Windfall tax on oil firms is justified; a robust ecosystem for hydrocarbons can give India the much-needed relief
Amid disruption in the global supply chain and steep spike in the international crude prices, the Union Cabinet last week took two major decisions pertaining to the oil sector—deregulation of the sale of domestically-produced crude oil and imposing a cess or windfall tax of Rs 23,250 per tonne on crude oil and a special additional excise duty (SAED) of Rs 6 per litre, Rs 13 per litre and Rs 6 per litre on exports of petrol, diesel, and jet fuel respectively.
The Covid-19 pandemic and the ongoing Russia-Ukraine war have acutely affected the global supply chains, besides giving legs to the prices of the international crude oil to run briskly.
The government hopes that the Cabinet decision will spur domestic production of crude oil as it offers incentives to exploration and production (E&P) companies like Oil India Limited (OIL) and Oil and Natural Gas Corporation (ONGC), Cairn Oil and Gas, etc., thereby cutting down on imports of costly oil from global suppliers. Additionally, the Cabinet decision will help in curbing fuel shortages in the domestic market.
Under the extant arrangements, a condition in Production Sharing Contracts (PSC) (every E&P company which is given right or license to explore oil from a field is required to sign a PSC that lays down the terms and conditions for exploration, production and marketing of throughput) requires the operator to sell crude oil to the government or its nominee or government companies only.
This meant that domestically produced crude could only be supplied to refineries of Indian Oil Corporation Limited (IOCL), Hindustan Petroleum Corporation Limited (HPCL), and Bharat Petroleum Corporation Limited (BPCL), which are majority-owned and controlled by the Government. Effective from October 1, 2022, this condition has been waived off, implying that E&P firms will have freedom to sell crude oil to whoever they want.
However, the freedom of marketing to E&P companies will be available only in respect of sales in the domestic market even as exports shall continue to be prohibited.
In view of domestically produced crude, constituting barely 15 percent of India’s demand and public sector refineries such as IOCL/BPCL, etc., processing bulk of it, prima facie, E&P firms should have a readily available outlet for their throughput even if their sale is restricted to these government undertakings. But, such sales are generally hamstrung by bureaucratic red tape. Giving them freedom to sell, including to private refineries, will unshackle them, thereby removing a major constraint on increasing production.
The freedom to sell could be extrapolated to cover exports, while this would open up infinite opportunities for the E&P companies for selling their produce. But, for a country (read: India) which has to import 85 percent of its requirement, this is a bizarre proposition. No sovereign Government would ever permit it. Therefore, prohibition on export of crude rightly continues.
Currently, E&P firms are allowed to sell their crude at parity with its international price without any restriction. The steep increase in the international price has meant corresponding increase in the realization for these firms.
The resulting increase in their profits is due to the fortuitous circumstances (read: Ukraine war), as a big slice of global crude supply got disrupted. These are ‘windfall gains’, a portion of which is being mopped up by levy of a windfall tax on domestic crude. Against a realization of around US$ 40 per barrel in normal times, if today producers are getting upto US$ 80 per barrel more, the Government is justified in taking away a portion of this bonanza – Rs 23,250 per tonne or US$ 40 per barrel, this comes to 50 percent.
However, a stipulation that “no cess will be imposed on such quantity of crude that is produced in excess of last year’s production by a crude producer” was avoidable. It will prompt producers to show more quantity under the ‘incremental’ head to escape levy of cess, thereby defeating the very purpose.
The freedom of selling crude by itself won’t galvanize E&P firms to boost domestic output. This is because the majority of the fields produce both crude oil and natural gas (NG). The NG is subject to controls on pricing and selling.
The Government hands out at least half-a-dozen prices. The NG flowing from fields given on nomination to ONGC and OIL under pre-NELP (New Exploration Licensing Policy) and NELP is covered under the administered price mechanism. There is a premium price for gas extracted from deep and ultra-deep water fields. Though market determined, this price is subject to a cap; in effect, even this is controlled.
Other categories include market-based price for fields given under the Hydrocarbon Exploration Licensing Policy (HELP) or Open Acreage Licensing Policy (OALP); special price for unconventional stuff like shale gas, coal bed methane (CBM) from fields given under NELP as well as HELP; and for small and marginal fields whose ownership has been transferred from ONGC/OIL to private firms.
Furthermore, marketing (who gets to sell how much gas and from which field) is decided by an inter-ministerial committee, headed by secretary, ministry of petroleum and natural gas (MPNG). It creates a fertile ground for intense lobbying by interest groups to get the best deal in terms of the price and quantity sold. This distracts attention from maximizing production even as E&P firms are focused more on managing the officials.
In view of above, for E&P firms to get enthused, alongside crude, it is also necessary to grant them freedom for marketing and pricing of NG. The freedom should also embrace companies engaged in refining and marketing of petroleum products.
Although petrol and diesel are deregulated, de facto central public sector undertakings (CPSUs) viz. IOCL/BPCL/HPCL (they account for 90 percent of retail outlets) are not free to fix their prices. These CPSUs receive tacit instructions from their bosses to maintain prices at levels desired by the latter. For instance, the current pump price of petrol in Delhi at Rs 97 per liter, Rs 13 per liter less than the international parity price.
This artificial suppression of the retail price by CPSUs has prompted private refiners such as Reliance Industries (RIL) and Nayara Energy to cut supplies to the domestic market as they can’t match the prices offered by the former. In turn, this has led to fuel shortages in several states such as Rajasthan, Madhya Pradesh and Gujarat.
To alleviate shortage, the Government has come up with a tax on export of these fuels. It also wants exporters to supply 50 percent of the quantity of petrol exported during 2022-23 (30 percent in case of diesel) in the domestic market. It is missing the wood for the trees. While domestic prices are artificially kept below the international prices and a private refiner stands to gain by exporting, merely imposing levy of export tax creates no deterrence, and there may be attempts to fudge data.
To conclude, instead of looking for short-term palliatives, the Modi Government should free up the hydrocarbon sector, covering the entire supply chain from E&P to refining and marketing.
(The author is a policy analyst)
https://www.dailypioneer.com/2022/columnists/hydrocarbons-may-give-india-energy-freedom.html
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