Explained | What are oil bonds and are they to blame for high fuel prices?

For instance, previously, if crude oil prices were high, oil refining and marketing companies would technically sell petrol and diesel at retail outlets at a loss. The government, however, compensated oil companies by issuing long-term bonds that they could redeem at a later date, typically ranging 15-20 years.

High crude prices and the blowback from the recession of 2008 increased the fiduciary pressure on the government. By raising capital through bonds, these payments could be made in a deferred manner without causing a major escalation in prices, thus insulating customers.

These bonds are, in essence, promissory notes of deferred payment of subsidies that the government owes to oil marketing companies. Since the government did not subsidise these companies upfront, these payouts did not show up in budget documents, until the repayment of the principal or interest components took place.

These ‘off-budget’ items, also sometimes described as under-recoveries of oil companies, therefore, did not show up in the fiscal deficit numbers disclosed during the annual budget. The fiscal deficit started factoring these only when the repayment of the principal and interest of these bonds started to take place, years after they were issued.

Moreover, oil bonds do not qualify as statutory liquidity ratio (SLR) securities, making them less liquid when compared to other government securities.

What are under-recoveries?
Under recoveries are revenues foregone by state-run refiners for selling fuel below cost. This is what kept diesel and petrol prices artificially in check.

Between 2005 and 2009, the government issued bonds worth Rs 1.4 lakh crore. This was done to partially compensate OMCs for recoveries amounting to Rs 2.9 lakh crore. Under-recoveries are the difference between the cost of purchasing crude oil in the international market and the price at which petroleum products are sold in the domestic market.
In the aftermath of the recession, OMCs were facing large under-recoveries. This presented the government with the dilemma of ensuring the financial stability of state-owned OMCS, while taking into account political repercussions of allowing fuel prices to rise. Oil bonds were chosen as the vehicle to dampen the pressure on OMCs while keeping prices in check.

When were oil prices deregulated?
The first step towards deregulation was taken in 2010 with the announcement that oil bonds will be discontinued, and OMCs will be paid in cash. In June 2010, petrol prices were deregulated, mirroring the market price of crude. The government freed up diesel prices in October 2014. Initially, prices changed on a fortnightly basis, based on the average global crude prices. In June 2017, India adopted the system of dynamic fuel pricing where the retail price of petrol and diesel fluctuate on a daily basis.

Why are oil bonds in the news now?
Finance Minister Nirmala Sitharaman said on August 16 that the Narendra Modi government is paying off dues to OMCs for oil bonds that the Manmohan Singh-led UPA government had issued.
Sitharaman said that as of 31 March, 2021, there was Rs 1.31 lakh crore in outstanding principal and Rs 37,340 crore in interest yet to be repaid on these oil bonds.

"We should have released a white paper in 2014 listing out all that we inherited from the previous government. Oil bonds were a big part of that. The previous govt had reduced prices but that burden had to be taken by the Oil Marketing Companies (OMCs) through these oil bonds," Sitharaman said at a media interaction, on being asked whether the Centre would follow Tamil Nadu's example and slash excise duty on fuel.

What are total outstanding payments on oil bonds?
The government has so far paid Rs 70,195.72 crore as interest on oil bonds in the last seven years. Of the Rs 1.34 lakh crore worth of oil bonds, Rs 3,500 crore principal has been paid and the remaining Rs 1.3 lakh crore is due for repayment until 2025-26.

Are oil bonds alone to be blamed for high fuel prices?
The Modi-led NDA government has blamed these oil bonds that are hitting payback time now for the Centre’s inability to cut taxes and enable cheaper petrol and diesel.

The government has to repay Rs 10,000 crore in the current fiscal year, another Rs 31,150 crore in 2023-24, Rs 52,860 crore in 2024-25, and Rs 36,913 crore in 2025-26.

On an accumulated basis this is still far less than what the government collects from central excise duties on petroleum products alone. For instance, in 2020-21 it collected Rs 3.71 lakh crore as central excise revenues from petroleum products, nearly three times of what it has to pay—Rs 1.34 lakh crore—over the next five years to square up the oil bonds.
In effect, repayment of oil bonds issued by the previous government alone is not the only reason why retail fuel prices are high. High crude prices and taxes are key reasons.

How are petroleum products taxed?
Taxes and duties account for nearly 60 percent of the price that the consumer pays at a petrol pump. The price of a litre of petrol includes: Base Price, Freight, Price charged to dealers (excluding Excise Duty and VAT), Central Excise Duty (including road cess), Dealer Commission, VAT (including VAT on Dealer Commission).

Successive governments, both at the Centre and states, have used petroleum products as milch cows. In 2020-21, the Centre earned Rs 3.71 lakh crore from central excise duty on petroleum products, which is about 20 percent of the Centre’s total gross tax revenues of Rs 19 lakh crore earned during the year.

Likewise, states earn significant revenues from taxing petroleum products. In 2020-21, all states put together earned Rs 2.02 lakh crore from state VAT on petroleum products.

The pattern is more or less similar across most states, illustrating how a disproportionately high amount of tax revenues are coming from just one set of products, both for the Centre and the states.

Has Covid-19 prompted higher taxes on fuel?
Yes. Last year, during the first wave, the Centre had raised duties on diesel by Rs 13 a litre and on petrol by Rs 10 litre. A government notification said the special excise duty on petrol was hiked by Rs 2 a litre to Rs 12 a litre and by Rs 5 a litre to Rs 9 a litre for diesel. Road cess on both petrol and diesel has also been increased by Rs 8 a litre to Rs 18 a litre.

What prompted such a move?
This was an attempt to raise revenues to help the government deal with the extraordinary economic situation in wake of the Covid-19 pandemic.

But petrol and diesel prices have gone up in many states. How?
Many states have increased the value added tax (VAT) to raise revenues to shore up their own revenues. On May 5, last year the Delhi government raised VAT on petrol and diesel to 30 percent from the existing 27 percent and 16.75 percent, respectively.

The Tamil Nadu government has raised VAT on petrol and diesel resulting in a price hike of Rs 3.25 a litre of petrol and Rs 2.50 a litre of diesel. Haryana has hiked VAT on petrol by Re 1 a litre and VAT on diesel by Rs 1.1 a litre last week.

Wasn’t there a cap on central excise duty on petrol and diesel?
Yes there was. In March 2020, however, the government had changed the rules through an amendment in the Finance Act of 2020 which raised the cap on special additional excise duty by Rs 8 a litre on both petrol and diesel, taking the cap to Rs 18 a litre on petrol and Rs 12 a litre on diesel. This allowed the Centre to raise duties on the two transport fuels.

Estimates suggest that a rupee’s hike in excise duty results in additional annual revenue of Rs 13,000-14,000 crore annually.