Case of Oil Subsidies

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Information about Case of Oil Subsidies
Business & Mgmt

Published on February 5, 2014

Author: DarshitPaun1

Source: slideshare.net

SPM School of Petroleum Management PDPU Pandit Deendayal Petroleum University WE FUEL AMAZING CASE STUDY CHALLENGE Case of Oil Subsidies: Are we stealing from future generations? P R E PA R E D B Y B H AR G AV B H AT T M B A( E & I ) , PGP13 D AR S H I T PAU N M B A( E & I ) , PGP13 S WAP N I L R AY J A D A M B A( E & I ) , PGP13

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? Composition of Household Fuel Expenditure by Income Group, 2009/10 The given figure is indicative of the composition of household fuel expenditure by income groups. • It is clear that bottom two deciles spend nearly 2% of their total monthly expenditure on fuel whereas the top two deciles spend around 6% of their monthly expenditure of fuel1. • Given the amount of subsidy provided by the government so that the poor and middle class people can afford the fuel, the statistics reveal that the rich enjoy almost 6 times as much benefits as the poor in terms of per capita expenditure. • For diesel and liquefied petroleum gas (LPG), respectively, 65 and 70 percent of subsidy benefits About a fifth of diesel sales are bulk sales, largely for accrue to the top two quintiles2. transportation and power generation, and almost half of diesel sales are retail sales along the national highway network, much of which would also be for long-haul freight.15 “We’re far too dependent on fossil fuels, and the longer we let that go on and subsidize it, the more we’re just making it so much tougher for future generations.” -David Macdonald, Chair of Canada’s House of Commons Environment Committee

How does subsidy impact the upstream oil companies? Impact on OMCs and Upstream Oil companies • Subsidies keep the fuel prices lower resulting in higher consumption of fuel which in turn causes high accrual of under recoveries for the OMCs which causes short term financial crisis for the OMCs. • The weight of building under-recoveries(Rs 60907 crores in 1st half of 2013-14)3 causes shrinking liquidity and significantly impaired corporate flexibility. • 40% of under recoveries of OMCs are shared by the upstream PSUs (ONGC, OIL, GAIL) which hurts their growth and limits their oil exploration activities.(Out of the total Rs 1,38,541 crores under recoveries in 2012, Rs 55000 crores were provided by upstream companies)4 • Due to under recoveries PAT of upstream companies is reduced making them less attractive to investors which results in higher interest rates for loans. (ONGC’s PAT reduced by 16.7% in 2012-13 due to increased under recovery burden)5 • It becomes difficult for the upstream companies to fund the acquisition of assets abroad. ”Of the three Fs – food, fuel and fertilizer – the subsidy for fuel is the most perverse….if we have to start attacking subsidies, then fuel is a good place to begin. It has been postponed for too long.” - Jairam Ramesh, Minister of Rural Development, India

Does it affect India’s position as a net importer of oil? • Lower the price, higher the consumption which means higher the oil import bill of the country. • The increased imports and the growing subsidy burden causes larger fiscal deficit and CAD. (Rs 4508 billion worth of Oil imported in 2012)6 • Credit rating agencies might downgrade India owing to the high fiscal deficit and CAD drawing away the FIIs. • Rupee devaluation due to distorted balance of trade.12 • Negative impact on nation’s GDP (Expenditure method).13 • The reduced budget of NOCs makes them a small player in competitive bidding market of oil assets. This forces NOCs to make bets on riskier oil fields to match the returns. • 3 channels are affected as shown in fig. 14– - Trade(Import) channel - Financial(Price) channel - Fiscal channel “We said we should phase out fossil fuel subsidies, then we should take into consideration that we should phase out first the most harmful, and in the way you phase out, take care of the poorest people’s interests.” -European Union Climate Commissioner Connie Hedegaard

If subsidy is abolished or reformed what sort of reform is required? DIESEL(under recovery Rs 10.24/litre)7 Subsidy Reform Plan Challenges Directly raising the • price to International price • Solution • Increased Inflation(Raising Rs 10.53 (20%) of diesel • price(current under recovery can raise inflation by 1%). Increase in price of Public transport(6.4%), Freight transportroad(8%), Rail transport(2.4%)8. • Protest from public. Government intervention by not allowing the price increase in specific sectors reducing the inflation rate. Government can reduce the taxes time being on diesel so as to reduce the increased the inflation. Increasing the price in • phases • As long as the subsidy part remains, the OMCs and upstream • PSUs will continue bleeding. Growing inflation and protest from public. • Reducing the tax burden if inflation rate reaches high levels. Raising awareness among public about the long term disadvantages of the subsidy. • Finding the potential BPL families through UID based Aadhar • is a challenging task. Develop a strong base of UID throughout the country and then remove the oil subsidies. Cap on use subsidized • diesel Keeping a track on diesel usage of individual customers is • again a challenging task. Use of IT systems that keeps a track on use of fuel as per vehicle registration number. Direct Cash transfer “End-user subsidies, while carrying noble social objectives, are often economically inefficient and distort price signals to consumers. The public will not respond to triple digit international prices if it is paying only a fraction of that at the pump.” -Maria van der Hoeven Executive Director of the International Energy Agency (IEA)

If subsidy is abolished or reformed what sort of reform is required? LPG(under recovery Rs 411.99/cylinder)8 Subsidy Reform Plan Challenges Solution Directly raising the • price to International price • • Increased price of cooking items, increase in inflation for short • term. Protest from the public Lower and middle income groups will be unable to afford LPG leading to increased dependency on kerosene again leading to higher subsidy. Provide a shield to price volatility if international price change above a level in fixed interval of time. Decreasing the cap of • LPG usage in phases and meanwhile • establishing a strong base of UID Aadhar • based Direct Cash transfer(DCT) Decreasing the cap in phases will lower the sudden rise in • inflation rate but it will cause inflation. Cap on LPG won’t affect lower income groups(avg consumption 5 cylinders per annum but will affect groups in riches decile)9 • Strong base of aadhar required so that BPL and (middle class families initially to avoid public protest and political unrest) are not affected when the cap of on LPG usage will be removed and Direct cash transfer is availed timely to them. Raising awareness among public about the long term disadvantages of the subsidy Raising awareness about UID Aadhar through media, newspapers, public bodies in rural and urban areas. Tracking BPL families and availing them Direct Cash Transfer advantages Increase the price in • short term and increase prices in phases when inflation rate is low Till the time country achieves a growth rate of around 8-10% • with inflation rate being lower, subsidy burden will continue hurting OMCs, Upstream PSUs and government Till then allow OMCs to increase the prices and decrease the taxes which can be increased in phases as the price gets linked to international price. “Today, the most important roadblock for renewable energy implementation is the world’s fossil fuel subsidies. You say you want to have a higher share of renewables then you protect and foster fossil fuels by giving substantial subsidies – it doesn’t work.” -Fatih Birol Chief Economist of the International Energy Agency (IEA)

If subsidy is abolished or reformed what sort of reform is required? Kerosene(under recovery Rs 38.82/cylinder)10 Subsidy Reform Plan Challenges Solution Adoption of effective beneficiary • and monitoring system to reduce illegal usage • • Again the nationwide roll out of UID holds important in this context for removal of duplicate ration cards. Protest from the public Availing the DCT benefits for the BPL households. Considering higher usage by BPL • households, kerosene subsidies in among APL households can be removed totally Tracking APL and BPL families is a major issue. • Raising awareness about UID Aadhar through media, newspapers, public bodies in rural and urban areas. Tracking BPL families and availing them Direct Cash Transfer advantages Considering it is majorly used for • lighting and cooking, Kerosene subsidies can be removed totally for families registered for electricity connection and LPG connections Tracking the families with electric connections • and LPG connections and linking them with ration cards. Till then allow OMCs to increase the prices and decrease the taxes which can be increased in phases as the price gets linked to international price. Enroll the Aadhar based DCT • system for LPG and through that road map avail the DCT benefits of subsidies to BPL Families Subsidy burden prevails till the complete road • map for LPG Aadhar based subsidy allotment is prepared Enroll the DCT benefits of kerosene subsidies also along with Aadhar based DCT allotment of LPG subsidies “When applied to fossil fuels, subsidies discourage the development of and investment in low carbon alternatives…” -Lord Nicholas Stern, former World Bank chief economist, author of Stern Review on the economics of climate change

Are you for or against oil subsidy in today’s world? Why? We are against the oil subsidy in today’s world, because Reason Impact Benefits of Deregulation Unequal benefits of Fuel subsidies The top income quintile receives almost 6 times more subsidy benefits than the lower quintile. Identifying the BPL and middle income groups through socio economic surveys and providing them centrally sponsored transfer schemes. Increases Under recoveries of OMCs Difficult for OMCs to manage short term working capital. Increased Fiscal deficit for the government(*1.9% of GDP in 201112). Subsidies are a hurdle in the growth and expansion of OMCs as well as upstream PSUs. The subsidy benefits if transferred to the potential customers directly can decrease the short term borrowings for OMCs allowing their expansion and more funds available to upstream companies allow them to carry out exploration activities more intensely. Subsidy inflation causes Subsidizing fuel raises the subsidy bill of the country which has a negative effect on growth and thus causes inflation. Subsidizing fuel keeps the prices of products that are linked to transportation, low which temporarily is good for people but on a long term hurts the growth. Deregulation of prices of petroleum products(especially LPG and Diesel) causes an increased inflation in short term which is reversed in around 4 years. But it also reduces CAD since higher fuel prices reduces Oil imports which can be used for alternative public expenditure resulting in growth. Overconsumption of fuel Subsidizing fuel also promotes overconsumption because the fuel is available at a low price it increases exploitation. The low price also promotes black markets. It also causes results in increased pollution level. Linking it to market price increases competition providing more options to the consumer. Less scope for black markets causing exploitation the petroleum products. Higher price results in increased usage of public transport reducing pollution level. Delayed adoption of energy efficient technology Since the petroleum products are available at a cheaper price than alternative cleaner sources of energy their penetration gets delayed. Energy efficient technologies results in decreased levels of pollution decreases fuel usage which in turn reduces the oil import bill of the country. “Both developing and developed countries, As they look for policy responses to the worst economic crisis of our lifetimes, phasing out subsidies is an obvious way to help governments meet their economic, environmental and social” -Angel Gurria, Secretary-general of the Organization of Economist Cooperation and Development (OECD)

Conclusion • For diesel phasing out of subsidy part in steps with increase of Rs 0.5 is the best option as adopted by the government of India which will remove the subsidy part in mid 2014. Since direct removal of subsidy part is prone to cause high levels of inflation in short term and also opposition from the public, it is the best alternative. The government can avoid the increase in price when the inflation levels are higher than desired levels to facilitate the public to deal with increased prices. (This reform successfully phased out petrol subsidy in Brazil) • For LPG UID based Aadhar is best alternative despite of the fact that a lot of ground still needs to be covered. Awareness should be created amongst the common people about how fuel subsidies hurt the growth of the country as a whole. • For Kerosene, since 33.54% of users are in rural areas11, subsidies should be removed totally from urban areas initially rolling it out from metropolitan cities and then subsequently from the cities at the same time providing the users in urban areas the facility to register for LPG connection instead. On the grounds laid by Aadhar based DCT for LPG, the BPL families in rural and urban India then can be identified and DCT benefits for kerosene can be given to them. Design Elements Who should benefit? •Identifying BPL families Challenges Designing better surveys How much to transfer and when? •Determining amount and frequency of transfer Addressing inter temporal issues How to deliver cash? •Mode of cash transfer •Effective communication strategy Ensuring financial inclusion Who will judge the impact? •Socio Political impact.(Ensuring desired benefits are achieved) Setting up independents evaluation body “Fossil fuel subsidies amount to a huge inducement to prefer carbon-based fuels over the alternatives and seriously tilt the playing field away from renewables.” -Achim Steiner, Director General of the UN Environment Programme (UNEP)

References • • • • • • • • • • • • • 1, 2http://www.imf.org/external/pubs/ft/wp/2013/wp13128.pdf 3,7,8,10http://ppac.org.in/WRITEREADDATA/PS_oil_prices.pdf 4,6http://petroleum.nic.in/petstat.pdf 5http://www.thehindubusinessline.com/companies/additional-costs-push-ongc-q4-net-down- 40/article4763077.ecehttp://www.iisd.org/pdf/2012/india_fuel_subsidies_policy_brief.pdf http://www.imf.org/external/pubs/ft/wp/2010/wp10202.pdf 8http://www.iisd.org/pdf/2012/india_fuel_subsidies_policy_brief.pdf 11http://www.observerindia.com/cms/export/orfonline/img/analysis/img-ta1.jpg 12, 13 http://www.investopedia.com/articles/investing/100813/interesting-facts-about-imports-andexports.asp http://www.imf.org/external/pubs/ft/wp/2001/wp0175.pdf http://www.imf.org/external/np/pp/eng/2013/012813.pdf http://www.imf.org/external/pubs/ft/wp/2013/wp13127.pdf 14 http://www.nipfp.org.in/media/medialibrary/2013/04/wp_2012_99.pdf 15 http://www.nipfp.org.in/newweb/sites/default/files/WP_2012_108.pdf(Anand, M. K. (2012), “Diesel Pricing in India: Entangled in Policy Maze”) “Reform of huge subsidies for fossil fuels deserves to be far higher up both the climate change and general economic reform agendas.” -Tim Groser, New Zealand Minister Responsible for International Climate Change Negotiations

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