FM should not rob oil companies to show a lower deficit

There are right ways and wrong ways of cutting down oil subsidies. The finance ministry, in a bid to show the markets that it is cutting down on oil subsidies, is choosing the wrong way.

Yesterday, after much hemming and hawing, the ministry agreed to reimburse the oil marketing companies (OMCs) - Indian Oil, Bharat Petroleum and Hindustan Petroleum - for losses incurred in 2012-13 and pay them Rs 1,00,000 crore in subsidies. The remaining part of the losses of Rs 1,61,029 crore will come from the oil and gas producers - ONGC, Oil India and Gail.

The ministry’s grudging approval for last year’s subsidy means the oil companies will now be able to announce their fourth quarter results for last year this month - and show a profit.

But the finance ministry is clearly trying to make its own books look better by knocking the oil companies’ books out shape in future. It has proposed that subsidies should be calculated on the basis of export parity pricing instead of import parity. This is an effort to deny the OMCs around Rs 15,000-18,000 crore of subsidies by changing the rules, a report in Business Standard suggests.

Currently, oil companies are compensated for losses depending on trade parity - the ratio of imports to exports, which is 80:20. This means their losses are calculated to the extent of 80 percent on the basis of the prices of imported crude and petro-products, and 20 percent on the basis of domestic output - which is priced lower.

The finance minister wants to shift to export parity pricing, since oil companies will then be compensated for losses based on the prices at which they export petro-products - which are lower.

The right way for the finance ministry to cut subsidies is by gradually letting the market determine prices instead of fixing prices arbitrarily through import or export parities. But in the interim, there is no cause for it to change the pricing formula since its basic premises are wrong.

First, there is a presumption that import parity pricing is giving OMCs easy money. This is far from being the case. As a BusinessLine report notes quoting an oil industry source: “If refining companies are importing crude, paying freight, port and transportation charges and then don’t recover these costs, it becomes unviable for them to continue. Export parity is not possible when we are importing 80 percent of our crude requirements.”

Second, the finance ministry is not doing charity by enabling the oil companies to generate profits from subsidies. The purpose of having a surplus is to make investments, and oil companies that generate no profits will not be able to invest in refining capacities or even new refineries. Tomorrow’s lower subsidies depend on investments today, which calls for higher subsidy payments as long as OMCs are not allowed to charge market prices for their products.

Third, the finance ministry is anyway underpaying the OMCs by delaying payments. Delayed payments mean oil companies function on borrowed money, which raises interest costs. The oil companies are the biggest borrowers from banks - and these costs hardly figure in subsidy calculations.

Fourth, if the finance ministry shifts to export parity pricing, it would make better sense for oil companies to import petro-products from abroad instead of refining them here.

Fifth, and most important from a corporate governance perspective, the finance ministry is raiding ONGC, Oil India and Gail to pay the OMCs. In 2012-13, these indirect third party subsidies amounted to Rs 60,000 crore between these three companies. Robbing Peter to pay Paul is hardly the right way to go just to show a lower fiscal deficit.

The finance ministry’s best and only option is to free market pricing of diesel and cap the subsidies on kerosene and cooking gas so that subsidies can be cut. By trying to shave a few thousand crore from here and there with faulty logic, it is only compounding the mess it created by using taxpayer and investor money to subsidise consumers in UPA-1. The folly continues and is being compounded with talk of export parity pricing.