Relentless flaring of international oil prices is threatening to spoil the party to mark UPA's four years in saddle at the Centre.

Along with the high prices of foodgrains, which refuse to come down, crude oil's continuous rise is hemming in the Manmohan Singh government. It can either opt for hard options such as raising fuel prices in an election year or let state-owned oil marketing companies slide into red.

The signs of the government's realization of the tight situation became clear from Singh's statement on Thursday.

"We will not allow (government-run) oil companies to suffer," he told reporters at UPA's fourth anniversary celebrations at his residence. "It is a big problem.".

He acknowledged the problem in his speech as well: "The sharp rise in global oil prices, the price of steel, and the price of food crops has impacted our domestic economy."

With crude oil spiking to $135/barrel on Thursday, and showing no sign of cooling anytime soon, indications are that the government is considering the hard option of raising the petrol price by up to Rs 2 a litre but leaveing diesel unchanged. This, along with a reduction in excise and customs levies, form the key elements of a rescue package being worked out for the state-run oil marketing firms.

A decision on the package is expected next week only after political consultations with UPA stakeholders. Oil minister Murli Deora will examine the companies' financial health on Friday for reporting to the Prime
Minister and UPA chairperson Sonia Gandhi.

With state elections looming, the government will be required to balance the conflicting considerations, with indications that a setback in Karnatka will increase the already high premium on caution.

The option of leaving the price of diesel, the primary fuel for the transport sector, unchanged is aimed at avoiding pushing up commodity prices further, and protect the "pro-farmer" posture.

Reducing levies on motor fuels is another likely solution that the government could opt for in combination with a marginal rise in the petrol price.

Reducing central excise by Re 1 will provide a relief of approximately Rs 7,000 crore a year to the three state-run oil marketing firms - Indian Oil Corporation, Bharat Petroluem and Hindustan Petroleum. Similarly, if customs duty is reduced by 5% to zero on crude and 2.5% on motor fuels, the companies will get a relief of roughly Rs 13,300 crore a year. The customs duty reduction has to come on both crude and refined products to avoid giving windfall gains for private refining companies such as Reliance Industries and Essar.

Sources said there is a possibility of issuing more bonds to the companies to cover their losses. But the measure faces opposition from many within the government as a bad business practise. Besides, it is unlikely to help the oil companies which are running short of cash and borrowing heavily for running their operations.

The companies are losing roughly Rs 580 crore daily on motor and kitchen fuel sales. They are losing Rs 16.34 a litre on petrol, Rs 23.50 on diesel, Rs 29 on kerosene and Rs 316 on each cylinder of cooking gas. Present pump prices correspond to approximately $70-75/barrel of crude, which they are buying at $125-130 a barrel.

The government had allowed them to raise petrol prices by Rs 2 a litre and diesel by Re 1 in February. By then, however, international crude prices had moved to the $90-100/barrel region. As for cooking gas, the price was last raised by Rs 20 twice in 2004 - on June 5 and November 5 - when the international price of LPG stood at $368.57 a tonne and the companies were buying crude oil at $39.21/barrel. This January, the price stood at $873 a tonne, with crude oil purchases averaging $103.26/barrel.

In contrast, high oil prices have meant the exchequer has grown fatter by Rs 35,000 crore to Rs 180,000 crore from higher customs mop-up, other taxes and dividend from oil firms. For example, oil companies paid $2 as customs duty per barrel when the price was $40 and have to pay $5 if the price rises to $100. Besides, other central and state taxes push up pump prices. Out of the Rs 45.52 a litre price of petrol in Delhi, the oil companies get only Rs 22.02 and the remaining money goes into the government kitty as taxes.

The three state-run oil marketing firms suffered a loss of Rs 70,579 crore in 2007-08. They will get bonds - Centre's IoUs - to cover half of it.