WE FUEL AMAZING

case study Challenge Case of Oil Subsidies: Are we stealing from future generations?

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Foreword
Petroleum oil has been known to human civilization for a long time. Oil, in the present, caters to a large percentage of energy requirements in the world. Its importance has greatly increased mainly as transport fuel. The invention of the internal combustion engine, the rise in commercial aviation, and the importance of petroleum to industrial organic chemistry, particularly the synthesis of plastics, fertilizers, solvents, adhesives and pesticides have actually boosted its consumption. Oil consumption as a percentage of total energy is as follows: Europe and Asia- 32%, Middle East - up to 53%, South and Central America-44%, Africa-41% and North America 40%. In India 23% of total energy consumption was through oil usage (2011).

In 2011, fossil-fuel consumption subsidies worldwide are estimated to have totalled US$ 523 billion, US$ 111 billion higher than in 2010. In particular, as subsidy policy is so politically sensitive, the pace and ambition of reform efforts is often dictated by political realities and electoral cycles. If the OMCs are not adequately funded against their under recoveries there is a genuine risk that is analogous to the case of the state electricity boards, the high debt of the OMCs could lead them into financial crisis. This in turn, could not only cause an oil supply breakdown resulting in immense public hardship but also adversely impact the banking system from where such debt is sourced.

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Subsidy
In India and elsewhere, oil subsidy has been historically used and has always been a very powerful tool for economic policy making and re-allocation of resources. However, as subsidy generally influences the short term life of a huge section of common people subsidy has always been at the centre of political interest. And politically it is often extremely difficult to repeal an already existing subsidy. Probably the only way to build a case to abolish a subsidy is to show the common people, with hard numbers, how their lives would be much better if the amount spent on subsidy is channelized otherwise. Oil subsidies can be provided in the following forms: 1. Direct Financial Transfers 2. Preferential tax treatment 3. Trade restrictions 4. Oil related services at discounted rates 5. Regulation of the energy sector Subsidies for energy can be broadly classified as producer subsidies or consumer subsidies. Producer subsidies are provided to companies to encourage investment and increase output. Consumer subsidies, as the name implies, support the consumption of energy, by lowering prices at which energy products are sold. Govt. of India currently exercises consumption subsidy. Moreover, oil prices in India have its spill over effects. Most of the oil is used transportation of goods and commodities. Market prices of different commodities include their transportation cost or freight charges for getting them delivered from the source to the destination. So, increase in oil prices would mean increase in freight charges and hence increase in commodity prices. Also, products and by-products of oil refineries are used in various industries. If oil prices go up, the prices of the products of these industries would also go up. All these would lead to higher price levels and result into inflation. So, from this perspective oil subsidy is doing a great job of providing affordable fuel to the needy and controlling the inflation. But this is only one part of the story. Oil prices or oil subsidy is interlinked with so many various other national and international factors that this issue cannot be analysed in isolation.

Nature of Oil Subsidy in India

LPG, PDS kerosene and diesel are sold to the retailers at less than international market price. Therefore there is a gap between the cost price (including marketing cost) and the selling price. The Govt. provides fiscal subsidy for LPG and kerosene. But that fiscal subsidy is not enough to bridge the gap between the cost price and the selling price. Therefore in spite of the Govt. providing fiscal subsidy there remains a gap which is called under recovery. Under recovery is generally calculated as the difference between the cost price and the regulated price while accounting for the fiscal subsidy. A large part of the under-recovery is compensated by the Govt. by cash assistance (in addition to fiscal subsidy) and another big chunk is taken care of by financial assistance from upstream National Oil Companies (NOCs).The rest of it is borne by the Oil Marketing Companies (OMCs).

Rationale behind Oil Subsidy

The idea behind lowering price of oil through subsidy is to make energy in the form of oil available to the common people, especially to the poor. Such subsidy also aims to protect the domestic consumers from unforeseen fluctuations in the international market. Oil subsidy, therefore, makes oil and hence energy in India more affordable to the public.

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Cash assistance is allocated from the fiscal budget and is accounted for as expenditure. The cash assistance is paid on ex-facto basis i.e. after the under-recoveries have incurred. Therefore the OMCs often face crunch of investible funds in the short run and they resort to raising loans.

subsidy, the government also granted assistance to the OMCs in the form of cash and oil bonds to share the under-recovery burden. In 201011, this assistance amounted to INR 41,000 crore (US$8,995 million) (MoPNG, 2011). In 2012 RBI stated: The centre has already exhausted its budgetary provision for petroleum subsidies and has indicated additional provisions (Rs. 300 billion) in the second supplementary demand for grants presented in November 2011. It is estimated that the higher expenditure on petroleum subsidy could drive up the fiscal deficit by around 0.8 percentage points of GDP for 2011-2012. Black market Subsidized domestic LPG and kerosene are available at a much cheaper rate than other fuels and hence it encourages the misuse for industrial purposes and beyond the control of PDS. As per one estimate, 40% of the PDS kerosene was mixed with other fuel and was being used for non-PDS and non-household purposes (NCAER 2005). Impact on Public Sector Oil Companies

The following figure shows how governments share in under-recoveries has changed from 2008-2011 (The cash assistance system was started in 2008).

Consequences of subsidies
Fiscal deficit Subsidies specifically impact the fiscal balances of the country. The fiscal subsidy to the petroleum companies in India in 201011 was INR 2,904 crore (US$637 million). In addition to the fiscal

Under-recoveries are shared by both the upstream and downstream companies. So, subsidies have an impact on the petroleum sector as a whole. Upstream oil companies, namely Oil and Natural Gas Corporation Limited (ONGC) and Oil India Limited (OIL), sell crude oil to downstream refineries at discounted rates and the downstream companies also bear a portion of the underrecovery burden. In 201011, the burden borne by upstream and downstream companies was INR 30,297 crore (US$6.65 billion) and INR 6,893 crore (US$1.51 billion), respectively. This not only affects the cash flow and profitability of oil companies adversely but also hinders the upstream sector from investing in improving and expanding their exploration and production operations.

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These upstream PSUs take up exploration and production activities with some technological partner who is capable of running the operations on behalf of the PSUs. But exploration itself is an activity with high financial risk and any party involved in it needs to have huge investible funds. Because the upstream companies share a significant burden of the oil subsidy their investible funds decrease and hence they cannot aggressively pursue & execute E&P activities. This ultimately results in less number of oilfields being discovered and hence less number of oil wells from which oil can be ultimately extracted. In essence it decreases the domestic oil production in India resulting in net increase of imported oil. This not only reduces Indias energy sufficiency but also depletes Indias forex reserves as crude oil is always pegged in USD. It also affects Rupee exchange rate as higher oil demand weakens Rupee. Among the upstream companies, ONGC bears the largest burden of the total subsidy followed by OIL and Gas Authority of India Limited (GAIL). See figure below:

Do the poor really gain?

Liquefied petroleum gas(LPG) In 200708 only around 8-9% of the rural population consumed LPG as a primary fuel for cooking, compared to 62% in urban areas (NSSO, 2010). Although LPG is subsidized to meet the fuel requirements of the poor, in reality a larger share of LPG is consumed by economically welloff urban households (GoI, 2010b).According to an earlier study by The Energy and Resources Institute (TERI), 76% of the LPG subsidy goes to urban areas and nearly 40% of the LPG subsidy is enjoyed by the wealthiest 6.75% of the population (Chawla et al., 2005). Diesel Almost 60% of the diesel consumed in India was in the transport sector, of which 54% was consumed by the road transport sector (GoI, 2010a).Within the road transport sector, the consumption of subsidized diesel by private vehicles has increased substantially; a trend that is further exacerbated by the price difference between petrol and diesel. PDS kerosene PDS kerosene was conceptualised and subsidised to increase its accessibility to the poor. In rural areas this fuel is used primarily for lighting purposesonly 1.3% of rural households use it for cooking (NSSO, 2010). However, in urban areas, 8% of the households use kerosene for cooking. In 200708, 39% of rural and 5.1% of urban households used kerosene as the primary fuel for lighting.

It is important to note that the subsidy and cash assistance is provided only to public sector companies. Private companies are free to market these products at competitive market prices. But it does not make their lives any easier. On the contrary, higher market prices make it uncompetitive for private companies to retail these products; therefore, while private participation is increasing in the exploration, production and refining of petroleum products, there is practically no private participation in marketing these fuels (petrol, diesel, LPG and kerosene).

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Opportunity cost, Environment and long term energy security

Combustion of fossil fuel is one of the biggest contributors to greenhouse gases and severely pollute the air. Not only that, many of the byproducts of oil are also hazardous to environment. Subsidy to oil incentives use or over-use of it. If oil subsidy were abolished the same amount would have been channelized to invention and discovery in the fields of alternative energies. These energies are generally cleaner, greener and more sustainable, leading to long term energy security. In fact their usage could prove to be cheaper after initial investment and in that case it would not be necessary for India to bear the huge burden of oil subsidy. Rather, funds from the subsidy could be utilised for further improvement of our living standards.

Concluding thoughts
Oil subsidy, although only a consumption subsidy, creates a multitude of adverse consequences. Some are immediate and some are a little farfetched. It impacts fiscal deficits, exchange rate, and possibility of research on alternative energy and overall living standard of our country. Moreover, because of the over-usage, we may actually be depriving our future generation. The amount of oil that was supposed to be consumed over generations is smoked up by one generation only because for the time being it is artificially made cheaper than the other forms of energy. Perhaps it is time we stopped, looked back and pondered over our own footprints which are getting larger, deeper and darker with every passing year.

Questions
1. 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? 2. How does subsidy impact the upstream oil companies? Does it affect Indias position as a net importer of oil? 3. If subsidy is abolished or reformed what sort of reform is required? 4. Are you for or against oil subsidy in todays world? Why?

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Appendix
Global Oil Consumption over the Years
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Consumption (Thousand barrels/day) 59,928.84 58,013.31 56,722.96 56,002.25 57,064.08 57,382.49 58,996.11 60,385.75 62,269.80 63,497.39 63,875.13 66,970.88 67,136.27 67,587.53 68,927.09 70,130.20 71,712.41 73,459.28 74,109.43 75,872.74 76,779.14 77,468.54 78,163.60 79,708.27 82,564.87 84,067.14 85,132.05 85,901.96 84,463.22 84,756.56 87,371.34 87,356.29 Change NA -3.20 % -2.22 % -1.27 % 1.90 % 0.56 % 2.81 % 2.36 % 3.12 % 1.97 % 0.59 % 4.85 % 0.25 % 0.67 % 1.98 % 1.75 % 2.26 % 2.44 % 0.89 % 2.38 % 1.19 % 0.90 % 0.90 % 1.98 % 3.58 % 1.82 % 1.27 % 0.90 % -1.67 % 0.35 % 3.09 % -0.02 %

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Indias Oil Production and Consumption

Indian Subsidies

Acknowledgement
oil subsidy - The Economic Times www.indexmundi.com www.iisd.org www.teriin.org

References
IEA, World Energy Outlook 2012 IEA, Southeast Asia Energy Outlook 2013 GOI, Report Of The Committee On Roadmap For Fiscal Consolidation, September 2012 http://articles.economictimes.indiatimes.com/2013-08-26/news/41455220_1_hpcl-rs-indian-oil-corp-ioc http://en.wikipedia.org/wiki/Energy_subsidies http://economictimes.indiatimes.com/topic/oil-subsidy http://www.business-standard.com/article/economy-policy/finmin-hopes-for-50-cut-in-oil-subsidy-infy14-113052300894_1.html http://online.wsj.com/article/SB10001424127887324463604579040611737389236.html http://www.thehindubusinessline.com/features/oil-subsidies-politics-first-economics-last/article4458680.ece