Fuel Prices: A mind-boggling lesson on magic of Modinomics

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Till around April 2014, Prime Minister Narendra Modi was so concerned about the rising fuel prices that he never minced words while targetting the then government of Manmohan Singh.

 

It was not only him, but his party colleagues and even his hardcore supporters, who often joined the chorus. They effectively used social media platforms to amplify their noise. But all of them have gone silent now.

You may think that the reason for their stoic silence is that the fuel prices may have come down. Wrong! Let us try to find out that with the help of documents available for public consumption in PPAC (Petroleum & Products Analysis Cell) and those of Public Sector Oil Marketing Companies.

When we discuss a subject as important as petrol and diesel prices, we must first understand the basics. As all of us are aware that India imports nearly 80% of crude and any fluctuation in the international crude oil prices affect us in a big way.

To understand this, let us check the Indian basket crude oil prices since 2006. We are starting from 2006 because by then the price fluctuation in international crude oil market was beginning to peak and by 2011-12, it touched a record high of $120 per barrel before gradually crashing and later stabilising in the range of $45 – $53 per barrel.

The price chart below will be helpful to understand the kind of variation that happened in the selected time period. (To make the charts shorter and for the easy understanding of the readers, all the prices mentioned in this article are yearly average prices except the taxes and prices per litre of petrol and diesel mentioned)

This data from the PPAC website clearly shows the variation in international crude oil prices. It peaked to a yearly average high of $ 111.89 in 2011-12 before coming down to the lowest average point of $46.17 in 2015. From this premise, we should check how it affected the fuel prices in India and the variations in petrol and diesel prices. To explain it further in a simple way, let us check the price chart.

Historical price data of petrol and diesel is extracted from IOC website and the prices mentioned here are yearly average. 

fuel prices

This chart above clearly explains when international crude oil price was at $111.89 in 2011-12, petrol price in Delhi was Rs 65.76. But when crude oil price came down to $47.16 in 2016-17, petrol price in Delhi was Rs 64.84.

And this year, till 20 August petrol was being sold at Rs 65.26 per litre when crude oil price in international market is $49.37 is per barrel. That means, when crude oil prices came down by $64.33 from $111.89 in 2011-12 to $47.16 in 2016-17, Modi government reduced petrol price in Delhi by a ‘whopping’ 92 Paisa!

And, if we take the same peak crude oil price and petrol price of 2011-12 and compare with the average in 2017, international crude oil price for Indian basket is $62.52 cheaper than the price then. But in Delhi, petrol price has seen a reduction of 50 Paisa! No, I’m not kidding, that is the truth.

Puzzled? Not to be. We have to discuss diesel price variations too. Diesel, as a fuel has more prominence in Indian economy because prices of a lot of things – from vegetables to rail passenger and freight charges and so many commodities used by ordinary public – are closely linked with its prices.

All the previous governments in India have kept a close watch on diesel price variations – even if it was minute one because they knew the consequences of a free pricing policy of diesel. But, let us come back to this point a bit later.

See the diesel price comparison chart below for a detailed understanding of what happened in last three plus years.

This simple chart clearly explains when crude oil price was $ 111.89 per barrel in 2011-12, diesel price in India was Rs 45.88 per litre. And in 2016-17 when crude oil price came down to $47.56, diesel price in India rose to Rs 53.97. That is, when crude oil price is reduced by $64.33, in Delhi, Modi government increased its price by Rs 8.09! And crude oil price stands at an average Rs 49.37 till 20 August in 2017 – a price fall of $62.52. But the diesel price in Delhi went up by Rs 9.19. Why? That is the magic of Modinomics!

Will Mr. Modi still be remembering this claim?

Let us try and second-guess the counter arguments coming our way from from the BJP and its die-hard supporters also known as bhakts (a colloquial words commonly used to describe people who blindly believe whatever Modi says without any comprehension or applying thought).

The first argument will be that the government was giving subsidy on diesel and it was creating a huge hole in the government budget, which could be used more constructively for some developmental work. Another argument could be that the subsidy is creating a huge dent in the profit of Public Sector Oil Marketing Companies because of underwriting.

Post 1997 IK Gujaral government

To check these claims, we have to go back in the past and start from 1997. The then Janata Dal (United Front) government under IK Gujral decided to withdraw the “Administered Price Mechanism” (APM) of petroleum products in a phased manner.

Investopedia define APM as “The price of a good or service as dictated by a governmental or other governing agency. Administered prices are not determined by regular market forces of supply and demand. They are often imposed to maintain the affordability of certain goods and to prevent price gouging during periods of shortages (such as gas prices)”. Based on that decision, the petroleum minister in the Vajpayee government Ram Naik announced the complete removal of APM in press conference in 2002.

This press release mentions that the government’s decision to withdraw APM will lead to a free market scenario in the sector. Immediately after this move, the pricing mechanism of Aviation Turbine Fuel freed in 2002. Eight years later, Manmohan Singh government freed petrol in 2010, but they did not touch diesel even though they had the intention to do so. But in 2014 Narendra Modi government freed diesel.

Even if petrol and diesel prices were freed in 2010 and 2014, the oil marketing companies could calibrate the fuel prices according to the market price of the raw material (crude oil) only twice a month – 1st and 16th of every month. They calculated the average price of crude in these fortnights to determine the retail price of fuels. So, whatever variation came in during this calibration period, these companies were asked to absorb a major portion of that. But that scenario changed under Modi.

Citing the loss incurred by the oil marketing companies, this corporate friendly government decided to remove that barrier and allowed these companies to decide the prices according to the daily variation in international crude oil prices.

In this background, it is important for us to understand that governments never gave any subsidy on transporting fuels to the consumer. And of late, the hike in diesel and petrol prices took place largely because of the skewed taxation on petroleum products.

When the business magazines and English media in the country were busy showcasing the loss to the exchequer because of fuel subsidies and the loss to oil marketing companies because of underwriting, the fact was that the government had imposed huge taxes on these fuels and earned many times more than the subsidies they provided. To understand the subsidy drama in detail click and for more details on under recovery.

Tax effect on petroleum products

Let us check the tax effect on petroleum products in India. When the government introduced the much-touted GST, petrol and diesel were kept out of its basket because different states charged different rate of VAT on them.

As per PPAC website, Andaman & Nicobar charged the lowest VAT – 6%- while Mumbaikars paid 48.98% – the highest in the country.

But still, when crude oil prices have come down to a point which was prevalent almost 15 years ago, why are we still paying such high prices for petrol and diesel? The answer is very simple – effect of Modinomics! Confused? Don’t be.

We have to check the price building mechanism of Public Sector Oil Marketing Companies to understand that magic. Let us do a price comparison between March 2014 and August 2017 to explain this in a simple way.

Check these two self explanatory price build up calculations on petrol.

RTP as on 23 August 2017 is Rs 26.22 per litre for petrol. After adding the transportation and marketing expenses and their margin, OMCs charge Rs 29.41 per litre from a petrol pump owner in Delhi. Add the dealer commission of Rs 3.23. It shows the actual price of one litre petrol in Delhi – Rs 32.64.

Now add the taxes – Rs 36.09. Did you get today’s petrol price in Delhi? In simple words, we are paying 110.57% tax on one litre petrol. Column number 5 in the above screenshot shows that in 2014, total excise duty component on one litre petrol in Delhi was Rs 9.48 while it was Rs 21.48 as on 23 August 2017. That is 126.58% jump in excise duty!

Let us do a similar comparison for diesel too. The two comparative price build up chart shows that in 2014, diesel attracted an excise duty of Rs 3.56 per litre and on 23 August 2017, it stood at Rs 17.33. Do you know how much difference is that? Nothing much; just 486.8% increase!!

This above calculation (column 4+2) shows the actual price of one litre diesel is Rs 31.28. Rs 25.77 or 82.38% is the tax you are paying. And don’t forget to check the first and last column of all the four price build-up charts to do a comparison and understand the quantum of price reduction under this government as proclaimed by Modi.

Phenomenon called Modinomics

Modinomics is a very interesting subject. It is not a boring subject like economics; but an interesting puzzle asking readers to solve themselves. It gives a lot of clues, half truths, clear timelines etc. Check another puzzle here.

Let us go back to APM and fuel price deregulation for a minute. Reliance, Essar oil and Shell started fuel retail outlets around 2006. RIL had approx 1500 outlets and Essar opened almost the same number while Shell operated 100. Gradually, in the next four years, almost all of them closed down because they could not compete with Oil Marketing PSUs as, whenever the prices shot up, government urged these companies to absorb a portion of that hike.

Such a business model was not sustainable for companies like RIL and Essar because the very fact that they are corporate entities, serving people’s interests doesn’t form the core value of these companies. Their only agenda, often, is to make maximum profit from whatever investments they make. By 2008, almost all these outlets were closed down.

When UPA II deregulated petrol prices in 2010, Essar Oil reopened few of their outlets and started to sell petrol. But they couldn’t match the diesel prices. Hence RIL didn’t move. Essar gradually expanded its area of operations, but only after diesel prices were deregulated. Once the government completely deregulated the transport fuel prices, the RIL too reopened 90% of the outlets and secured licenses for 3500 outlets.

Essar followed the same plan. As per some reports, before closing down, RIL had already captured 14.3% of market share in diesel and 7.2% in petrol by heavy discounting. A plan that’s now being replicated through the Reliance Jio business model.

Just because Essar and RIL’s competitors were PSUs in fuel retailing, they couldn’t sustain for long. The PSUs enjoyed government support, the private entities such as Essar and RIL didn’t. That support to PSUs are history now as prices have been deregulated. So the game is on now!
(Ravi Nair is a Delhi-based analyst. He can be reached on Twitter: @t_d_h_nair)

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