In just four years the Indian government has had three high-level committees recommend how petroleum product prices should be determined. All three have shared the same general conclusions: the government should reform fuel-price subsidies and use other, more effective policies to improve the welfare of the poor. But the reality behind India's reluctance to liberalize prices is not a lack of good policy advice. It is that dealers and wholesalers can make large amounts of money out of the subsidies, and, one way or another, some of this ultimately ends up supporting politicians.

The first committee was commissioned in 2006, as international crude oil prices were climbing, and oil companies were losing money because of the price controls. The government asked the chair, Dr. Chakravarthi Rangarajan, former Chairman of the Economic Advisory Council to the Prime Minister, to look at the pricing and taxation of petroleum product prices, with a view to rationalizing them. The committee concluded in no uncertain terms that the government should allow oil companies to set prices based on trade parity – in other words, at international prices – and there should be no further interference with the market. The committee also warned that if the government failed to liberalize prices, oil-marketing companies would become non-viable, unable to recover costs and with mounting losses. This is of course something that has now taken place.

In India, the government subsidizes petroleum products by requiring the companies who sell them – referred to as ‘oil-marketing companies' – to do so at a fixed price. If the companies are private, they receive no compensation and must absorb any losses. If they are government-owned, they are given government bonds in return: financial instruments that guarantee a fixed payment at a future time period, and can be immediately traded for their future value on financial markets. Giving out government bonds is essentially the same as printing new money. Government-owned oil-marketing companies are also compensated with some of the profits earned by government-owned upstream oil companies. Even state oil companies, however, lose large amounts of potential revenue and the entire sector blames the arrangement for continued under-investment and financial difficulties. Between fiscal years 2004–2009, the subsidies resulted in under-recoveries of US$ 67 billion. It is difficult to estimate the total government expenditure because the creation of bonds is not recorded as spending in the national budget.

The kerosene vendor shown here is unable to earn enough money for a living, while government-appointed kerosene distributors can practically mint money by diverting public kerosene supplies into higher value products.

In 2008, as crude oil prices continued to increase, and the financial situation of oil companies worsened, a second high-level committee was organized under the chairmanship of Shri B. K. Chaturvedi, a former member of the Planning Commission, the government body that draws up India's Five Year economic plans. Unlike the Rangarajan committee's report, the Chaturvedi report did not recommend the liberalization of prices in direct and unambiguous terms, but its recommendation that product prices be based on "export parity", as opposed to trade parity, amounted to the same thing. They suggested very strongly that there should be no subsidies on kerosene and liquified petroleum gas (LPG), and that the poor could be more effectively helped through a smart card or coupon system. In December 2008, dramatically lower oil prices offered an ideal opportunity for reform, but the government did not act on these recommendations because of populist political pressure from opposition parties and some allies. The window of opportunity soon closed: prices climbed to over US$ 70 per barrel, once again affecting the bottom lines of the oil-marketing companies.

In 2009, the government instituted the formation of a third committee, this time headed by Dr. Parikh, another former Planning Commission member, who in his Integrated Energy Report of 2006 had already recommended the liberalization of petroleum product prices and the distribution of subsidized kerosene through a smart-card system. It was not a surprise that the committee's report eventually recommended market-based pricing (without specifying trade or export parity) for petrol and diesel. It also recommended the gradual removal of subsidies on kerosene and LPG, while suggesting an immediate increase of US$ 0.13 per liter in the case of publically distributed kerosene and US$ 2.20 per cylinder in the case of LPG.

Most importantly, the Parikh committee report discredited the reason most commonly given for the control of petroleum product prices: fear of increased inflation and price volatility that would negatively affect the poor. In the view of the committee, as petrol is largely an item of final consumption in India, price increases would not be expected to have much impact on inflation, and as it is only consumed by the poor in small amounts, liberalization would not be expected to significantly affect them. A similar conclusion was arrived at in the case of diesel fuel.

While some of the leaders of the Congress party in the Indian government, especially finance and petroleum ministers, are currently inclined to implement the Parikh committee's recommendations, their allies in the United Progressive Alliance (UPA) – the coalition of political parties heading the government – have been slow to show their support. Even in the Congress party, there is unlikely to be much backing. The same old arguments are given: price liberalization can give rise to inflation, and the poor will be affected.

The real reason for their reluctance is that the rationalization of petroleum product prices will reduce opportunities to collect economic rents. I have conducted analysis into the diversion of subsidized products, like the adulteration of reduced-price kerosene in petrol and diesel, or the redirection of residential LPG to commercial and automotive sectors, as well as the misuse of subsidies intended for the poor, which concludes that about US$ 48 billion of ‘black money' has been generated between 2004–2009. Unfortunately, while all three government-appointed reports have discussed that this diversion of products is taking place, none have even attempted to analyze the impact of such colossal amounts of money on India's governance or energy security.

Reform of India's petroleum subsidies would affect the dealers and wholesalers involved in the distribution of these sensitive products, and it is a well known and established fact that most of these dealers are either political leaders or among those close to them. Rationalizing prices in one stroke would eliminate the opportunity to earn as much as US$ 8–10 billion per year. Which political parties would like to lose such an opportunity? It is this factor which has prevented any previous efforts to implement well-argued recommendations from high-level committees. The Parikh committee will see the same fate as those that have come before. Adam Smith's invisible hand of self interest is indeed at work, but if left to its own devices I doubt it will promote the common good!
 
Dr Bhamy V. Shenoy is a graduate of IIT Madras. He is a currently a consumer activist in the city of Mysore in Karnataka, India, where he has worked on issues including education for children from slums, energy and development. He regularly writes articles on India's energy sector, and recently authored a report for the Global Subsidies Initiative on kerosene subsidies in India: Lessons Learned from Attempts to Reform India's Kerosene Subsidy.