Subsidies on cooking gas, kerosene and diesel have resulted in perverse outcomes not envisaged when they were introduced

With the Aadhaar-based direct cash transfer scheme facing so many glitches in implementation, any hopes that the country’s energy sector can soon dismount the subsidy tiger it has been riding so dangerously have receded into the background. Had the Aadhaar scheme worked satisfactorily, the next logical step would have been to extend it to leaky petroleum subsidies in order to limit them only to those who need and deserve to be subsidised.

‘Lifeline energy’

Like all subsidies, petroleum subsidies too began with good intentions but soon spun out of control. In 2002, when the government dismantled the cost-plus administered pricing mechanism in the petroleum sector and linked petroleum product prices to import parity, it chose to subsidise through the budget, two products — kerosene and LPG. The rationale was that these constituted ‘lifeline’ energy which had to be supplied to all households irrespective of their ability to pay for it.

So far so good. But then, the oil marketing companies, at the behest of the government, failed to make the crucial distinction between those households that could pay the economic cost of cooking fuels and those that couldn’t. The subsidy was extended to every domestic LPG connection. Kerosene subsidy was extended to every ration card holder whether BPL or not.

In an unforeseen development, deregulation of petroleum product prices in India coincided with a steady and steep increase in the global price of crude, which accounts for almost 90 per cent of product cost. From around $23.65 for a barrel of Indian basket crude in March 2002, prices went up to more than $115 in 2012. Consequently, product prices had to be revised frequently to keep up with rising crude prices. However, both LPG and kerosene were insulated from such price increases to a very large extent. That encouraged rapid increases in LPG penetration to households as well as subsidised kerosene allocations through ration cards. Apart from spiralling budgetary subsidies, this has resulted in perverse outcomes not envisaged when these subsidies were first introduced.

While LPG penetration on the records of oil marketing companies soared, all one has to do is to just ask around to find out how many domestic maids, helpers, cleaners, drivers and a host of other blue-collar workers who live in our cities and towns have access to LPG connections. Most of them don’t, basically because they cannot produce an identity proof or give residence proof without which their neighbourhood gas agency would not even countenance their application. Many are itinerant workers and even those that are not rarely have a lease document for their rented homes. So, they end up procuring 5 kilo empty cylinders from the market which they fill illegally (and dangerously) every few days from their friendly gas shop in the same neighbourhood. And they pay at least five times the price of a subsidised LPG cylinder.

Not only does this class, which most needs the subsidised cooking fuel, not get it, worse, those who don’t need the subsidy — basically, the middle class — often have more than a single LPG connection. Some of the supplies accessed by the illegal neighbourhood gas shop may come from these middle class households with more than one connection, who are often culpable by default.

Diversion of cooking gas

Most households can get by with a single LPG cylinder a month and they do not draw their second subsidised entitlement of LPG, enabling the gas agency to divert it to whomsoever it chooses, for a premium. More often than not, it is supplied to commercial eateries and, at times, even established hotels which are supposed to get the bigger 19 kg cylinder at commercial prices. Enterprising private car-owners illegally convert their car engines to run on subsidised LPG meant for cooking. The oil marketing companies came up with Auto LPG cylinders to be sold at commercial rates, but it has been a cat and mouse game between the OMCs and the flourishing illegal LPG market. The ensuing rents have created a chain of beneficiaries all of whom have a stake in keeping LPG prices subsidised. They constitute a valuable vote-bank.

Only now oil marketing companies are waking up to the bane of multiple LPG connections in urban households which they are trying to weed out. The attempts to limit the number of subsidised LPG cylinders have witnessed some policy flip-flops.

Yet another perverse outcome of LPG subsidisation is the crowding out of piped gas in cities. While LPG is subsidised, piped gas is not. Even though currently piped gas is cheaper than even subsidised LPG, shrewd consumers foresee a steep increase in piped cooking gas prices, especially after the collapse of domestic gas production from KG basin. CNG prices in Delhi have more than doubled in the last three years. Eventually, piped gas prices will also go up as more and more city gas companies are sourcing LNG (liquefied natural gas) from international markets. Shrewd households used to subsidised cooking fuels are actually refusing piped gas connections. Yet piped gas is a far superior option compared to LPG. It is uninterrupted, cannot be diverted to other consumers and is safer than LPG in cylinders. Many a city gas distribution company has complained about lackadaisical response to their efforts to expand pipeline connections.

Kerosene subsidy has also produced equally perverse outcomes. Unsurprisingly, ration outlets report full drawal of subsidised kerosene quota. But only a part of it reaches the intended beneficiaries. At Rs. 27 a litre, the price differential between subsidised kerosene and diesel is indeed very significant, pushing the former into diesel tanks of cars, lorries and trucks. Kerosene mixed with diesel defies easy detection. It is estimated that half of all subsidised kerosene goes to adulterate diesel in cars and trucks, reducing their efficiency. Unlike LPG diversion which takes place at the level of the dealers and gas agencies, kerosene diversion is controlled by mafia-like operations often with local political patronage. Corruption at all levels has ensured that chemical markers that would distinguish subsidised kerosene from the rest used in other industries get neutralised within a few weeks of their introduction.

The most egregious perverse outcome of the government’s misguided subsidy regime, however, pertains to diesel which is not even a cooking fuel. Even though diesel prices were linked to import parity prices from 2002 onwards, they were not revised in tandem with global crude prices except in the initial two years, thanks to the invisible hand of government restraining the oil marketing companies. Diesel is used in irrigation pumpsets used by agriculture and in public transportation, especially trucks and the railways. Frequent elections to State Assemblies, even by-polls, can make the government jittery about raising diesel prices, as a result of which the gap between domestic market price of diesel and its import parity price begins to widen, giving rise to an implicit subsidy borne primarily by the oil marketing companies.

Diesel cars

Cashing in on this unexpected windfall, car manufacturers have been flooding the Indian market with diesel-fuelled cars. Initially these addressed the urban taxicab segments but, gradually, even luxury brands have come up with diesel-fuelled models to entice the fuel-price sensitive consumers. In fact, one study found that 40 per cent of the diesel used in the country is by diesel cars. Cheap diesel, primarily meant for freight, has also led to indiscriminate increase in truck-borne traffic as opposed to rail-borne freight, a more economical way to transport goods. Indian highways are perpetually clogged with truck traffic, endangering the environment as well as human lives, not to speak of the quantum jumps in diesel consumption in recent years. In fact, 60 per cent of the diesel consumed in the country is accounted for by the transportation sector. The share of diesel in the petroleum fuel basket rose to 43.7 per cent in FY 2011, up from 35.19 in FY 2002. Diesel car output growth has outpaced growth of petrol-driven private cars so much so that the diesel automobile lobby is threatening to become a forceful voice in ensuring that diesel remains a subsidised fuel.

That apart, the automobile manufacturers skim a substantial chunk of the subsidy by pricing diesel cars considerably higher than their petrol counterparts. The vehicle owner pays an upfront premium which unduly enriches the automobile manufacturer, a very perverse outcome indeed.

If the government is serious about fuel subsidies reaching only the intended beneficiaries, it must act fast to curb these unintended and perverse outcomes.

(The writer is an independent energy analyst and a former petroleum regulator).

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