Petroleum Pricing in India

Introduction: 

Petrol and petroleum products have become a necessity in today’s world. The pricing of these products greatly affects consumer demands and consumption. This article aims to discuss certain aspects of pricing of petroleum in India such as, its calculation, the taxed imposed on it and subsidies given on these products as also, inter alia, the issue of under-recovery.

Some Facts and Figures:

• India imports 83 per cent of its crude oil.
• In the last 3 years the gross subsidies on food, fertilizers and fuel have jumped 3 fold to Rs 2500 billion (approx $50 billion).
• The government had budgeted just 400 billion rupees for fuel subsidies for FY 2012. It has allocated almost 385 billion rupees from that to compensate the marketing companies for their losses on fuel sales in FY 2011.
• Elimination of subsidies on POL (Petroleum, Oil and Lubricant) products would force the economy to be more fuel-efficient and cut the demand for POL by initiating the development of other options such as solar or wind power. We often forget that subsidies hurt the larger economy by killing off innovation that would reduce the current problem.
• Subsidised diesel helps the common man less than the better-off, people who can afford petrol but buy diesel to exploit the price difference. This is evident in increased sale of diesel-based SUVs and luxury cars. Two, the diesel price hike and cap on LPG cylinders will help curb wasteful consumption of these fuels.
• Petrol prices in countries like Pakistan and Sri Lanka are way less than India.
• 50% of price we pay at the gas station goes to the government in form of taxes.
• Excise duty is at 30% for diesel.
• High taxation is the reason why OMCs are forced to show losses.
• The government compensates the firms for selling below cost via the issuance of oil bonds.
• These oil bonds do not comply with one of the basic principles of corporate finance – that the cash flows of the source of funds should approximately match the cash flows of the application of funds i.e Assets=Liabilities.
• In the case of oil bonds these long term bonds are being used to finance immediate expenses.
• Bonds are just used to postpone the losses, and also, in a way, amortize them over several years.
• Since 2005-06 till 2009-10, the Government has issued oil bonds worth over Rs 1.42 lakh crore.
• Even the the government claims it has deregulated the sector, but artificial control still continues.
• Recently, dual pricing for diesel was introduced, where bulk consumers — Railways, Defence, State Transports, and Industries — are paying market price, while the retail consumers are seeing minor increases.
• As a result there has been a hike in rail fares, a mode of transport mostly used by the common man. It has also diverted bulk customers such as State transport corporations to buying fuel from retail outlets, as there is no way of stopping vehicles from filling tanks directly from petrol pumps. This increases the chances of black marketing.
• In case of cooking fuel (domestic LPG and PDS kerosene), in 2002 it was decided that subsidy would be on specified flat rate for each depot/bottling plant and would be met through fiscal budget. Currently, this subsidy allowed on PDS kerosene is Rs 0.82 a litre and on domestic LPG is Rs 22.58 a cylinder. This scheme is till March 31, 2014.

Calculation of the net price of petrol:

The net cost of fuel we arrive at is Rs 49.6. However the cost of petrol in Delhi is Rs 63.09 as on May 1^st 2013. This means that 21% of the price we pay for fuel goes to the government in the form of taxes.

Only in the recent months, the government has been reducing the price. Initially despite low crude oil prices in the international market Indian consumers were still paying high prices for fuel.

Most of the countries have either imposed high taxes or are giving very high subsidies. However in case of India, high taxation is imposed ALONG with granting high subsidies.

This leads to a dichotomy of sorts. A country would normally generate revenue through levying high taxes on fuel. But giving out a high amount of subsidies along with that does not make economic sense. It seems as if the politicians adopting these policies have a certain agenda behind and economic efficiency is definitely not it. Policy makers want to cater to the masses via low fuel prices as well as make money through high taxation. As a result the OMCs end up as the casualties.

Looking at a breakdown of how petrol is priced in India and the US we can see that the pricing in USA is largely determined by the international crude prices. 58% of the price accounts for international crude prices. This implies that if there is an increase/decrease in international crude oil prices there will be a proportional change in petrol prices in India. However it is not the same with India. Around 44-48 % of the petrol price is determined by Federal and State taxes which implies that fluctuations in international crude prices do not have a significant impact on petrol prices in India.

Breakdown of petrol price in terms of percentage for FY2013:

• The Central govt has different taxes, which amount to about 24-26% of the final cost.
• The states taxes vary, but on average end up making about 20-25% of the final cost.
• As a result, approximately about 47% of the fuel cost goes to govt in form of different taxes, which is the main contributor to the price of fuel in India.

Since state taxes contribute towards a major chunk of the price, the petrol cost vary among different states.

Players in the Fuel Petroleum Sector and their roles:

1) Upstream Companies

• Companies such as ONGC and OIL.
• They supply crude to the oil marketing companies.
• They also bear a significant part of the fuel subsidy by giving discounts on the crude they sell to the refiners.
• The discounts accounted for about 40% of the total assistance to oil companies in FY12.

2) Oil Marketing Companies

• Oil Marketing Companies (OMCs) include companies such as IOC, BPCL and HPCL that buy crude from upstream companies, and refine it into diesel, petrol and other petroleum products.
• The ‘refinery’ arm of the OMC then sells it to the marketing arm of the OMC at the international benchmark price, which sell it to the end-customer.
• They sell it at controlled prices to the end-consumers, as a result, the marketing arm of OMCs sustain losses.

3) Central Government and State Government

They mobilise a lot of funds via taxes and compensate the OMCs via oil bonds.

Under-recovery:

Under-recovery is a notional loss in revenue to the extent the international price of the fuel is higher. It may or may not be a loss-making proposition to produce the fuel when there is an under-recovery. It is not exactly a ‘loss’ as the common public believes or rather made to believe.

Indian Oil Corporation (IOC), which is the largest player in oil refining and marketing space, paid excise duties to the extent of Rs 309 billion as compared to the total Government grants/subsidies of Rs 243 billion towards fuel subsidies.

As a result the Government registered net inflows of Rs 66 billion from IOC. The complaints with regards to the subsidies and under recoveries making losses do not hold ground since the inflow is over and above the corporate tax rates paid by the Oil Marketing Companies.

Conclusion:

Policy makers must realise that the under recoveries are not dragging down the feasibility of the oil marketing business but the intricate and complex taxation and pricing policies formulated by the Government. If the Government does away with such taxes and even if it deregulates ALL the fuel products in a phased manner, increased competition from the private sector will lead to an adequate or even excess supply of petroleum products and a pricing war will ensuring affordability of fuel products for the Indian consumers. The oil marketing companies would also stop making ‘losses’ and the end consumer would benefit from the deregulation and the free-market forces.

By: Vinayak Oleti