8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 19Electronic copy available at httpssrncomabstract=2047018

Kerosene subsidies in India When energy policy fails as social policy

Narasimha D Rao

International Institute for Applied Systems Analysis (IIASA) Schlossplatz 1 A2361 Laxenburg Austria

a b s t r a c ta r t i c l e i n f o

Article history

Received 8 August 2011

Revised 23 December 2011

Accepted 23 December 2011

Available online 26 January 2012

Keywords

Kerosene

Developing countries

Climate change mitigation

India

Energy subsidies

Distributional impacts

Kerosene subsidies intended for Indian households have been known for their poor targeting and high 1047297scal

costs However the distributional bene1047297ts to the 160 million households that use kerosene are not well un-

derstood In this paper the kerosene subsidy is formally assessed as an instrument of income redistribution

The subsidy incidence progressivity and ef 1047297

cacy of the kerosene subsidy are calculated for the state of Ma-harashtra under actual and ideal implementation conditions

The analysis shows that kerosene subsidies are regressive and of minimal 1047297nancial value to poor rural house-

holds This is in part because household quotas are based on cooking needs but kerosene is used predomi-

nantly for lighting In urban areas subsidies are progressive and provide bene1047297ts of up to 5 to 10 of

household expenditure among poorer households which lack affordable access to LPG and biomass Overall

only 26 of the total subsidy value directly reaches households This analysis suggests that subsidies targeted

only to kerosene-dependent urban areas would have a higher ef 1047297cacy than broad-based subsidies

copy 2012 International Energy Initiative Published by Elsevier Inc All rights reserved

Introduction

Energy consumption subsidies have attracted renewed attentionwith the urgency of climate change (UNEP 2008) Globally annual

consumption subsidies for electricity and fossil fuels outside the

OECD were estimated at about a quarter trillion dollars in 2005 or

07 of world GDP (IEA 2007) These subsidies are often justi1047297ed as

instruments of redistribution in many developing countries in part

because of the lack of broad-based institutions that enable direct

cash transfers (Piketty and Qian 2009) However these subsidies in

many developing countries incur high costs encourage wasteful con-

sumption and increase greenhouse gas emissions without necessarily

providing intended bene1047297ts to the poor The International Energy

Agency (IEA) estimates that the cost to economic growth from con-

sumption subsidies in just the eight largest non-OECD countries is

257 billion dollars (IEA 1999) Among household cooking fuels

while LPG subsidies typically bene1047297

t higher income households thedistribution of bene1047297ts from kerosene subsidies are more ambiguous

(Heltberg et al 2003) This is part due to kerosenes usage among

urban low-income groups such as in India Nepal Vietnam and

South Africa

According to the IEA India is among the highest of the non-OECD

subsidizers of energy consumption with subsidies of over $10 billion

peryear despite undertaking price reform of fossil fuels in the last de-

cade With the recent run-up in world crude oil prices since 2005 the

cost of subsidiesmorethan doubled (Shenoy 2010) Kerosene usealso

accounted for over 28 million tons of CO2 emissions in 2004ndash051 or

over 2 of the countrys CO2 emissions A number of expert commit-

tees commissioned by the Indian government in the past have recom-mended phasing out the kerosene subsidies and replacing them with

alternative subsidy mechanisms (Chaturvedi 2008 Parikh 2010)

Government reports show that kerosenes use as a primary fuel for

lighting and cooking has been on the decline However these assess-

ments neglect the widespread use of kerosene as a supplementary

fuel for both lighting and cooking Considering all uses the potential

removal of kerosene subsidies could affect over 160 million Indian

households (or 800 million people) In rural areas kerosene is mostly

used for lighting while in urban areas cooking is the predominant

use About 350 million people (in 74 million households) who lack

electricity access use kerosene for lighting but millions of others in

both rural and urban areas with electricity access use kerosene for

lighting during power outages which are frequent and chronic Sim-

ilarly although about 19 million rural households (~12) and 58million urban households (~102) use kerosene as their primary

cooking fuel another 28 million households in rural areas and 55

million urban households likely use kerosene as a supplementary

fuel for cooking andor water heating2 In total cooking use may

Energy for Sustainable Development 16 (2012) 35ndash43

E-mail address nraoiiasaacat

1 Assuming emissions of 25 kg CO2l from 11 billion l of annual consumption in

2004ndash05 (Indiastatcom)2 Cooking use is estimated based on the assumption that households use no more

than 4 liters per month for lighting Two sources make this a reasonable upper bound

An average kerosene lantern (~37 lumens) used for 4 hours a day would not consume

more than 3 liters per month In India lanterns vary from 12 to 80 lumens Second

households in all income deciles without electricity access consumed 275ndash39 l per

month on average as per the National Sample Survey of India 2004ndash05

0973-0826$ ndash see front matter copy 2012 International Energy Initiative Published by Elsevier Inc All rights reserved

doi101016jesd201112007

Contents lists available at SciVerse ScienceDirect

Energy for Sustainable Development

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 29Electronic copy available at httpssrncomabstract=2047018

have contributed 23 of the 72 billion l of kerosene consumed in

Indian households in 2004ndash05 which amounts to about 15 of total

consumption in rural areas and 44 of kerosene consumption in

urban areas

Subsidized kerosene is distributed across the country through the

Public Distribution System (PDS) which consists of over 460000 pri-

vate licensed retailers who sell subsidized grains and kerosene In

contrast with LPG and subsidized grains which are sold in ldquodualrdquo

markets ndash

one subsidized and the other an open market ndash

keroseneis sold only through the PDS (ldquoPDS kerosenerdquo) However PDS kero-

sene is leaked to black markets through well-established channels

in the distribution chain where it is sold to households at higher

prices or as an adulterant to automotive fuels In Maharashtra the

site of this study these distribution channels are often controlled by

organized crime syndicates3

The Kirit Parikh expert committee recommendation to reduce

kerosene subsidies is justi1047297ed in part from their 1047297nding that the in-

come shocks on poor households on average would be fairly small

(Parikh 2010) Their recommendation rests largely on the premise

that kerosene is used primarily for lighting in rural areas However

these averages mask the distribution of bene1047297ts particularly to the

41 million households who cook with kerosene and therefore use

larger quantities Though kerosene subsidies in India are known to

be poorly targeted due to these diversions their distributional bene-

1047297ts are not well understood (Gangopadyaya et al 2005 Morris

et al 2006)

In this paper I formally examine the performance of the kerosene

subsidy as an instrument of redistribution using several measures I

evaluate the subsidys materiality (how does the energy budget

change with its removal) and its progressivity (do poor households

bene1047297t more than the average household) For purposes of compari-

son with other redistributive policies I assess ef 1047297cacy (what share

of the total subsidy value goes to poor households not counting

indirect impacts4) Among the novelties of this study is that I explore

the distinction between implementation failures and design limita-

tions and evaluate the subsidy bene1047297ts under ideal implementation

conditions This is also the 1047297rst use of ef 1047297cacy metric in terms of

subsidy value rather than quantity This study highlights an underem-phasized feature of kerosenes use as a cooking fuel in urban areas

The study does not consider recycling of government revenues from

removing subsidies that may offset the income shocks such as

through other redistributive schemes (eg food stamps) Thus the

absolute impact on energy budgets may be considered an upper

bound The focus of this study is the relative impacts on different

types of households

Previous literature

As mentioned several studies examine the macroeconomic costs

of energy subsidies in developing countries On the bene1047297t side the

World Bank 1047297nds that in general quantity-based utility subsidies

tend to be regressive because their use increases with income(Komives et al 2005) However this principle does not apply to ker-

osene whose use does not correlate well with income particularly

when considering its use for cooking This makes its distributional

bene1047297ts more dif 1047297cult to predict Many case studies in various devel-

oping countries examine the income bene1047297ts or the progressivity of

household fuel subsidies (Dube 2003 Gangopadyaya et al 2005

Hosier and Kipondya 1993 Kebede 2006 Komives et al 2005

Morris et al 2006 Olivia and John 2008 Pitt 1985) Among these

studies that examine kerosene generally 1047297nd that kerosene subsidies

provide income bene1047297ts to the poor and that kerosene use tends to

1047297rst increase and then decrease with income

The high 1047297scal and environmental costs of household fuel subsi-

dies in India have been well documented in the above cited studies

Economists estimate that kerosene subsidies in particular cost

the government $4ndash6 billion per year and carry ef 1047297ciency losses5 of

$1ndash2 billion per year (IEA 1999 Morris et al 2006) It is well

known that suppliers and distributors divert 40ndash66 of kerosene allo-

cated for states to other lucrative markets such as transportation

6

forcing some households to purchase kerosene in the black market

(NCAER 2005 Shelar et al 2007) But the 1047297nancial impacts of

the subsidies that do reach households are not formally estimated

One study of fuel taxation in India 1047297nds that the direct income bene-

1047297ts from household kerosene use are progressive (Datta 2010) How-

ever the study offers limited detail on underlying regional differences

and causes Further progressivity alone may not justify public spend-

ing on kerosene subsidies Subsidies may be regressive but still

provide substantial income relief to the poor Conversely even if ker-

osene subsidies are progressive other less progressive redistributive

policies may have higher impacts on poverty and cost less to deliver

The ef 1047297cacy measure used in this study provides a metric for such a

comparison across policies

Many studies illustrate the inappropriateness of encouraging ker-

osene use for lighting but no study critiques the subsidy for cooking

use Many studies have pointed out that kerosene lamps are the

most expensive and inef 1047297cient form of lighting (Dutt and Mills

1994 Mahapatra et al 2009 Reddy 1981) Rehman Malhotra et al

(2005) have pointed out that rural kerosene quotas are based on

cooking but used only for lighting However subsidy quotas may be

better suited to urban kerosene use for cooking In this study I assess

the contribution of design and implementation failures to targeting

ef 1047297cacy of kerosene subsidies in urban and rural areas

This study relies on data from the National Sample Survey of India

for Consumption Expenditure 2004ndash05 (NSSO0405) and draws qual-

itative insights from a primary survey I had conducted of 450 house-

holds in urban and peri-urban parts of Maharashtra in 20092010

(ldquoprimary surveyrdquo)

In Section 2 I describe the various uses for kerosene in differenthousehold in Maharashtra and how these functions in1047298uence the

subsidys relative bene1047297ts In Section 3 I discuss the measurement

approach and the results of the subsidy performance analysis In

Section 4 I discuss the subsidy performance under ideal implemen-

tation conditions I close with some policy recommendations in

Section 5

Kerosene market and use characteristics in Maharashtra

In Maharashtra 70 of households (68 million people) use

kerosene Of these about 50 million users are in rural areas (91 of

the rural population) and 18 million are in urban areas (49 of the

urban population)Urban use of kerosene is higher in Maharashtra than in the rest of

the country and even more so in the vast slums of metropolitan

Mumbai (Fig 1) The average kerosene consumption among house-

holds earning less than Rs 4000 per month (or $250 PPP) in urban

Mumbai was over 10 l per month As a result though 26 of kerosene

users in Maharashtra are in urban areas they consume 45 of total

household kerosene use in the state

3 See lsquoMaharashtra Cracks Down on Oil Ma1047297arsquo Hindu Business Line January 28 20114 Kerosene that is diverted to automobile and other markets have income distribu-

tional impacts as well such as the rents earned by middlemen or the marginal pro1047297ts

earned by bene1047297ciaries of adulterated fuel Data on these diversions are unavailable

5 Ef 1047297ciency losses refer to reduced aggregate income from the misallocation of in-

vestments in response to price signals that do not re 1047298ect actual costs In economic jar-

gon this is calculated as the lsquodead weight lossesrsquo that result from pricing below

marginal cost6 In transportation kerosene is used to adulterate gasoline and diesel In construc-

tion kerosene is used in making tar for paving roads

36 ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 39

Kerosene is used widely across income groups This is in contrast

to LPG which is a preferred cooking fuel and whose use correlates

well with income as shown in Fig 2 One reason for this is that

kerosene is often used as a backup cooking fuel to LPG and biomass

to meet gaps in supply availability which does not necessarily

depend on income

Two underemphasizedcharacteristics of kerosene use in households

are important in understanding the bene1047297t incidence of subsidies

actual kerosene market prices and kerosenes use as a cooking fuel

These are discussed next along with how they affect subsidy bene1047297ts

Kerosene markets

Households are supposed to purchase all their household kero-

sene needs through the Public Distribution System (PDS) To use the

PDS households register their household characteristics on ration

cards which indicate various eligibility criteria on the basis of

which each households quota is calculated and in turn each ration

shops aggregate quota is calculated based on the households allotted

to each shop However households in Maharashtra purchase over

40 and in urban areas over 50 of their consumption from second-

ary (black) markets (Table 1)For kerosene unlike other subsidized products householdsrsquo quotas

are de1047297ned based on their assumed reliance on kerosene for cooking

and not on their poverty status7 Lighting needs are not included in

the design of the quota The quota criteria include two household

characteristics the number of LPG cylinders8 and household size

(See Appendix A) Households with two cylinders are not entitled to

kerosene Households with one cylinder are entitled to 4 l per month

The quota of households without any LPG cylinders increases with

family size up to a maximum of 15 l for most areas or 24 l in particular

urban areas Both criteria however weakly correlate to income Lower

income households tend to have fewer LPG cylinders and larger fami-

lies Thus in principle the kerosene subsidy does have the potential to

serve as a redistributive instrument but an imperfect one

About 130 million l were allocated on a monthly basis to rationshops in 2004ndash05 of which about 129 million l on average were

claimed for distribution9 A bottom-up aggregation of household

quotas from NSSO0405 indicates that 118 million l ought to have

been allocated The discrepancy may re1047298ect a margin of error from

using a sample survey to determine householdsrsquo eligibility criteria10

and the likely mismatch between households actual and recorded

eligibility Regardless as mentioned earlier a large share of this allo-cation is diverted upstream to third parties who sell kerosene to other

markets and to households in the black market As a result based on

an aggregation of the sample in NSSO0405 only 40 million l of the

118 million l of subsidized kerosene were purchased by households

through the PDS and only 68 million l consumed by households

Notably in rural areas the quota (80 million l) is more than double

actual consumption including black market purchases (37 million l)

This mismatch between the quota and actual demand encourages

kerosenes diversion to other markets

While this quantity diversion is well understood the prices in

these markets have not been analyzed in literature The market prices

for kerosene vary widely but on average are double that of PDS ker-

osene These prices are the lowest alternate price most households

would face should kerosene subsidies be lifted11

More importantlythe PDS kerosene price that households actually pay also varies

widely but only to a minority of households (Fig 3)

About 56 million people in Maharashtra (13 of PDS kerosene

users) bought PDS kerosene at above Rs 12l (higher than the highest

intended price including transport and pro1047297t) in 2004ndash05 In many

districts prices are as much as double the wholesale rate

Fig 1 Variation in urban household kerosene use mdash Mumbai Maharashtra and India

2004ndash05

a) Rural

b) Urban

Source National Sample Survey of Consumption Expenditure 2004-05

Note Kerosene use below 4 liters is assumed to be for lighting

Fig 2 Cooking fuel shares by income decile mdash Maharashtra 2004ndash05

7 Ration cards are issued to citizens of India which delineate broad categories of an-

nual income for households yellow (bRs 15000 below poverty line) saffron (Rs

15000-Rs 100000) and white (gtRs 100000) Food subsidy quotas are allocated based

on these categories8 Households purchase LPG in cylinders that typically contain 142 kg of LPG House-

holds pay a deposit to get a cylinder then subsequently buy re1047297lls by swapping out

empty cylinders for full ones Households face delays in receiving re1047297lls Thus house-

holds that can afford two cylinders have a reliable supply9

lsquoState-wise Superior Kerosene Oil (SKO) Allocated under Public Distribution Sys-

tem (PDS) in India mdash 2004ndash5 to 2007ndash8 and lsquoState-wise Superior Kerosene Oil (SKO)

Uplifted under Public Distribution System (PDS) in India mdash 2004ndash5 to 2007ndash8 IndiaS-

tatcom These allocations and claimed 1047297gures have remained fairly constant in the

time period covered by the data source

10 See Appendix A for how the household quota was inferred from sample survey

data11 Theoretically one would expect that black market prices would be set by the prices

of fuels that they substitute in other markets namely diesel In reality black market

prices are lower and vary by region due to market imperfections Data on black mar-

ket prices are available in NSSO0405 in household surveys as the price of lsquootherrsquo kero-

sene purchases made outside the PDS

37ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 49

Kerosene as Primary Cooking Fuel in Urban Households

A neglected fact in subsidy analysis is that many urban households

rely exclusively on kerosene as a cooking fuel In Maharashtra about

12 of urban households (1 million households 45 million people)

fall into this category In my primary survey 33 (of 450) households

all slum dwellers who did not have access to wood and who stated

they could not afford LPG cooked exclusively with kerosene These

circumstances may be commonplace among the urban poor across

India particularly in large metropolitan areas

These households on average use more kerosene than all keroseneusers and therefore stand to bene1047297t the most from kerosene subsidies

Kerosene use as secondary cooking fuel

Even though the vast majority of rural households do use kerosene

primarily for lighting kerosene use as a secondary cooking fuel is

widespread (See Table 2)

In urban Maharashtra 10 million out of 18 million kerosene users

use it as a secondary cooking fuel As mentioned Maharashtras house-

hold quota allocation scheme is indeed based on household cooking

needs This group of households not only would consume more

kerosene than lighting users but a subset of them might also pay a dif-

ferent replacement price in the absence of subsidies namely LPG prices

The distribution across income groups of kerosene use as a

cooking fuel also varies between urban and rural areas (Fig 4)

These patterns are explained by their relative reliance on LPG

which is more closely tied to kerosene usage In rural areas kerosene

use increases with income since LPG use increases with income

Among poorer households kerosene is used as a backup to wood

albeit to a lesser extent when wood is unavailable (such as during

monsoon) or too expensive (where purchased)

In contrast in urban areas such secondary use is highest among

lower and middle income groups but then decreases with income

at the highest income levels as more households have two LPG cylin-ders or piped gas supply

Drivers of kerosene use as a secondary cooking fuel

An important feature of kerosenes secondary use is that it is driven

not only by unreliable supply of households rsquo primary fuel but also by

the desire to save fuel costs Households for which kerosene is cheaper

than LPG on a useful energy basis (ldquoEconomy Usersrdquo) use kerosene re-

gardless of LPG availability12 Based on a heuristic to identify Economy

Users (discussed in Section 3) there are about 4 million such users in

Maharashtra One indication of this phenomenon is that a large number

of households use different fuels for cooking and for water heating re-

gardless of their supply conditions13 For example in the primary sur-

vey 60 of all households and almost all low-income households usedifferent fuels for cooking and water heating respectively regardless

of their primary fuel Many low-income urban households particularly

in Mumbai use LPG for cooking and kerosene for water heating

The importance of the distinction between Economy Users and those

using kerosene due to insuf 1047297cient LPG supply (ldquoLast Resort Usersrdquo) is

that the former bene1047297t less from subsidies since they can switch back

to LPG if cooking with kerosene becomes more expensive14 Note that

some low-income households who use kerosene because they would

otherwisepay more forusing wood may switch back to wood if kerosene

subsidies are removed However in Maharashtra this group was found

to be negligibly small and was therefore omitted from the analysis15

It would seem that the margin of subsidy bene1047297ts for Economy

Users is small For these households the economics of cooking with

LPG and kerosene depend on their relative energy (rather than lifecycle) costs since these households already own an LPG range and

kerosene stove (Fig 5) A rough calculation of the energy used for

heating bath water shows that the total savings from using subsidized

kerosene in comparison to subsidized LPG may be up to Rs 30 per

a) Subsidy Prices

b) Black Market Prices

Source National Sample Survey 2004-05 Sales prices shown for all retail sellers in the state

Fig 3 PDS kerosene prices by quantity sold mdash

Maharashtra 2004ndash

05

Table 1

Kerosene consumption by market Maharashtra 2004ndash05

Monthly

million liters

HH quota

total

HH PDS

purchase

HH black market

purchase

Diversions to

other markets

Rural 80 25 12 42

Urban 38 15 16 7

Totals 118 40 28 50

Source for PDS and black market purchases National Sample Survey Consumption

Expenditure 2004ndash5

See Appendix A for details on quota estimation

Numbers dont add due to rounding

Table 2

Household kerosene use by function region and priority in Maharashtra

Million users Lighting Cooking

Primary 122 (R) 13 (U) b01 (R) 45 (U)

Secondarya NAb gt170 (R) gt100 (U)

Source National Sample Survey of Consumption Expenditure 2004-05a Secondary use for cooking estimated as households with LPG or wood use and

gt4 lmonth of keroseneb The purpose of kerosene use up to 4 l cannot be inferred from NSSO data

12 A numberof otherfactors in1047298uence households cookingfuel choicesother thanfu-

el economy otherwise lsquoEconomy Usersrsquo would not use LPG at all Non-economic prefer-

ences for cooking fuel are a rich and underexplored topic in literature that merits

further research13 This was observed in the household survey14 The heat content of the fuels and their stoves ef 1047297ciencies determine their cost in

energy terms given fuel prices15 Wood was found to be more expensive than PDS kerosene on an energy basis for

only about 230000 households There may be some others who do not show wood

use in the survey but have wood stoves but there is no way to identify this group from

NSSO data

38 ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 59

month for a family of seven 16 This is less than a half a percent of poor

householdsrsquo monthly expenditure Such households may overesti-

mate these savings or consider even such small savings worthwhile

Households that cook with black-market kerosene pay approxi-

mately the same fuel price as LPG (about Rs 22kg on average in

urban Maharashtra) which implies they pay more on an energy basis

than they do to cook with LPG (since kerosene stoves are less ef 1047297cient)

This suggests thatLPG users whobuy black marketkerosene forcooking

must also be Last Resort Users who lack reliable access to LPG

In summary Economy Users may represent a minority of kerosene

users However the 1047297nancial risk to them of removing subsidies is

signi1047297cantly less than others given the thin margins of savings from

using subsidized kerosene over LPG To the extent possible differen-

tiating these households would be important in calculating the distri-

bution of subsidy bene1047297ts

Assessment of subsidy performance

In this section I discuss the merits of kerosene subsidies as a redis-

tributive policy based on three measures materiality progressivity

and ef 1047297cacy I 1047297rst present the measurement approach and metrics

I then discuss the results and the drivers of low ef 1047297cacy

Measurement approach

I 1047297rst present the method for calculating individual household

bene1047297ts in terms of budget share based on the categorization of

kerosene users discussed in the previous section Based on these

budget shares I estimate progressivity and ef 1047297cacy

Several approaches have been used to assess the distributional

bene1047297ts of subsidies to households in other developing countries Acommon approach is to compare energy budgets with and without

the subsidy (Dube 2003 Kebede 2006) for different types of house-

holds I use a similar approach to estimating materiality Dube (2003)

compares households willingness to pay to the price they would pay

without subsidies However this carries a hypothetical bias Instead I

use market prices for substitutes to evaluate budget impacts Saboohi

(2001) calculates Lorenz curves for energy subsidy bene1047297ts to assess

progressivity Olivia and Gibson (2008) use an aggregate welfare

measure that incorporates an inequality aversion parameter Both

approaches capture equity in terms of inequality but not necessarily

poverty impact In order to capture the subsidy bene1047297ts around an

absolute poverty threshold I use a Growth Incidence Curve as de-

scribed below

Previous studies that quantify the impact of subsidy diversions in

India focus on the quantity of subsidized kerosene that households

actually receive I also account for the actual PDS kerosene price

paid by households which varies signi1047297cantly around the intended

subsidized price

Materiality

The value to households of the subsidy is a reduction in energy

expenditure which enables more discretionary spending on other

goods In contrast to prior studies that focus on mean bene1047297t inci-

dence for households in an income decile I calculate the bene1047297t for

different types of households based on fuel choices which affects

the price they would pay with the subsidys removal In particular

Economy Users would switch to LPG while Last Resort would be

forced to continue using kerosene and pay black market prices

Identifying Economy Users required a heuristic in the absence

of data on LPG reliability Note that all households fall into the 1047297rstcategory (including primary cookinglighting users) except for

those select LPG users whose cost of using subsidized kerosene is

less than that of LPG in energy terms The prevailing relative prices

of LPG and kerosene for a household were used as proxies to identify

this group If households used kerosene as a supplemental fuel even

when LPG was cheaper on an energy basis they presumably had

fuel availability issues They are thus assumed to be Last Resort

Users If the LPG price falls between the subsidized and black market

price of kerosene households are assumed to be Economy Users

The real income loss ΔI caused by the subsidy removal can be

estimated as follows for a given percentage change in the kerosene

price Δ pk for the two groups

Last Resort Users (No Fuel Switch)

ΔI frac14 Q ksdot pkminusQ k 1 thorn Δ pksdot η k

sdot pk 1 thorn Δ pketh THORN eth1THORN

Economy Users (Switch to LPG)

ΔI frac14 Q ksdot pkminusQ LPGsdot 1 thorn Δ pksdot η klPG

sdot pLPG eth2THORN

where η k is the own-price elasticity for kerosene demand η kLPG is

the cross-price elasticity of LPG to a change in kerosene price Q k

and pk are the original quantity and price of kerosene and Q LPG

and pLPGare the original quantity and price of LPG (all in energy

units) Note that kerosene demand is inelastic for last resort

users since cooking is an essential function However to allow

for some conservation a sensitivity analysis incorporates elasticity

16 This estimate is based on each family member bathing every day each using 10 li-

ters of hot water heated from 10 degrees C to 70 degrees C and with savings of Rs 025

per megajoule of delivered energy from using kerosene instead of LPG

Note Cooking use assessed as household use above 4 liters per month

Source National Sample Survey of Consumption Expenditure 2004-05

Fig 4 Kerosene use for cookingwater heating mdash Maharashtra 2004ndash05

Fig 5 Kerosene vs LPG delivered fuel cost comparison (2004ndash05 prices)

39ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 69

Subsidy progressivity

Progressivity is an important metric for policies that have a wide

impact A poverty index for example would not provide an indica-

tion of the relative bene1047297ts between the poor and non-poor Thus a

policy that reduces the poverty gap can be regressive if it bene1047297ts

middle income groups to a greater extent Such a policy could be an

expensive instrument of redistribution

I adapt a measure of lsquopro-poorrsquo growth used in the development

economics literature which uses a lsquo

Growth Incidence Curversquo

(GIC)to measure the extent to which income growth accrues to the poor

relative to what accrues to those above poverty as de1047297ned by some

poverty threshold (Grosse et al 2008)

Speci1047297cally a variation of the GIC is constructed with the average

income percentage change for every population centile in order of in-

creasing income If the slope of this curve is increasing (decreasing)

the subsidy provides greater (lesser) bene1047297ts to higher income

groups on an individual household basis In aggregate the average

percentage change in income for all centiles (H ) below the threshold

( μ p) is compared to the average percentage change ( μ ) for the entire

population (n) The former would be higher for a progressive policy

μ p frac14 1

H

XH

ifrac141

ΔI i=I i eth3THORN

μ frac14 1

n

Xforalln

ΔI i=I ii

eth4THORN

μ pgt μ rArr Progressive subsidy

Subsidy ef 1047297cacy

One way to compare redistributive policies is to consider them as

various mechanisms for enabling a lump sum transfer to particular

household groups In this vein the ef 1047297cacy would be the share of

the total subsidy value that the intended bene1047297ciaries receive The

inverse of ef 1047297cacy can be interpreted as the cost per unit of income

relief provided to the intended bene1047297ciaries The ef 1047297cacy can be cal-

culated as follows

sumforallHH

ΔI

C minusP Subsidy

Q AggQuota

eth5THORN

The denominator represents the aggregate subsidy value or 1047297scal

cost where Q AggQuota is the total quota allocated to targeted house-

holds C is the cost of production and P subsidy is the subsidy price

The numerator represents the actual savings to households where

∆I is shown in Eqs (1) and (2) in Section 311

I evaluate the metric for two sets of bene1047297ciaries all households

and only those households earning below $2capitaday17 The for-

mer captures the subsidy value that is lost due to reasons other

than targeting among household groups while the latter includestargeting failures as well

Data

All household expenditure and household fuel use data are drawn

from the NSS0405 Surveys show quantities and prices for all fuels in-

cluding both subsidized and black market kerosene No estimates are

available for kerosene cooking elasticity in India There are only two

known studies that estimate own- and cross-price elasticities of

household fuels in India (Gundimeda and Koumlhlin 2008 Gupta and

Koumlhlin 2006) However these estimates are not appropriate in the

current context for several reasons primarily because they measure

substitution effects which are not applicable to ldquolast resortrdquo users18

Since kerosene is a last resort and both cooking and lighting are

essential functions demand ought to be inelastic To be conservative

however I test a range of own-price elasticities of minus01 to minus025

and present results for the lower 1047297gure This is similar to the lower

end of ranges for elasticities of residential utilities that have few

close substitutes (minus039plusmn025 for electricity and minus038plusmn022 for

water (Komives et al 2005))19 For similar reasons the base case

cross-price elasticity for LPG was assumed to be 09 But for some

conservation in the face of higher kerosene prices Economy Users

would have no reason to shift less than the full amount of cooking

energy to LPG

Subsidy performance results

Here I present the results of the analysis

Materiality

Among those spending less than$2day in rural and urban areas the

average income relief from the kerosene subsidy amounts to 03 and

05 of household expenditure respectively However the bene1047297ts

vary widely by income centiles from 0 to 13 of household expendi-

ture Further almost 24 and 47 of the rural and urban kerosene-

using population respectively receives bene1047297ts that exceed 1 of total

expenditure (Fig 6) With an elasticity of minus025 these 1047297gures drop to

10 and 33 Savings are highest in metropolitan urban areas such as

in Mumbai and in remote districts with limited LPG supply

For instance for the poor in District 1 ndash a remote district with 13

million people ndash the savings on average are 17 of their monthlyexpenses and over 5 for those earning less than $1day Considering

that the poorest urban households spend over 10 of their income on

energy (World Bank 2003) this could double their energy budgets in

the worst case

Among LPG (higher income) users Last Resort users have an aver-

age savings of 05 while Economy Users have savings of 04 with

the reduction being higher at upper middle income levels

17 Equivalent to a Monthly Per Capita Expenditure (MPCE) of ~Rs 1000 assuming a

purchasing power parity exchange rate of Rs 16$ in 2004ndash05 (Source http

unstatsunorgunsdmdgSeriesDetailaspxsrid=699)

18 The studies use cross-sectional data (and therefore estimate long-term elasticity)

for the entire country do not differentiate cooking from lighting and capture the ef-

fects of substitution rather than just conservation19 Figures show median and one standard deviation for studies from 31 countries

and 57 separate estimates of elasticities for electricity and from 18 countries and 155

separate estimates of elasticities for water

Note based on estimates of lsquomaximalrsquo savings ndash kerosene price elasticity of -01

Total Population Urban ndash 37 million Rural ndash 55 million

Fig 6 Population share by kerosene subsidy bene1047297t mdash Maharashtra 2004ndash05

40 ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 79

This 1047297nding has important implicationsfor the relationship between

LPG and kerosene policies The more liquid and reliable the LPG market

the less upper income households would use kerosene This would im-

prove theprogressivityof kerosene subsidies simply by altering market

incentives Note thatthis 1047297nding is different fromthe conventional wis-

dom that LPG pricing alone would in1047298uence kerosene use

Progressivity

Fig 7 below shows the cumulative average savings as a share of

household expenditure Several observations stem from the 1047297gures

First in rural areas the subsidy bene1047297ts are regressive The cumula-

tive average savings rate (Eqs (3) and (4)) is 037 for those who

earn under $1day 041 for those who earn below $2day

However in urban areas the subsidy is consistently progressive

for the entire population using the same thresholds20 The average

income relief is 058 for lower income groups and 053 for middle

income groups

Policy ef 1047297cacy

The ef 1047297cacy of the kerosene subsidy (Eq (5)) from the perspective

of al l households is at best ~265 That is for every 100 Rupees of

subsidy only Rs 265 of income relief is delivered to households

directly The ef 1047297cacy for delivering income relief to those earning

under $2day is 17 Thus for every rupee of income transferred to

these poor six rupees has to be spent by the government

The low ef 1047297cacy re1047298ects thefact that only 313 of thekerosene pick-

ed up by wholesalers was delivered to households through the PDS in

2004ndash05 based on NSSO0405 The difference of ~5 percentage points

between the quantity (313) and bene1047297t (265) shortfalls is attributable

to price discrimination That is householdspay prices that include actu-

al transport costs and rents in addition to the wholesale subsidy price

Kerosene subsidies and ideal implementation

The shortfall in the subsidy value that reaches households can be at-

tributed to design failures and implementation failures For policy re-

formists this distinction would be important Even under idealimplementation conditions a kerosene subsidy can only bene1047297t

kerosene users up to the use of their quota The mismatch between de-

mand and the quota re1047298ects the limits of the value of the subsidy even

under idealimplementation conditions (Fig8) The correlationbetween

household quotas and their usage was found to be only 22 in rural

areas and 58 in urban areas indicating that the quota design is better

suited to urban kerosene needs Implementation failures on the other

hand are re1047298ected in the fact that households purchase part of their en-

titled kerosene quotas in the black market or that they fail to obtain the

intended subsidy price for the part of the quota they do obtain Indeed

67 million of the 10 million urban dwellers in Maharashtra who cook

with kerosene purchase at least as much kerosene in the black market

as the shortfall in their quota Both these types of failures and their con-

sequences for ef 1047297cacy are discussed next

Design failures

Most poor households do not claim their entitled share of subsi-

dized kerosene as re1047298ected in the gap between the average quota

and total usage (Fig 8) This is the case in rural areas across all income

groups As mentioned earlier most rural households cook with wood

Since the government allocates quotas based on cooking needs but

rural households purchase PDS kerosene mostly for lighting rural

households forego most of their quota In urban households and par-

ticularly metropolitan areas on the other hand kerosenes use for

cooking aligns with the quota except for where low-income house-

holds have access to wood as discussed earlier (Note that in Maha-

rashtra I estimate cooking demand to account for only 21 of

kerosene demand in rural areas but 61 in urban areas which is

slightly higher than the national averages shown earlier)At the same time about a 1047297fth of households in the lowest three

deciles in urban areas buy kerosene in excess of their quotas

(Fig 9) This heterogeneity among the urban poor stems from varying

access to wood as re1047298ected in the fact that those who forego their

quotas consume on average about four times the quantity of wood

as those that consumer above their quotas In rural areas because

kerosene use increases with income the share of households whose

kerosene purchases exceed their quota also increases with income

Thus the discrepancy between allocated quotas and demand

reinforces the difference in kerosene bene1047297ts between urban and

rural areas The progressivity of subsidies would likely increase in

urban areas from better targeted and potentially higher quotas for ker-

osene subsidies In rural areas on the other hand the extent of unused

quotas only provides incentives for their diversion to other sectors

Fig 7 Kerosene subsidy progressivity urban and rural Maharashtra 2004ndash5

20 Note that prices in urban areas are signi1047297cantly higher so the same cutoff re1047298ects

greater poverty than in rural areas Data were unavailable to create price-adjusted pov-

erty thresholds

a) Urban

b) Rural

Fig 8 Kerosene subsidy quotas and actual use

41ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 89

The question then arises as to what the best attainable ef 1047297cacy

would be under lsquoidealrsquo implementation conditions given the design

limitations This is discussed next

Subsidy performance under lsquo idealrsquo implementation

Subsidy bene1047297ts in ideal implementation conditions entail that

households satisfy all their kerosene requirements through the PDS

and at prices corresponding to the intended subsidy price (including

a legitimate distance-sensitive transportation charge) The three

metrics ndash materiality progressivity and ef 1047297cacy ndash under lsquoidealrsquo imple-

mentation conditions are as follows

If the subsidy were ideally implemented its material impact

would double For urban households earning under $2day the bene-

1047297ts would amount to 11 (compared to 05 in practice)

What subsidized kerosene does reach households does not appear

to have a distributional bias compared to their ideal delivery imply-

ing that income does not seem to be a basis for denying households

their quota21

With regard to ef 1047297cacy the share of subsidy value that would

go to households would increase to 39ndash46 using a subsidy price(including transportation) of Rs 11 and 10 per liter respectively22

Results summary

In urban areas coverage of the poor is relatively low but the

materiality of subsidies is higher and black market purchases repre-

sent a higher share of total consumption This makes the subsidies

progressive and their removal potentially costly for particular urban

groups that have few alternative cooking fuels For these households

income relief from kerosene subsidies amounts to a range of 1ndash5 of

their monthly expenditure

In rural areas the subsidy coverage is high but of low material

value because of widespread use of small amounts of kerosene for

lighting It is also regressive since higher income households whouse kerosene as a backup to LPG have higher bene1047297ts The bulk of

households that use kerosene for lighting obtain income relief of

0 to 04 Most of the quota goes unused

Most of the loss in subsidy value seems to result from poor suit-

ability of kerosene subsidies as instruments of redistribution Even

under perfect delivery of subsidies to households the policy ef 1047297cacy

improves from 26 to 46 at best

Policy implications

The Kirit Parikh expert committees recommendation to phase

out kerosene subsidies may be premature Reforming the kerosene

subsidy requires different approaches in the short and long term By

focusing on rural kerosene use for lighting current policy analysis

neglects important distributional bene1047297ts of the subsidy in urban

areas where access to biomass and affordable LPG for cooking is lim-

ited On average income bene1047297

ts of the kerosene subsidy are about05 of household expenditure but among the urban poor income

shocks of 1ndash5 are likely corresponding to at worst a doubling of

households cooking budgets

In theshort-term theef 1047297cacy of the subsidycan be improved without

losing these limited bene1047297ts by redesigning households quotas of subsi-

dized kerosene to better re1047298ect households needs mdash cooking in urban

areas and lighting in rural areas This would reduce the total subsidy re-

quirement considerably by preventing the loss of about half of the 74

of the subsidy value that gets diverted as rents along the supply chain

In the long-termwhether the subsidy distribution systemshould be

reformed or eliminated requires a broader evaluation of alternative re-

distributive instruments This study shows that kerosene is typically a

backup cooking fuel making the value of the subsidy dependent on

theavailability of other preferred fuels such as LPG and woodThis em-

phasizes the importance of the kerosene subsidy as only an instrument

of redistribution Alternative redistributive instruments should there-

fore be evaluated among other things based on the metrics used in

this study The feasibility and cost of institutional reform is also impor-

tant to study in evaluating alternative redistributivepoliciesThe major-

ity of the loss of subsidy value results from rent extraction at numerous

points of distribution that are controlled by entrenched interests These

entrenched interests that drive the kerosene black market may make

subsidy reduction or removal politically challenging

Acknowledgements

I am grateful to my Research Assistant Evan Woods and to Gautam

Dutt and two anonymous reviewers for their comments

Appendix A Maharashtra kerosene quota allocation

Source Maharashtra Food Civil Supplies and Consumer Protec-

tion Department (httpwwwmaharashtragovinenglishfood

schemesKerosenephp )

Methodology for Determining Household Quotas from NSSO Data

Households entitlementswere calculated based on fuel usedata in

the NSSO0405 Households that did not useLPG were identi1047297edby the

21 In the primary survey several interviewees described methods of discrimination

by ration shop owners that could be in1047298uenced by their income (such as conditioning

the sale of subsidized kerosene on other grocery purchases political and social connec-

tions etc) But these do not manifest in NSSO data as robust trends across the state

Their examination would be a topic for future research22 Using a distance-sensitive transportation surcharge for households by district

would yield a 1047297gure in between these

LPG non-LPG A rea Quantum

[liters per person]

Maximum

(l)

Non LPG

connection

holder

Rural 15 to 2 15

Urban 2 15

Municipal

corporations

amp lsquoArsquo class

municipalities

Persons Liters 24

1 Person 3

2 Persons 8

3 Persons 10

4 and more persons 3 per person

MumbaindashThane

rationing area

1 Person 5 24

2 Persons 12l

3 Persons 154 Persons 18

5 Persons 21

6 Persons 23

7 and more persons 24

LPG connection

holder

All areas 1 Cylinder 4

2 Cylinder Nil

Note Data show households that purchase any amount of kerosene in excess of their quotas

Fig 9 Households with insuf 1047297cient kerosene quotas mdash Maharashtra 2004ndash05

42 ND Rao Energy for Sustainable Development 16 (2012) 35ndash43

8172019 Kerosene Subsidies

httpslidepdfcomreaderfullkerosene-subsidies 99

absence of LPG consumption in the survey TheNSSO0405 does notin-

dicate how many cylinders households own Households with two

LPG cylinders were assumed to be those households that did not use

any backup fuel All other households that used LPG were assumed

to have one cylinder Data on household size and location were used

to determine the 1047297nal kerosene entitlement (as de1047297ned above)

References

Chaturvedi BK Report of the High Powered Committee on Financial Position of OilCompanies Petroleum Ministry Government of India 2008

Datta A The incidence of fuel taxation in India Energy Econ 201032S26 ndash33Dube I Impact of energy subsidies on energy consumption and supply in Zimbabwe

Do the urban poor really bene1047297t Energy Policy 2003311635ndash45Dutt GS Mills E Illumination and sustainable development Part II Implementing light-

ing ef 1047297ciency programs Energy Sustain Dev 1994117ndash27Gangopadyaya S Ramaswami B Wadhwa W Reducing subsidies on household fuels in

India how will it affect the Poor Energy Policy 2005332326 ndash36Grosse M Harttgen K Klasen S Measuring pro-poor growth in non-income dimen-

sions World Dev 2008361021ndash47Gundimeda H Koumlhlin G Fuel demand elasticities for energy and environmental

policies Indian sample survey evidence Energy Econ 200830517ndash46Gupta G Koumlhlin G Preferences for domestic fuel Analysis with socio-economic factors

and rankings in Kolkata India Ecol Econ 200657107ndash21Heltberg R Household energy use in developing countries a multicountry study In

ESMAP Technical Paper editor Washington DC The World Bank 2003Hosier RH Kipondya W Urban household energy use in Tanzania Prices substitutes

and poverty Energy Policy 199321454ndash73IEA Looking at energy subsidies Getting the prices right World Energy Outlook

Washington DC International Energy Agency 1999

IEA World Energy Outlook 2007Kebede B Energy subsidies and costs in urban Ethiopia the cases of kerosene and

electricity Renew Energy 2006312140ndash51KomivesK Foster Vivien Halpern Jonathan Wodon QuentinWater Electricity and the

Poor Who Bene1047297ts from Utility Subsidies Washington DC World Bank 2005Mahapatra S Chanakya HN Dasappa S Evaluation of various energy devices for

domestic lighting in India Technology economics and CO2 emissions EnergySustain Dev 200913271ndash9

Morris S Pandey A Barua Samir K A Scheme for Ef 1047297cient Subsidization of Kerosene inIndia Indian Institute of Management Working Paper Series 2006 Ahmedabad

NCAER Comprehensive Study to Assess the Genuine Demand and Requirement of SKO

(Special Kerosene Oil) India National Council for Applied Economic Research2005Olivia S John Gibson Household Energy Demand and the Equity and Ef 1047297ciency

Aspects of Subsidy Reform in Indonesia Energy J 20082921ndash39Parikh KS Report of The Expert Group on A Viable and Sustainable System of Pricing of

Petroleum Products Government of India 2010Piketty T Qian Nancy Income Inequality and Progressive Income Taxation in China and

India 1986ndash2015 Appl Econ 2009153ndash63Pitt MM Equity externalities and energy subsidies The case of kerosene in Indonesia

J Dev Econ 198517201ndash17Reddy AKN A Strategy for Resolving Indias Oil Crisis Curr Sci 19815050ndash3Shelar M Barahate SD Rathi MR Pethkar VD Energy stamps to discourage inef 1047297cient

use of kerosene and reduce emissions from autorickshaws a case-study fromMaharashtra India Energy Sustain Dev 20071174ndash7

Shenoy BV Lessons Learned from Attempts to Reform Indias Kerosene SubsidyGeneva International Institute for Sustainable Development 2010

UNEP Reforming Energy Subsidies Opportunities to Contribute to the Climate ChangeAgenda Division of Technology Industry and Economics United Nations Environ-ment Program 2008

World Bank Access of the Poor to Clean Household Fuels in India In South AsiaEnvironment and Social Development Department editor Washington DCWorld Bank 2003

43ND Rao Energy for Sustainable Development 16 (2012) 35ndash43