The central Indian government began subsidizing petroleum derivatives as a result of the oil-price shocks of the 1970s, in order to soften the impact of oil price swings on the poor. According to several studies conducted in the last decade, it has become increasingly clear that the government's energy-subsidy programs are a costly way to achieve this goal and are not effective in meeting the needs of the less well-off.

In 2009, the burden of India's energy subsidy on the national budget climbed steadily with petroleum prices. In a statement to the Parliamentary Consultative Committee in December, Minister for Petroleum and Natural Gas Mr. Murli Deora estimated India's energy-subsidy spending at the end of the current fiscal year would be around US$ 9.76 billion (based on December petroleum prices). Although this is less than half the amount spent on energy subsidies in the previous fiscal year, due to the lower oil prices caused by the world economic slowdown, the total still amounts to 4.5% of the country's estimated US$ 219 billion budget.

Four petroleum products are subsidized by the central government: gasoline, diesel, domestic liquid petroleum gas (LPG) and kerosene. LPG and kerosene subsidies make up two-thirds of the spending, intended to help lower-income Indians gain access to cooking fuel. Yet a 2005 study by The Energy and Resources Institute (TERI), a New Delhi-based non-governmental organisation promoting sustainable development, found that the kerosene and LPG subsidies are inefficient and easily redirected to unintended purposes: "76% of the LPG subsidy goes to urban areas with 25% of [India's] total population, and... 52% of this urban subsidy is enjoyed by the top 27% of households."

Ruchika Chawla, Associate Fellow at TERI's Centre for Research on Energy Security and one of the authors of the study, confirmed for Subsidy Watch that the general distribution of benefits conferred by LPG subsidization remains unchanged.

"A similar situation is seen in the kerosene subsidies as well, where a large portion of subsidized kerosene is siphoned off to the black market, where either it is sold at higher prices or used to adulterate diesel," added Ms. Chawla.

In order to reduce these problems the TERI study recommended that the government stop producer subsidies and instead use ‘smart cards', special debit cards that can be used to transfer cash directly to low-income Indians.

Similar conclusions were reached in August 2006 in a prominent study conducted by a government-appointed committee, the Planning Commission of India's Expert Committee on Integrated Energy Policy, chaired by Dr. Kirit S. Parikh.

According to the Parikh Committee "The current delivery system of [the] kerosene subsidy by keeping the price of kerosene to the consumer low and compensating the oil companies for the difference in the consumer price and the import parity price has led to shockingly high rate of corruption in the petroleum distribution agencies."

A high percentage of the kerosene that is supposed to be distributed under the subsidy system is diverted for the adulteration of higher-priced diesel even at the depot level, leading to a leakage of 44% which amounts to approximately US$ 2.29 billion, found the Committee.

"If kerosene is to be subsidized as a cleaner fuel, the only way of preventing this pernicious adulteration and the widely prevalent corruption is to make the price of kerosene and diesel very close and give the subsidy to the consumer directly by way of coupons or smart cards," it concluded.

More concretely, the Parikh Committee recommended that the best way to improve access to kerosene and LPG for poor consumers would be to create a targeted entitlement to energy products, equal to 30 kilowatt-hours and 6 kg of cooking gas, or an equivalent amount of kerosene to cover one or both needs. Like TERI, it also proposed managing distribution with smart cards, specifically designed to purchase entitlements.

Acknowledging that smart cards are not a fool-proof system, the report noted that they have been used before in India and are subject to black market sale. In order to prevent this, the Committee suggested using cards with physiological identification, though adding, "even if a household decides to sell the entitlement and not use power, LPG and kerosene, it would still be welfare improving."

The central government has yet to implement an energy subsidy smart card system, though pilot programs have been considered in the past. According to Ms. Chawla, one of the hurdles has been a lack of coordination between the central and state governments, caused by disagreement over who should be entitled to the aid.

A pilot project that was to use smart cards for the delivery of the kerosene subsidy was put on hold in May 2007, because the states selected to take part in the pilot - Bihar, Uttarakhand and Maharashtra - wanted the scheme to include families above the poverty level, according to Indian newspaper Mint.

The kerosene and LPG subsidies were originally supposed to be removed by March of 2007, but have remained in place. As recently as September 2009, the central government delayed another planned withdrawal of the LPG subsidy due to the potential unpopularity of such a move. In the same month, India and the other G-20 member countries pledged to phase out fossil-fuel subsidies in the medium-term.