Mechanics of fuel price in a deregulated regime

A litre of petrol costs Rs 90.44 and a litre of diesel costs Rs 80.77 in the national capital Delhi and Rs 96.81 and Rs 87.79 in the financial capital, Mumbai (as per data, IOC, April 16, 2021). The scenario of the retail price surge is not different in cities like Bengaluru (petrol - Rs 93.43 and diesel - 85.60, as of April 25, 2021), the electoral battlegrounds of South India.

Mainstream political parties are damn silent about the ever time spike in oil prices which affects the lives and livelihoods of people. The inherent upward trend has lost some momentum after the election commission announced results in some states. Although there was a marginal cut in Petrol (16 paise per litre) and Diesel (14 paise per litre) by the OMCs on April 15, it does not provide adequate benefit to the common man. Prices tend to go up again after the election.

Both centre and state governments blame the international price fluctuations when there is a hike in petrol price. India imports more than 82% of crude oil from other countries and fuel price is correlated with the international price of Brent crude oil. But as everyone knows, by the same token, domestic prices also must decline followed by a decline in global prices. Quite often, the upward movement goes hand in hand but not the downward movement. Why?

Theoretically, the demand-supply factors determine the high prices, but often economic theory alone cannot explain the rise in oil prices as it has other components of central and state taxes and dealer commission. The high price is always associated with the ‘dynamic pricing’ by the government.

Deregulation of fuel prices

In order to understand how fuel prices are being decided, we should see a bit of the deregulation of petrol and diesel prices. The government had periodically intervened in the retail prices of fuel, in 2010 (Dr Manmohan Singh) deregulated the price of petrol and gave liberty to Oil Marketing Companies to fix the price of petrol based on the calculation of their cost and profit. Further deregulation of diesel was implemented in 2015 (Narendra Modi).

The rationale of deregulation is to manage the cost of the oil prices by retailers like BPCL, Indian Oil Corporation, HPCL as these companies were suffering due to losses and the compensation from the government do never reach them on time. The deregulation of petrol prices in 2010 and diesel prices in 2014 gave companies the rights to revise the prices. Despite these changes made in the system, the oil prices are at a skyrocketing level, and the progressive promises made by the political parties during the times of election are nowhere helpful at this critical juncture.

Why a small country like Nepal, which has no refinery and mainly depends on India for its oil requirement, has a lower price of fuel? Major oil-producing countries had a cut in oil production since there is a steep fall in the demand especially when the transportation sector was standstill during the days of the Covid-19 pandemic-induced lockdown. Why oil prices in India are high despite a fall in the international prices of crude oil? the trend in prices gives a clear picture.

The trend shows the domestic prices are not coupled with the fall in international prices. Then what would be the reason for the current surge in oil prices? Therefore, it is important to look at the methodology of oil prices in India.

Fuel price dynamics

The composition of oil prices consists of three factors. 1. Processing and cost of refining crude oil – base price. The OMCs purchase crude oil from the international markets. After the processing, the fuels like Petrol and diesel produced also require substantial freight charges 2. state and central tax 3.dealer commission. The prices are calculated based on this criterion.

The methodology of prices shows the various costs involved in the production of fuels from the initial stages to the final stage. Petrol and diesel are refined and processed from the crude oil and it is distributed by the retailers in the final stage. The cost involved in the initial stage of processing, refining and freight charges of petrol come at the base price of Rs 30.09 (April 2021). The Central excise duty is Rs 36.47, the state duty is Rs 20.96, the dealer commission is Rs 3.65. and the final retail price is Rs 91.17 which includes a major portion as tax. Although the base price was high, the retail price was comparatively low in May 2014.

Hence the pricing shows the increase in fuel prices is correlated with the tax by the central and the state government and not always due to the spike in the price of crude oil in the international market. Thus, the common man is forced to pay a high tax for fuel, which is nearly 200% of the cost of refining. Juxtapose the current situation to countries like the USA, the average price of diesel is $0.82; in Germany, it is Euro 1.276 per litre and in Netherlands Euro 1.391 per litre (March 29, 2021), where people receive high income in the form of wages and salaries whereas a country like India, where a substantial section of the society lives on less than 99 cents a day, has to suffer this burden involuntarily.

At present, India has more than 256 refineries like Jwalamukhi, Digboy, KG Basin etc and two oil producing authorities such as IOC and ONGC. The government stopped the subsidy to the oil marketing companies and the fuel prices are under the control of the state and central government and there is a habitual increase in the fuel price bimonthly since July 2016. Now that it is not a surprise as it changes every 24 hours. Even if there is a fall in the international prices, Government still charges fresh taxes to assimilate profit from the fall in prices.

Often, a clear picture of the situation can be brought into light with an interaction with auto men/taxi drivers which divulges the pain of the common man in the scenario of escalating fuel prices creating a heavy burden on people’s lives. This despair continues in every Indian household irrespective of their ownership of a vehicle. The lives of the people cannot be improved without adequate measures to boost the demand in rural-urban households.

Although the trend in headline inflation remains at a moderate rate of 5%, the core inflation increased to 5.96% in March 2021. The rising prices put pressure on the cost of inputs and other commodity prices.

Keeping high oil prices and reducing fuel subsidies to the oil-producing companies create a detrimental situation to the economic growth as oil is a commodity which fuels the dreams and development of the nation.

(The writer is a Doctoral fellow at ISEC, Bengaluru currently working as Asst Professor at Christ (Deemed to be) University, NCR)