The large subsidy on oil and petroleum products has proved a contentious political issue for the Indian government all year. A global oil price rise of some 50% in 2005 has twice forced it to raise petrol and diesel prices by7%, in June and then again in September. Nevertheless, JP Morgan warns that the increase is less than half of what's needed to relieve state oil companies and bring prices in line with international benchmarks.
Petroleum and natural gas minister Mani Shankar Aiyar knows that the problem isn't going to go away. He reckons that the burden of the subsidy on state oil companies is likely to double this year to Rs400 billion ($8.8 billion). Consumers must bear some of the burden of the rising prices of international crude, he told members of parliament in mid-August. The Communist parties in the ruling coalition have resisted these moves.
The other option is to cut taxes and duties on petrol.
"The government must make a political decision. Either cut taxes on oil or raise consumer prices, or do a bit of both," says Dr Kirit Parikh, an energy expert and a member of the Planning Commission, a government-appointed panel chaired by Prime Minister Manmohan Singh that draws up the country's economic policy. More than half the retail price of Rs45 per litre that the consumer currently pays for petrol goes to pay taxes, transport and distribution costs, he adds. The government collects more taxes as the price of petrol rises; so there is a case for rationalization of those duties to moderate levels. The finance ministry is reportedly reluctant, however, as it already faces constraints on the budget.
The larger issue this throws up is the need for reform of India's oil sector. The previous government had announced that it would move towards market prices for oil and petroleum products; but political compulsions of the present government and the unprecedented rise in international crude prices had aborted that move. Aiyar says that a new oil pricing policy can only be announced once international oil prices stabilize.
Even where subsidies may be justified, there is a case for a more efficient and transparent system, Parikh points out. "Dual pricing of any commodity will lead to leakage, and about one-third of the subsidized kerosene goes to adulterate other fuels, while the rest reaches the not-so-poor. Leakage in the subsidy of liquefied petroleum gas (LPG) or cooking gas can be better managed by mandating distribution in small cylinders so that commercial use is discouraged," he adds.
For now, India's oil companies such as Oil & Natural Gas and Indian Oil will continue to bear most of the burden, and just how this will affect their investment plans is uncertain. It seems ironic that, while the government is keen for them to buy international oil and gas assets aggressively as part of its energy security plan, it has dealt them a body blow