• Formal diesel price decontrol a welcome conclusion to prior price reforms
• Natural gas price revision balances revenue, investment and input cost objectives
• Proposed re-adoption of DBTL represents a step backwards from genuine reform

On Saturday 18th October the Indian Government announced a series of policy decisions in relation to energy, including decontrol of diesel pricing, revision of natural gas prices on a market-linked basis, and proposed changes to domestic LPG subsidy entitlements and delivery mechanisms. This package of measures, presented as a reflection of the new NDA administration’s reformist intent, represents a complex mix of continuity and change in relation to the previous UPA government’s policies, with important implications (both positive and negative) for the future direction of Indian energy policy.

Diesel price decontrol

The decision to fully decontrol diesel pricing, allowing public sector Oil Marketing Companies (OMC) to price diesel on a cost-recovery basis, is an important symbolic development. The removal of diesel subsidies, effectively achieved in mid-September 2014 through the cessation of OMC under-recoveries, was made possible by the price reforms instituted by the UPA government from September 2012 onwards (in particular the phased price increases introduced in January 2013), alongside lower international oil prices and a stronger domestic currency — a point clearly recognised by the new government’s Finance Minister. While an ideal programme of reform would have taken advantage of falling international prices to implement decontrol through a phased monthly reduction in prices (and associated over-recoveries) to offset prior under-recoveries, the decision to formally discontinue diesel price controls represents a significant milestone. The greater test of the new administration’s commitment to rational and equitable energy pricing will, however, be its willingness to re-balance fuel taxation in order to recover the massive (and highly regressive) expenditure incurred under the previous subsidy regime, reduce the diesel/petrol price differential and associated market distortions (central taxes on diesel are currently less than half those on petrol), and more effectively reflect the chronic environmental and public health externalities generated by diesel use.

Revision of natural gas prices

In relation to natural gas markets, two key policy announcements were made: the adoption of an amended version of the Rangarajan formula for pricing gas produced under the Administered Price Mechanism (APM) (increasing prices from US $4.2 mmbtu to $5.61 mmbtu on a Net Calorific Value (NCV) basis), and the non-allowance of additional revenue receipt for disputed production pending the outcome of arbitration and associated legal proceedings.

The new gas pricing mechanism retains the principle of market-linked pricing recommended by the Rangarajan committee, but amends the initially proposed formula — most importantly by removing any linkage with Japanese and Indian LNG import prices — leading to a substantially lower level of increase than that approved by the UPA government. The new pricing formula will be applied from November 1st 2014 (rather than retrospectively from the initially scheduled date of price revision in April 2014), and updated on a six-monthly basis from 31st March 2015. Disputed gas production from the KG basin will receive the earlier price of US $4.2 mmbtu for production within previously agreed production volumes, with the balance of the revenue received (the difference between the earlier and revised prices) being deposited in an escrow account pending the outcome of ongoing contract disputes, allowing price revision to proceed while not prejudging the outcome of arbitration and related legal proceedings.

Across the three policy areas, the NDA administration’s revision to the Rangarajan gas pricing formula represents the clearest divergence from previous UPA policy. The revision attempts to more evenly balance revenue, investment and input cost objectives, and will be revenue positive, however significant elements of the new pricing approach remain to be clarified, and it is unclear to what extent additional policy adjustments will be made in relation to key affected sectors (power and fertiliser) and associated subsidy mechanisms. 

Re-adoption of DBTL

In relation to LPG subsidies, two policy announcements were made: the proposed reintroduction of the Direct Benefit Transfer for LPG (DBTL), and a statement of the government’s intention to fix the per unit subsidy for LPG.

Of the three policy areas, the announcements in relation to LPG policy are the most problematic. The proposal to reintroduce the discredited Direct Benefit Transfer for LPG (DBTL) scheme represents a disappointing continuity with the previous UPA government’s policy. As previously outlined in IISD’s March 2014 briefing note on LPG subsidy reforms, there is no case for the introduction of DBTL on the grounds of equity, administrative efficiency or fiscal responsibility. DBTL does not decouple receipt of subsidy from fuel consumption (subsidy receipt is contingent on purchase of LPG), nor does it apply any form of targeting in selecting beneficiaries (retaining the highly regressive distribution of the existing subsidy). DBTL reduces the net value of the subsidy to the consumer, increases the administrative cost of delivering the subsidy, exacerbates the regressive distribution of subsidy expenditure, and will not significantly decrease total fiscal outlay (potentially even increasing it). 

Constrained by the Supreme Court’s order that enrolment in the UPA’s controversial Aadhaar scheme could not be made mandatory for the provision of public services, the government has modified DBTL to remove the compulsory linkage with Aadhaar. This is a welcome development — operationally, Aadhaar was essentially irrelevant to the functioning of the DBT mechanism even for the narrow purpose of removing duplicate connections, and compulsory Aadhaar linkage represented an attempt to instrumentalise the existing subsidy transfer in order to compel enrolment. 

Despite this modification (and the associated reduction in programme complexity and related administrative and beneficiary costs), the implementation timetable adopted — covering an initial 54 districts from 15th November 2014, and all remaining districts from 1st January 2015 — is highly unrealistic and, if retained, will result in significant supply disruptions (imposing additional costs on beneficiaries) and substantially increase the direct and opportunity costs associated with implementation.

The announcement of the government’s intention to fix the total unit subsidy for LPG, although not as directly antithetical to genuine subsidy reform as the reintroduction of DBTL, also raises questions about the direction of subsidy policy. The fixing of a per-unit subsidy could result (dependent on subsidy value and associated methodology of calculation) in a reduction in total fiscal outlay, however a uniform price cap per cylinder uniformly reduces the value of the subsidy to all users. Assuming it is applied at a lower rate than current under-recoveries, the introduction of a fixed subsidy per cylinder is therefore a regressive method of reducing total subsidy outlay relative to the alternative (intermediate) policy option of reducing the total subsidised cylinder allocation per household, which disproportionately affects wealthier households (thereby improving subsidy targeting by flattening the per-decile distribution profile). 

While an appropriate per-unit subsidy cap would potentially be useful in the context of a broader programme to restructure subsidy entitlements and expand subsidised LPG access, if (as reported) the government intends to introduce a fixed subsidy at a rate significantly higher than the current level of subsidy, while retaining the existing quota cap of 12 cylinders per household, this would effectively reinforce the inequitable distribution of current LPG subsidies while increasing total fiscal outlay.