Fuel pricing – My Analysis

Disclaimer : I have not done a lot of research on this, at least not up to my satisfaction and therefore the data I present is not exhaustive and at places an approximation rather than the accurate value. I have tried to be as close to reality as possible but any major deviations from the actual is due to the lack of deeper research. Please feel free to correct the figures if necessary

Today the petrol price was hiked by Rs 7.50 inclusive of tax or Rs 6.28 exclusive of tax as has been reported. This reminded me of the various price hikes in the recent past and the discussions associated with them. So, I decided to assess the situation and did a bit of googling myself. So, what I present here is my logic and what data I could mop up from the search. First, I want to analyse the price of Rs 81 that we will be paying here in Bangalore for Petrol.

The most recent quote of an IOC (Indian Oil Corporation) official says that the base price (i.e., production cost) of Petrol is about Rs 36.53 per litre. Now, lets add the hike of Rs 6.28 to this and it comes up to Rs 42.81. This is the actual cost of Petrol produced by the Refineries. Now comes the various taxes.

The central government levies

  • Rs 6.35 per litre basic cenvat duty
  • Rs 6 per litre special additional excise duty
  • Rs 2 per litre additional excise duty towards highway cess (Cess means “tax on tax” for special purpose, in this case the Highways. The entire 2 rupees is invested in the Highway projects)
  • A 3 % education cess. The total of previous 3 comes up to 14.35 and cess of 3 % on this will be Rs 0.43 (Cess = tax on tax) Hence, total comes up to Rs 14.78 per litre. The amount 14.35 before education cess is fixed in the budget and does not vary.
  • A Central Customs duty on Petrol of 7.5 % on base price (42.81) which is Rs 3.21.

State Governments also levy taxes on fuel and they vary from State to State. In Karnataka there are two more taxes to be added

  • A 5 % entry tax or Octroi on the base price (42.81) which is Rs 2.14
  • A 25 % sales tax or VAT on base price (42.81) which is Rs 10.7

Over and above this there is a dealer commission of Rs 1.05 and Approximate Transportation charges of Rs 6. So, the total approximate price of Petrol becomes (42.81 + 14.78 + 3.21 + 2.14 + 10.7 + 6 + 1.05) Rs 80.69. Please note that this is the approximate price which is pretty close to the average Petrol price from various dealers. There is difference of Rs 30.83 between base price and cost price (Excluding transportation and dealer commission). This means that we are paying about 38 % tax on the Petrol we are using. At this point I can definitely point out how USA taxes approximately about 10 % and China about 20 % on Petrol. But I dont think comparison is necessary here to say 40 % tax is pretty high. Even income tax is not so high.

Another aspect related to this tax is the subsidy part where I lack clarity. So, this analysis will be inconclusive, yet it may give some perspective on the problem. In 2010-11, Indian Oil Corporation, Bharat Petroleum Corporation and Hindustan Petroleum Corporation paid Rs 92,176 crore to the central government in customs duties and excise taxes plus an additional Rs 78,690 crore in sales tax or value-added tax (VAT) to state governments. In the same year 2010-11, these companies under-recovered (that is what they call the losses incurred due to subsidies) Rs 78,190 crore because of the government order that they sell petrol, diesel, LPG and kerosene at prices below cost. 2010-11 was not a unique year. Every year for the past five years, these three companies have seen an erosion in their net worth. Oil Marketing Companies (OMCs) hit an all-time highest under-recovery of Rs 1,38,406 crore in 2011-12. They are said to be losing Rs 500 to 550 crore every day. This is all mind-boggling but what does it all mean?

What is this under-recovery? In layman’s words it is the difference between the government subsidised price and the actual market price. But for more formal analysis we can listen to what Government says about it. The government measures under-recovery as the loss that an OMC would make if it imported a petroleum product, say Petrol, from the international market and after paying ocean freight, import charges and customs duty and incurring inland transport and marketing costs, sold the product to a dealer at the government specified price. Some questions arise when this is read. This is not done to Petrol in its entirety, crude is bought and then refined here on our land. So, it is my inference that the price fluctuations in Petroleum products must happen due to refining capacity shortages. Basics of economics, demand-supply relations. When demand is more and supply is less due to shortage in refining capacity, prices will rise. So, refining costs here and elsewhere will definitely differ and that is why when you calculate for “under-recovery” using international prices there will be a difference since its a refined product you are taking into account and not crude oil. Same concept applies to the international market as well where the Petrol price may increase due to higher demand and we will sit here and calculate the under-recovery based on inflated prices in international market thereby exaggerating the amount of under-recovery. This is where I stopped since I noticed a lack of transparency in calculations of these values. I have to dig deeper to get the details, I got some figures about the subsidies though. The Excise duty paid by the companies and the subsidies given is shown below

Excise and subsidy comparison for 2010-11 (Rs crores)
IOCL BPCL HPCL TOTAL
Excise 30861 12394 9743 52998
Subsidy 24282 10048 9727 44056

So, as we can see from above it looks more like tax refund than subsidy. Now we will take a little detour and learn about the Oil companies in brief

There are three types of oil companies:

  • Upstream companies (Indulged in exploration of hydrocarbon)
  • Midstream companies (indulged in refining of hydrocarbons)
  • Downstream companies (indulged in retailing and marketing)

There is no issue of losses in case of Upstream and Midstream marketing companies. The losses are made by the marketing and retailing companies. In-fact because of Import Parity Prices, the Upstream Companies make heavy profits. (Import Parity Prices make the prices of both domestic production as well as imported price at par. Thus the increase in global prices improve the profitability of Upstream Oil Companies). Thus it is the Marketing and retailing companies that has to bear the burnt of the losses between the international prices and the retail prices in the country. In order to bear this losses the government gives the budgetary allocation in the form of fuel subsidy while a part is now shared by the Upstream Oil companies like ONGC, OIL, etc. So, what does this mean?

Private oil producers like Reliance, Cairn, etc get rights to oil fields after signing production-sharing contracts with the government. These contracts mandate selling oil to Indian refiners at no less than the prevailing international prices. The contracts are structured such that government’s share of production will increase if the producers get a higher price for the oil. While providing the government with another source of revenue, these contracts, by locking Indian oil produce to international prices, ensure that the Indian public does not enjoy the benefits of local production since the oil we find in our land is still as costly as the one we import. This does has a reason that this will attract private investors to help in exploration but how genuine is this reason I am not sure. The government treats the public sector oil producers like ONGC, OIL, etc somewhat differently, based on historical imperatives. They must sell their oil at a ‘discount’ to international prices to the public sector refiners. The ‘discount’, however, is not tied to the rise in international prices or the windfall profits made when this happens; it is fixed every quarter, at the government’s discretion.

After having understood the mechanism lets see how these companies are doing. The Q1 results of 2011-12 showed a combined loss of around Rs 9000 crores by the OMCs. Then, the government delayed the Q1 subsidy cash payments, forcing the OMCs to borrow from banks and pay high interest charges to finance crude oil imports since they did not have enough liquidity to buy. This resulted in them posting a loss of around Rs 14,000 crores in Q2 results of 2011-12. Again, this time the announcement of Q2 subsidy itself was delayed. Apart from this the public sector oil producers provided sharply lower ‘discounts’ to the OMCs on crude oil price in Q2 compared to Q1 and showed sharply climbing profits. Remember that this ‘discount’ is at government’s discretion. While Oil producers showed sharp profit OMCs posted huge losses. Isn’t this a very favourable climate for price hike of retail petrol citing that the under recoveries are mounting and the OMCs are in huge losses? This is somewhat suspicious behaviour and I did not get much material for the more recent times which has lead to price hike of Rs 7.50. I tried to find the data for the past few months but I didnt get lucky yet I didnt dig deeper. Hence, this whole analysis will remain inconclusive beyond any doubts. But the policy and procedure of this whole “under-recovery” business will remain the same even now. So, an approximate conclusion can be reached that this policy is neither transparent enough nor sound enough to continue like this.

The central government has several revenue streams from petroleum products collected at different stages of processing. At the crude oil stage, it collects royalty, a share of the production (from private producers), and excise on oil produced and customs duty on the oil imported. At the refining stage, it collects excise on the refined products such as diesel and petrol. Oil producers, refiners and marketers also contribute to the central exchequer by way of taxes on their profits, dividends and tax on the dividends. State governments collect royalty on crude oil and sales tax on petroleum products. Sales tax rates range from 18-25 per cent on diesel and 19-33 per cent on petrol, with a few exceptions. Last year, the central government’s income from the public sector oil & gas producers, refiners and marketers alone was in excess of Rs 1,00,000 crores. State governments were not far behind, collecting over Rs 80,000 crores. In fact over the past five years, the government has collected Rs 3,48,987 crore in customs and excise duties. Over the same period, companies have under-recovered an almost equivalent amount (Rs 3,54,043 crore). Taxes on petroleum products add to the cost of all goods and services and reflect in their prices. Far from subsidising the public, governments made the public bear a substantial part of their expenditure.

This is where I get confounded as to what is subsidy and what is tax. There have been many suggestions to deregulate the prices but there are apprehensions as to the huge fluctuations of crude oil prices (it had crossed $ 150 mark once) can affect this adversely and rightly so. The subsidy mechanism cushions us from such market fluctuations but at the same time the current mechanism too is not helping us in anyway. Indian consumer pays more for petrol compared to many other developing and developed countries. Both the Centre and states levy taxes on the petroleum sector. But increasingly, the sector has attracted attention not only for its taxes but also subsidies, reflecting the tangle of taxes and subsidies in which we are caught up in terms of collecting revenues, subsidising consumers and encouraging investment in the sector. Even the proposed goods and services tax leaves the petroleum sector out of its ambit. Many questions arise out of the above discussion. Should upstream companies use their resources for new investments to find fuel for the future? Which expenditures would the government have to reduce to meet the additional subsidy bill? Should cheaper diesel benefit the use of luxury automobiles (as it is basically for farmers)?

This issue is embedded in a larger question that has an impact on an already delicate fiscal position. With the current status of our fiscal deficit reduction of tax revenues, and that too in Petroleum sector which is a major contributor, is not a viable option ; how will the government meet the revenue shortfall? Obviously, it cannot touch subsidies in the sector at the same time it reduces the taxes. This will not help the consumer. It may need to cut some other expenditure or run higher deficits. Also, we wake up to this problem only when there is a price shock through higher crude oil prices or Rupee depreciation. Without a more comprehensive approach to addressing at least the fiscal implications, merely cutting taxes on petrol would not lead to any real benefits. So, the issue when looked at on the surface appears to be simpler than it really is. Only a comprehensive change in the policy will be able to provide a lasting solution to this problem. Periodic price hikes or tax cuts will only be short term patches rather than solution to the problem and it might also increase the problem over time.

Since this is only an analysis I will end this here. Any attempt to find a solution requires deeper knowledge of the dynamics involved in this sector. Any different perspective on this is always welcome.

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7 Responses to Fuel pricing – My Analysis

  1. gadhadar says:

    I stopped reading after the 3rd para that said (“under recoveries- that’s what they call losses”).

    The oil companies never lose nor have they ever lost money in the real sense of a loss because they have never had a loss. They never sell refined oil below the cost of refining.

    Under recoveries means that “If” the state-owned petrol companies were to sell their refined oil (India only imports crude oil. We do the refining within our country) on the international market; they could have gained more. Because they are selling refined oil at a lower rate than what they “could” have sold, they call it an under-recovery and write it off on their account books!!!

    This is a scam and the Finance ministry has tried convincing the Oil ministry to mend its ways (google for references) but why should they give up an oppurtunity to con the Indian tax payers of a 1.5Lakh crore rupees in lost “presumtively” lost profits? There’s also a case in the High court (Kerala?) that seeks a court directive to stop this practice immediately.

    We’re so screwed up!

  2. cognoscis says:

    @Gada

    I know that. In fact that is what the rest is about actually. That is where I have talked about the whole “scam” and the shortcomings of it and how it is infact the public that ends up paying those bills in the end.

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