The Fuel Price Conundrum
How are fuel prices determined and why is the issue of their rise in prices significant? Let’s explore.
Recently, we came to know about the ban on Chinese applications on primetime television, a controversial issue on national media. However, due to this unforeseen move, a significant bit of news has been marginalised: the continuous rise in fuel prices.
Most of us know or have at the least heard about the huge increase in the prices of petrol and diesel on the news or through social media, which is indeed a matter of serious concern.
As of July 1st, the price of a litre of petrol is Rs. 80.43 and that of 1 litre of diesel is Rs. 78.40.
We maintain an ignorant attitude, sit at home and simply complain about the rise in fuel prices. But how many of us know about the factors that lead to the rise in prices of petroleum and why does the price rise occur? To rephrase: What are the determining factors in deciding the price of fuel?
Let’s understand this in detail, as well as the repercussions of the price rise and what it holds for the future.
For the ease of understanding, we’ll use the example of petrol throughout the entire article, as the factors are the same for both petrol and diesel. Please note that all the values are as of 1/7/2020 and with respect to a litre of petrol, unless specified otherwise.
If we have to understand the underlying components of the reason for this price rise, we have to understand the route through which we get petrol, i.e., we have to understand the supply chain of fuel. Where does petrol originate from?
An Origin Story: The Supply Chain of Petrol
The journey of petrol begins from the oil fields as crude oil. The crude oil is extracted from the oil fields which are located all over the world but are in excess in the gulf region.
This crude oil is brought to India by the oil marketing companies (OMCs) like IndianOil and Bharat Petroleum. There is a global standard price for crude oil which is in dollars per barrel, and only by paying this amount do the OMCs get the crude oil from the oil manufacturers. The crude oil so bought is refined and processed into petroleum products like petrol, diesel, kerosene etc. After this value addition of crude oil by the OMCs, they supply the fuel through their networks to the dealers, through their own transportation system. Who are the dealers? Yes, they are the petrol pump owners.
In short, the crude oil brought to India by the Oil Marketing Companies is cleaned, processed and refined to form petrol and diesel. This is then dispatched to the petrol pumps and we, the consumers, finally obtain the petrol from them.
Now that we know the processes through which crude oil is converted into the petrol that we use daily, the factors behind the price rise become easy to understand.
So for petrol sold at Rs. 80, these are the factors at play:
1. The Global Crude Oil Price
The global price of crude oil is a fluctuating price based on the supply and demand for crude oil in various parts of the world. This is the price at which the OMCs buy the crude oil from the Crude oil manufacturers. As of today, the price is approximately $40 per barrel. The price of crude oil is always expressed in dollars per barrel, which is an industry-standard.
A barrel has a capacity of 159 litres. Now, with a conversion rate of Rs. 75.56 for $1 as on the 1st of July, the price of crude oil comes out to be Rs. 19 per litre. Also note that as the exchange rate of the Indian Rupee with the US Dollar increases, crude oil prices decrease and vice versa. As to how this value changes, that’s a story for another day.
Price after consideration of factor 1: Rs. 19.
2. Price Charged From the Dealers
This refers to the money that the dealers pay to the Oil Marketing Companies for refining, logistics, transportation, overhead charges etc. This amount is decided by the oil marketing companies, taking into consideration the cost incurred on the processes and a basic profit margin. According to the Economic Times, as on 30 June 2020, this figure was approximately Rs. 8.5. This was the price charged by the OMCs from the dealers to refine and transport petrol to the dealers, i.e. the petrol pumps. Taking into account the entire costs incurred by the OMCs, they charge a total of the two costs.
Price after consideration of factor 2: Rs. 27.5.
3. Dealer’s Commission
Every dealer incurs costs like the wages of the workers, maintenance of the petrol pump and many other expenditures, which are a mainstay of any business. And obviously, we don’t expect them to work without any profits. Hence an amount of 3–4 rupees is generally charged by the dealers as commission. For our ease, we will take this as Rs. 3.5.
Price after consideration of factor 3: Rs. 31.
Petrol has reached the pumps at this rate, but a significant amount of Rs. 49 still remains to be added to achieve the retail price.
4. Central Excise Duty (CED)
Here is where the taxes begin to rear their ugly heads. For every litre of petrol sold by the dealers, the central government draws a tax from the sale. This tax has a peculiarity, in that it is not a fixed percentage; rather, it is a fixed amount.
As of today, we pay a staggering Rs. 32.98 as tax to the Central Government for every litre of petrol bought. A very huge amount in itself. This is almost 40 per cent of the current retail price of petrol, an alarming fact indeed. As we can see, in the financial year 2014–15, the CED was only around Rs. 9.5 but within a year, we could see a huge change as this rose to Rs. 21.5. Even that pales in comparison to the CED now, which is a staggering Rs. 33.
Price after the consideration of factor 4: Rs. 64.
5. State Specific Value Added Tax (SS-VAT)
The last factor is the State Specific Value Added Tax (VAT). How is it levied?
We consider the sum after taking into account all the factors till factor 4; In this example, an amount of 64 Rupees. To this amount, the State Government adds a specific percentage of the same as Value Added Tax.
Each state has its own VAT percentages. It is only when you add this percentage to the mix that we get the final cost of petrol that we get in the pumps. So how much is this sales tax?
A majority of the states have VAT percentages greater than 20%. As the national average of the state-specific VAT is approximately 26%, we can consider the VAT to be the same in our example. 26% of 64 is approximately 16, and when this is added, brings up the total cost to 80, the retail price of petrol.
Price after consideration of factor 5: Rs. 80, the final retail cost of petrol.
Now that we understand why the cost of petrol has come to what it is today, why do we tax fuel in the first place?
A fuel tax is basically an excise tax imposed on the sale of fuel. In most countries, the fuel tax is imposed on fuels which are intended for transportation. Fuels used to power agricultural vehicles which are similar to diesel are taxed at a different, usually lower rate. Sometimes, the tax is used as an eco-tax, to promote ecological sustainability.
In countries like India, the fuel tax is a source of general revenue.
What we need to be concerned about here is the sheer magnitude of these taxes. When the cost of petrol is Rs. 80 like it is now, the actual cost minus the taxes is only 31 rupees. This is alarming. We were bothered about several items being taxed at 18%, like the GST on Porotta which caused a furore on social media.
But as we’ve seen in this case, the tax addition is a staggering 158%, which is an amazingly huge number.
So how did the taxes reach this level? Is this an anomaly or was it always like this?
In the 2014–15 financial year, the crude oil price in the international market was Rs. 51. But still, we got petrol for Rs. 75, i.e. only a bearable cost addition of Rs.24 was present. But after that, we could see that the price of crude oil in the international market kept on dropping, but still the cost of petrol that we got never reduced. Why did that happen? That is where the Government subtly and tactically increased the central excise duty.
As mentioned earlier, in 2014–15 when the crude oil price was approximately Rs. 50 the Central Excise Duty was only Rs. 9 but as the cost of crude oil decreased, they increased CED so these two balanced out; making the price of petrol remain constant. However, this backfired in mid-2018 when crude oil prices gradually started to rise but the taxes weren’t reduced. As a result, the nation witnessed the price reach an all-time high of Rs. 85 per litre, followed by protests and hikes against the same. The situation is eerily similar now. Recently, as we have seen in the lockdown period, the prices of fuel are being hiked daily for many days in a row, which has resulted in serious inflation in the cost of petrol available to the consumers.
What is concerning is the fact that India is the country with the highest taxes on fuel in the world at 69 per cent, and even then, there are even plans to increase the CED again so as to generate more revenue for the Central Government.
Some semblance of relief comes from the fact that some State Governments are utilizing the State Specific Value Added Tax by taking a small cut on it and returning it back to the consumers through welfare schemes.
To better understand the implications of these taxes, we’ll take into account the entire revenue generated by the central Government.
How much money does the Government make through the taxes?
In 2014–15, Central Excise Duty levied alone was 31165 crores. It is estimated by Moody’s investor Service that if the new increase in the CED by the Government (for both petrol and diesel) is maintained for the full year, they will have an increase in the collection (not the entire amount) of 21 billion dollars. Even this figure is a conservative estimate, taking into account the reduced number of vehicles out on the road in the times of the pandemic.
As per CNBC-TV18, the Government has collected 40000 crores in the first two months of the financial year 2020–21.
Even though taxes are imperative for the sustenance of a developing nation, burdening the poor with exorbitant taxes is not the best-suited option, but unfortunately, it is the stance of the Government as well.
What does the future hold?
Due to the increased demand caused by the easing of lockdown measures, the price of crude oil is expected to rise in the coming weeks. The Government should reconsider the policy of increasing the taxes so as to steady the fuel prices. If this is not done at the earliest, the day is not far off when the price of petrol touches the 100 rupees mark!
