Friday, 13 January 2012

Why subsidies on Petroleum Products should be removed

We see folks all around us blaming the government for increasing the fuel prices. However, seen from a long term perspective, the government policy is quite reasonable. The government should remove all subsidies on fuel. Here are the reasons in support of this argument.

When the government subsidizes the prices of petroleum products, it creates a multitude of problems.
Suppose, for example the government imports a particular amount of fuel at say Rs. 100 and sells to consumers at say Rs. 95, the government is losing money in subsidies. This money can otherwise be used for more constructive purposes. Again suppose the price rises from Rs. 100 to Rs. 110, the government has to bear this extra burden as well. Private sector businesses such as Reliance and Essar cannot match these subsidized prices and as the magnitude of subsidy provided by government fuel companies increases, the private sector companies steadily lose market share and at a point just close the petrol pumps and wait for crude oil to fall back to reasonable levels. During this time all motorists lap up subsidized fuel from the government companies.

When the government is absorbing the fuel price shock, the motorcyclists and motorists do not have an incentive to reduce fuel wastage. Neither do automobile companies have incentive to develop more fuel efficient vehicles.

Normally, prices are influenced by demand and supply. If the Arab cartel arbitrarily raises prices and the demand drops because of affordability, the demand supply mismatch will again bring down the prices. But the subsidies do not allow the price shocks to reach the end consumer keeping the demand strong. So one of the causes of high fuel prices is the government subsidies.

The rising price of crude oil in turn attracts the hedge funds to buy and hoard crude oil as an investment further pushing up the prices.

More the money the Arab cartel makes money from crude oil, more money is available as venture capital for Islamic terrorism.

Given the subsidies, people have less incentive to use environmentally friendly means of transportation like bicycles and battery operated vehicles. Subsidized use of petroleum derived fuels helps in promoting environmental pollution.

The various components of crude oil are separated and refined through fractional distillation.
The cost of production of kerosene and diesel is almost the same with kerosene marginally cheaper. In free markets, where kerosene and diesel cost much the same, there is little incentive to substitute kerosene for diesel. But the government heavily subsidies kerosene which is sold in government ration shops for the benefit of the poorer sections of society at about one third of the open market price. This ensures that the profit margin for diverting kerosene to adulterating  diesel is around 200 percent. This also ensures that just a small quantity of the kerosene in ration shops goes to the poor people and the rest ends up in the open market or in adulterating other fuels.

Given such attractive operating profit margins and huge volumes, honest and competent officers like Yashwant Sonawane  and Manjunath  are murdered for interfering with India's oil adulteration mafia.
The adulteration mafia has the incentive and resources required to corrupt as many state functionaries as they deem necessary, and to eliminate those who refuse to take a cut.  

Clean energy initiatives like wind, solar and tidal have multiple benefits. They have the potential to reduce pollution. They will reduce our addiction to Arab oil and save a lot of foreign exchange. We will  have more energy security because we will be less dependent on the whims of the Arabs. However the clean energy initiatives are currently not economically very viable and this problem is further aggravated by subsidized oil.

People complain of taxes on oil but if other imported goods are taxes then why not crude oil?

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