The international oil prices have continued to tumble for many months now and we are currently looking at crude oil being available at around $30 per barrel. In spite of this, the price of petrol and diesel in India hasn’t come down by much. The purpose of this article is to review the situation and understand the economics behind how oil is priced in India.
Why this article: Social media is ripe with posts about how the central government is cheating us by pricing petrol and diesel so high when oil price is so low. Unfortunately most posts ignore many basic facts and just consider the crude oil price in the market. Even though the price of Petrol has returned to around 60 rupees from its all-time high of around 75 rupees, people are still wondering if its really worth that much. So, I thought it would be a good idea to share the requisite details.
How Fuel is Priced in India
There are four main components in the price of Fuel in our country. They are:
- How much it costs to Procure & refine Crude Oil to Generate Petrol or Diesel
- Excise Duty charged by Central Government
- VAT Taxes charged by State Governments
- Commission to Fuel Pump Operators
How Much it Costs to Procure & Refine Crude Oil to Generate Petrol or Diesel
Explaining how much it costs to refine Crude Oil to produce Petrol or Diesel is a sensitive subject better left to experts in the Oil Industry. This is the variable part in the equation – whenever the international oil prices change, the amount of money required to produce petrol or diesel in our country is going to vary. So, am going to skip that part.
Of course, we also need to consider the cost of transporting the crude oil to the refinery and the refined product to the fuel stations which would also get added into the cost of fuel. This shipping could account easily for about 5% of the cost of the fuel we buy.
Central Government Excise Duty on Petrol & Diesel
The Central Government charges an Excise Duty on Petrol and Diesel that is sold to the market. So, for every litre of fuel you buy, you are actually paying this excise duty to our government. Ever wondered what this amount is?
As of January 2016, the Excise Duty is:
Petrol: Rs. 20.48 Per Litre
Diesel: Rs. 15.83 Per Litre
That’s a lot of money isn’t it?
Just to give you more information, the Excise Duty has been hiked multiple times in the last 2-3 years. The Excise Duty on Petrol was around Rs. 10 per litre in 2014 and has almost doubled in the past 2 years. Similarly, the Excise Duty on Diesel was around Rs. 4 per litre in 2014 and has almost quadrupled in the past 2 years mainly because the government feels the low diesel price has resulted in many folks opting for fuel guzzling SUV’s and personal vehicles instead of Petrol. The main reason for lower excise duty on diesel was because diesel was used in Agriculture and the government wanted to help farmers.
State Government VAT on Gross Price of Petrol and Diesel
The State Government charges a Value Added Tax on the Gross Price of Petrol & Diesel (Refinery Price + Excise Duty) to generate revenue for its exchequer. This % actually varies state to state which is the reason why the price of 1 litre of fuel is different in different parts of our country. Take a look at the table below:
As you can see some states charge a higher VAT while the others a little lower. In most cases the VAT is charged at around 20-30% of the gross price of fuel. This amount ranges between Rs. 10-15 per litre for Petrol and Rs. 7-10 per litre for Diesel (approximately)
The reason I mention the amount here is to highlight the fact that both State and Central Governments are collectively responsible for the high petrol prices in our country.
As you can see, the taxes we pay to the state and central governments is around 50% of the cost at which fuel is being sold in our country. Even though the price per barrel goes down, these taxes are pretty high which is one of the reasons for the high prices. If our State/Central Governments wanted, we could actually get fuel at much lower prices.
Commission to Pump Operators
Of course, the people who operate the Petrol Pumps need to make a living and pay for their staff who fill-up petrol or diesel in our vehicles when we visit them – right? On average the pump operators make around Rs. 1.5 to 2.5 per litre of fuel they sell.
So, all things staying As-Is, when the international oil prices Go Down, Petrol and Diesel prices should Go Down – Right?
Unfortunately No. We have missed considering an important piece of the Equation that is going to impact the price of petrol and diesel. Do you want to venture a Guess?
Yes, you guessed it right, Exchange Rate.
The Key Difference Maker – The Exchange Rate
Below is the USD vs. INR exchange rate chart (Source xe.com)
As you can see, 1 USD was ranging at around 40 rupees in 2006 but we are beyond 65 rupees per dollar now. The Indian rupee has lost more than 50% of its value in the past 10 years.
How Exchange Rate Affects Oil Price
India pays in USD for oil but our home currency is the Rupee. So, if our rupee is weak, for the same amount in USD, we pay more in Indian Rupee – correct?
Look at the table below for stats for the past 5 years:
Oil Price per Barrel was $96 in Jan 2011 and we paid Rs. 4320 per barrel. In Dec 2015, even though oil price came down by 60% and was at $37 per barrel, we are still paying Rs. 2479 which is only a 40% reduction in rupee terms. So, just because the price per barrel in USD is coming down it doesn’t mean oil price is going to fall because our rupee has been falling consistently every year in the past 5 years.
Some Last Words:
Revenue generated by sale of fuels is one of the biggest sources of income for our state and central governments. With a falling rupee, though oil prices have dropped, the amount in rupee hasnt dropped that much. However, both state and central governments have hiked their share of taxes to generate additional revenue for themselves which is why we havent been able to reap the full benefit of the crude oil price drops.
Note: India buys around 40% of its oil imports from Iran and pays in Rupees per barrel however still more than 60% of our oil is still imported in USD. Hence the comparison using INR & USD.