Subsidy on Petrol

After the recent hike on prices of petrol, there has been lot of *discussion* on twitter.  My thoughts on the discussion:

View: A generally held view is that Petrol is consumed by elite. Exceptions are diesel SUVs.

Counter view: Would assume the millions of two wheelers on roads are driven by middle class and run on petrol.

View: Government needs revenue and if not tax on petrol may be other taxes so why not on petrol – after all (loop back to view 1).

Counter view: A more elaborate reply

  1. Government needs money and so can tax – Fine! Agreed! But can we ask why they need the money? How much? What they intend doing with it?
  2. Is this the most  equitable form of tax – the fine difference between Direct taxes and Indirect taxes is lost – Case in point – Rediff’s famous article using Amar, Akbar and Anthony – explained it neatly but the focus (read outrage) shifted to use of names indicating religion. Manmohanomics (the Desai variety :D)

To explain, Direct taxes are collected from the man who bears the ultimate burden. Hence the adjective *Direct*. Essentially Income Tax. These are higher for higher income. May look lopsided but is equitable. A man earning say Rs. 3 Lakh pays as little as possible. A man earning Rs. 10 Lakh pays may be 10%. Something like a Lakh, leaving him Rs. 9 Lakh. A man earning Rs. 30 Lakh pays 25%. Say Rs. 7.5 Lakh leaving Rs. 22.5 Lakh. Would assume the man earning Rs. 30 Lakh and paying Rs. 7.5 Lakh is still better off than the other two. The man earning Rs. 10 Lakh and paying Rs. 1 Lakh is still better off than the man earning Rs. 3 Lakh.

Sounds like communism? Would assume any welfare state would look at things this way.

But in case of indirect taxes – a tax on expenditure, the burden is sly. Taking our earlier example, the man earning Rs. 3 Lakh would also pay 10% while the man earning Rs. 30 Lakh would also pay 10%. The man earning Rs 3 Lakh would hardly save any money and the tax would come from reducing expenses – essential expenses. The man earning Rs. 10 Lakh would save some money (hopefully). This tax would eat away that. May be little tightening of belt. But man earning Rs. 30 Lakh would be splurging money and then save some. The tax would come off these extras. So is it equitable?

Taxes on petrol are the indirect taxes. So there is a limit on how much you can burden the common man.

Next is the issue of Subsidy. Also called as *Under recovery*. When you junk all the jargon it boils down to this – The Indian petroleum market has 3 major players – those extracting crude, refining crude to get the petroleum products and those marketing. The first category till recently included only ONGC. Now you can add a few like Reliance. The second includes Indian Oil (IOC), Bharat Petroleum (BPCL), Hindustan Petroleum (HPCL, MRPL, Reliance and a few others. The third includes IOC, BPCL, HPCL, IBP and a few others. It can be seen that some companies form part of more than 1 category.

The fun is in the inter play between these categories. Crude has no cost. Nature gives it free! There is a cost involved in extraction. But it does not vary day to day. So why the daily variance in Crude prices? What happens to the supposed Profit or Loss?   Commodity prices are mainly driven by Demand and Supply. When demand exceeds supply, prices go up. The seller makes a killing. When demand falls prices falls and the seller is hurt. But if he is badly hurt, he is going to sulk. Play truant. Supply falls below demand leading to situation 1. It is natural that the supplier makes enough profit to exist. He is not into charity.

The second category involves those who buy crude and split into various products. Crude is not a chemically similar compound. It is a mixture of any number of compounds in varying proportions. But we can use only certain products and at certain quantities. Petrol is itself a mixture of a certain range of compounds. Hence the varying grades of Petrol. Similarly Diesel. In India we do not use most other compounds at levels proportionate to use of these fuels. So when we distill Crude we extract some products required and sell the rest to those who can use it. Outside India.

The third category involves those who market the petroleum products. The lop sided nature of consumption in India has ensured that we have to import products. You can’t import Crude and distill and sell the rest to the extent you want. To put it differently, when Lakshmana needed the Sanjeevi Herb, Hanuman could not locate it. So he carried the whole Hill. Once in a life time is fine. If this has to be done day in and day out, look at the wastage. So we tend to import products. This means that we lose on extracting and refining margins.

Seen as a whole the following emerges:

  1. The first category extracts crude at a cost but sells at an enormous profit. But India has very little Crude so imports around 80% of it requirement. Not much of profit here.
  2. The second category buys crude, takes out useful components and exports back the rest. There is a reasonable profit. Needs to be run efficiently. Mix of extracts highly fluctuating. Market needs lop sided. A mad situation to be in. Highly taxed.
  3. The third category buys the products from the second group or imports. Again taxed. Selling price is fixed. Purchase prices fluctuates madly. Under recovery is the difference between the actual selling price and the correct selling price that would leave a reasonable profit for this category.

Now coming to under recovery or subsidy – It is clear that there is a cost on crude. If it local crude, there is a large profit on same to ONGC. Even after paying royalty to the Government. Then both this local crude and imported crude is refined, to get value added products. There is a refining margin here. And obviously Caesar gets his dues! Then there is a Marketing Company profit, along with the Governmental levies. Here is where the Gap comes. If the OMC s do not get the right profit the same is called Subsidy.

Would take an example to explain the Under Recovery in simple terms – A man asks his friend for a loan of say Rs. 500. The friend an obliging one immediately agrees. Taking his purse out, the friend realizes he has only Rs. 300 which he promptly hands over to the first man. The first man immediately replies – *Ok! So you owe me the remaining Rs. 200*. The Rs. 200 is the under recovery. Jai Ho!

To elaborate the Central Government collects more than Rs. 175,000 Crores on Petroleum Products and the State Governments close to another Rs. 90,000 Crores.  We are told there is an Under recovery of Rs. 50,000 Crores. After recovery of more than Rs. 250,000 crores. I have deliberately not used exact figures.

I have limited myself to Under Recovery here. But have touched on subjects that need more elaboration. Will try and write it in next part. Especially would want to elaborate on varying *Subsidies* for varying products and the impact it has on consumption pattern, the impact such a pattern has on product mix.


One thought on “Subsidy on Petrol

  1. I cant say the under recoveries have been properly dealt with. You had taken some data from Mr.Sunil Jain for compiling this report. Is it possible to share it with me?

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