Fuelling Fuel Price – Bizarre Rationale

Mohamed Asif Ben Mammutty

Boiling Frog Syndrome is the state of the current Indian common man with respect to the spiking petroleum fuels price. Barring sporadic protests, it is of no concern to majority of the people. They are accustomed to it and have accepted it as a routine, though the fuel price hike has direct impact on the day-to-day life of the people, as it causes inflation, and commodity price rise. It pinches the pocket of the common man.

“Surge of crude price” as the reason for the sky-rocketing price by the government is bizarre. The main cause of price-hike is the government policy, and let us just analyse the factors that lead to the daily price rise of petroleum fuels.

Price Decontrol

Fuel price decontrol was a step-by-step exercise, with the government freeing up prices of Aviation Turbine Fuel (ATF) in 2002, petrol in 2010 and diesel in 2014. Before this, the government used to intervene in fixing the price at which the fuel suppliers used to sell diesel or petrol. Price decontrol essentially allows fuel suppliers such as Indian Oil, HPCL or BPCL the freedom to fix prices of petrol or diesel based on calculations of their own cost and profits. While fuels such as domestic LPG and kerosene still are under price control, for other fuels such as petrol, diesel or ATF, the price is supposed to be reflective of the price movements of the so-called Indian basket of crude oil.

Pricing Methodology

Dynamic fuel pricing system is followed in India to determine the retail price of petrol and diesel. Since the pricing decontrol, the government is not directly involved in fuel pricing. Government imposes duty/tax on the petroleum products, without directly indulging in the pricing process. At present, the fuel prices are revised daily, and this is supposed to be done to transfer any gain due to falling crude oil prices to the consumer.

Dynamic Pricing

The practice in India had been to revise the petrol/diesel prices fortnightly. Accordingly, the prices changed on the 1st and 16th of every month. This pricing system was changed on June 16, 2017, by implementing a new system altering the then fortnight revision of price to daily revision, and the prices started to be revised at 6 am every morning. This shift from administrative price mechanism (APM) to dynamic pricing was done to ensure that even the benefit of the smallest change in international oil prices gets reflected in the retail price. Prevention of huge leaps in prices at the end of the fortnight too was an objective of this change.

Arithmetic of Pricing

Pricing of petrol and diesel involves various factors. Basic factor is the cost of crude oil in the international market. The crude oil is transported to the refineries to extract petrol and diesel. The crude price, freight charges and refinery charges are added to the price of crude oil. This is called the Refinery Transfer Price (RTP), i.e., the price paid by the Oil Marketing Companies (OMC) like IOCL, BPCL and HPCL to the refineries. OMCs charge a margin. Dealer commission and duty/taxes imposed by the Union government and respective states (VAT) are added to this price. All these add up to the final Retail Selling Price (RSP) of Petrol that reaches the consumer. There are differences in the price in various states because of the different VAT rates. The price also varies between a pump owned by different OMCs. These minor differences are because of the variations in margins and dealer commission.

The retail price calculation is just simple arithmetic:

Retail Selling Price (RSP) = Crude Price + Freight Charges + Refining Charges + OMC Margin + Excise Duty & Central Taxes + Dealer Commission + VAT

Note: As the crude oil price is in US Dollars, and freight is paid in Dollars, the Rupee – Dollar exchange rate has an impact on the crude price and freight charges.

International Crude Oil Price Vs. Rocketing Fuel Price in India

Globally, the retail price depends on the fluctuation of crude oil price in the international market. When crude price goes up, fuel prices too go up and vice versa. But crude price has no role in the rise of petrol and diesel prices in India, at present. The one and only factor that causes the fuel price rise is the indiscriminate imposing of excise duty by the central government and corresponding VAT charged by the state governments. The Income from the duty/tax on petroleum products is a huge revenue generator for the government, and it will be foolish to think of a reduction in duty/tax. Government would pass the buck to the “crude oil price rise,” as the statement “surge in global crude oil prices” is the reason for price-hike by the Union Petroleum Minister Dharmendra Pradhan, reveals.

As has been mentioned earlier, the most important factor that impact the retail price is the duty/cess/tax levied by the state and central governments. Petroleum fuels are, at present, kept outside the purview of Goods and Services Tax (GST). It had been the practice in the past to cut duties when global crude prices increased, so as to benefit the end-user. However, since 2014, the government has been increasing excise duty irrespective of the global crude price fluctuation.

Since 2014, fuel prices go up in India, even when crude oil price in the international market falls. To take an example, the petrol prices now (in June 2021) is much higher than the Full Year 2014 price – Rs 71.51 a litre and Rs 57.28 in Delhi – when India’s crude basket price was $105.5 per barrel. The current crude price is around $73 per barrel and the petrol price has hit century. Petrol has crossed the Rs 100 mark in some states as a result of a Rs 4.9 per litre hike in its price since the beginning of May. In Mumbai, petrol is retailing at Rs 101.76 per litre, while diesel is retailing at Rs 96.94 per litre after total hikes of Rs 11.6 per litre and Rs 12.4 per litre, respectively since the beginning of the year.

On May 5, 2020 the Centre announced one of the steepest ever hikes in excise duty by Rs 13 per litre on diesel and Rs 10 per litre on petrol, following up another round of sharp hikes in the first week of March. Prior to the increase in excise duty in February 2020, the government, centre plus states, was collecting around 107 per cent taxes as excise duty and VAT, on the base price of petrol and 69 per cent of diesel. On March 16, 2020, through the first revision the government collected around 134 per cent taxes, on the base price of petrol and 88 per cent of diesel. The second revision in excise duty on 6th May 2020 amounted to around 260 per cent taxes on the base price of petrol and 256 per cent of diesel, according to estimates by CARE Ratings.

In Delhi, central and state taxes account for about 57 per cent of retail prices of petrol and about 51.4 per cent of the retail price of diesel. The central government had in 2020 hiked the excise duty on petrol by Rs 13 per litre and on diesel by about Rs 16 per litre to shore up revenues as the pandemic led to a sharp fall in economic activity. Central levies account for 71.8 per cent of total taxes on petrol and 60.1 per cent of total taxes on diesel in the national capital.

Crude prices nosedived from an average of about $55 per barrel in February 2020 to $35 in early March, and then falling to $20 by end March as demand slumped because of the pandemic. From that point, the prices have recovered to around $73 now. Amazingly, for more than 80 days starting 27th February, after the declaration of state assembly elections, the fuel prices were frozen, even as the excise duty on fuels was hiked by the centre twice.

While a number of states including Rajasthan, West Bengal, Assam and Meghalaya have reversed hikes in state levies imposed during the pandemic, the central government has not cut central taxes despite calls from the RBI that taxes on auto fuels should be cut to curb inflation.

Oil price decontrol is a one-way affair in India. Here, the consumer is the victim always. It is him to cough up more, irrespective of the crude price fluctuation. As a global practice, the price rise of crude oil is inevitably passed on to the consumer. Logically, the consumer should benefit when the crude price declines. But in India it is not the case. The government, as a natural process, raises the excise duty/cess and taxes to “make up” the price dip and keep the revenue to the coffers maintained. The key beneficiary in this subversion of price decontrol is the government; and the consumer is the clear loser.

LPG Price

Liquefied Petroleum Gas (LPG) is the gas we use for cooking. It is a mixture of butane and propane.

LPG pricing is not decontrolled, as of the petroleum fuels. It is determined by the state-run oil companies and revised on a monthly basis. Domestic LPG comes under the purview of GST and hence its price is not affected by the excise duty imposition and VAT, unlike petrol and diesel.

Import parity price (IPP) formula is the basis of determining the price of LPG in India. This formula is driven by the international LPG prices. Saudi Aramco’s contract prices are considered as the benchmark for this calculation. The IPP formula includes the FOB (free on board) price, ocean freight, insurance, custom duties, port dues, etc. This price, quoted in dollars, is then converted to rupees. To this is added the cost of inland freight, marketing costs and margins charged by the oil companies, bottling charges, dealer commission and the GST. This gives the retail selling price of the non-subsidised LPG cylinder for the Indian customer. Dollar-Rupee exchange rates also affect the prices.

The Centre provides subsidy, through direct bank transfer, on 12 LPG cylinders (14.2 kg) a year per household. So, many customers pay a subsidised rate of about ₹530-550 (current price) per cylinder. The subsidy amount changes month-on-month based on international LPG prices and dollar-rupee exchange rate. On purchases beyond 12 cylinders a year, the household has to pay the non-subsidised price. The Centre has done away with the subsidy for those with annual taxable income of over ₹10 lakh.

Excise Duty and GST

Excise duty is a sort of tax levied on goods produced within the country, as opposed to customs duties, charged on goods from outside the country. It is a tax on the production or sale of a good. This tax is now known as the Central Value Added Tax (CENVAT).

GST or Goods and Services Tax is an indirect tax which has replaced many indirect taxes in India such as the excise duty, VAT, services tax, etc. The Goods and Service Tax Act was passed in the Parliament on 29th March 2017 and came into effect on 1st July 2017.

Under the GST regime, the tax is levied at every point of sale. In the case of intra-state sales, Central GST and State GST are charged. All the inter-state sales are chargeable to the Integrated GST.

The figure below explains the taxing system before introduction of GST.

After the introduction of GST, all goods except petrol, diesel, ATF and tobacco and alcohol have been brought under GST regime and hence, petroleum fuels, tobacco and alcohol are still levied with the excise duty.

Will Bringing Petroleum Fuels Under GST Regime Cause Reduction of Fuel Price?

As has been seen earlier, the fuel price (except LPG) hike is caused by indiscriminate levying of excise duty by the centre and the VAT collected by the states. So, if the petroleum fuels are brought under the purview of GST, naturally the excise duty and VAT will vanish, and the price spike will be curbed. The price fluctuations will then bank only on the international crude price.

A question, ‘then why is the LPG price going up despite it being charged only GST and not excise duty and VAT?’ would naturally arise.  

The answer is: Indian LPG is a mix of butane and propane in 60:40 ratio. And, the basic factor of LPG retail price calculation is the Saudi Aramco price of butane and propane. Saudi Aramco set its term contract price at $625 per metric tonne in March, up by $20 per mt from February. Similarly, butane price also increased by $10 to $595 per mt in March. This is a 171 per cent increase in propane and a 148 per cent increase in butane prices since May 2020, when the propane price was at $230 per mt and butane at $240 per mt.

 

Unlike in the case of petroleum fuels, LPG price is directly impacted by the international crude price and the dollar-rupee rate, and not by excise duty and VAT.

 

GST has four fixed slabs of 5%, 12%, 18% and 28% for taxing and even if the highest slab of 28% is charged on petroleum fuels, a drastic price-dip will result. Both the centre and state governments will not agree to bring the petroleum fuels under GST, as it will block the humungous flow of revenue to the coffers, through excise duty for the central government and through VAT for the state governments.

 

Nobody will kill the goose that lays golden egg! 

 

——

 

Statistical data are collected from the web

Prepared on 15th June 2021

WordPress Image Lightbox