The administered pricing mechanism (APM) for oil products was dismantled in April 2002. But the nightmare continues for oil companies, investors, consumers and even the government. At least the APM had a ‘logic’, however questionable. To call what we have now a system would be a travesty of the word, which presumes some logic, some method, in government determining the final retail prices and the losses the oil companies have to bear.

From APM we slid to ‘arbitrary pricing mechanism.’ What we now have is the government micro-determining for each product and each region the tax, duty, pricing and losses and surpluses. The ‘adjustment’ at the margin principle stands completely exposed. Prices have been robbed of the role they perform in a market economy, the allocation and use of resources.

The oil sector contributes to over 20% of central taxes and 22% of state taxes. Total taxes amount to 64% of value added (including taxes), assuming all taxes ultimately fall on domestic producers and users. Oil and energy are not generally VATtable. The high taxes are crazy enough. The madness lies in the uncountable rates of excise, customs, surcharge, additional duties and royalties, that vary with the user, the purpose and the imported price.

As import prices rise, the additional ‘objective’ of moderating inflation makes the government cut rates on a product here and raise it there, and/or cajole the companies to bear a part of the burden, or force it on domestic crude producers. The distortions created by the resulting varying prices are there and continue to worsen after APM ‘dismantling.’

The demand for petrol is much lower than otherwise. Then, there is excess naphtha production, which has to be used in the fertiliser and power industries. Naphtha then goes into adulterating petrol, while kerosene is used to adulterate diesel. These days, small vehicles are opting for diesel and liquefied petroleum (LP) instead of the socially correct petrol engines. So, LP is being diverted from cooking to other applications, including industrial, commercial and automobile use. Much of city pollution in India is due to emission from adulterated fuel and distorted usage arising from absurd prices, not an externality. Also, third order distortions arise when, based on these prices, investments take place, or gas as an option is chosen in cities.

Adulteration cannot be controlled since the ‘price arbitrage’ continues to remain large and open. Oil company managers are being forced to fight an absurd battle in trying to control adulteration and diversion. Companies’ accounts and profits have anyway become arbitrary. When distributorship generates rents rather than profits, it results in excessive numbers of retail outlets. With rents being generated in thousands of crores, the government cannot distance itself from dealer selection (read micro-management of and institutionalised interference, in public enterprises). The political force of dealers would nip any freshness in the approach of the government to reform the oil sector.

It goes without saying that no sensible privatisation, or ownership dilution of oil companies, is possible in this situation. Oil was one sector that had been left out of the indirect tax reform revolution. It was a big mistake to do so, despite it being the single largest revenue earner for both, state and central governments.

There is no longer a ‘logic’ to curb the consumption of oil products if sold at their correct social prices. So, the first bet would be to go for standard 16% VAT (value added tax) on the oil companies,’ with the states being allowed another 16%, as this sector has the highest rate of taxes. That would leave both governments gasping for revenue, though their revenue shortfall is quite exaggerated. In fact, medium-term price elasticities are large, especially for petrol, which is priced above revenue maximising rates.

What would be feasible is to work for a higher rate on value added that is revenue neutral and leave the oil companies to fix their final retail prices. This could be implemented immediately, by imposing uniform taxes on crude and oil products, with VAT being allowed on trades within the limited set of the petroleum companies. This could also be translated to a tax per litre or kg of product/crude, that is based on density. Then the tax would not discriminate on the basis of the degree of vertical integration of operations. Retail prices would not differ sufficiently to allow arbitrage opportunities to adulterate and divert and a whole bureau of calculators within the government and companies could be put to better use.

The inter-fuel substitution distortions having gone, the revenue can only go up, as the cost of savings now diverted from unproductive activities and investments would bear on increased and useful consumption. The current revenues foregone on adulteration and diversion would be immediately realisable. Rents, too, would vanish. The Dealer Selection Board could be wound up, with guidelines to the oil companies to serve ex-servicemen and the handicapped. Airli-nes, too, would come back, not only for aviation turbine fuel, but also for servicing and equipping. It is then that our oil companies can talk of mergers and alliances and become globally confident players. Private capital that is profit-rather than rent-seeking can then begin to flow into the sector.

The question now is: what about kerosene and the poor? And LPG and the not-so-poor? They could be issued with endowment identification cards and issued kerosene and LPG coupons to buy these in the market, or even to sell these to buy food. That would also be honest. The fiscal cost of such a subsidy would then be less than a third of what it is today.