The government will formulate a new pricing mechanism for petro fuels in order to ease its subsidy burden and offset losses of upstream oil firms such as Oil and Natural Gas Corp (ONGC) from selling crude cheap.

The new pricing mechanism, which would also help compensate oil marketing firms, is expected to be in place by the middle of January.

Under the current administered pricing mechanism, upstream oil companies share one-third of the revenue losses of oil retailers by offering discounts on crude sales, while the government compensates for most of the refiner-marketers' losses by issuing special bonds, which they can sell.

While both upstream and downstream oil companies have limited room for price manoeuvres, state-run fuel marketing firms have suffered combined losses of Rs14,430 crore so far this financial year.

A slump in global oil prices will help oil firms reduce their annual loss on fuel sales to about Rs110,000 crore, from over Rs240,000 crore projected on a price of $100 a barrel, in June.

In July-September quarter, when ONGC's gross billing was $119 a barrel it got only $46 a barrel from oil refiners.

The new system may limit the subsidy share of upstream firms to Rs30,000 crore ($6.40 billion) for the current financial year ending March 2009.

Under the current APM, ONGC supplies gas to power and fertiliser sectors at Rs3,200 per thousand standard cubic metres (TSCM) and to transport sector and court mandated small consumers at Rs3,840 per MSCM.

In the North East, the prices are even lower at Rs1,920/MSCM and Rs2,304/MSCM respectively.

The demand for petroleum products, meanwhile, grew 6.7 per cent from 113.213 million tonnes in 2005-06 to 120.749 million tonnes in 2006-07 and by 6.8 per cent to 128.946 million metric tonnes in 2007-08, government data showed.

For April-October 2008-09 demand for petroleum products was up 4.1 per cent at 75.521 million tonnes.