Windfall tax on oil: medicine worse than disease

Windfall tax on oil: medicine worse than disease

With crude oil prices falling in the international market and decreasing a bit in India, anger against the government’s policy of keeping petrol and diesel prices high through excise duties has subsided. With that has gone the debate over imposing so-called windfall profit taxes on oil producing companies. But, for how long? Will it be considered again ahead of the Lok Sabha election in 2019 if oil prices start rising above $80 a barrel? 

When petrol price reached a historic high of Rs 78.43 in Delhi on May 29, the Modi government came under intense pressure to reduce prices not only from the opposition parties but also from the general public. It was not easy to find any support in the media — print or TV – for the government’s policy of not allowing the benefits of lower crude prices (which had fallen from above $100 per barrel during UPA rule to less than $30/b during BJP rule) to the consumers. The question often raised was, when petrol price was just Rs 50 per litre even when international crude price hit a high of $147/b under the Manmohan Singh government, how could the Modi government hold consumers to a price above Rs 75/litre when crude prices ranged between $75-80 a barrel. 

Under UPA rule, public sector oil marketing companies were forced to sell below cost and incurred a loss (called under-recoveries) of Rs 4.3 lakh crore between 2005-06 and 2014-15. But the NDA’s progressive policy of not interfering with fuel pricing (excepting during some assembly elections) and also increasing central excise tax rates has generated additional revenues of Rs 4.4 lakh crore during its four-year rule. But such an explanation of fiscal prudence has not convinced the public. 

Former finance minister P Chidambaram added fuel to fire by tweeting that Modi can cut petrol price by Rs 25 a litre. He did not elaborate how, knowing full well how oil marketing companies suffered under his government. 

It is under such intense pressure to reduce petrol and diesel prices that the Modi government floated a trial balloon to impose windfall profit taxes on oil companies, public and private. Any profit over $70 per barrel would be considered as windfall profits and taxed. It is not clear how the oil ministry has computed that at $70 per barrel, oil companies are able to generate adequate cashflow to support needed capital expenditure. No oil expert is likely to agree with such an assumption. 

Besides, such windfall tax will be in contravention of production or revenue-sharing agreements signed with the oil companies. In fact, the underlying philosophy of PSA or RSA was to share profit/revenue above a certain level with the government. When such is the case, it does not make sense to levy a separate windfall tax. Examples of the UK and the US were given to justify India imposing windfall tax. Neither of the examples is relevant in the Indian context. 

In 2011, the UK government imposed a Fair Fuel Stabiliser, which actually was windfall profit tax on the oil industry when oil prices were above $120 a barrel. As in India, it was to reduce petrol and diesel prices to the consumer by diverting revenues from oil producers to oil consumers.

The move was roundly criticised, even by some members of the cabinet. The oil industry warned that investment would suffer. Since the UK did not have contracts like PSAs to share profits when oil prices skyrocketed, the government could justify the windfall profit.

America experimented with profit tax in 1980. After the two oil shocks in 1973 and 1978, the US had controlled oil prices for domestic production. To decontrol the prices, the government was forced to accept profit tax. There was fear that oil prices would skyrocket and oil companies would earn excessive profits. Windfall taxes were meant to claw back the excess profits. The result was that oil production in the US fell and its oil dependency increased. Later, under the Reagan presidency, the windfall tax was eliminated. 

The recent US shale revolution, which has benefited India and the world by bringing down the oil price, happened mostly due to the liberalised pricing regime. Instead of India learning from the US experience, the government is looking to the UK example. If India does not want foreign investment to come to India, imposing this tax is a perfect formula. 

In this background, a statement made by a former petroleum secretary during a recent discussion on a TV news channel on unleashing India’s potential in oil and gas sounds prophetic. He said that under a democratic set-up like the one in India, investors should not expect sanctity of contracts and they should be able to work around it. I was one of the panellists and had earlier pointed out that unless the government can assure foreign investors complete sanctity of contract, it is not possible to attract much-needed investment. The proposed windfall taxes will surely override the terms of PSAs or RSAs and sanctity of contract will be violated.

Given the poor prospectivity of India’s sedimentary basins, uncertainty surrounding peak oil demand and finally the huge risk involved in exploration, any imposition of windfall tax would go against the government’s own efforts to attract badly needed foreign investment.

In recently held auction blocks under the new Hydrocarbon Exploration Licensing Policy, not one foreign oil company participated. Now, with the Damocles sword of windfall tax hanging over the oil industry, chances of any foreign investment in India’s exploration would be even lower. 

To avoid such fears on the part of investors, government should send a strong message that it is not considering imposing windfall taxes, now or in the future.