Fuel Woes - Part I

More facts from the IMF report:

- Petrol price in India is double that in China.
- Kerosene is cheaper in India than in any other country.


* fob (free on board) is the price standard for international trade

I found another report by TERI, which tries to analyze the issues involved in petroleum pricing in India and comes up with some interesting observations. I am trying to build upon the analysis in this three-part series of posts.

We have a build up of prices in which more than 50% of the price is taxes. Effective tax rate on petrol in Mumbai is 146% of the basic price [TERI]. These rates are likely to be among the highest in the world.

To its credit, the government has cushioned the impact of the recent surge in oil prices through a price ceiling on oil prices and some duty relaxation (although absolute taxes collected on petroleum still increased). However, high crude oil prices are here to stay and the current price protection is only a postponement of the inevitable. Maintaining current high taxation, petroleum prices will have to be adjusted by an additional 40–45 percent. Petrol prices can reach Rs.75 per litre.

Such prices will lead to high inflation and slowing down of economic growth. We don’t want that. The TERI report presents data that suggests that oil prices can be reduced while maintaining revenue levels for the government. Two policy changes and an administrative change can help a great deal:

I. Price ceilings for petroleum products are based on the international free on board (fob) prices rather than import parity prices.
II. No subsidies are provided to reduce prices of LPG and kerosene in the market.
III. Fuel subsidies for poor households are distributed through cash transfers to special accounts created for all PDS consumers in state banks.

The three parts of this series will explain the rationale behind one each of these propositions.

I. FOB v/s IPP

The present pricing of petroleum products in the country is based on the import parity principle, that is, retail prices are to be comparable with the price of the product if it were to be imported. The parity provided to domestic refiners equals the fully loaded cost of the imported product [TERI].

IPP = FOB + logistics & overheads (~10%) + customs duty (~10%)

In reality India is importing only LPG/LNG while exporting most other products. So refiners are not actually paying out any logistics & overheads. Moreover, customs duty incurred on the imported crude oil (70% of total consumption) is much less than the duty added up in IPP.

As such, refineries are obviously making significantly higher margins than are apparent. Their margins include a “notional” component which is a direct result of a petroleum policy that favors the producer over the consumer.

When these high ex-refinery prices are subject to the high sales and excise taxes, the impact of the notional margin on retail prices is even higher. More data is needed for computation of the notional component of prices, but 15% should be a reasonable estimate.