By Diya Philip
The spiralling prices of petrol and diesel have been in news for quite some now. But the regularity of the hikes and a sense of inevitability surrounding them have stripped the news of any shock value such events may have had in the past. The impact of high fuel prices is more pronounced now because of the economic crisis triggered by the Covid-19 pandemic and the subsequent job losses and salary cuts in the private sector.
Rise in the prices of petroleum fuels and cooking gas has a huge impact in countries like India where a large chunk of the population earns less than $2 a day. The current crisis saw the number of people who earn less than $2 a day rising to 134 million from 60 million, say a recent study by PEW Research. The country is staring at mass poverty for first time in 45 years.
The world is going through the most severe health emergency since the Spanish flu of 1918. The impact of high fuel prices is pushing more and more people into abject poverty every day. There is no justification for raising the prices as the demand has been subdued due to the lockdown measures. During most of this period, global crude prices also remained subdued. The fuel prices are being raised again as the global crude prices firm up. However, there was no price cut when the global crude prices were slipping to historic lows amid the pandemic crisis.
Factors behind high fuel prices
Excise duty levied by the central government is a major component of the recent increase in retail fuel prices. The central tax has increased many times since 2014, while the states’ share in retail price remained steady. Excise duty was raised sharply in 2020 when the global crude prices crashed during the pandemic. The hike has not been withdrawn in 2021, and the crude prices are on the rise.
The crude prices are at a three-year high at present. The pricing strategy followed in India means the increase in global crude prices is passed on to the end-user. But whenever the global crude prices drop, it is not passed on to the customer. Here are some of the factors that determine fuel prices in the country.
- Supply conditions
- Demand conditions
- International crude prices
- Cost of refined fuel
- Central taxes
- State taxes (VAT)
- Government subsidies
- Refining capacity
- Additional cess imposed by the government/s
- Dealer commission to gas stations
- Freight charges at all levels
- Processing/ refining charges
- Exchange rates
- Speculation in the market and expectations
Among these, the most important factors are import prices of crude, and central / state levies. State governments impose VAT at 25%. VAT in the cases of petrol is a mix of percentage and fixed rate.
Petroleum pricing strategies over the years
Before administered price mechanism was introduced in 1974, India had market determined prices. Under the administered price mechanism, the well head price of indigenous crude oil was determined as the weighted average of the cost of production of Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL), which are government-owned companies involved in exploration and production, plus 15 per cent post-tax return on operating expenses.
APM primarily supported the orderly growth of the oil industry. It also ensured continuous availability of products to consumers at a stable price. This mechanism insulated marketing companies, refineries and oil producers from crude price fluctuations. In the initial years when the demand for oil products was quite less, the capital requirements of PSUs did not exert much pressure to the government.
From April 1, 1998, import parity mechanism was introduced. The crude oil producers were paid a pre-announced phased increase in percentage (75% for 1998-99, 77.5% for 1999-2000, 80% for 2000-01 and 82.5 % in 2001-02) of the international FOB prices on a year-to-year basis that was raised to 100% in 2002.
From 2006, the trade parity mechanism was introduced under which the price was fixed at 80:20 ratio, i.e., 80% import parity and 20% export parity which is almost equal to the respective percentages of imports and exports. The export parity price could be incorporated because India began to export petro products. So, by shifting to this mechanism meant a considerable cut in prices.
The petrol prices were deregulated in 2010 and diesel in 2014. From 2017 onwards the prices are revised on a daily basis. Till then, the revision was made fortnightly. The change from the administered pricing strategy which was followed till then to market driven price mechanism has had a major impact in the market, affecting common people the most. The base price of petrol in India is Rs 41 per litre .The central and local levies and the dealer commission add Rs 60, pushing the retail prices above Rs 100. The government generates Rs 8.5 lakh crore of from taxes on petroleum products.
The base price is determined by the refiners and the government. Even when the price of crude oil fall in global markets, the opposite can happen in fuel prices. India is exporting fuel to 15 nations at Rs 34 per litre.
The impact of high fuel prices
Modern economies are energy dependent and emerging economies like India are particularly energy hungry. Low priced fuel is a key ingredient to power economic growth. It keeps inflation under control and make the products globally competitive.
The poorest people are affected most by the fuel prices. The daily wage earners and the office going public end up paying a large proportion of their income for transportation. Use of two-wheelers, three wheelers, four wheelers and heavy vehicles become costlier. Another major chunk of their income is consumed by the expensive LPG cylinders.
The high fuel prices also push inflation and food prices. As the economy is trying to revive, inflation stands as a major hurdle. In a scenario where there is much consumer demand, it can be safely assumed that the inflation is triggered by soaring fuel prices.
Oil Bonds and fiscal deficit
Oil bonds worth Rs 1.4 lakh crore were issued by the UPA government during 2005-2010 to oil marketing companies with a coupon rate of 6.35-8.4% to cover the losses from selling products below cost. This was done to reduce annual fiscal burden and liabilities. They were issued only up to the deregulation of fuel prices in 2010. The finance minister has recently blamed the oil bonds for high prices of petrol and diesel.
Table II presents data for a period between 2003 and 2021 October. The crude oil price rose initially, the impact was not felt by the economy as it was managed by the government. After deregulation, the burden fell on the public. The fall in crude prices should also have been transferred. But the prices continued to rise during the period.
In the last five years, the gap between diesel and petrol prices was bridged. In addition to this, oil marketing companies seem to work as a cartel totally in agreement with each other. As there are only a few of them, they sell at high prices and enjoy heavy margins.
The Brent crude is ruling around $84.86 at present. The crude basket of India comes at a lower price. The fuel prices include the base price plus OMC margin, fright and logistics cost as well as the central and state taxes. The dealer charges are Rs 2.5 and Rs 3.5 for diesel and petrol respectively. An additional cess is also charged by central government.
Crude oil imports
The government is evolving strategies to revive the economy hit by the pandemic. India is the third largest importer of crude oil. Almost 70% of its energy requirement is imported and the economy is still hungry for more. Petroleum products occupy the second position in India’s export basket and the country is the tenth largest exporter of petro fuels.
The high fuel prices provide an opportunity to think of alternative sources of energy and green technology. But not much support is given to this segment as the electric cars and bikes are highly priced compared to petrol/ diesel versions. A strategic shift is expected at the COP26 summit when the world leaders meet at Glasgow to discuss future plans for the planet. Burning of hydrocarbons will become a thing of the past if world leaders show enough political will for a shift towards green energy.
The dynamic pricing strategy as well as the central and state taxes are the reasons behind high oil prices. An efficient strategy and careful government intervention are needed to get the economy back on track. The lowering of taxes from the present 200% will be a welcome step, both for the economy and the citizens alike.
If there is no agreement to bring petroleum products under GST purview, there should be an effort to cut taxes by at least half. A novel approach can be introduced whereby the supply price to dealers by OMCs is lowered. Indian consumers can expect some relief if the Centre and states are willing to cut their respective levies.
Some states have already started cutting taxes. Assam has reduced fuel prices by Rs 5 on February 12, followed by Meghalaya which slashed it by Rs 7. Similar cuts by other states can put pressure on the Union government to cut excise duty on fuels.
(Diya Philip is Assistant Professor, Department of Economics, BK College, Amalagiri, Kottayam.)