(Fortune Magazine) -- High crude prices may be fattening profits at oil companies around the world, but in India state-controlled refiners and retailers are losing money hand over fist. In the fiscal year that ended in March 2006, those companies lost a combined $8.6 billion. And Merrill Lynch (Charts) estimates they will lose another $12 billion to $20 billion this year.

The reason: government price controls on gasoline, diesel and cooking fuels. "Today we are selling gasoline at 8 cents a liter below cost, diesel at 17 cents a liter below cost and kerosene at 39 cents a liter below cost, to retail customers," says N. Srikumar, a spokesman for Indian Oil, the country's largest refiner, which reported its first quarterly loss, on revenues of $41 billion, last year.

Bharat Petroleum, another Fortune Global 500 company, also posted its first loss, of $145 million, in the quarter ended in June. And Hindustan Petroleum had a loss for the quarter of $130 million. Says Sudhir Joshi, finance director at Bharat Petroleum: "Kerosene used by poor families in India for cooking and lighting is sold at less than the price of packaged drinking water."

Murli Deora, India's Minister of Petroleum and Natural Gas, acknowledges that the international price for kerosene, widely used for cooking in India, has increased by 254 percent since 2002 without any increase in cost to individual consumers. But he defends the government's price-control policy. "The citizens of the country," he says, "have limited capacity to bear high price increases, particularly in the case of lifeline fuels like kerosene. The government is making every effort to see that the impact on our consumers is minimal."

Fund managers take a dimmer view. "The government's petroleum-pricing policy is creating problems in realizing the sector's huge potential," says Paras Adenwala, chief investment officer at ING Investment Management in Mumbai.

Indeed, shareholders are feeling the pain. The stock price of Bharat has fallen by more than 15 percent since May, while Indian Oil has dropped 7 percent and Hindustan Petroleum 11 percent in the same period. All those stocks have been underperforming India's benchmark indexes for two years, although they make up the largest single chunk, by way of value, of public-sector companies traded on the country's bourses.

To help offset the burden placed on the oil sector, the government will issue bonds worth $6 billion. It has also directed state-controlled exploration companies to sell crude oil and gas to state-owned marketing companies at discounted prices, a move that will cause the exploration majors to lose approximately $5.2 billion this year, according to Iyer. The government has also cut some taxes and allowed a small increase in the price of auto fuel in June.

The rest of the loss will have to be borne by oil marketers, who are borrowing record amounts. Indian Oil's borrowings rose by 52 percent last year, to $5.7 billion. "Over the longer term, if the market and prices are freed, then everything will get normalized," says Indian Oil's Srikumar. "Right now we can't put the average Indian to inconvenience for our commercial gain, and yet we need to earn a surplus to invest for the future."

Private-sector refiners and marketers, such as Reliance Industries, have found a way out of the dilemma. Rather than sell auto and cooking fuels below cost in India, the company has taken to exporting a large part of its output. Reliance's exports for the quarter ended in June rose more than 85 percent over the previous year, to $2.9 billion, helping boost net profit by 10 percent , to $553 million.

State-owned companies don't dare export - or complain too loudly. Earlier this year Subir Raha, the outspoken chairman of Oil & Natural Gas Corp., was shown the door after publicly demanding that the government pay the company prevailing international prices for the crude oil it produces.

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