Govt May Switch Over To An Ad Valorem Cess In The Forthcoming Budget

Domestic oil producers such as Oil and Natural Gas Corporation, Oil India and Cairn India have been hampered over profitability due to paying a higher cess at Rs 4,500 per tonne, when currently crude oil prices are dipping below USD 35 per barrel for the first time since 2004 due to oversupply of crude inventory; while other sectors continued to have concerns about the pace of growth of the world economy.

Market participation expects that the government may switch to an ad valorem cess in the forthcoming budget and it will bring relief to the industry without hurting the exchequer.

Let’s go over a flash back of 2005-06, when the crude oil prices had increased from an average of USD 40 per barrel to USD 60, the Oil Industry Development (OID) cess was raised from Rs 1,800 to Rs 2,500 per tonne effective March 1, 2006.

Again, In March 2012, when the crude prices climbed to over USD 100, the rate of cess increased to Rs 4,500 (USD 12 per barrel). Therefore, in the current situation the current cess rate constitutes about one-third of the oil price, which has severely impacted several small discoveries and marginal fields, making many of the projects unviable. (Seven barrels equal to one tonne).

Therefore in the month of October, Cairn and ONGC have written to the government for relief on levy of cess, citing the production sharing contract (PSC) for Rajasthan field, which is silent on such a levy and does not specify any rate. Cairn argues the levy was taking away nearly a fifth of revenue from the Rajasthan fields at a time when oil prices have almost halved.

They have approached the government for the cess pattern to be changed to ad valorem from fixed rate currently imposed which means that it will be formula-driven. They want to fix the levy at around 8-9 per cent of the crude oil price.

The change to ad-valorem cess rate will spur investments for additional oil from existing players, and will create a level playing field between pre-NELP and NELP participants. Right now under the New Exploration licensing Policy (NELP), akin to KG-D6 of Reliance Industries it is not levied on areas award.

Currently, the cess rate constitutes about 20 per cent of the Brent. If the government reduces the cess rate to 8 per cent then the above companies defiantly will save around USD 7 per barrel. In rupee terms they will benefit around Rs 2,700 per tonne.