The Rising Fuel Price

REALITY CHECK

The Rising Fuel Price

Fuel and its various components are integral parts of our day-to-day life. A fuel is any material that can be made to react with other substances so that it releases heat energy to be used for work. Crude oil, a naturally occurring unrefined petroleum product, consisting of organic materials and hydrocarbons, is removed from the ground and sent to the refinery, where different parts of crude oil are separated to form various liquids and gases. These liquids are further utilised in making petrol, diesel, and other petroleum products.

In India, one-fifth of the crude oil requirements are met from domestic production, and for the rest four-fifth, we are heavily dependent on the US, Africa and Middle East countries to support our nation’s demand.

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Petroleum Products Made from a Barrel of Crude Oil

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The products and by-products of crude oil are directly or indirectly consumed by the end-users. With the rise in oil prices, people, especially the poor, who are already working very hard to earn their daily bread and whose conditions have already been worsened due to the ongoing pandemic, are among the ones are most affected. This daily hike in fuel prices will further paralyze the lives of these already burdened people. Fuel, being the necessity in our day-to-day lives, has affected not only the people but also various sectors like transportation, textiles, auto, FMCG, etc., for manufacturing and transportation. Daily essential commodities have also been affected eventually due to a lack of such factors.

Petrol & Diesel Price History in India

Info 4The prices of petrol and diesel have risen to a great extent today in comparison to 2002. The following table displays the price of petrol and diesel per litre in Delhi since 2002. As seen in the table, the petrol price has consistently gone up and the same can be seen with diesel prices.  Prior to 25th June 2010, the oil companies used to receive a massive subsidy from the government, but it was discontinued from this date onwards. The government allowed Public sector undertaking (PSU) oil companies to price petrol freely. Later, the subsidy on diesel was withdrawn on 18th October 2014 by the then elected government. The excise duty on fuel was hiked almost nine times when the global prices came down between ’14 & ‘16 – reduction of duty was noticed in 2017 once. Between 2002 and 2014, both the prices of petrol and diesel had doubled. The government allowed Public sector undertaking (PSU) oil companies to price petrol freely. Later, the subsidy on diesel was withdrawn on 18th October 2014 by the then elected government. The excise duty on fuel was hiked almost nine times when the global prices came down between ’14 & ‘16 – reduction of duty was noticed in 2017 once. Between 2002 and 2014, both the prices of petrol and diesel had doubled.

The fuel prices are primarily dependent on two factors: Crude Oil prices in the international market and the taxes levied by the central and state governments, whereby the crude oil price depends on the international market and the currency rates worldwide. It can be observed that even if the crude oil price started decreasing after 2014, the retail price increased. In fact, in 2019-20, crude oil was as low as approx $39 a barrel, whereas petrol was approximately Rs. 80. This implies that the tax rate, i.e. excise, VAT, and others levied on fuel, has not been reduced to benefit the ordinary people. Ever since the dynamic daily pricing was implemented (2017), an increase in petrol and diesel prices were observed.

Info 5The various changes in crude oil prices and their reason in brief have been mentioned in the diagram beside. The Covid -19 pandemic, which affected the economy worldwide in the year 2020, was the cause of the fall of crude oil prices due to the fall in demand. There was no transportation as mobility was curbed due to worldwide restrictions to contain the deadly virus. Also, there was a need to cut down the production of crude oil, for which OPEC+ held a meeting but it did not produce useful results. With demand down, the addition of fuel (increase of supply) to an already saturated market led to a record production and also diminishing storage space, the result of which led to a price fall in April 2020.

The decision of OPEC+ to cut down production, along with the increase of demand in fuel which was due to ease of restrictions during the pandemic, led to the prices respond quickly and an increase was gradually seen.

Factors Responsible for Price Movement of Crude Oil in Global Markets

Supply Initially, the pricing powers rested with the USA as oil was first commercially extracted there but post 1973, the balance of power shifted to OPEC counties.

The Organisation of Petroleum Exporting Countries (OPEC), with its oil producing member nations, is working together to determine crude oil prices by reducing or increasing crude oil production. Even though the grip of OPEC has loosened in the past few years, its decision still plays a vital role in policymaking. Therefore, governments, oil companies, traders, policymakers, consumers, etc., closely observe the OPEC movements.

OPEC +, formed in 2016, is basically an amalgamation of OPEC and 10 other oil-exporting nations such as Russia, Sudan, South Sudan, Azerbaijan, Brunei, Bahrain, Malaysia, Kazakhstan, Oman, and Mexico, has control over the price of crude oil. OPEC+ remains influential due to 3 factors:

  • No alternative source which can be equivalent to its dominant position
  • Saudi Arabia having the lowest Barrel production cost
  • Absence of any other source in the energy sector matching crude oil in terms of being economically feasible.

Drastic price movements, in the past, have been due to supply disruptions triggered by political reasons such as the Iranian revolutions, the Iran -Iraq war and the Persian Gulf War, along with the global economic crisis of 2007 – 08. In addition, some external factors also impacted oil supply includes technological innovations (the USA in 2018 global source of oil production – shale oil production and drilling technique advancements), Exploration and Production cost, natural calamities, war, etc.

info 5Demand – Strong economic growth and industrial production boost demand for oil. Other factors are transportation (commercial and personal), population growth, natural calamities, etc. To explain the demand concept here, we look at the situation of the Covid-19 pandemic that triggered the unprecedented demand shock. The worldwide shutdown of business – stay at home rules, travel restrictions to contain the pandemic led to a massive reduction in oil demand. Hence, the impact of reduced economic activities led to oversupply and prices fell to a large extent.

Along with this issue, there was a month-long price war between Saudi Arabia and Russia, which finally concluded after OPEC and its allies cut production of Crude oil by 9.7 million barrels per day for an initial period starting May 1, 20 and then 7.7 million barrels per day from July ’20 through Dec ’20. This delay in production cut was in a way responsible for the volatility in their prices. With ease in restrictions, the rollout of vaccines, demand gradually increased and so was the supply and prices of crude oil per barrel ($18/barrel in April ’20, $43/barrel in November’20, $66/barrel in May’21).

Changes in the Energy and Fuel IndustryAn increased awareness of the benefits of renewable energy resources, and hybrid and electrical vehicles might lead to a decline of reliance of the world on oil. Countries such as Denmark are aiming to be completely fossil fuel free by 2050. It will lead to a decline in oil demand and, therefore, the prices will drop.

Market Speculation & Derivatives – Oil prices are set on the futures markets, which mean that market speculation about future events could impact oil prices. With time more and more market participants are buying and selling crude oil in the form of contracts. Derivatives are used to hedge against fluctuations in oil prices while speculators move those prices upwards or downwards when opportunities for buying and selling are there in the market.

Strength of the US Dollar – Prior to 1971, US Dollar was pegged to the price of gold and every other currency was pegged to the dollar. As a result, the dollar became the world’s reserve currency and oil was brought and sold in terms of US$.  Oil is exchanged in US$ even now, though, after the year 1971, the US had scrapped the gold standard.

The value of the dollar has a significant impact on the price of oil. The oil price tends to drop nominally if dollar becomes stronger and vice versa.

How Are the Prices Set in India?

To begin with, we shall talk about the pricing mechanism of fuel in India. The Administered Price Mechanism (APM) (1975-2002) by which prices of oil are controlled at four stages viz. Production, Refining, Distribution, and Marketing, work on the principle of compensating normative cost and allows a pre-determined return on investment. The national oil-producing companies such as ONGC and OIL were compensated and allowed a percentage of post-tax return on capital employed – whereby, the two companies sold crude to the refiners at less amount than the international prices. The sourcing and import of crude and petroleum were done by the Indian Oil Corporation (IOC), controlled by the empowered standing committee of the centre. The refining sector was also compensated for acquiring crude and raw materials, and operating costs allowed a percentage of post-tax return on net worth. The consumer prices were also fixed under a similar cost-plus formula wherein marketing and distribution costs were compensated and return percentage was guaranteed. The government also maintained the commissions and margin of dealers at the distribution level to maintain uniformity in the commission rate.

The APM was not much encouraging for the then-existing PSUs as investments and costs were only reimbursed and there was no incentive for further expansions. Also, opening up of foreign and private investment door inflated the cost and risked the PSUs.  Private participation was first opened in the refinery sector with the Industrial Policy of 1991 (Reliance Refinery). Industry to the market-driven decision was an important decision that led to the dismantling of the APM in 2002. This had led to the private sector rapidly set up retail operation (Petrol pumps by shell, Essar, RIL).

A new regime eventually came to being, where the OMCs were to set retail product prices based on a formula of Import Parity Price was made – continuance of which was abandoned after mid 2004 and the Central Government once again had control over the prices. After the government regained control over price, the retail licence of private firms was forced to close because of the uneconomical business of retail trading of petrol and diesel.

The price of diesel and petrol in India is determined by the method of TRADE PARITY PRICE (TPP) and not by the actual costs incurred by the PSUs (IOCL,HPCL and BPCL). In India, 80% of petrol and diesel is imported while 20% is exported – as assumed.  Hence, petrol and diesel prices are assumed on the basis of the prices of fuels in the international market and not on crude oil prices. The crude oil prices do not always move in a similar direction to that of the petrol-diesel prices in the international market as the market mechanism of demand and supply of crude oil varies from that of demand-supply of petrol and diesel and, thereafter, their pricing behaviour also differs.

Managing the cost of the oil prices by retailers like BPCL, IOC, HPCL was a serious task as they were suffering huge losses. The periodical intervention of government in retail prices of fuel – which in 2010, petrol prices, was freed from government control and liberty, was given to OMCs to fix petrol price based on cost and profit calculations.  In 2014, the deregulation of diesel had taken place.

Info 6 Info 7Dynamic Fuel Pricing, which came into effect in 2017, was claimed that the benefit of even the slightest change in international oil prices would pass to dealers and consumers. In this pricing method, the state-run fuel retailers – IOC, HPCL, and BP revise rates on 1st and 16th of every month based on international prices in the preceding fortnight and the currency exchange rate. The retail selling prices of petrol and diesel are also revised on a daily basis.

The TPP in dollars is converted to rupees along with other costs and margins of oil companies, dealer commission and taxes.

Furthermore, the method of dynamic pricing, which is based on the 15-day average international rate, affects the time lag. Fuel cost has also increased due to the weakening of the rupee against the dollar over the years.

Taxes by the central government such as central excise and VAT by state governments, are also added to the fuel cost.

Factors Affecting the Fuel Prices in India

Oil being one of the most important sources of energy is a finite and non-renewable source of energy. The increasing demand for oil due to its immense importance in our daily lives is likely to be responsible for its rising prices. Some of the factors affecting fuel prices in India have been summed up as follows:

Cost of Crude Oil – Unrefined oil or crude oil is an international market commodity whose price change affects the prices of fuel in India. Price varies with the demand-supply factors of crude oil, geopolitical relations and future reserves & supplies.

Price Charged to Dealers – Crude oil is acquired and distributed by Oil Marketing Companies (OMCs), and they charge a price to the dealers. This price, which is based on several factors such as freight charges, refining cost, etc., becomes one of the components in deciding the fuel price.

Commission For Dealers – Fuel dealers are paid a commission by OMCs, which includes earnings, costs and profits of petrol pump owners.

Central Excise Duty – The excise duty charged by the central government on petrol and diesel is a pre-determined amount of money, which is irrespective of the rise and fall of crude oil.

Value Added Tax – This tax is imposed by the respective state governments, which is basically calculated taking into consideration other factors such as the excise duty charged by central government or commission to dealers, etc.

Valuation of INR Against USD – This factor is one of the important aspects in the price determination of petrol and diesel in India. Crude oil, which is refined to obtain petrol and diesel, is bought from the international market and the transaction is done in US dollars. Hence, the strength of USD against INR is a direct factor. If US$ is stronger than the Indian rupee, then the cost of purchasing crude oil will be higher and hence, the price of finished products will also be higher.

Refineries – Imported crude oil in India are sent for processing across refineries. Having less number of refineries will imply that there are less quantity of diesel and petrol for sale. Hence, prices are meant to increase if there are lower supplies.

Demand For Fuel – Steadily increasing two-wheelers and four-wheelers on the Indian roads has led to an increase in petrol and diesel demand. The oil refinery companies have to acquire crude oil from the international market in order to process the same into petrol and diesel; the supply might not be fulfilled always. Less supply and demand being more, the price of fuel is bound to increase.

PRICE RISE IN INDIA DESPITE FALL IN INTERNATIONAL CRUDE OIL PRICE

During the first wave of Covid-19, the international crude oil prices were lower than usual since restrictions imposed to curb the deadly virus caused immobility and supply were more than the demand. The fall in the crude oil prices has not transmitted into the petrol and diesel retail prices. Back then, it was told by the Principal economist of ICRA that a dip in consumption of fuel during the lockdown period of 2020 has had an impact on the state government revenues. Taxes, commissions and other charges levied on the end-users ensure that fuel rates are high even when crude oil prices are lower. Hence, it can be concluded that to offset the losses incurred by the government, more tax is being collected, and hence, the advantage of lower crude oil prices are being taken. In addition, there was also a hike in excise and special excise duty of petrol and diesel. Simultaneously, during this phase, the slump in fuel demand has caused a tremendous loss to the Oil Marketing Companies (OMCs). Hence, to offset their losses, they are also taking advantage of low crude oil prices and did not pass the benefits on to the retailers.

Info 8After a gradual easing of lockdown, the crude oil price revived but the fuel prices in India increased – the reason stated for which is the imposition of fresh taxes with fall in crude oil price. During the period of May 2020, when the crude oil price was halved (From Rs. 28.84/litre to Rs. 14.75/litre), excise duty was hiked by Rs.10 on petrol and Rs. 13 on diesel per litre. Thus, when tax collection on every other sector dropped, it increased for fuel – excise duty on petrol and diesel collected was 48% more from end-users from April-November 2020 in comparison to 2019.

It was noticed that in March and April 2021, the fuel prices was almost static. However, during the peak of the Covid-19 second wave in India, the fuel prices have surged almost 24 times since May 4 ‘21 and more than 8 times in June alone. As a result, petrol prices crossed Rs. 100 mark in various states and UTs of India.

The global crude oil prices are hovering around $75 per barrel with petrol prices around Rs.96 whereas, in October 2018 it was $80 a barrel with petrol prices Rs.80. Hence, we can observe that although price of crude oil is low yet the fuel price has hit a century and crossed by a wider margin in most parts of India.

The government had debts in the past due to unrealistic subsidies, which are now partly being repaid with the collection made due to low oil prices. The increase in taxes on petroleum products can be seen as a safety valve, the effect of which becomes a transfer from state treasuries of oil producers to the treasury of India. The government has the option of cutting down the excise duty once the international price of crude oil increases. But in case the international crude oil prices rapidly increase, this process may not be useful in controlling the situation to benefit the consumers. In such a scenario, the Government may have to bring back some of the subsidies, and for that to happen, its current deficit has to be kept much lower.

Another reason for which government is not lowering the price is that it does not want wasteful use of some petroleum products by the people, as it has been mostly seen that people have the tendency not to use things judiciously when it is cheap. Fuel being a finite resource, has to be carefully and judiciously used up. For instance, in Scandinavian countries, fewer vehicles are used due to high gas prices, resulting in it being the most energy-efficient and least polluted.

Impact of Fuel Price Rise in India

Rising fuel prices in India have become a major concern for citizens as it impact their livelihood, either directly or indirectly. Citizens have certainly felt the pressure after the OMCs during the month of May hiked prices of fuel.  It is assumed that the citizens are likely to pay even a higher price in the future as there is no clear directive on resolving the fuel price crisis. Below given are some of the common impacts of rising fuel prices in India.

Fuel prices are affecting both vehicle owners and non-owners in India. The vehicle owners, on the one hand, are finding it difficult to check on their fuel costs, whereas, on the other hand, the non-owners, who were planning on purchasing a vehicle are postponing or cancelling their purchasing decisions due to increasing automobile prices. Higher fuel cost inflation is likely to increase and it will force RBI to increase repo rates, which may act as a discouragement to the demand for cars in the future. This will ultimately lead to a delay in recovery in the overall automobile sector.

Value of other commodities – Rising fuel prices is leading to an increase in the price of essential items like food, medicine and other FMCG goods.

Diesel is the most-used auto fuel in India and is used by transport companies for delivering commodities over long distances. Hence, the increase in transportation costs has made prices of other commodities and services expensive. The poorer people are finding it most difficult to fill their bellies amid the rise in prices of essential food items and medicines.

The cost of public transportation has significantly increased due to increase of fuel prices and the transport companies had no choice but to ultimately pass the hike on consumers.

With the gradual easing of restrictions and roll-out of vaccines, there has been an increase in fuel demand, and hence, global crude oil prices are rising. With India’s crude oil requirements being almost 86%, this rise of price will also lead to an increase of India’s expenditure, thus, adversely affecting India’s fiscal deficit – the difference between government’s total revenue and total expenditure. A fiscal deficit indicates the amount of money the government borrows to meet its expenses, and the increase of which affects the economy and the markets.

Impact on inflation – Oil being an essential commodity is required in domestic fuel needs which is also an essential raw material used in a number of industries for the production of various goods. An increase in crude oil prices would lead to an increase in the cost of producing goods. This price rise finally passes on to the consumers resulting in inflation. Household incomes will see a perceptible drop and gradually demand for commodities will decline.

Impact on stocks – Various Indian companies depend on healthy crude oil prices which include tyre, lubricants, footwear, refining and airline companies. Due to higher input costs, the profitability of these companies is highly affected, thus, impacting stock prices.

Current Account Deficit (CAD) – It is a measure of India’s trade where the value of goods and services imported exceeds the value of exported goods and services. It indicates how much the country owes the world in foreign currency. India’s dependency on crude oil imports has been increasing, which has an impact on CAD. Increasing CAD puts pressure on rupee value as well as the economy.

Way Forward

Tax Reduction – The increasing fuel prices in India are posing a great threat to our economy. The economists believe that for economic recovery, It is important to reduce the taxes levied on petrol and diesel, which is essential to decrease price pressure in the economy. India’s inflation for the month of May ’21 had hit 6.3%, which was higher than RBI’s threshold of 6%. This retail price inflation is taken into consideration by RBI while setting benchmark interest rates. Untill inflation remains high, RBI will not be able to cut the key interest rates – leading to expensive industrial and personal loans, which are the need of the hour as India’s demand and consumption are affected by the pandemic. A slight decrease in the excise duty can offset the fuel prices as in the coming year when fuel demand will come back to pre-pandemic level; risk to inflation will be much higher. With the current crude price per barrel, the situation is still manageable, but it might not be the case in the coming year as forecasts of crude oil prices have been predicted.

Petrol and Diesel Under GST- Crude oil, motor spirit (petrol), high-speed diesel, natural gas, and aviation turbine fuel lie outside GST. GST will provide uniformity and ensure that there are no cascading effects of taxes like double taxation. It will also reduce the burden on consumers depending on the product consumed and the state in which it is consumed.

Reduction of Dependency Promotion of renewable and alternative fuel like ethanol, second-generation ethanol, compressed biogas and biodiesel are essential. Biofuels (Green Fuel) need to be used in transportation to reduce crude import bills. Proper design and implementation of biofuel solutions can provide both food and energy. These also release less carbon in comparison to fossil fuels which can be helpful for the environment. Local production of bio fuels can decrease the nation’s dependency on foreign energy and help employ workers and create new jobs in rural areas.

Large scale adoption of Electric vehicles is projected to save a huge amount on oil imports. Not only will it save money that is spent on fuels in India, but it also will reduce carbon emissions.

Creation of Stabilisation Fund or Reserve Account- The government should set up a crude oil stabilization fund that can be used in crisis times to compensate revenue loss by cross-subsidising funds saved from good times without harming consumers.

Conservation of Fossil Fuels- Reduction of oil consumption by using public transports, use of cycles instead of bikes or cars to go nearby places, cutting off fuel supply or switching off engine when traffic is halted for long are all the necessary steps one should adopt for conservation of fuels.

Conclusion

Fossil fuels are an indispensable part of our day-to-day life. It being a finite source of energy, one must use it judiciously so that it can also be used by our future generation and thus lead to sustainable development. Careful use of such fuels will not only help to save money but also reduce environmental pollutions. We are in the need of energy-efficient machines and technology, especially in the case of vehicles, as they consume most of the energy produced by petroleum. Nuclear, solar, wind, biogas are alternative sources of energy that can and must be used more efficiently and optimally with the help of advanced technology.

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