The fuel price conundrum

Recently we have witnessed huge criticism of the NDA Government over the Fuel price increases on petrol & diesel with the price of petrol at almost Rs 85 and diesel at Rs.72.76 in Mumbai under the dynamic pricing scheme. The new fuel pricing policy was adopted by the NDA government in 2014 when pump station prices moved up and down depending on international crude prices in a dollar every day.

Dollar Brent crude price has risen from $44.0 in June 2017 to $78.34 in May 2018. Correspondingly the price of petrol at the pump station has gone up from Rs.68.82 (Avg. Delhi+Mumbai) on 17th July 2017 to Rs 81.38(Avg. Delhi+Mumbai) on 24th May 2018. While Media has highlighted the price increases corresponding to the increase in Crude Oil, the  Opposition parties have outraged and claimed that the Narendra Modi Government is “looting the poor” while filling up the coffers thru taxes. The point though is why have the prices of petrol and diesel not come down in India since 2014 although the prices of Crude reduced from a high of $115.67/- in Jun 2014 to below $30/- in Jan 2016.

To find answers to this, one has to go deeper and unravel the economics and politics behind the Fuel Pricing Policy followed by the NDA Government under Narendra Modi v/s the UPA Government under Manmohan Singh.

This article attempts to untangle and explain, “The Fuel Price Conundrum” and help the average person to understand – why it is better to keep up fuel (Petrol and Diesel) prices in line with the prices of crude globally and not tinker with taxes.

The Chart below gives the comparison of the prices of Petrol at the Point of sale between August 2013 and May 2018 (Average Price of Delhi and Mumbai). (some assumptions made for ease of comparison)

Petrol Price Comparison – May 2018 v/s Aug 2013
Crude $/Barrel Crude Rs./Barrel Crude Price Rs/Ltr Additions to Basic Price INR/Litr Price of Petrol Rs/Ltr Approxm. Excise+VAT Fuel Subsidy Rs Crores
28 Aug-13 116.30 8005.19 50.35 22.83 73.18 15.5 250000
23 May-18 79.71 5454.56 34.31 46.77 81.08 36.7 50000
a b c d e

1 Barrel = 169 Ltr

(Fuel Subsidy Includes Under Recovery by Oil Companies like Indian Oil And ONGC)

a-  See Graph above

b- crude in $ terms converted Aug 2013  @ Rs 68.83 per $

c- crude in $ terms converted May 2018  @ Rs 68.43 per $

d- The Previous price of petrol in its peak in 2018.

e- Oil Squeeze.

The Cascading Effect of Subsidy

Current Account Deficit % Consumer Inflation % Food Inflation % Real Interest %
2012-13 4.7 10.9 14.2 2012 – 2.47      2013 – 3.87
2017-18 Oct-Dec 2017- 2.0 3.0 3.0 2016 – 5.9
1 2 3 4

1- Current account deficit widens to 2% of GDP on higher oil import bill

2- India’s BoP position improves dramatically

3- Historic inflation India (CPI)

4- India food inflation

5- India- real interest rate

The price of Petrol of Rs.81.08 in May 2018 is higher than the price in Aug 2013 although the $ price is far less in 2013. Hence, the outrage seems justified as most of the price difference is because of Taxes (Excise+Vat) in 2018 v/s 2013, Rs.36.7 v/s Rs.15.5. This contradiction is explained by the Policy of subsidy given by 2 different Governments in 2018 v/s 2013. The low price in 2013 has been heavily subsidized by the then UPA Government and the cost to the country of this policy was a whopping Rs. 2.5 lakh crores.

Let’s go through the chart in some detail :

  • Additions include Oil Manufacturing & Marketing Co. costs and margin / Transportation costs /Dealer Margins etc / Excise + Vat
  • The Government – Centre+States get all the added Costs (Excise +Vat) paid by Consumers
  • The Centre for Transfers to States from Excise gets a Lesser Share -30% of the total Excise + Vat
  • For any Meaningful Price Reduction, both the Centre & States have to Reduce Excise & Vat
  • Other facts Diesel makes up almost 45-50% of Fuel consumption and Petrol 10-12%.
  • 2/3 wheelers account for 64% & Cars 36% of total consumption of Petrol.
  • Cars+2 Wheelers account for 30% & Trucks & Buses etc. 40% of total consumption of Diesel.
  • Petrol Price Hike affects Owners of-Cars+2 Wheelers both in Petrol & Diesel
  • Diesel Price Hike affects Public Transport & Agriculture although a lot of Vehicles are now moving to CNG.

The Impact:-

  • Every dollar per barrel change in crude oil prices impacts the import bill by Rs 823 crore (USD 0.13 billion) & India annually Imports more than around 200+million metric tonnes of crude.
  • Every dollar per barrel change in crude oil prices the currency exchange rate fluctuates by Re 1 per US dollar.
  • This huge subsidy led to very high inflation & rocketing food inflation affecting the daily purchasing power of the common man
  • The Real Interest Earned on Bank Savings by middle class went down (Real Interest is Bank Interest minus Inflation).
  • Diesel Subsidy was cornered by diesel cars & UAVs – leading to higher sales of diesel cars as diesel was cheaper. This benefited only the rich, not the common man.
  • This also led to massive corruption in LPG cylinders & kerosene sale as fake LPG & kerosene users were registered.
  • The OIL Manufacturing & Marketing Companies like ONGC & Indian Oil suffered massively as they had to bear their share of the Subsidy (45% of total Subsidy+ Under Recovery)in the form of lower prices to dealers.
  • This resulted into losses & paucity of Finance for Capital Investment and Expansion.
  • Indian Oil Corp. had-Operating Profit-4% & Net Profit Ratio-1% in 2012-14.
  • The impact of this profligacy on the common man and the economy was disastrous and ruined the country’s economy and finances and affected the UPA in the 2014 elections.

The Reversal:-

  • The New NDA Government under Narendra Modi Changed the Policy in 2014.
  • Diesel & Petrol were put on Market determined Rates & Subsidies were discarded. Currently, there are Subsidies Only on LPG & Kerosene.
  • It was felt that this policy reversal will hurt the middle class and common man as the cost of petrol and diesel at the pump station would rise, transport costs would go up beside affecting farmers who use diesel.
  • The results, however, showed a different picture and over 4 years 2014-17- Subsidy has come down to around Rs.50000 Crores a massive reduction since 2013.
  • CAD has come down to 2.0% of GDP from a high of 4.7% in 2012-13.
  • For the middle class and the common man on the street Inflation 3.0% -2017-18.
  • Added to this Real Interest improved to 5.9%.
  • Oil Companies recovered as their under-recoveries reduced and Profits improved – Indian Oil recorded – Operating Profit -7% & Net Profit Ratio-3% in 2015-17.
  • The economy recovered and politically too, the Narendra Modi government won most of the state elections since 2014.

What do the experts opine? Most Economists have this to say –

“This is an unpopular decision, but full credit needs to be given to the NDA regime for sticking to this decision and believing in the economic benefits. It is good economics to keep the prices of petrol and diesel higher, especially when the country is reforming the energy usage pattern and is dependent on the imports of oil to sufficient demand.”

“It is much wiser to pay tax upfront.”

“The second argument, which supports high taxation on petrol and diesel during the low crude oil prices is that it allows controlling the demand for these products.”

Subsidised LPG & kerosene is now paid to the most deserved of consumers thru Direct Credit of Subsidy into their Jan Dhan Account. Direct transfer of LPG subsidy resulted in Rs 15000 crores saving.

Next the question was what is the Government using these Funds for –

While taking care of CAD/ Inflation & Real Interest for the Middle Class & Poor the monies collected thru taxes are being spent in creating Capital Assets.

Infrastructure spending has increased exponentially

“Budget 2018: With a whopping 50% increase from the last Budgetary allocation and a 20% hike from the revised estimate, the infrastructure sector continued to stay one of the thrust areas for the Narendra Modi government in the Union Budget 2018 as well – Capital outlay towards the infrastructure sector up to Rs. 5.97 lakh crore from 3.96 lakh crore budgeted last year, which was later revised to Rs 4.94 lakh crore.”

“Construction of national highways hit an all-time high of about 10,000 km in 2017-18, which translates to 28 km a day. The previous record was 8,231 km, achieved in 2016-17.”

This is already providing a massive boost to the economy & creating jobs at the same time.

However, given the Public sentiment and the need to give relief the Government is looking at ways to give relief and a long-term solution to Fuel Prices.

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