kerosene adulteration, Crude and Diesel Prices and their interplay

Fluid logic - an article by Gireesh Chandra Prasad / The Financial Express




The kerosene adulteration scam is valued at Rs 10,000 crore based on current prices. If crude prices go up and the difference between kerosene and diesel prices rises, so does the incentive to scam



How big is the kerosene adulteration scam that took the life of Nashik additional district collector Yaswant Sonawane on January 25?



It is believed to be in the region of Rs 10,000 crore to Rs 13,000 crore a year.



What drives the scam?



The price differential between kerosene prices and those of diesel—lower-priced kerosene is mixed with diesel and sold at diesel prices. While in the public distribution system (PDS) kerosene costs Rs 12.4 a litre, diesel costs Rs 38 or so. So there’s Rs 26 to be made per litre of PDS kerosene.



So how do you get to the Rs 10,000 crore figure?



An NCAER study estimated that 35% of subsidised kerosene made available through PDS is diverted to adulterate diesel. Given that 11 million tonnes of subsidised kerosene is sold through the PDS system, the scam is easy to calculate. If there’s Rs 26 to be made per litre of kerosene and 11 million tonnes of kerosene are supplied through the PDS each year, that’s Rs 28,600 crore. If you assume 35% of kerosene is used for adulteration, though market sources say the figure is higher, that’s a scam size of Rs 10,000 crore—if you assume half of kerosene is used for adulteration, the scam size is around Rs 14,000 crore.



How much do the oil companies lose on this?



Since all fuel prices are controlled, the oil companies make losses on them. As of today, fuel retailers lose Rs 6.8 on each litre of diesel, Rs 18.66 on each litre of kerosene, Rs 366.28 on each 14.2 kg cylinder of cooking gas and Rs 1.22 on each litre of petrol, despite the recent price increase. That works out to a total of Rs 31,500 crore in just the first half of the year (see table). The oil companies are partly compensated for this by the government—in the first six months of the year, the government gave them about Rs 14,369 crore, including a freight subsidy, the rest is borne by the upstream companies like ONGC and the oil marketing companies like IOC, HPCL and BPCL. The total subsidy requirement this year is expected to be Rs 72,000 crore, against Rs 46,000 crore last fiscal.



Does anyone else lose out?



The government clearly loses since it pays part of the subsidy on kerosene, but this gets eaten away by those who use this to adulterate diesel. The biggest loser is the private individual since adulterated diesel lowers engine life.



The government also loses out in a very big way in terms of the capital value of the PSU oil firms. The Rs 18,000 crore paid out by oil firms in the first six months of 2010-11 as subsidies end up lowering their profits—Rs 36,000 crore over the year if you assume what happened in the first half of the year will get replicated in the second. If you assume, for the sake of argument, that the average price-earnings ratio of oil firms should be 20, this means the market capitalisation of these firms has gone down by Rs 720,000 crore. If the government has a shareholding of 60% in these companies, that means it lost Rs 432,000 crore.



Thanks to the subsidy burden, the price-earnings ratio for PSU oil firms is much lower than that for private oil firms like RIL. While RIL’s PE is 15.3, IOC is 9.94.



How do you tackle the scam?



Raising kerosene price to the level of diesel is the best solution, but petroleum minister S Jaipal Reddy said this would not be possible. The government is reintroducing the idea of putting in chemical markers in kerosene and pushing state level administration to put GPS devices in kerosene tankers to track movement of consignments. Markers were used and then discontinued and putting GPS devices hasn’t helped much in the past.



What did the Kirit Parikh report on this say?



The Kirit Parikh committee, which advised the government to rationalise prices said, using 2005 data, that there is scope to cut down kerosene allocation by 20% across the nation.



How many expert committees have addressed this issue in the recent past?



There was one headed by C Rangarajan and another by BK Chaturvedi.



What did these committees recommend?



All recommended rationalising the prices of fuels.



What solution did Kirit Parikh recommend?



The Kirit Parikh panel recommended de-regulation of both petrol and diesel prices at the refinery gate level and at the retail level besides raising kerosene price by Rs 6 a litre and LPG price by Rs 100 a cylinder. The panel also recommended levying extra tax on diesel cars and reducing the allocation of subsidised kerosene to states. The panel also asked the government to use kerosene and LPG subsidies only for the benefit of the poor. Using a unique identity number and smart card, this could be achieved.



Why a special tax on diesel cars?



There is a lower excise duty on diesel to keep its price low, but since this is used by richer car owners, the idea was to find a way to get this back without affecting the price of diesel. Parikh took the average consumption of diesel over the lifetime of a car, calculated the lower excise duty paid as compared to the case of a petrol car, did an NPV of this and arrived at its figure. This worked out to Rs 81,000.



Would raising kerosene prices hit the poor?



Not really, and this is where the Parikh report scores over most others. The report found that just 1.3% of all rural households use kerosene for cooking. It also found that while the number of households using kerosene fell a third between 1999 and 2005, the government cut kerosene allocations under the PDS by just 13%. Parikh also found that high-income states such as Delhi, Maharashtra, Haryana and Punjab consume 41% more kerosene than low-income states like Bihar, Jharkhand, Mizoram and Tripura.



How did Parikh arrive at his conclusions for raising prices?



He did a simple calculation based on per capita incomes. He said that, since prices of kerosene were last raised in 2002, India’s per capita incomes had risen 60%, so kerosene prices could have been raised 60% without affecting anyone’s welfare. Based on this, prices could have been raised by Rs 6 per litre instead of the Rs 3, as was done.



In the case of LPG similarly, prices can be raised by Rs 200 per cylinder without adversely affecting anyone.



At the end of all this, we’re saying the scam is restricted to Rs 10,000 crore a year?



Not at all. That’s Rs 10,000 crore based on current prices. If crude oil prices rise further and the difference between kerosene and diesel prices rises further, so does the size of the scam. If crude oil costs $100, diesel prices will need to go up to Rs 48 a litre according to the Parikh calculations. So, if there is no change in kerosene prices, the incentive rises to Rs 36 a litre, or around 40% more than what it is today. At $120, diesel needs to be priced at Rs 56 a litre, so the incentive to adulterate diesel with kerosene goes up to Rs 44 per litre, or 70% more than what it is today!



And of course, there is the huge subsidy loss that the oil PSUs have to bear, the oil subsidies the government has to shell out and the huge loss the government bears when the market value of its shares in oil PSUs falls.