The Hindu Business Line : Distilling the concept of under-recoveries

It was probably the proverbial last straw on the aam aadmi's back. Already reeling under skyrocketing inflation, the petrol price hike last weekend had consumers crying hoarse. On their part, the public-sector downstream oil marketing companies (OMCs) viz. Indian Oil, HPCL, and BPCL, laid blame on rising global crude oil prices, and cited mounting and unsustainable “under-recoveries” as having forced their hand. What exactly are “under-recoveries”?

As the name suggests, under-recovery means recovering less than what could have been realised. That's what the OMCs have been forced to do for long in the case of two auto fuels — petrol and diesel — and two cooking fuels — kerosene and liquefied petroleum gas (LPG). These products are sold at less than notional market price (or trade parity price, as the government terms it) to make them affordable for the consumer.

The resulting gap between selling price and market price constitutes under-recoveries. Since June last year, when the government deregulated petrol pricing, there has been a series of price hikes in the fuel to moderate under-recoveries. The irony is that petrol constitutes only a small portion of the burden, with diesel and LPG contributing the bulk.

Big burden

With oil on the boil, under-recoveries have been ballooning over the years and exceeded a mind-boggling Rs 1,03,000 crore in 2009, when oil price touched $140 a barrel. 2010 was much better, with under-recoveries of Rs 46,000 crore.

In the current fiscal, with oil close to the $100 mark, the burden is set to exceed Rs 70,000 crore. In fact, OMCs claim current under-recoveries of around Rs 1.2/ litre on petrol (even after all the hikes), Rs 7/litre on diesel, Rs 19/litre on kerosene, and Rs 365/cylinder on LPG.

So, who pulls this mighty burden? Three groups — the government (which compensates OMCs — earlier through bonds and now by cash), the upstream companies viz. ONGC, Oil India and GAIL (through product discounts to the OMCs), and finally the OMCs themselves. The share has varied, depending on how much the government bears.

In the crisis year of 2009, the government bore as much as 69 per cent, with the rest contributed by upstream companies. However, in 2010, the government, upstream and downstream companies shared 57 per cent, 31 per cent and 12 per cent respectively. How 2011 will pan out is anybody's guess, with the government not yet fully revealing its hand.

A big problem for OMCs is uncertainty in the quantum and timing of the government compensation. With piecemeal announcements and delayed disbursements, OMCs are kept on tenterhooks, earnings yo-yo wildly, cash flows are affected, and they are forced to borrow copious amounts to keep the show running, till reinforcements finally come in. Upstream companies also suffer from suboptimal realisations. Clearly, not the best of situations for an industry which needs massive investments to improve the country's energy security.

Inflated?

The quantum of under-recoveries has been a matter of debate for some time now. As indicated by several committees, the current trade parity pricing method of calculating under-recoveries, which assigns an 80 per cent weight to refined product imports and 20 per cent weight to exports may be overstating the actual burden.

This is because, although India imports most of its crude oil, it is an exporter of refined products such as petrol and diesel, thanks to the country's surplus refining capacity. Result: The under-recovery calculation formula loads import costs such as freight, insurance, and customs duties on refined products, which may not have been incurred in the first place.

Also, under-recoveries are often confused with losses. While under-recoveries would be incurred if sale price is less than market rates (which includes margins), loss would be incurred if sale price is less than cost. In effect, OMCs may be bearing a portion of the under-recovery burden, yet manage to post profits , as seen in fiscal 2010. Of course, if under-recoveries to be borne becomes too large, OMCs would slip into the red.

More transparency in the under-recovery calculations would help get a correct sense of the real burden.

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