How India’s windfall tax could hurt oil companies but help the economy

The government slapped a levy on local crude sales this month, reducing some of the energy industry's gains from higher global prices

Reliance Industries, India’s biggest fuel exporter, controlled by billionaire Mukesh Ambani, is one of the companies to be affected by the latest taxes. Reuters
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There is little sign that India will ease new windfall taxes on domestic oil production and fuel exports any time soon.

As a result, oil companies will be significantly affected and there will be ripple effects in the global market, analysts say.

India's government this month slapped a 23,250 rupee ($293) per tonne levy on local crude oil sales, in addition to imposing increases on petrol, diesel and aviation fuel exports, to take away the massive gains that Indian companies have been reaping from the rally in global crude oil prices.

The steps are aimed at shoring up domestic supplies and government revenue, as the South Asian country tries to keep its fiscal deficit under control. India is the world’s third-biggest importer of oil, meeting 85 per cent of its requirements.

The windfall taxes “would hit the incomes, profits and profitability of some Indian companies”, says Manoranjan Sharma, chief economist at New Delhi-based Infomerics Ratings.

“This measure would adversely impact global fuel supply to a limited extent,” he adds, as fuel supplies around the world have already been squeezed by Russia’s war in Ukraine.

Companies affected by the taxes include Reliance Industries, India’s biggest fuel exporter, controlled by billionaire Mukesh Ambani, and state-run Oil and Natural Gas Corporation (ONGC), which produces crude domestically.

The impact has already been reflected in the companies’ share prices. Since the move came into effect on July 1, Reliance’s share price fell about 8 per cent to 2,391.40 rupees, while ONGC's stock price plunged 20 per cent to 121.50 rupees a share.

“The key downsides of these would be on the earnings of oil companies who earned premium in global markets on rising oil prices,” says Niraj Bora, founder and director of Pune-based Surmount Business Advisors.

“For the economy as a whole, I think this will be good to contain inflation. One might disagree that level playing fields are disrupted by the government imposing such duties. However, these are unusual times and my view is that the overall benefits outweigh the losses.

“This is certainly a net positive decision, while oil companies take a bullet for the public."

When India’s Finance Ministry announced the windfall taxes this month, it said such action was needed to ensure domestic supplies and ultimately keep prices in check for its population, as the country grapples with high inflation. Retail inflation stood at 7.04 per cent in May, above the central bank’s upper threshold of 6 per cent.

“The refiners export these products at globally prevailing prices, which are very high,” the ministry said. “As exports are becoming highly remunerative, it has been seen that certain refiners are drying out their pumps in the domestic market.”

The ministry raised export duties by 6 rupees per litre on petrol and 13 rupees per litre on diesel.

The government’s move is positive for the country, Mr Sharma says.

“Given the high price differential, it is no wonder that private refiners were increasingly taking the export route rather than doing local sales,” he says.

“These well-conceived measures would thus help to boost domestic supplies of petrol, check abnormal profits of a few firms, reduce sectoral arbitrage and the inherent asymmetry in the system.”

India’s introduction of windfall taxes is in line with steps being taken globally as oil prices have risen. In the nine months remaining of the current financial year, the measures could potentially raise 1.1 trillion rupees ($12.6bn), according to Japanese investment bank Nomura.

“The measures are positive for the centre’s fiscal finances,” says Sonal Varma, chief India economist at Nomura.

The government has set a fiscal deficit target of 6.4 per cent of the gross domestic product for the current financial year to the end of March, and the taxes aimed at avoiding exceeding this.

The Finance Ministry cut excise duty on petrol and diesel last month in an effort to cool prices in the domestic market, and new taxes will replace these losses in revenue to the government.

However, some analysts question whether the negative effects of the windfall export taxes on refiners will outweigh the potential benefits.

Analysts at Kotak Institutional Equities, Anil Sharma and Hemang Khanna, describe these duties as “irrational” and “ill-advised”.

“Even as India has been deficit in domestic crude production, the successive governments have incentivised setting up of refining capacity to make India a refining hub,” they explain in a research note.

Over the years, the refining industry had been given several tax incentives by central and state governments to boost output.

“Over the past two decades, this has led to India becoming a refining hub and an exporter of petroleum products. In our view, the imposition of taxes on exports of petroleum products goes against this historic policy of incentivising refining,” the Kotak report says.

The government has said it will review these taxes every two weeks but this provides little clarity on for how long they will be in place.

“The indefinite period of the new taxes on petroleum products will create large uncertainty about government revenues and companies’ earnings,” analysts at Kotak wrote in a separate note.

There are downsides to the move but the Indian government is currently grappling with several economic challenges, which it is looking to alleviate with the new duties.

These include the slide in the rupee, which has plunged to a series of record lows against the US dollar, fuelled by factors including the US Federal Reserve raising interest rates and the outflow of funds from Indian markets amid liquidity tightening globally. High crude oil prices are also stressing India’s current account deficit further.

Given that a wider current account deficit is linked to currency depreciation, the windfall taxes are aimed at stemming the rupee’s plunge, says Sugandha Sachdeva, vice president of commodity and currency research at Religare Broking.

“Apart from the active intervention strategy by the RBI [Reserve Bank of India] in the forex markets, these are further steps taken by the government through duty hikes to ease the pressure on the current account deficit and slow down the pace of currency decline,” she says.

India’s current account deficit widened to 1.2 per cent of the GDP in the financial year to the end of March 2022, compared with a surplus of 0.9 per cent in the previous year. Official data released this month showed that the trade deficit reached a record high of $25.63 billion last month, partly driven by oil imports.

This is certainly a net positive decision while oil companies take a bullet for the public
Niraj Bora, founder and director, Surmount Business Advisors

India’s demand for costly oil imports is increasing as the economy has opened up after easing of Covid restrictions.

With the windfall taxes, “as there has been a shortage of fuel supplies for almost a month, the administration has taken a huge step to meet the rising domestic fuel demand and ensure an ample supply of petroleum products”, says Ms Sachdeva.

“This will eventually decrease the import of oil at a time when oil prices are holding steady around multi-year highs, on the back of sanctions imposed by western countries on Russian oil.”

On July 4, Reuters reported that India would remove its windfall tax for oil producers and refiners only if crude prices drop by $40 a barrel, citing India’s Revenue Secretary Tarun Bajaj.

Other factors may come into play alongside international oil prices, including inflation and currency depreciation, in a decision to roll back the duties, says Infomerics Ratings’ Mr Sharma.

But as global turmoil continues, there is no certainty on when this might be.

“In the event of crude prices crashing because of a prolonged global slowdown, windfall gains will cease and there could conceivably be a rollback of these creative measures,” Mr Sharma says.

Updated: July 11, 2022, 1:42 PM