Why pay more for diesel?

Thu, 20 Sep Pre-Open

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The government seems to have finally taken the bull by the horns. The Center recently announced easing norms for Foreign Direct Investment (FDI) in retail and aviation. Plus it hiked prices of diesel by Rs 5 per litre, its steepest ever hike much to the disdain of the opposition. Higher costs of diesel may help somewhat in fiscal consolidation, but it will also stoke inflation increasing the cost to ferry goods across the nation. The government also capped the sale of cheaper cooking gas to six cylinders a year for each family. The decision to limit the sale of subsidised liquefied petrol gas (LPG) will hit the monthly budget of households. Every seventh LPG cylinder in a year is now likely to cost Rs 743, nearly double the subsidised price of Rs 399.

Now, while these non-populist moves may be good for the financial health of the nation, are they veiling any hidden truths? Let's find out. The ministry of petroleum and natural gas says that the government collected Rs 837 bn in taxes on petroleum products and paid out Rs 1.4 trillion as subsidy compensation to oil marketing companies (OMCs) such as Indian Oil Corporation (IOC), Hindustan Petroleum Corporation Ltd. (HPCL), and Bharat Petroleum Corporation Ltd. (BPCL). Thus, the government of India was a net loser by more than half a trillion rupees. But, the harsh reality is that it did not pay out the entire Rs 1.4 trillion in cash.

What actually transpired was that it paid Rs 835 bn and asked the upstream oil and gas producers - Oil and Natural Gas Corporation (ONGC), Oil India and Gas Authority of India Ltd. (GAIL) to pick up the tap of around Rs 550 bn. Firstpost adjusted the subsidy payments paid by each of these companies and accounted for the private (i.e. non promoter) shareholding. It finally arrived at a figure of Rs 166.5 bn that private institutions and retail investors used to bail out the government. Plus, the duties collected are almost equal to the taxes paid, thus the government did not pay anything out of its own pocket in order to compensate the OMCs. It simply arm twisted the upstream producers. Unfortunately minority shareholders have to pay the price of public ownership.

So should the government roll back the diesel price hike? Well maybe not. These subsidies are simply unaffordable and will get more so as the price of oil increases and rupee depreciation continues. Under pricing these limited resources encourages their misuse. Encouraging renewable sources of energy, imposing carbon tax and pricing fuels based on their actual costs may be the way to go. But this is not without the risk of higher inflation and voter backlash.