Under-recoveries: How far under?

In the wake of rising international crude prices, state-run oil marketing companies (OMCs) like Indian Oil (IOC), Bharat Petroleum (BPCL) and Hindustan Petroleum (HPCL) have been making profits in recent years even as they reported rising under-recoveries from sale of sensitive petroleum products like petrol, diesel, LPG and kerosene in the domestic market. This apparent contradiction has led some quarters to wonder if the claims made by OMCs on revenue under-realisation are real. The lack of transparency about the methodology adopted by OMCs also strengthened the suspicion. Meanwhile, the government's decision to allow oil marketing companies to raise prices of petrol and diesel by Rs 5 and Rs 3 a litre, respectively, on June 4, added fuel to the fire. To put a lid on the controversy, Prime Minister Manmohan Singh constituted a high powered committee under the chairmanship of BK Chaturvedi, member, Planning Commission, to examine the financial position of oil companies. The committee is mandated to revisit the concept of ‘under-recoveries' and examine the reported deficit and the real deficit faced by OMCs as a result of price constraints imposed on them.

Under the envisaged subsidy-burden scheme, the government compensates 42.7 per cent of the under-recoveries by issuing oil bonds while upstream oil companies like ONGC, Oil India and GAIL bear 33 per cent. Upstream companies pay their share by providing discounts to OMCs on crude sales. The rest is borne by the OMCs.

The three state-run oil companies reported combined under-realisation of Rs 77,123 crore for 2007-08. But at the same time, they also made profits, though lower compared with the previous financial year.

For example, IOC reported a net profit of Rs 7,912.4 crore in 2007-08 even as it claimed under-recovery of Rs 9,774 crore. This figure was arrived at by IOC after taking into account compensation of Rs 18,997 crore from the government. In the same period, BPCL and HPCL reported net profits of Rs 1,769.5 crore and Rs 1,364.1 crore, respectively, while they claimed increased under-recoveries.

Refining of crude oil is a process industry where crude oil constitutes around 90 per cent of the total cost. The OMCs are currently sourcing their products from the refineries on trade parity basis, which then becomes their cost price. The difference between the cost price and the realised price represents under-recoveries. So, while refining is a profitable business for integrated OMCs, they are losing money in retailing.

After the dismantling of the APM regime in 2002, oil companies were allowed to charge import parity prices that included customs duties, insurance and freight charges, apart from actual product cost. But later, trade parity was adopted as a pricing principle in 2006, after the government slashed custom duty on these products from 10 per cent to 7.5 per cent. Under the trade parity principle, the weighted average of the import and export parity prices is taken in the ratio of 80:20. Pricing is lower than the import parity to the extent of freight cost and other taxes and duties. The move, aimed at softening the impact of rising crude prices on domestic consumers, was in line with the recommendations of the C Rangarajan Committee constituted by the government in 2005 to suggest pricing reforms in the petroleum sector.

The committee did a comparative analysis of the refinery gate price of diesel under alternative pricing models based on the international prices during April-September 2005. The cost of one litre of diesel at HPCL's Mumbai refinery worked out at Rs 19.27 as per cost-plus calculation prevalent under the APM regime, Rs 20.48 as per import parity pricing (with applicable customs duty at 10 per cent) and Rs 18.77 on export parity basis and Rs 19.77 if trade parity principle was applied at 7.5 per cent customs duty.