Commodity Analysis

Fuel turbulence for aviation sector

Anand Kalyanaraman | Updated on June 15, 2018 Published on June 10, 2018

High taxes, pricing mechanism need a re-look

Effective May 30, aviation market leader IndiGo re-introduced fuel surcharge on domestic trips — ₹200 on routes shorter than 1,000 km and ₹400 on those farther than that. This move, the airline said, was to counter the sharp up-tick in the price of oil and aviation turbine fuel (ATF).

Steep cost rise

Indeed, ATF prices have shot up steeply over the past year or so with the pace accelerating in the past six months. At about ₹70,000 a kilolitre in Delhi (Indian Oil prices) now, the fuel is at a three-year high — about 50 per cent costlier than in July 2017 (about ₹47,000) and about 22 per cent expensive than at the beginning of 2018 (₹57,460). The rally has been driven by the sharp rise in global crude-oil prices over the past year and the weakness in the rupee since the beginning of 2018.

The high ATF price, along with the inability to fully pass on the cost increases arising because of steep competition, has been a huge drag on the financial performance of the country’s airlines.

With ATF cost continuing to rise since March, it’s no surprise that IndiGo finally decided to bite the bullet. Other airlines could also follow suit. Ergo, passengers should be prepared to pay more to fly.

GST pitch

Meanwhile, airlines and the Civil Aviation Ministry have made a renewed pitch to the Finance Ministry for the inclusion of ATF under the GST regime. Currently, five key petroleum products — crude oil, natural gas, petrol, diesel and ATF — are outside the GST ambit, and are subject to Central excise duty as well as States’ sales tax/VAT. If ATF is brought under GST, airlines hope the fuel cost will moderate, thanks to lower rates and also due to the benefit of input tax credit being fully available. Currently, tax credit benefit is available only on the value-added tax on the ATF.

Reports suggest that the GST Council, in its next meeting, will consider the request to transition ATF to the GST regime. But whether the proposal passes muster needs to be seen, primarily because, similar to petrol and diesel, there are big revenue implications for both the Centre and the States from changing the tax regime for ATF.

The governments, both at the Centre and States, treat petroleum products as cash cows, and impose heavy taxes. The 2016 Budget increased the excise duty on ATF from 8 per cent to 14 per cent. State taxes on the fuel vary widely, going up to even 40 per cent. Airlines have for long been demanding rationalisation of these taxes. But barring a few, States generally don’t oblige meaningfully, though they do some tinkering occasionally. The levy remains quite high in major consumption centres such as the major metros.

Effective tax rates on ATF currently could exceed 50 per cent in some States. Under the GST regime, the maximum rate is 28 per cent, and including cess, it will go up to 45-50 per cent. Accounting for the benefit of input tax credit, the effective rates under GST will be lower. It needs to be seen whether the Centre and States will agree to such loss in revenue.

The impact of sales tax is quite significant. Consider this. The cost of ATF in India for international airlines is much lower than that for domestic carriers, since the former pay in dollars and are not subject to sales tax. So, at $738 a kilolitre at Delhi, the rupee cost (at 67 to a dollar) of ATF for foreign carriers is about ₹49,450 — nearly 30 per cent less than what domestic carriers pay.

Flawed pricing mechanism

Airlines have earlier also complained, without avail, about the pricing mechanism of ATF, and the opacity surrounding it. ATF in India is not priced on a cost, plus margin basis. So the final price is not based on the cost of crude oil, plus the margins for refining it into ATF and then marketing it.

Instead, similar to many other petroleum products, ATF is priced based on the import parity mechanism. That is, it is priced as if it is imported into the country. So to the international price of ATF, notional costs such as freight, insurance and customs duty are added. Then come the marketing margins of the oil companies and taxes that add to the final price of the product.

This pricing mechanism has been criticised, and needs a re-look. India, while dependent on crude-oil imports, is an exporter of petroleum products including ATF, thanks to its huge refining capacity. The import parity pricing mechanism is meant to protect the margins of public-sector oil refiners — Indian Oil, HPCL and BPCL. It probably made some sense in the earlier days when the pricing of key fuels such as petrol and diesel was controlled, and the oil refiners suffered huge under-recoveries due to selling below the market price.

But with petrol and diesel pricing now decontrolled, there are no under-recoveries on that front. So continuing with import parity pricing to offer protection to PSU refiners no longer seems justified. There is a need to move to a pricing model that factors costs of refiners, plus margins. Refiners should be encouraged to price their products independently and transparently based on their cost structures, efficiencies and market principles. This will also help address the problem of near-same pricing by the three PSU oil marketing companies that leads to allegations of cartelisation.

Airlines also have a point when they label the ATF pricing “opaque”. That’s because unlike petrol, diesel, LPG and kerosene, where the final price build-up details are regularly published by the oil companies, it is not so the case with ATF. To sum up, lower taxes and a fair, transparent pricing mechanism could go a long way in lowering the costs for Indian carriers and fares for passengers.

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