Inept Government, Bankrupt Nepal Oil Corporation and Distorted Fuel Market in Nepal

- by Ram C Acharya-

Again, we have seen the usual drama of the last few decades unfolding in Nepal: the government increases fuel prices, the students and political parties’ sister organizations protest, the prime minister meets with them and the increased prices are rolled back. By doing so both the government and the protestors have imposed numerous costs to the country: the continuous drainage of public resources to the bankrupt Nepal Oil Corporation (NOC). The government’s decision to hike prices is yet another testimony of its rent-seeking mentality that chooses to hit not where the problem is but where the politically weak and vulnerable people are. The protestors are also wrong in imposing the status quo, which is so detrimental to the economy. 

The NOC is a state owned enterprise (SOE)—a legal entity created by the government to import fuels on its behalf—and a monopolist—only it can import fuels. The economic rationale for having a trading monopolist would be if, as a single buyer in lieu of a country, it were able to negotiate better price with seller without imposing cost to the treasury. But NOC does that pass this test. More or less the fuel price is fixed by the producer cartels, with little room for buyers. Furthermore, as NOC has only one potential supplier and refiner—the Indian Oil Corporation— its bargaining power as a buyer is further weakened.

By harboring an inept monopolist, the government has imposed huge cost to the society. Last year, NOC had a loss of Rs 9.53 billion (Nine arab 53 crore) loss. This year, it is expected to lose Rs 21 billion,which with total of 5.42 million households, comes to about Rs 4,000 per household. And make note that NOC is a chronic loser and such loss happens every year. In the last ten years it was in loss for nine years with meagre profit for a year. This is not all; NOC has loan of Rs 41.2 billion to the government and the financial institutions, with Rs 7.1 billion as delinquent. No need to worry as government writes-off accumulated loss using tax revenue.

The recent drama of price hike is a ploy to deceive the public and bypass the real problems. Aggravating the already distorted fuel market, the government has raised the prices of the items that are notsubsidized and kept the price of the item that is heavily subsidized and constitutes 62% of NOC’s loss untouched. Among the six products that NOC sells, price of petrol is raised by 7.7% to Rs 140 per liter, of kerosene and diesel by 8.8% to Rs 109 per liter and of aviation fuel (domestic and international) by about 4%. The price of the sixth item, liquefied petroleum gas (LPG), at Rs 2,334 per cylinder, remained sacrosanct.

Even before the price hike, there was no subsidy for the four products—kerosene, petrol, and both types of aviation fuel—that saw the price increase. The subsidy was only for diesel and LPG. On average, the NOC’s selling price for unsubsidized four items was 9% higher than its landed price—Raxual price, plus government tax and NOC’s cost on administration, transport, insurance, including technical loss, and dealers’ commission—indicating profit. With increased prices, the selling price would be 17% higher than the landed price. For diesel, before, its price was subsidized by 9% and it will be subsidized by 4% after the price hike. For LPG, the selling price is lower than its landed price by 37%; a subsidy of 37% which has not changed.

From unsubsidized four items, the annual profit that was expected to be Rs 4.3 billion (at the old prices), would increase to Rs 7.6 billion at new prices. From subsidized diesel and LPG, the annual loss from subsidy that was expected to be Rs 25 billion (Rs 16 billion for LPG and Rs 9 billion for diesel) at old prices and would fall to Rs 20 billion, (Rs 16 billion for LPG and Rs 4 billion for diesel) at new prices.

The entire loss is caused by subsidy in two times that contribute more than two-thirds of NOC’s revenue—diesel (54%) and LPG (22%). The remaining unsubsidized items constitute small revenue shares, kerosene (1%), domestic aviation fuel (2%), foreign aviation fuel (4%) and petrol 16%. The ongoing saga of price hike and protests is about protecting the perks and privileges of those who are benefiting from the use of diesel and LPG, items whose consumption rises with income.

The case of LPG is even more notorious, which obtains Rs 16 billion as subsidy—more than 62% of NOC’s total subsidy. Who are benefitting from this subsidy? It is mainly urban dwellers, big business, and international chain hotels. According to population census 2011, only 21% household reported using LPG for cooking (although we don’t know how many of them were using LPG only), and 75% reported to have used either wood or cow dung. Thus LPG subsidy is limited to only those one in each five households and about half of those households are in three districts of capital, residential area of political party members and their students.

Assuming that one household needs about 8 cylinders per year, with per cylinder subsidy of Rs 865, (per household subsidy of Rs 7,000) the total subsidy to household would be Rs 8 billion, and the remaining Rs 8 billion subsidy is obtained by hotels and big business. Poor Nepalese, who cannot afford to have a bit of kerosene to light the lamps, are subsidizing the international hotels owners and foreigners. This needs to be stopped, but the present price hike is a fiasco that strengthens this perverse policy.

There are several problems in the way the NOC is established, operated and “rescued”. Besides costing public purse, it has created distortion in many aspects of the economy which demands urgent actions.

First, there are no economic rationales for having SOE—suppression of market activities—in fuel trading. Nepalese are paying higher price (let’s not be fooled, subsidy is paid by nobody else but the Nepalese) because of NOC’s inefficiency. The wrong policy of decorating a monopolist from public purse has done enormous damage. Dismantle the NOC; let the market compete.

Second, by subsidizing imports of fuel, Nepal has suppressed the incentives for harnessing other energy sources—hydro and solar—that it has hope of getting competitive edge. Subsidizing imports of products that is substitutable (competing products) to potential domestic products is like shooting on own foot. The subsidy—that favors owning transport vehicles over producing alternative energy—has distorted investment and needs to be scrapped.

Third, subsidizing diesel on the rationale that it would lower the price of food items by lowering the transport cost—as is heard in Nepalese media—is both illusive and wrong. We don’t know whether the subsidy has indeed lowered the costs of the farmers and the travellers or has just been absorbed by thick transport cartels. In any case, if the objective is to provide cheaper food items, the sensible policy is to subsidize directly to farmers for production of food not transportation.

Fourth, even if subsidy is chosen as a policy goal, it must be income-based not consumption-based. Provide a lump sum amount of subsidy (by combining all purposes into one) and let the households decide its use. This way it will not distort the consumption patterns by raising the demand for fuel items—causing immense environmental cost—as is the case now. The subsidy to fuel imports is one of the main culprits in changing crystal urban cities into environmental hazard.

 

Fifth, the trade performance of Nepal has been negatively affected—increasing the already ballooning trade deficit—by fuel policies. The fuel subsidy is like salt to the injury for a country whose total export value in 2102 was only 80% of the costs of fuel imports. Moreover, the induced increase in imports of motor vehicles and their parts caused by the suppressed price of diesel has further deteriorated the trade performance. Related to that by subsidizing fuel imports, Nepal is increasing the demand for fuel and its price in international markets, an unjust cost to many poor fuel-importing countries. If anything, the optimal policy is fuel import tax (lower international price) not import subsidy.

 

Sixth, because of large subsidy, the prices of diesel and LPG in Nepal are lower than in India and as a result one cannot rule out the occurrence of unrecorded illegal cross-border transaction, costing more to the Nepalese. For example, the retail price of LPG in Nepal is 20% lower than what NOC claims of what it pays at Raxaul. Add to that the fuel taxes in India (which is very high), the price difference between two countries is substantial.

 

The fuel subsidy is wrong on both aspects: it is inefficient and inequitable. It is inefficient because it distorts the investment and incentive against the products that Nepal has potential to have competitive edge and it siphons hard earned public money to unproductive purposes. The subsidy is inequitable as it favors those with higher energy consumption over subsistence farming and favors foreigners at the cost of citizens. Time has come to get rid of monopolist NOC which would help not only to create more efficient energy market but also reduce the rents that politicians and their cozy bureaucrats would grab—essential conditions for Nepal’s economic development.

 

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