reasons why the prices of petroleum products have not responded appropriately to the price structure of the international market. The pricing of petroleum products, especially diesel and kerosene, has been a sensitive issue in Nepal. The upward revision in pricing of these items has always attracted negative reactions leading to political and social dissatisfactions. Consumers in the remote areas of the country have to pay more prices for kerosene, due to heavy cost incurred in transportation of the product. In these areas, kerosene is used mostly for lighting, and some for cooking, including cooking in the restaurants and hotels. Kerosene and petrol have almost equal production costs and in most countries they are priced almost the same. In Nepal kerosene is cheaper than petrol, due to the subsidy given by the government. Kerosene is considered as a fuel consumed by the poor for cooking purpose. But the subsidy on kerosene has rather benefited the rich more than the poor. Petroleum subsidies tend to be inefficient in part because they are poorly targeted (Baig, Mati, Coady, & Ntamatungiro, 2007). The higher the household income, the higher is the subsidy, because higher-income households consume larger quantities of petroleum products and thus benefit relatively more from subsidies (Baig, Mati, Coady, & Ntamatungiro, 2007). Moreover, many transporters in Terai use kerosene as fuel in their vehicles especially in heavy vehicles like trucks & tractors and enjoying the benefit of cheap kerosene. Consumer activists are demanding dual pricing a cheaper one (less than the actual cost) for the poor and expensive one (more than the cost price) for the rich - by adopting the ration card system that India has been using; however, the experts do not see this idea as practical. An effort by Salt Trading to use ration card system for kerosene in 2010 did not work out. As such a system has proved to be a breeding ground for corruption in India, the economists and other experts in this field are strongly against this idea (www.economist.com). The petroleum prices in Nepal are kept in close proximity to that in India to avoid the chances of cross border smuggling. The prices in India were fairly stable, and it was possible for Nepal
to follow the Indian pricing pattern in the past. Currently, India has deregulated the petroleum industry and with this deregulation a fortnightly price adjustments have been implemented. This has affected NOC considerably. The sensitive political issue regarding the petroleum pricing for the government and the frequent adjustment of petroleum prices in India has made it is very difficult for NOC and the Nepali government machinery to respond quickly to the price hikes in India and avoid huge losses. Due to the decrease in cash flow, which usually is spurred by net losses incurred by NOC, the usually response of NOC is to curtail volume of the import of petroleum products. This phenomenon has lead to the massive scarcity of petroleum products in the past. Most of the time, whenever there is a short supply, a typical government response is to form a committee to evaluate the current status of NOC and recommend future course of action including pricing mechanism. Since 2050 B.S. several committees were formed and very few recommendations from these individual committees were implemented. The current situation of NOC including the monopoly in oil supply and full ownership of the government is likely to continue, unless some economic intervention is made.
Purpose:
The problem in broad terms is the recurrent shortages in supply of petroleum products in Nepal managed by a firm that operates at a loss most of the time. The main purpose of this paper is, therefore, to investigate the current pricing structure of different petroleum products of NOC and make a suitable recommendation to avoiding the perennial problem. at the company. As mentioned above, tThe current situation mentioned above is likely to continue as the government which meanscontinues to be un-willingness of the government to adjust the price based on international market. This will means a definitely result cash flow problem for the NOC in future which willand ultimately lead toa short supply of the oil petroleum products in Nepal. Therefore, rather than pressing for an adjustment to international market, it is prudent to analyze the current pricing structure of NOC. Our analysis focuses on the following areas: i. ii. iii. The current pricing structure of petroleum products. Cost and benefit of the tax collection from NOC and subsidy provided to NOC. A new pricing mechanism.
In India, if we look at the figure of 2008, Indian Oil IOC was running at losses of $76 million a day, and would run through its line of credit of $21.4 billion by July 2008 (Bloomberg.com). That's because the Indian government insisted that Indian OilIOC subsidize all the gasoline, diesel, and cooking oil it sells, so much so that prices were a third cheaper at the a pump in India than they were in the U.S. Since the oil it purchases purchased abroad wais more expensive than what it sellsold at home,. Indian OilIOC basically loses lost money every time it makes made a sale. This situation has improved a bit after the hike in the oil prices in 2010 by 13%, but the main problem still exists. This example of India also highlights the need to reform oil pricing in Nepal.
The sales data (see table: 2) and chart of FYs 1993/94 to 2009/10 (Figure: 1), shows unprecedented increase in sales of diesel and swift decline in kerosene. In these petroleum products NOC incurs huge losses. Some of the reasons for the trends can be attributed to the following:
In 2000, a year before the sales of kerosene, kerosene used to cost Rs 13 per liter and diesel Rs 23 per liter (www.noc.gov.np). This difference used to be a big incentive for some dealers to mix kerosene into diesel. Although, it is difficult to verify, the dealers were alleged to have mixed as much as 25% kerosene with 75% diesel. However, as the price gap between kerosene and diesel started to narrow, the incentive declined, and so did the consumption of kerosene.
The increasing use of generators to avoid longer hours of load-shedding has also resulted in substantial increase in demand of diesel in both manufacturing and service sectors of Nepal.
The use of diesel in agriculture sector has also increased substantially due to the increasing trend of using diesel water pumps. The booming construction sectors especially the housing sector has led to the increase in the use of trippers to transport construction materials. The trippers are fueled by diesel.
Nepal governments policy to subsidize petroleum products especially diesel, LPG and kerosene is in line with the intention to provide greater benefits to the economically marginalized population. But the question arises if this subsidy is really benefittingbenefiting the indented end users or a different segment of users that are already well-off to do in the
society and would not require a subsidy to consume these products. In this project we will try to accommodate such discrepancies that existsdiscrepancies that exist, due to which the nation at large is facing mass shortages of petroleum products..
Only about 31.3% of total consumption of diesel per month is in the road sector diesel fuel consumption (World Bank report 202 MT per year, i.e. 244,420 KL2 of oil equivalent).
The subsidies on diesel and LPG are for all sectors including household, industrial and service sectors.
The analysis is based on monthly volume and the base date is April 2011
First alternative:
This first alternative that we propose is to use the f first degree price discrimination. The approach is to charge different prices for diesel and LPG products for different groups of consumers. The price discrimination is not based on different utility functions of the groups, but based on the equitable use of subsidy. Subsidies in diesel and LPG are intended for transportation and household consumption respectively, because cost of fuels that in transportations of goods and cooking aeffects the livelihood of a common man. Table 2 shows that the total monthly loss in April 2011 was Rs. 1.96 billion. It is safe to assume that NOC incurs loss in most of the months. Such recurrent losses have been attributed as the cause of the shortage of the supply of petroleum products by NOC. Any price discrimination that does not address this issue will not solve the problem of short supply. Therefore, we propose to discriminate prices so that the total profit/loss is at least zero. Table 4 shows the result when the above proposed model is imposed on the sales of petroleum products in April 2011 (Table: 2). The following assumptions were made in the model:
The total consumption of diesel per month in the road sector diesel fuel consumption is 31.3% (based World Bank report3) which comes to 20,370 KL for transportation sector and 47,630 KL for non transportation sector.
Since there is no data available for the consumption of LPG in household cooking and commercial use, it is equally distributed between the two sectors. The retail price of diesel for transportation sector and those of LPG for household
2 1 MT = 1,000 Ton; 1MT (of HSD) = 1.210 KL 3 202 MT per year, i.e. 244,420 KL/ year; 1 MT = 1,000 Ton; 1MT (of HSD) = 1.210 KL
cooking and kerosene remain the same; however the rest of the prices are subject to change. The total profit/ loss of NOC is set at zero, which implies that the firm is at break even.
The table below shows that the retail prices of diesel (for non-transportation sector) and LPG for (non-household cooking) increased by 50% and 36% respectively. However the retail prices of petrol, aviation fuel (domestic) and aviation fuel (international) increased only slightly. Table 4: Change in prices imposed by model Table
Impact Analysis: The subsidized diesel price will lowermaintains the cost of operation for transportation companies at the current rate, (since most of the trucks that carry goods run on diesel engines). The lower transportation cost will lowers the prices of foods and groceries items. Hence, the subsidy will continues to have a positive impact on the mass. Whereas the commercial/industrial sector that uses diesel and LPG as a source of fuel will now have to pay more for the fuel. It does not make sense for the government to provide subsidized diesel and LPG for profit making companies and collect a tax on their earning. It is also safe to assume that for these companies the fuel constitute small portion of their cost structures. Since the model assumes break even situation, NOC does not face cash crunches and therefore roots out the cause of short supply. Any other intervention that reduces cost or increases revenue leads to profit for NOC. The price discrimination, if implemented, would result in substantial reduction in the subsidy burden by around Rs 1.27B, and increase in the revenue for the government by Rs. 927Mill, which ensures the governments tax revenues and also solves the cash flow problem for NOC.
Second alternative:
In this model, we proposed equal distribution of monthly sales volume of diesel to both transportation and non transportation sectors. Accordingly, we proposed the same pricing as first alternative (i.e. Rs. 68.50 per liter in diesel for transportation sector and Rs. 90 for non transportation sector). The price discrimination of LPG gas is same as first alternative (see Table No. 4). Impact Analysis: The recommendation, if implemented, would result in substantial reduction
in the subsidy burden by around Rs 964Mill and increase in the tax revenue for the government by Rs. 651Mill.
Interpretation:
In our proposed model, the main focus is on the segregation of different end users of petroleum products and the impact on subsidy vis a vis tax collection. We showed that, if government can scientifically segregate the end users of diesel and LPG gas, it can save substantial amount of subsidy.
This phase is politically sensitive and difficult to implement. Different interest groups will put pressure on the government to include them within the favorable group i,e. within household
group or transportation group. Another challenge of segregation of group is the formulation of eligibility criteria. It may take longer period i.e. more than probably a year so to finalize segregation due to the sensitivity of the issue. The government use population census data has two options to formulate the eligibility criteria. i.Taka data from population census report of 2058. ii.As the new population census is going to start very soon, government may wait to get final report and start segregation after the report. Second Implementation Pphase: Discriminate the price as per the alternatives as above once the segregation of group is completedThis phase begins after the segregation phase is over. Though the above model uses the sales data of a month, it may not be practical for NOC to readjust prices so often. It can project sales of extended period and use the model. Evaluation/ Control Phase: This phase should begin from the day the price discrimination is implemented. This requires that indicators that would be used for the evaluation be identified in advance. The indicators need to measure the extent of cross-selling of diesel and LPG from subsidized sectors to non-subsidized sectors. NOC will need to chart out corrective actions in the event of this inevitable phenomenon before the implementation phase. This phase should mainly be used to focus on the evaluation of the effectiveness of pre-identified corrective actions, than to come up with brand new corrective actions. NOC will not have time to wait for the inevitable problem of cross-selling to arise, as some black marketers will have started laying networks as soon as they get the hint of price discrimination and long before NOC actually implements it. Increase in consumption of diesel and LPG by subsidized sectors and corresponding decrease in their consumption by non-subsidized sectors will be a good indicator of cross-selling.
The pricing structure also includes government taxes including VAT. A comparison between tax collection and subsidy given by the government gives an interesting insight. On April 1, 2011, the government collected tax revenue of Rs. 1.61 billion from NOC, and gave it a subsidy of Rs. 1.96 billion (source). A deficit for the government was Rs. 350 million. On June 1, 2011 the government collected Rs. 1.62 billion in tax revenue from NOC, but gave a subsidy of Rs. 1.34 billion (source), earning a surplus of Rs 280 million. These figures clearly indicate the irrationality on the part of the government to provide subsidy to NOC when we compare it with the tax revenue. A separate study will be required to analyze the disparity. A debate on the benefit of subsidy as compared to tax collection can be initiated to find a solution for the problem of revenue and or profit for NOC.
products would be phased out except for LPG and kerosene which the government pledged would see their subsidies phased out within a 3 to 5 year period. LPG and kerosene are used as domestic cooking fuels by a large portion of the population. As per the government policy of 2003, the subsidy component by the government has remained constant since 2004-05 at Rs 22.58 per per LPG cylinder and Rs 0.82 per litre of kerosene. The balance subsidy is provided by the marketing companies from their own pockets. The Indian government has provided an outlay of 236.4 billion rupees ($5.3 billion) for fuel subsidies in the next fiscal year, less than an estimated 383.86 billion rupees for the current fiscal year, according to the budget. (www.businessweek.com/.../mukherjee-signals-costlier-oil-may-boostindia-subsidy-bill.html) In view of other countries experience and current condition of NOC, the government has very little option rather than deregulate the oil pricing. The country cannot afford subsidizing oil price for long given the fact that it imports 100% oil to meet the domestic demand. Due to the ballooning trade deficit with India and limited foreign currency reserve, sooner or later it must allow private sector to come into the picture thereby reducing the monopoly of NOC. Parikh Committee India also suggests that at current levels of prices of petrol, diesel, PDS kerosene and domestic LPG, the financial burdens on the companies as well as on the government will be unsustainable. But for a country like Nepal, deregulating the price should be based on clear long term policy. The long term policy should be open oil market for the private sectors which will ensure the demand and supply and fix the price accordingly. However, to reach that point, government should formulate careful strategy. The first degree price discrimination as proposed above should be the first step of deregulation. The next steps would be to reduce the subsidy and improve the functioning of NOC by cutting down its costs, allow private sectors to operate in the oil market and slowly deregulate the oil price. A viable and sustainable pricing system for petroleum products is a key requirement of stable, long-term growth of the economy. Similarly, a financially strong and globally competitive oil market provides an enduring platform to strengthen energy security of the country. It is therefore important that private sectors should have the freedom to set prices based on competitive market conditions. The government needs to extend subsidy to the targeted
consumers in such a manner which does not impinge on the freedom of oil companies to set prices in the market place.
Diesel
Annex
Kerosene
Figure 2: Sales of petroleum products (all except LPG in kiloliters, LPG in metric ton)
Source:
Source: www.noc.gov.np
Dates
10/4/2003 4/4/2004 10/4/2004 4/4/2005 10/4/2005 4/4/2006 10/4/2006 4/4/2007 10/4/2007 4/4/2008 10/4/2008 4/4/2009 10/4/2009 4/4/2010 10/4/2010
Diesel* 73.08 12.42 0.90 1.85 0.50 0.56 1.75 0.69 91.75 68.50 (23.25) 68,000.00
Kerosene* 71.32 2.04 0.76 1.85 0.50 0.47 1.97 0.84 79.75 68.50 (11.25) 4,500.00
Aviation* 63.55 12.73 0.77 1.85 0.50 0.57 79.97 90.00 10.03 2,500.00
Aviation Intl* 63.55 0.27 0.66 1.85 0.50 0.49 67.32 77.40 10.08 6,500.00
LPG per cylinder 1,167.52 212.07 14.08 105.81 7.10 1.39 56.00 49.89 1,613.86 1,325.00 (288.86) 1,100,000.00
64.67 30.90 0.98 1.85 0.50 0.88 2.47 1.06 103.31 97.00 (6.31) 16,000.00
Table 4: Price Discrimination Model with the Road Sector Diesel Fuel Consumption Data from World Bank
Diesel per liter w/ PETROL per liter price discrimination 16th April 2011 purchase price from Raxaul All Govt. taxes incl VAT Interest Expenses Transportation & Insurance expenses Administration expenses Technicall loss Dealer comission Dealer expenses TOTAL COST KTM retail price Profit/Loss per liter Monthly sales vol. PROFIT/LOSS 2011 APRIL 64.67 30.90 0.98 1.85 0.50 0.88 2.47 1.06 103.31 97.00 (6.31) 16,000 (100,960,000.00) 73.08 12.42 0.90 1.85 0.50 0.56 1.75 0.69 91.75 90.00 (1.75) 47,630 (83,352,500.00) Aviation fuel per Aviation fuel for liter international 63.55 12.73 0.77 1.85 0.50 0.57 79.97 90.00 10.03 2,500 25,075,000.00 63.55 0.27 0.66 1.85 0.50 0.49 67.32 77.40 10.08 6,500 65,520,000.00 LPG per cylinder w/ price discrimination 1,167.52 212.07 14.08 105.81 7.10 1.39 56.00 49.89 1,613.86 1,800.00 186.14 550,000 102,377,000.00
Diesel per liter 73.08 12.42 0.90 1.85 0.50 0.56 1.75 0.69 91.75 68.50 (23.25) 20,370 (473,602,500.00)
Kerosene per liter 71.32 2.04 0.76 1.85 0.50 0.47 1.97 0.84 79.75 68.50 (11.25) 4,500 (50,625,000.00)
LPG per cylinder 1,167.52 212.07 14.08 105.81 7.10 1.39 56.00 49.89 1,613.86 1,300.00 (313.86) 550,000 (172,623,000.00)
TOTAL
(688,191,000.00)
Bibliography
Baig, T., Mati, A., Coady, D., & Ntamatungiro, J. (2007). Domestic Petroleum Product Prices and Subsidies: Recent Developments and Reform Strategies. IMF Working Paper. NOC. (2011, June). Retrieved 2011, from Nepal Oil Corporation website: www.noc.gov.np IOC (2011). Retrived 2011, from Indian Oil Corporation website: www.iocl.com ONGC (2011). Retrived www.ongcindia.com 2011, from------------------------------website:
Center for Energy Economics, The University of Texas at Austin LPG subsidies in India, Demsetz, H. (1968): "Why Regulate Utilities?" Journal of Law and Economics, 11, 55-65. Edlin, A. S. (1993): "The Efficient Recovery of Fixed Costs: A Collection of Essays," Ph.D. Dissertation, Stanford University. Edlin, A. S., & M. Epelbaum (1994) "Surplus Maximization and Price Discrimination in General Equilibrium: Part 2," Manuscript. Edlin, A. S., M. Epelbaum, & W. P. Heller (1995): "Is Perfect Price Discrimination Really Efficient? Welfare and Existence in General Equilibrium," Burch Working Paper No. B95-9, U.C. Berkeley. http://www.opec.org/opec_web/en/). (http://www.enerfaxgold.com/)
(www.businessweek.com/.../mukherjee-signals-costlier-oil-may-boost-india-subsidy-bill.html)