High fuel prices- Swindle or savior?

On the last day of this January, the Ministry of Finance of the Government of India (GoI) gleefully announced that GST collection in that month was ₹ 1,19,847 crore, a record since GST was introduced in July 2017. One can understand their feeling of relief as the cumulative revenue in FY 2020-21 was well short of the target as pandemic-induced lockdown froze the economy, albeit briefly.  When most ordinary citizens would have hardly noticed this good news, almost none missed the steep price hike in domestic LPG rates that came up just a couple of days later. Citizens who were riled by this hike that came on top of the daily raise of retail prices of petrol and diesel, took to social media to share their anguish. One of them jocularly posted ‘Investment Tip: Buy Petrol at ₹97; Target ₹105 in two weeks’.  

In mid 2017 too, the chatter was quite loud as the fuel prices went up daily for a few months, albeit by only a few paisa at a time. But then, the reasons were different and less widely understood. In the decade prior to FY 2014-15, huge subsidies on Petroleum products had become a major component of GoI’s expenditure, leading to unavailability of those much needed funds for the growth and development activities. From 2014-15, the present government had orchestrated a high mop up through excise duty & cess to repay the gargantuan debt it inherited; it was followed suit by the State governments by levying higher VAT. The determinate actions by the GoI, as highlighted in my article High Fuel Prices – The Method in the Madness (September 2017), can be appreciated if one understands what good this has done to the Indian Economy.

The PPAC Ready Reckoner on petroleum products dated June 2020 shows that the consumption of LPG, petrol and diesel in India have grown 62%, 75% and 21% respectively (in quantitative terms) in the 6 years till FY 2019-20. This was despite a subdued GDP Growth in the quarters after the announcement of Demonetisation (Nov 2016). This makes one conclude that the consumers were not too much worried about the additional burden due to the increase in the price of fuels in those years. Further, the lack of any major and sustained protests or general strike against the higher fuel prices during the said years reinforced the belief that the Indian public trusted and supported the initiatives of the GoI.

But that is history!. Having tamed the subsidy monster, the widespread expectation over the last 3 years was that widely consumed Petrol and Diesel will be brought under the ambit of GST thereby passing on the benefit of lower prices to the consumers. But it hasn’t happened, much to the disappointment of the citizens and industry alike. Read on to understand why.

The Subsidy Support

It will help to understand the bigger picture if one gets know what all are provided subsidy now, its purpose and how long it will continue.

The aggressive and innovative measures towards reducing subsidies on Domestic LPG, Kerosene, LNG and Diesel reduced the total subsidy to ₹ 26,482 crores in FY 2019-20 from an unsustainably high level of ₹1,64,409 crores in FY 2012-13. The subsidy / under-recoveries on Petrol and Diesel were eliminated in Jun’10 and Oct’14 respectively and their prices are market-determined since then. The prices of LPG and Kerosene are market-determined since 2016 and the subsidy amount is directly transferred to the Aaadhaar linked bank accounts of the consumers, who chose to avail the benefits. Subsidy for Kerosene is available to the Below Poverty Line (BPL) consumers.

As per data available, for the first 10 months of the current fiscal (2020-21) the subsidy spent is around ₹ 7100 crores. This excludes ₹ 8091 crores spent under the new PM Garib Kalyan Yojana implemented to overcome the economic impact of the pandemic induced lockdown on the poor. To be sure, the subsidies on LPG and LNG are going to remain for some more years to come. The only solace is the continuing reduction in the consumption of kerosene over the last decade (75% over 2014-15 levels), apparently due to switching to LPG for cooking. This has reduced the kerosene subsidy substantially.

In the above graph one can easily observe that the total subsidy provided in a fiscal tends moves in tandem with the Indian Crude Oil Basket price. But it is unlikely to reach the levels during UPA rule as the prices of all petroleum products are now market determined and the subsidy is provided directly to non-commercial consumers only for THREE products.

The Consumption Crunch

During the pandemic-stricken 2020-21, the only petroleum product whose consumption has grown (in quantitative terms) is LPG and that too is likely to be due to the country-wide expansion of Ujwala scheme through which LPG cylinders are provided to the economically weaker section. This was despite the lower consumption by eateries, hotels and industries due the lockdown and restrictions. But this would only increase the subsidy outgo. The fuel trio – Petrol, Diesel and ATF – has shown a considerable shrinkage (16%) in consumption. In the case of ATF it is expected to be around 60% on an annualized basis.

An overall contraction in the consumption of petroleum products has hit the revenue of the central government as well as all state governments (Cess, Excise, VAT, Royalty, etc.) to the extent of a whopping 49% over FY 2019-20 though reduction is only 11% in quantitative terms. Due to this, the Centre’s share is seen coming down around 35% over the previous FY’s collection where as the states together are likely to take a hit of 50-55%. This has added insult to the injury caused by a tepid economic growth in the prior 3 years.

It is a no-brainer to understand that in the months of pandemic-stricken economy, the governments wouldn’t want to do anything to further reduce the revenue that they are getting when the economy revives in the post-lockdown months. This is the single most important reason why the benefit of a fall in the prices of crude early in 2020 was not passed on to consumers in full. Given this scenario, is there a case for reducing the fuel and LPG prices when the economic growth revives?

Fuel vs Crude Price Volatility

Before this question is answered one has to understand the changes in the Indian Crude Basket price vis-a-vis international crude prices. Indian Crude Basket price, is the weighted average of Dubai & Oman and the Brent Crude oil prices.

The above graph depicts the month-on-month percentage change in average price of Brent crude. Clearly the volatility has been very high in the last 12 months and has affected the retail prices of the petroleum products worldwide. Starting March 2020 and well into April, the Brent crude prices crashed severely to a low of $9.12 per barrel only to recover equally sharply to $43.2 within next 60 days. After fluctuating for a couple of months it has moved up sharply from a low of $36.33 on 30^th October 2020 to $65.37 on 23^rd February, an increase of 80%. The Indian Crude Basket price also has followed suit.

As one can observe, the retail prices of petrol and diesel have moved in tandem with the Indian Crude Basket price. As the prices crashed in 2020, the Indian government had to hike the fixed components of the Excise Duty / cess on Fuels in March and May 2020 to ensure that the revenues do not dip sharply. This also dampened the price volatility. Mind that India is not the only nation which had raised the taxes during 2020, as you would see in the data presented later in this article. The relative stability of the retail prices of fuels in India till Nov’20, indicates that the Indian oil refineries had created some sort of cushion at lower prices to absorb the volatility, but up to an extent.

The strong winter oil demand from North Asian countries combined with a number of other factors has pushed up the oil prices since Nov’20. This substantial increase has made it imperative to pass on the costs to the consumers as the subsidies on these fuels have ended years back.

The Indian Union oil minister Dharmendra Pradhan explained, “The crude manufacturing countries are producing less crude to gain more profit. We have continuously been urging the Organisation of the Petroleum Exporting Countries (OPEC) and OPEC plus countries that it should not happen. We hope there will be a change”. But no end is in sight for this vexatious issue and a solution doesn’t seem to be available for the GoI, either.

LPG Pricing

The LPG connections have grown from 14.6 crores as on 1^st April 2014 to 27.9 crores by 1^st April 2020 thereby increasing the coverage to 97.5% of households pan-India from 61% as on 1^st April 2014. Of these, 8.01 crores were the LPG connections given free to BPL sections under PM Ujwal Yojana since its introduction in 2016. That constitutes a considerable 29% of the total connections. Hence it becomes imperative that the government continues the subsidy to these households to insulate them from the impact of the fluctuating crude oil price.

From the above graph one can discern that the retail price of a 14.2 kg LPG cylinder usually moves in tandem with the price of Indian Crude Basket. But in the last few months it seems to have lost its mooring and moved much higher than what it was when the crude price was as similar levels in the past. In February 2021, the price has shot upto ₹ 769 and subsidy reduced to ₹ 24.

While a comprehensive explanation might be hard, some pointers can be extrapolated:

It is important to note that the % of Taxes in these countries have gone up 4-14% from what they were around the same time in 2017, except in Japan. Data shows that the variances in % of taxes Indians pay vis-a-vis many of the developed countries is very minimal, barring Japan, Canada and USA. The low prices in USA is explained by the fact that it produces about 45% of crude consumed locally and in Canada the prices are higher than in USA though it is a net exporter of crude.

Qn: ‘Why are the fuel prices much higher in 2021 when the crude price is lower than, it was in early 2014 when the crude hit $110 or higher?’

The answer is that the prior government was aggressively subsidizing the fuel prices and pushing the burden of the huge subsidy to the future government in the form of oil bonds. Also there was a substantial leakage of subsidy to the undeserving. This topic is dealt in detail in my prior article High Fuel Prices – The Method in the Madness.

Qn: ‘Why is the Government not reducing the duties and taxes to keep the fuel prices in check or bringing them under GST?’

The answer is multi-fold:

The above factors almost certainly reduce any wiggle room to provide an unplanned subsidy to reduce the fuel cost in the hands of the consumer. Undeniably, cheaper fuel prices are desirable but it cannot through artificial means. Let us hope that the crude prices cool down and the government finds some means to reduce the additional burden on consumers for whom LPG is a basic necessity for cooking.

It appears that one would have to wait longer to see the petrol and diesel included under GST regime.

Epilogue

A lot more can be said to justify why the a few hundred rupees more you pay annually to buy fuel is needed by the government to help in building the nation and making it a better place to live. But ultimately, it is only you – the consumer – who can decide whether that extra money is more important for you than for the country!

As far as India is overly dependent on imports of crude for auto fuel, the citizens have to face the vagaries of international crude prices. Some of the measures that could reduce the fuel consumption and lessen the impact of high fuel costs are :