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Prior to 2002, pricing of transport and domestic fuels were administered under the Administered Pricing Mechanism (APM). As a step towards free market pricing, the APM was dismantled on April 1, 2002. Further, increasing oil deficit and the need for attracting fresh investments necessitated the process of price deregulation. The key objectives of oil sector deregulation are 1) increasing competition in the industry by allowing entry of more players; 2) attracting private capital; and 3) removing constraints on economic pricing of products and services to enable the industry to earn a reasonable return on investment.

Currently, industrial fuels such as Aviation Turbine Fuel (ATF), kerosene (SKO), Motor Spirit (MS) remain un-administered; while prices of domestic LPG, Kerosene (Public Distribution System), petrol and diesel are administered.

International prices of global crude oil and petroleum products have been consistently rising, especially during the last three years. This steep increase in global oil prices and the resultant increase in under recoveries of oil companies and rising fiscal burden due to issuance of oil bonds necessitated the Government to increase the domestic prices of petrol, diesel & LPG twice within a span of five months. The Central Government decided to increase domestic fuel prices first in Feb 08 (February 14, 2008) and then subsequently in Jun 08 (June 4, 2008) when the prices of international crude oil crossed US$ 100 and US$ 130 per barrel mark, respectively. Prices of industrial fuels such as naphtha and bitumen, (which are not subsidised) also soared. These developments led the WPI inflation in fuel group to surge from 3.8% in Jan-08 to 16.3% in Jun-08. From Aug-08, global oil prices started receding and plunged to US$ 41.5 per barrel during Dec-08 from a peak of US$ 147.0 per barrel during Jul-08. With declining global oil prices, prices of imported minerals oils, particularly aviation turbine fuel (ATF), naphtha and furnace oil (which are not administered) also witnessed a substantial decline. Further, with the substantial fall in global crude oil prices and cut in prices of petrol & diesel by the Government during Dec-08, the fuel group inflation plummeted to a territory of deflation during Dec-08. Fuel group has been witnessing deflation since last ten months. Although fuel group continues to witness deflationary trends primarily due to the high base effect, the rate of decline in fuel group prices has witnessed considerable moderation since Jun-09. With a rise in global crude oil prices, inflation in fuel group turned positive, after a gap of almost 1 year to 4.3% during Dec-09.

In India, oil remains largely subsidised. The subsidy provided for PDS Kerosene and Domestic LPG is shared by the Government and the OMCs. This mechanism for sharing the loss was formulated by the Government in the financial year 2003-04.

Owing to the misalignment between domestic selling prices of oil and prevailing international crude prices, the Indian oil companies incurred huge under-recoveries to the tune of Rs 458.25 bn on a gross basis in PDS kerosene and domestic LPG and Rs. 574.67 bn in petrol and diesel in FY09. The gross under-recoveries of the PSU OMCs on the sale of sensitive petroleum products, i.e., Petrol, Diesel, PDS Kerosene and Domestic LPG in FY09 are estimated to be approximately Rs 1,032.9 bn. In order to reduce the losses suffered from marketing sensitive petroleum products by the OMCs in a manner that did not exacerbate the fiscal deficit, the Government resorted to issuance of oil bonds in lieu of subsidies. Special bonds amounting to Rs 5,904.0 mn (1.8% of GDP) were issued to oil marketing companies and fertilizer companies during FY09 to cover their under recoveries. Although these bonds are considered to be ‘off-budget’ or ‘extra-budgetary’, they would lead to considerable burden on the fiscal front and have long run implications.