Oil rich developing countries are well-known to suffer from ‘resource curse.’ The oil poor developing countries, besides having to allocate increasing percentage of export earnings to import energy, also suffer from the ‘curse of energy subsidies.’ Their impact on political fabric through rampant corruption at all levels of society like in India is not studied well and needs urgent attention.

Unprecedented energy crisis...

Today the world is facing an unprecedented energy crisis. In 2008, oil prices, after reaching a high of $147 per barrel fell to low 30s. It is not clear whether the market was influenced by speculation or it was signaling the beginning of the end of cheap oil era as predicted by Peak Oil theorists. The phenomenon of green house gases, because of greater use of coal, oil and gas and the resultant global warming, seems to be increasingly accepted by the scientific community. While bio fuels like bio diesel and ethanol from corn and sugarcane are promoted to reduce consumption of petroleum products, there are worries on their potential impact on world food production and water consumption. Possible impact on water shortage is predicted as greater convergence of food, fuel and water occurs. Each time Jihadi terrorists bomb the cities in the developed world, energy security and energy independence become their mantra for few months and then forgotten. IEA has published its flagship World Energy Outlook 2008 giving a call for energy revolution. This can happen if a country like India shows a different development model.

The Planning Commission of India, in its 2006 Integrated Energy Policy Report has forecasted India’s energy demand to go up from 471 million tonnes of oil equivalent to 1536 mtoe to 1887 mtoe depending upon GDP growth, success of energy conservation efforts, movement in oil prices, expansion of nuclear and renewable energy sources, implementation of energy policies by the government, etc. IEA’s 2008 forecasts India’s consumption to be less than 1279 mtoe, considerably less than the one forecast by the Planning Commission. In fact India should aim to minimize energy consumption as much as possible while ensuring the availability of energy requirements to all the poor. Its goal should be not to maximise energy consumption to meet the energy needs of the affluent in its urban areas as is attempted in many parts of the world.

Mounting oil subsidies

India must be one of the few large countries which have reduced prices for petroleum products during the relentless crude oil price increase from 2003. It was only in 2008 when crude prices shot above $120/b, that the government, with great reluctance, increased the prices and that too only marginally to compensate the marketing oil companies for an assumed crude price of about $60/b. This forced private companies like Reliance and others to shut down their service stations. Reliance had developed a world class network of service stations with modern IT facility to monitor the operations of the service stations from its headquarters. The company would have given a tough competition to poorly managed government-owned service stations often selling adulterated products. The public sector oil marketing companies were losing money by the millions every day. In a totally non-transparent and ad hoc manner, the government forced the government-owned upstream com-panies ONGC and Oil India to transfer some funds to public sector oil marketing companies. In addition, the government also subsidized, through a totally irrational system of buying oil bonds from the oil companies, a system of indirect subsidy never adapted anywhere in the world. As this was going on, oil traders, who are the owners of service stations, or distributing/selling LPG, or agents who were distributing kerosene through public distribution system (PDS), were minting money through adulterating high priced gasoline and diesel with low priced kerosene and also diverting highly subsidized residential LPG to commercial and automotive sectors where the prices are two to three times the residential LPG prices.

Mounting subsidies...

Graph-1 shows the huge subsidies doled out to the users of various petroleum products. It also shows the amount of black money generated by diverting subsidized products to more lucrative sectors as explained above when the world oil price was $120/b. Currently with lower crude oil prices, there are no subsidies on gasoline and diesel.

With lower oil price, even the subsidy on residential LPG has fallen . When the oil price was around $120 per barrel, total annual subsidy the government was doling out amounted to Rs. 175,000 crore and in addition through diversion of subsidized products, there was another implicit loss of Rs. 35,000 crore. Currently these losses have come down to Rs. 10,000 crore and Rs. 35,000 crore per year respectively. Even at this lower level, they are significant and black money generated through this system can be considered as the mother of all corruption in India. Of course when the oil prices were high, oil traders and their political supporters were earning huge profits though illegally when the country was losing valuable foreign exchange to import crude oil.

Failed attempt to liberalise oil market

With great fanfare the government dismantled the Administrative Pricing Mechanism (APM) in April 2002. APM was first introduced in 1976. But the euphoria of dismantling the APM lasted only a short period. Oil companies were given some freedom to determine the prices based on international petroleum market and that too within a band only for few more months. However when crude oil prices started to increase in 2004 and oil companies wanted to pass on the increases to customers, the government started to interfere with the pricing decisions.

When crude oil price was $120/b, the prices for gasoline, diesel, and PDS kerosene were $1.30, $0.90 and $0.21 per litre and the oil marketing companies were losing $0.16, $0.37 and $0.72 per litre respectively. In the case of residential LPG the loss was about $460 per tonne. Hundreds of studies have showed that more than 50 to 60 per cent of PDS kerosene did not reach the intended beneficiaries and was systematically diverted either to blend with gasoline and naphtha or sold in the black market at higher prices.

Petrol stations and political patronage

Licence to own and operate gasoline service stations is a largesse doled out to politically connected people though there are well spelt out criteria on books to select dealers – like giving preference to unemployed engineers or retired army people or people with disability, etc. Few years back the Supreme Court had to cancel the licences of more than 2000 owners of service stations when it was discovered that those licences were awarded out of turn by collecting bribes. One of the most celebrated cases involved the award of such a licence to the daughter of one of the former prime ministers of India. It also happens that many of these service station owners also happen to be dealers of PDS kerosene having easy access to subsidised kerosene. This is not a chance coincidence.

In the case of LPG also, the government, with the noble motive of helping the ‘poor’ and ‘middle class,’ has forced the oil companies to sell LPG at a highly subsidised price. Recently with the drop in oil price, LPG subsidy has come down. There is a long list of millions of customers waiting to get LPG connections. Again studies have found that more than 30 per cent of LPG connections in residential sector are bogus and LPG is regularly diverted to commercial and automotive sectors earning huge margins and causing loss of tax revenue. Not many poor can afford to have LPG connections. In rural areas the poor depend mostly on kerosene or firewood for cooking. Still the political class is not prepared to liberalise LPG market allowing free market to decide the price.

Use of energy sector to the benefit of political class

The competition among different political parties to offer subsidy for power to farmers and poor has some unintended consequences. India is a leader in the biogas technology for power generation from cow dung, agricultural waste and such biodegradable matter. But the amount of power generated using such technology has been less than 10 per cent of the potential. When the government is promising to sell free or highly subsidized power, one will not have any incentive to invest in such renewable energy sources. The same is true for solar, wind and other renewables. Farmers are not prepared to invest in inexpensive devices like the foot valve to reduce energy consumption when they do not have to pay for power.

Irrational pricing of gas

After India liberalized exploration and production of oil and gas investment by inviting private interests, there have been significant discoveries of gas reserves. However, there has not been commensurate development in gas markets because of irrational gas price policies by the government. Instead of allowing the free market to decide the prices, government has been fixing the prices, especially of the gas marketed by the public sector companies.

Through its pricing order of 1997, the government had mandated that by 2002 all gas prices should reach 100 per cent fuel oil parity. But the government has not been able to implement such an important recommendation. Only freeing the gas sector from government interference can prevent current distortions. This will also result in healthy development of the gas industry in India.

Subsidies offered to LPG and kerosene customers are well-known. But only a few know about the huge subsidies given to the customers in gas sector. Unfortunately no NGO or media or government bodies charged with the responsibility of monitoring revenue leakages in public sector has taken any interest to expose the amount of money that can be diverted to the private sector from the public sector at the stroke of a pen by petroleum ministry. Depending upon the level of international oil prices this can vary between as little as Rs. 10,000 crore and as high as Rs. 28,000 crore per year.

Now, with many gas producers developing gas reserves under production-sharing contracts in India, pricing gas has become extremely crucial. It is these prices which will decide how the government and private investor will share the total gas revenues.

In India only recently some thought has been given to develop the residential gas sector. It is likely that gas use for residences may give higher net back to the gas producers than in the industrial and power sectors. Natural gas would have penetrated this market if level playing field had been created and LPG was not sold at subsidised rates.

Umpteen committees and commissions have studied the gas sector. The integrated energy policy report by the Planning Commission has also made recommendations for streamlining the gas sector. Since such streamlining will prevent the discretionary power of the petroleum ministry, the political class has not showed any interest as in the case of eliminating irrational pricing in oil marketing.

Recommendation on new energy sector policies

The government should get out of the business of fixing energy prices as much as possible. To begin with the government should implement in true spirit the dismantling of Administrative Pricing Mechanism (APM) and enable free market to determine the prices. Even under this scenario the government can continue to assist those below the poverty line through a more transparent subsidy system.

There is a need to assist the poor with cooking fuel needs. But this can be done through a smart card system as recommended by the Planning Commission rather than providing them with subsidised products through government controlled market outlets. As described in the article such a system gives rise to diversion of such products for black marketing resulting in corruption.

Though there was a need to subsidise LPG when it was first introduced to popularise the product, there is no such need today. LPG is a popular cooking fuel and there is a long line of waiting customers to get the connection. This is not only subsidising the rich and the middle class, but also encouraging corruption by diverting residential LPG to higher priced commercial and automotive sectors.

The government should avoid selling the same or similar products at vastly different prices using its irrational taxing policy for some social goals. When diesel prices are below gasoline prices, demand got skewed towards diesel. Since diesel and kerosene have more or less the same chemical structure, PDS kerosene is blended with diesel. Another example is of residential LPG which is priced considerably below the commercial LPG.

There is an urgent need to liberalise gas prices so that upstream companies will have the incentives to explore for gas. At the same time gas gets used in those markets where it adds maximum value to the economy. When it is far more economical to import fertilisers produced using cheap gas from the Middle East rather than forcing the upstream companies to sell it at low prices as is done today. The optimum market for gas would be to distribute gas to residential market rather than forcing it to power or fertiliser markets.