Under-recovery

Under-recovery refers to the situation where the selling price of a product, particularly petroleum products, is lower than its cost of production or procurement. The difference between the actual cost incurred and the selling price realised is termed as under-recovery.
This concept is most commonly used in the context of India’s oil and energy sector, where government-controlled prices of fuel—such as petrol, diesel, kerosene, and LPG—are often kept below market-determined levels to shield consumers from high international prices. The resulting shortfall in revenue for oil marketing companies (OMCs) is referred to as under-recovery.

Meaning and Explanation

Under-recovery occurs when a company, especially a public sector undertaking, fails to recover the full cost of supplying a product or service due to regulated pricing policies or market distortions.
In India’s petroleum sector, the cost price includes factors such as:

• International crude oil prices,
• Refining costs,
• Transportation and distribution costs, and
• Taxes and dealer commissions.

When the retail selling price (RSP), as determined by the government, is less than this total cost, the oil company incurs an under-recovery equal to the difference.
Under-Recovery=Cost Price (per litre/kg)−Selling Price (per litre/kg)\text{Under-Recovery} = \text{Cost Price (per litre/kg)} – \text{Selling Price (per litre/kg)}Under-Recovery=Cost Price (per litre/kg)−Selling Price (per litre/kg)

Example

Suppose the cost of producing one litre of diesel (including import, refining, and distribution) is ₹100, but it is sold to consumers at ₹90 as per government regulation.
Under-Recovery per litre=₹100−₹90=₹10\text{Under-Recovery per litre} = ₹100 – ₹90 = ₹10Under-Recovery per litre=₹100−₹90=₹10
If 10 million litres are sold, the total under-recovery would be ₹100 million (₹10 crore).
This loss, although not termed a subsidy in accounting terms, functions like one, as the company does not receive full compensation for its costs.

Causes of Under-Recovery

1. Price Regulation:
   • Government intervention in pricing essential commodities to control inflation and protect consumers.
2. Global Oil Price Volatility:
   • When crude oil prices rise in international markets and domestic retail prices are not adjusted accordingly.
3. Exchange Rate Fluctuations:
   • A depreciating rupee increases the import cost of crude oil.
4. High Taxes and Duties:
   • Taxes on petroleum products can further widen the gap between market prices and consumer prices.
5. Subsidy Policies:
   • The government’s decision to keep prices artificially low for social or political reasons leads to revenue loss for producers.

Impact of Under-Recovery

1. On Oil Marketing Companies (OMCs):
   • Reduces profitability and financial strength of public sector oil companies such as Indian Oil Corporation (IOC), Bharat Petroleum Corporation Limited (BPCL), and Hindustan Petroleum Corporation Limited (HPCL).
2. On Government Finances:
   • The government often compensates these companies partially or fully through subsidies, increasing the fiscal burden.
3. On Consumers:
   • Helps maintain stable prices in the short term but may lead to supply distortions and inefficiencies in the long run.
4. On Economy:
   • Leads to fiscal deficits, delayed payments, and distortion of market signals, affecting investment in the energy sector.
5. On Investment Climate:
   • Reduces investor confidence in the sector due to unpredictable pricing and subsidy structures.

Methods of Compensation

The government and oil companies have used various mechanisms to manage under-recoveries:

1. Budgetary Subsidies:
   • The government provides direct financial support to compensate for part of the revenue loss.
2. Oil Bonds:
   • The government issues special bonds to oil companies in lieu of cash subsidies, which can be redeemed later.
3. Price Decontrol:
   • Gradual deregulation of petroleum product prices to allow market-based pricing. For example, petrol and diesel prices were deregulated in 2010 and 2014 respectively.
4. Cross-Subsidisation:
   • Profits from certain petroleum products (like petrol) are used to offset losses on others (like LPG and kerosene).
5. Cost Reduction Measures:
   • Improved refinery efficiency and supply chain management to minimise overall cost.

Historical Context in India

Under-recoveries have been a recurring issue in India’s petroleum sector:

• During periods of high global crude prices (e.g., 2008 and 2012–13), under-recoveries surged dramatically, burdening both OMCs and the central exchequer.
• In 2012–13, total under-recoveries for diesel, LPG, and kerosene were estimated at over ₹1.6 lakh crore.
• Post deregulation, under-recoveries have reduced significantly, although they still persist in subsidised products like domestic LPG and Public Distribution System (PDS) kerosene.

Current Scenario

• With the deregulation of petrol and diesel, prices are now linked to international market movements and reviewed regularly by OMCs.
• However, domestic LPG and kerosene remain partly controlled, and OMCs continue to experience under-recoveries that are compensated by government subsidies or budgetary transfers.
• Global crude price volatility, rupee depreciation, and taxation changes continue to influence the extent of under-recoveries.

Economic Implications

1. Fiscal Burden:
   • High under-recoveries increase government expenditure, contributing to fiscal deficit.
2. Inflation Control:
   • Regulated fuel prices temporarily control inflation but delay necessary price adjustments.
3. Resource Misallocation:
   • Encourages over-consumption of subsidised fuels and reduces incentives for energy efficiency.
4. Environmental Impact:
   • Artificially low fuel prices discourage the shift towards cleaner and renewable energy sources.
5. Market Distortion:
   • Creates uncertainty in pricing and affects competitiveness within the petroleum sector.

Measures to Reduce Under-Recoveries

• Complete Deregulation: Moving towards full market-based pricing for all petroleum products.
• Direct Benefit Transfer (DBT): Providing subsidies directly to beneficiaries instead of distorting retail prices (as implemented in LPG through PAHAL scheme).
• Diversification of Energy Sources: Promoting renewable energy to reduce dependence on imported crude.
• Rationalisation of Taxes: Harmonising central and state taxes on petroleum products.
• Efficiency Improvements: Enhancing refining and distribution efficiency to lower costs.

Conclusion

Under-recovery is a significant concept in India’s fuel pricing and fiscal management framework. It reflects the financial loss faced by oil marketing companies due to government-controlled fuel prices. While under-recoveries have historically protected consumers from global price shocks, they have also strained government finances and discouraged efficiency in the energy sector.