Comment: Windfall tax on oil production unlikely to bear fruit

Saudi Arabia, the second largest producer of crude oil to world, faced an attack on its oil infrastructure facilities on September 14, which caused a sharp increase in fuel prices. Do you know where petrol prices were the highest? Here's a list of the countries where petrol is the cheapest and most expensive. (Note: All price comparisons are on rupee terms only. Global rates as of September, 16 2019 - Image: Reuters)

Shishir AsthanaMoneycontrol Research

A commodity company goes through the periodic price cycles where it reaps profits when prices are high and struggles to keep its head above water when prices are down. The period when it is reaping higher profit helps it to create a war chest for its future for acquiring assets and conduct research and development activity to bring down its cost.

It is the higher profit during the up-cycle that ensures that the company is able to survive the down-cycle. Money accumulated during such periods is used to acquire weaker players during the down-cycle. That is how most successful commodity companies operate. Commodity companies that make reckless purchases during the up-cycle find it difficult to survive the down cycle. Tata Steel’s acquisition of Corus is a case in the point.

This simple business logic, however, seems to evade the government. Unable to find a solution to rising crude prices resulting in costlier petrol and diesel, the government is contemplating using its version of robbing Peter to pay Paul.

Reports say that the government may levy a windfall tax on oil producers, both public and private. The tax, which will be introduced as a cess, will be triggered when oil prices cross $70 per barrel. Oil producers are now getting paid international rates in dollar terms even when they produce oil from Indian fields.

Now the government is planning to take a chunk of its profits when oil prices cross the $70 mark. This is despite the fact that the government will be collecting the extra tax as profits of these companies go up when oil prices rise.

As the cost of production is same irrespective of oil prices, profits are higher when oil prices are higher and lower when prices are lower. Thus, higher profit means higher taxes for the government. Yet, the government wants to collect more from these companies.

However, by doing so it is thinking only of the short term. The idea is flawed in logic.

First India’s oil production is less than 20 percent of its consumption. ONGC’s production is less than 15 percent. Thus taxing these companies will have a limited impact on bringing the price of the final product down. For Rs 10 collected as windfall tax will bring down prices by only Rs 2.

Since most of the oil consumed by Indian refineries are imported, introducing windfall tax will not benefit the consumer but will hit the oil producing companies. It will act as a dampener for future investments in the oil and gas sector.

Though reports say that government is considering the windfall tax as a long-term solution, nothing can be further from the truth. The only long-term solutions are either to explore more oil or reduce its dependence.

The USA has shown the way by boosting the shale oil industry to come out from its dependence on oil. In India, the word shale oil brings the environmentalists out from the woods. The way left is to increase oil exploration and production for which it needs to incentivise oil exploration and production companies to invest more in search of more oil. Windfall tax does not look anything like an incentive.

Reducing dependence on oil is a long-term exercise which the world is still struggling to find.

The only way out for the government to reduce oil prices is to bring down taxes and ask the state governments to comply or bring petrol and diesel under GST.

A question for the decision makers, will they pay back the cess collected from oil producers when prices fall below say $30 a barrel, or will the government increase taxes to fill its coffers like it did in the past few years.