Recommendations Of The R-Group

Exploration & production

• Increasing the competency of ONGC & OIL by empowering the Board of Directors to diversify into downstream, allowing them to market their own produce, providing level playing field to all companies in bidding for blocks, relinquishment etc and providing international price for domestic crude produced by them.
• Enhancement of domestic production through reserve accretion in India and abroad
• Acquisition and absorption of new technology for reserve accretion
• Mobilization of venture capital required for building national oil industry
• Simplifying procedures in awarding production-sharing contracts, provision of fiscal incentives and rationalization of tariff structure
• Assignment of regulatory and monitory functions to Directorate General of Hydrocarbons (DGH) which shall be an autonomous body.

• International price to be paid for crude oil extracted from new wells to all companies including ONGC & OIL.
• On all new findings, cess abolished and royalty made advalorem at 12.50% for inland and 10% for offshore areas. For deep-water areas beyond 400 meters depth, royalty will be 5% for the first 7 years.
• Tax holiday for 7 years after commencement of commercial production from blocks in northeastern region.
• Total freedom to market crude in the domestic market.
• Any company can bid directly without participation of ONGC or OIL as against the earlier stipulation of mandatory participation of ONGC / OIL up to 40%.
• ONGC / OIL to compete with other companies for winning licensees.

Natural gas

• Market deregulation to be done in phases as the domestic industry is in a nascent stage.
• In the initial phase the sector may be opened up for private participation.
• A regulatory body that shall lay down transparent rules required to ensure a level playing field, to lay down safety practices, to ensure environment protection, fair return to investors and to prevent abrupt price movements.
• Freedom to foreign companies/ private sector parties to set-up terminals and pipelines and freedom to import, store and distribute LNG.
• Freedom to PSC awardees to transmit, distribute and market the gas produced by them.
• Freedom for setting up spur-lines and city distribution lines.
• Introduction of Common Carrier Principle for pipelines. In the next phase when optimal infrastructure has been created, all further steps to be taken for complete deregulation subject to compliance of rules laid down by regulatory body.
• Pricing of natural gas to be in-line with international prices

Refining & marketing.

Refineries to be decontrolled first followed by upstream and last by marketing sector.

Total freedom to refineries to decide their product mix to optimize their profitability through better yields and value added products.

Decanalisation of petroleum products.

Continuation of administered pricing for mass consumption products till the national economy is ready to accept market-determined prices.

Cross subsidization of products to be done away and all subsidies to be given through budgetary allocations in a transparent manner.

Marketing deregulation to be done in phases, by giving freedom to oil companies to appoint dealers/ distributors, by withdrawal of SPE mechanism and thereafter-full decontrol.

Tariff & pricing reforms

The pricing and tariff reforms to be done in phases as per timetable given in next paragraph.

Rationalization of tariff structure by bringing down customs duties to 0-5% and providing a maximum tariff protection of 25% on finished products. Tariff rates to be bound as per WTO protocol in order to provide a suitable and predictable investment environment

Rationalization of royalty and cess on crude to modest levels as prevalent internationally and calculation of the same on advalorem basis instead of specific values

DGH to be the regulatory authority for upstream sector and OCC to be the regulatory authority for the downstream sector. Close monitoring by the Government during the transition phase to prevent exploitative price rises

Schedule of timetable for reforms

The entire reforms to be carried out in three phases as per timetable given below.

Phase - I: 1996-98

• Rationalization of Tariff Structure
• Withdrawal of concept of retention margin for refineries
• De-regulation of natural gas pricing
• Decanalisation of FO and Bitumen
• Partial deregulation of the marketing sector including freedom to appoint dealers/ distributors

Phase - II: 1998-2000

• Rationalization of royalty & cess
• Pricing of indigenous crude oil on the basis of average FOB price of comparable imported crude (inclusive of cess and royalty)
• Further deregulation of marketing sector
• Reduction of subsidy on SKO, LPG, and input for fertilizers

Phase - III: 2000-02

• Decanalisation of ATF, HSD and MS
• Total deregulation of upstream and downstream subsections of the oil sector

Benefits of deregulation

The R-Group envisages that the economic value of reforms in hydrocarbon sector is potentially very large, inter-alia consisting of

• Direct one-time benefit of US$3.50bn
• Recurring annual saving of US$5.45-US$6.10bn
• Net present value of policy reforms at a discounting factor of 10% would amount to approximately US$30bn or Rs10,000bn.

Notwithstanding the economic rationale for deregulation, there are a host of problems, which need to be addressed by the government before it can push through the reforms in the sector. Some of the important issues, which could affect the pace and the mode of deregulation are discussed below

Subsidies on major products

Currently, three of the major products intended for mass consumption ie SKO, LPG and HSD are heavily subsidized. The estimated subsidy in 1995-96 for SKO, LPG and HSD was Rs41.9bn, Rs16.3bn and Rs21.8bn respectively. Thanks to the 25%-40% increase in global prices of these products and the devaluation of Indian rupee by about 10% in September 1995, the subsidy for 1996-97 was significantly higher. In the case of HSD, pricing has serious implications on macro-economic variables like inflation. The withdrawal of these subsidies is a socio-political issue. Very wide ramifications could be an inherent hurdle to the introduction of MDPM. To circumvent this problem, the R-group has recommended a soft-landing approach and through a phased withdrawal of subsidies. In a democratic polity, political consensus would be needed to achieve this and it is easier said than done. One has to view this against the background of the inability of the present government even to increase prices to offset the deficit in the pool account.

Sharing of infrastructure

Under the APM, the infrastructure of the oil companies has been treated as industry infrastructure to avoid duplication of investment. The marketing companies currently share the infrastructure of other oil companies on a reciprocal basis and in a deregulated scenario the continuation of this arrangement is fraught with uncertainties with one viewing the other with suspicion. This could result in each of the oil companies proposing to set up their own infrastructure and thus avoiding investment by the industry/ cost to the consumer. The R-group has acknowledged the problem that sudden deregulation can potentially destabilize the supply/ distribution channels and push up costs.

Subsidized input to specific industries

The pricing of products currently#includes surcharges and is used as a tool to cross-subsidize various products. The ex-refinery price of all the products are uniform and there is a standard procedure for recovery of transportation charges. All these would undergo drastic changes and could cause upheavals in the prices of finished products with attendant ramifications. This could specially affect industries like Fertilizers which are currently provided inputs at much cheaper prices and thus the issue of subsidy to the Fertilizer industry / Pricing of Fertilizers needs to be addressed even before the oil sector is fully de-regulated.

Increase in cost of crude

At present, refineries are given crude at an artificially low price and post-deregulation they would be required to procure crude at international prices. At US$19/ bbl, on a production base of 35 mmt, this would mean an additional cost of Rs65.5bn (an estimated 60% increase in cost) and this additional cost would necessarily have to be borne by the consumers. This would result in a one-time sharp increase in the price of the finished products. The effect would be much more with the addition of excise duty and sales taxes, which are currently recovered on advalorem basis. With the sales quantities of
1995-96 and the current prices of various products, the additional cost works out to approximately 13% of the existing weighted average realization by oil companies. Thus one time across the board increase of about 13% would be required to bridge the additional cost. This could be a critical issue that the proponents of deregulation would need to address before the upstream is fully deregulated.

Revenue loss to the government

The R-group has proposed rationalization of cess & royalty on crude and rationalization of tariff structure. Currently oil companies contribute about Rs250bn to Central/ State Governments in the form of royalty, cess, excise/ customs duty and sales taxes and thus constitute one of the important providers of revenue to the Central/ State Governments. As such deregulation proposal would be accepted by the Central/ State Government only if the proposal is revenue neutral. This could be one of the serious handicaps with which the rationalization process has to be undertaken.

Sharing of pipelines

IOC controls a significant portion of pipeline capacity and in a de-regulated scenario, IOC can use this as a tool to throttle competition. The Government has accepted the fact that pipelines are natural monopolies and that pipelines may continue to be regulated even after other areas are de-regulated. The Government is also trying to partially address this problem by not allowing the existing companies to set up fresh pipelines but by asking them to put up the pipelines through a JVC owned by all the oil companies. The R-group has not suggested any recommendations as to how pipelines would be regulated.

Profitability of new refineries

Under the APM, the profitability of new refineries is assured. This could however change in a de-regulated scenario. Large refining capacities are proposed to be added during the Ninth and Tenth Plan periods and the government would have to give a tariff protection sufficient enough to enable these refineries to earn a decent return. As a cost reduction measure, the government has already announced that no customs duty will be charged on equipment imported for refineries proposed to be set up in the Ninth Plan period. The attendant uncertainties on the profitability of these refineries would have to be clearly addressed by the Govt.

Large dues to oil companies

The estimated dues of oil companies are about Rs150bn and are growing by the day. No deregulation can take place unless the dues are fully settled and even with a substantial price hike, it may take years to completely settle all the dues owed to the industry. It is anybody's guess, as how and when this issue, which has reached unmanageable and alarming proportions, would be sorted out.