A seven-point guide to help you understand the fuel price hike

Narendra Modi was sworn in as the prime minister of India on May 2014. The price of the Indian basket of crude oil averaged at $106.85 during the course of the month.
Soon after, the price of oil started to fall. It fell to a low of $28.1 per barrel in January 2016 (As can be seen from Figure 1).

Figure 1:

Source: Petroleum Planning and Analysis Cell.

In an ideal world, the end consumer of petrol and diesel should have benefitted from this fall, by paying a significantly lower price for petrol and diesel.

However, that did not happen. The Modi government moved quickly to capture a bulk of this fall in price by increasing the excise duty on petrol and diesel. In this way, a bulk of the fall was captured.

The state governments all around the country also moved quietly and increased the sales tax/value added tax that they levy on petrol and diesel.

In this way, the Indian consumer was left in a lurch.

In May 2014, when the price of Indian basket of crude oil averaged at $106.85 per barrel. During the same month, petrol and diesel in Delhi, sold at Rs 71.41 per litre and Rs 56.71 per litre, respectively.

Cut to September 2018. As on September 10, 2018, the price of the Indian basket of crude oil stood at $76.22 per barrel. This is around 28.7 per cent lower than the price of oil which prevailed in May 2014.

Nevertheless, the price of petrol and diesel are higher now than they were in May 2014. On September 10, 2018, the price of petrol and diesel in Delhi stood at Rs 80.73 per litre and Rs 72.83 per litre, respectively.

One reason for this can be the exchange rate. As of May 26, 2014, the day Modi was sworn in as prime minister, the price of Indian basket for crude oil in rupees, was at Rs 6,330.65 per barrel, even though one dollar was worth a much lower Rs 58.59. As on September 10, 2018, the price of Indian basket for crude oil in rupees was at Rs 5531.49 per barrel, with one dollar being worth Rs 72.57.

What this proves is that even in rupee terms, oil was more expensive in May 2014, than it is now. Despite this, petrol and diesel prices are now higher than they were in May 2014. The question is why. The answer lies in Table 1 and Table 2, which follow.

Table 1 lists the price build-up of petrol, then and now. Table 2 does the same for diesel, then and now.

Table 1: Retail price build-up of petrol.

Source: Petroleum Planning and Analysis Cell and https://www.iocl.com/uploads/priceBuildup/PriceBuildup_Petrol_Delhi_as_on_10thSeptember2018.pdf

Table 2: Retail price build-up of diesel.

Source: Petroleum Planning and Analysis Cell and https://www.iocl.com/uploads/priceBuildup/PriceBuildup_Diesel_Delhi_as_on_10thSeptember2018.pdf

What do Table 1 and Table 2 tell us? Let’s list the points one by one.

1) The central taxes on petrol and diesel have gone up majorly, especially on diesel. In May 2014, the central taxes on diesel were limited to Rs 4.52 per litre. Now they have jumped up to Rs 15.33 per litre. That is an astonishingly high jump.

2) The dealer commissions in cases of both petrol and diesel have gone up.

3) The taxes collected by the state government have also gone up, though not as majorly as those collected by the central government. (This is in case of the Delhi government and varies state by state).

4) Currently, the price charged to dealers for diesel is higher than petrol. It is the taxes that ensure that the retail selling price of petrol is higher than that of diesel.

5) There is one point which isn’t really obvious in the first place. Take Table 1. The price of petrol charged to dealers is Rs 40.45 per litre. The central taxes are at Rs 19.48 per litre. Moreover, the dealer commission is Rs 3.64 per litre. If we add these three elements that constitute the price of petrol we get Rs 63.57 per litre. On this there is a state government tax of 27 per cent, this amounts to Rs 17.16 per litre. Once we add this to Rs 63.57 per litre, we get the retail selling price of Rs 80.73 per litre.

The problem here is that the state government is charging a tax on the central government tax. This is a tax on a tax, and it isn’t fair. Of course, if the pricing of petrol and diesel had moved to goods and services tax (GST) this anomaly of tax on tax would have been corrected by now.

What happens if this anomaly is corrected for? The state government tax of 27 per cent will then be calculated on the price charged to dealers and the dealer commission. In this case, when we sum up the price charged to dealers and the dealer commission on petrol, we get Rs 44.09. On this, a 27 per cent tax amounts to Rs 11.9 per litre. Hence, the retail selling price comes down to Rs 75.47 per litre (the price charged to dealers, dealer commission, state government tax, central government tax).

This price of Rs 75.47 per litre is more than Rs 5 lower than the current price of petrol of Rs 80.73 per litre. Similar logic can be applied in the case of diesel.

The point is that customers are paying more for petrol and diesel because of a mathematical anomaly. This can easily be corrected. Of course, it would mean state governments will have to give up some share of their revenue.

6) The central government taxes on petrol and diesel (basically excise duty in various forms) is fixed at Rs 19.48 per litre for petrol and Rs 15.33 per litre for diesel. On the other hand, the sales tax/value added tax charged by the state governments is a certain percentage of the price charged to dealers added to dealer commission and central government taxes. In the case of Delhi, the tax on petrol is 27 per cent, and that on diesel is 17.24 per cent. But there are states like Maharashtra which charge a tax of 39.12 per cent (in Mumbai, Navi Mumbai and Thane) on petrol. (The union territory of Andaman and Nicobar Islands has the lowest tax of six per cent on both diesel and petrol).

The point being the higher the price of petrol and diesel go, the more the state governments benefit. This is another anomaly which needs to be corrected. Every state government has an annual expenditure budget. Also, given this budget, a fixed rate of tax on petrol and diesel should be par for the course.

7) While the central government taxes on petrol and diesel have gone up. So have state government taxes. Take the case of Delhi. Earlier the rate of tax on petrol was 20 per cent. Now it is 27 per cent. States governments, like the central government, have also cashed in on the opportunity.

The big debate right now is who should cut taxes on petrol and diesel. Central government or the state government? A few state governments like Rajasthan and Andhra Pradesh have taken the lead, by cutting taxes. The government of Karnataka is also considering cutting prices. However, the central government has mostly been mum on the issue.

The explanations that have been offered have largely been along the lines of the international price of oil going up and the value of the rupee falling against the dollar. We have also been told that all the extra money being collected is going towards recapitalising public sector banks, which are in bad shape. Still, others have said that fossil fuels are a terrible idea and hence, their consumption should be discouraged through higher taxes.

But are these explanations enough? Or is there more to this?

I try answering these questions, in the second and the final part of this piece. Read it here.