Finance - Fuelling High

The largest constituent of an airline’s operating costs is incurred on ATF. Although this statement is universally applicable across the globe, in India, its impact is even more impairing in as much as the cost of ATF here is more than 50 per cent higher than the global average.

At the end of 2011, the trials and tribulations of Kingfisher Airlines reached its zenith. In an interview with CNN-IBN, Vijay Mallya blamed the state governments for the aviation crisis, saying, “I am a strong advocate for the rationalisation of state sales tax on fuel because I don’t think states should be making windfall profits as international crude oil prices rise.” A fair and balanced appraisal of the situation would undoubtedly throw up many other factors contributing to the current pitiable state of not just Kingfisher but all the Indian carriers. For the last five years, airlines have been projecting their wish-list at every possible opportunity to a largely unreceptive establishment with India’s general aviation sector also joining the chorus of protests. A common thread has been the constant refrain about the high user-end cost of aviation fuel in India.

Operating Costs of Airlines

The largest constituent of an airline’s operating costs is incurred on aviation turbine fuel (ATF). Although this statement is universally applicable across the globe, in India, its impact is even more impairing as the cost of ATF here is more than 50 per cent higher than the global average. Consequently, while globally, ATF constitutes 30 per cent of operating costs, in India it is 45 per cent. Until 2001, ATF prices in India were regulated through a government-imposed cross-subsidy, which for socio-economic reasons subsidised kerosene and diesel, resulting in higher price for ATF. In April 2001, the Administered Price Mechanism (APM) was set aside and oil companies were accorded the freedom to price ATF based on the price of crude in the international market and actual input costs. ATF prices in India since 2001 have thus fluctuated wildly; retail jet fuel prices rising over 81 per cent between August 2007 and August 2008. Understandably, airlines increased passenger fares affecting growth in traffic and impinging on passenger satisfaction. The only consistency ATF prices have demonstrated is in the fact that they have continued to be much higher than prices prevailing worldwide. Indirectly, cross subsidies still continue to afflict the price of ATF.

Dilemma before the States

Even though the APM has been dismantled, the government de facto controls ATF prices. The related infrastructure, hydrants and bulk storage facilities are largely owned by the three government-owned companies, Indian Oil Corporation, Hindustan Petroleum Corporation Limited and Bharat Petroleum. The ‘common carrier’ principle is largely not applicable to infrastructure facilities although Reliance has been permitted to supply ATF and is doing so at some stations in a limited manner. In response to the growing demand by airlines, especially in the recent past, the government has permitted import of ATF directly by airlines. However, as only limited private infrastructure exists to handle imported ATF, it may be some time before this concession actually impacts airlines. Government-owned oil companies, which control most of the infrastructure currently, are unlikely to cooperate with end users in distributing directly imported oil. And if they do, it will be at high cost, defeating the very purpose of the exercise. States are also not very happy about this and are contemplating a “state entry tax” on the directly imported fuel to compensate for loss of revenue. The avarice on the part of the states is not understandable as the total sales tax collection in respect of ATF is a small percentage, estimated to be one and a half to two per cent of the total levy. A drop in the sales tax to four per cent, as applicable to ‘declared goods’ would not make a big dent in the finances of the state. In fact, the larger volume of air traffic generated by a lower tax regime would adequately compensate for any loss of revenue. Of course, compliance with the industry-wide demand for listing ATF as a “declared goods” will resolve the issue altogether and pacify the industry.

Pricing of ATF

The three government-owned oil companies, which compete with each other, have varying input, establishment, marketing and refining costs. However, the ATF prices charged by all the three are higher than the global average and in effect, are cartelised. All the three import crude oil, refine and sell ATF to the end user. The import duty on crude is half than ATF. Oil companies, however, follow the “import parity principle” which adds shipping costs and insurance to the internationally traded price of ATF. However, Indian oil companies do not import ATF but only crude. Shipping costs and insurance, which they don’t actually incur but are added on to the final base price, help them make huge profits. The base price of ATF, the price at the refinery gate without the taxes and margins, is only marginally higher, about 10 per cent than the base price in Malaysia or Singapore. However, to this already unreasonable pricing is added the Central excise duty levied by the government which is to the tune of eight per cent. The icing on the cake is the sales tax levied by individual states, the rate varying from four to 33 per cent. Under the ongoing tax reforms, sales tax is being replaced in the states by value added tax (VAT). However, as VAT is yet to be universally adopted, the term ‘sales tax’ is used here.

The average sales tax in India on ATF at 24 per cent is the second highest in the world, second only to 27 per cent in Bangladesh. These two taxes hike up the final selling price nearly 50 per cent from the base price. Indeed, if taxes and duties are added, the retail price of ATF in Delhi and Mumbai, India’s largest aviation hubs is around 60 per cent more than the base price. In comparison, the final prices in Singapore, Malaysia and Dubai are only five per cent higher than the base price. So, is the high price of ATF going to come down in the future? The only way that could happen is if the prices of kerosene and LPG are also liberated from subsidies.