Economists are fond of saying that inflation is a tax on poor. Inflationary pressure in the Indian economy is persistently strong as WPI is upward of 7 percent but that didn’t deter the party in power from taking this anti-people measure. Inflation persists at a high level mainly on account of the fact that the inflationary situation in India can’t be understood only from the demand side as often articulated by government in power. The normal logic offered is that since the nation has been witnessing reasonably high growth despite global economic downturn, people’s income level is consequently on the rise, resulting in a demand-supply mismatch. The excessive demand in the economy thus is resulting in demand push inflation. Supply side pressure including cost-push inflation as witnessed in agrarian distress is generally not factored into such logic, though it has its substantial share in explaining the situation in a holistic way.
Oil Marketing Companies Making Hefty Profits
The hike in prices of universal intermediaries like petrol and diesel has certainly not assisted in controlling the price spiral. The hike in prices of petroleum fuels in India is generally justified in the wake of prevailing high levels of crude oil at a global level and consequent ‘under recoveries’ to the tune of Rs 1,38, 000 crore in FY 2011-12. Despite all this talk of a hit on the financial position of public sector oil companies, the upstream public sector ONGC registered a record profit of Rs 25,535 Cr (highest for any company in India) and HPCL, BPCL and IOC earned profits to the tune of Rs 911 Cr, Rs 1,311 Cr, Rs 3,955 Cr respectively in FY 2011-12.
At the same time it should be noted that high levels of ‘under-recoveries’ of oil companies, on the basis of which the argument for hiking fuel prices generally rests, are not “loss” as generally understood. Laypersons keep wondering why, when crude oil prices crashed to below $ 30/barrel in the wake of the global recession in 2008-09, there was no consequent decline in petrol and diesel prices, but whenever the crude oil prices rise in the international market, they are made to bear the burden. It would be striking to note that petrol price was just Rs 33.71/litre in 2004 when crude oil price internationally was pegged at $ 36.09 per barrel. The pertinent point will be elaborated later, but for the time being it would suffice to quote from the fortnightly statement of the Ministry of Petroleum and Natural Gas, dated October 18, 2011: “Under recovery is the gap between the desired price and the actual selling price of petrol. The desired price is not calculated on actual costs.”
How Is Price Fixed?
The Government of India announced in 2010 that petrol price will be deregulated, resulting in petrol price being hiked more than five times in last two years. This allowed the oil marketing public sector companies to set prices of petrol on their own. In this context it will be surprising to see how prices of petrol are determined in India presently after deregulation. Strangely, the retail price of petrol prevailing in the Singapore spot market, not production costs, is driving Indian petrol prices presently. The notional loss of ‘under-recoveries’ is also determined from the prevailing prices of petrol in Singapore spot market.
A strange world of petroleum pricing exists in the country. A world where the laws of economics regarding how prices are determined even in market-based mechanism based on cost of production and likely demand are turned on their heads. The price that we pay for petrol (or for that matter diesel and LPG) has no resemblance whatsoever to their cost of production. The world of petroleum pricing is a complex web of assumed prices and their derivative concepts such as “under-recoveries.” This is unlike in any other industry. The oil companies simply take the price of petrol in the Singapore market, apply the rupee-dollar exchange rate to that price, add other costs such as freight and import duties and insurance, and come up with the price that they should charge domestic consumers. Interestingly, not a litre of the petrol that these companies sell in the market is imported from Singapore; they are all produced here in their own refineries. Now, the problem is that most often the price that they so arrive at have no relation to the prevailing domestic retail price, which is invariably lower. Thus is born the concept of “under-recoveries,” something that is unique to our oil companies.
If the government insists that this model of pricing petroleum products is rational, then why not universalise it for all other commodities? This year, for example, the price of cotton in the international market has been around $1 per lb, making it Rs. 12,000 per quintal. But the Indian peasants are being paid a miserable Rs.3000 (that at times doesn’t even cover production costs). Following the import parity pricing model here, and without even levying fictitious duties, freight, insurance etc., the under-recovery turns out to be Rs. 9000 per quintal. Would the government contemplate compensating Indian peasants for this? While its heart bleeds at ‘notional’ under-recoveries of profit making companies, there is not even a tear shed on the deaths of hundreds of thousands of peasants in rural India.
No Net Subsidies
When the government says it is suffering huge deficits due to ‘under-recoveries,’ it is basically putting only half truths in the public domain. The petroleum sector in India has a highly skewed tax structure. This is clear from the break-up of retail petrol price in Delhi given on the Website of Indian Oil Corporation. Out of the retail price of Rs 70.24/litre in Delhi, the tax component accounts for Rs 27.22/litre, i.e 38.75 percent.
We must understand that there are no net subsidies in the petroleum sector, even inclusive of the erroneous “claimed” under-recoveries. For example, the total tax receipts of government (both centre and states) from taxes levied on petroleum sector was Rs 2,25,494 Cr in financial year 2010-11, a full year earlier, in compared to under-recoveries to the tune of Rs 1,38,000 Cr in FY 2011-12. Thus, the total tax collected from the petroleum sector by the central and state governments is a multiple of the combined fiscal subsidies and the claimed “under-recoveries”.
For any meaningful subsidy to petroleum sector, it is essential that the cost of production should be higher than the retail selling price. A rough attempt to calculate the cost of petrol reveals that it costs around Rs 40 at your near-by petrol pump.
1. One barrel of crude oil yields 150 litre of petrol
2. Average value of dollar this year (January to May) = Rs. 53.34
3. Average price of crude oil barrel this year = $101.46
4. Refining, margin, transportation, commission per barrel = Rs. 672 (approx $12)
5. 150 litre of petrol = 101.46 × 53.34 + 672 = Rs. 6084
i.e. 1 litre of petrol = 6084 / 150 = Rs. 40.6
The cost depends on factors like quality of crude oil, refinery. However changes in it would not greatly affect product price.
A loss will be caused when a company is forced to sell a product below its cost of production. This, clearly, is not the case. So they don’t call it a loss but ‘under recoveries’ which is nothing but a bogus number that bears no resemblance to reality. Yet, pricing decisions for the domestic market are based on these numbers.
The question is: why should we in India pay a price for petrol that has no resemblance to either the cost structure of Indian Oil or Hindustan Petroleum or Bharat Petroleum or to competition in the market? Prices in Singapore are determined by a variety of factors, ranging from fundamental reasons such as consumption levels by countries in the region or shutdown of refineries or pipelines, to market-related reasons such as levels of speculation and money flows into the commodities market. A senior official in a leading oil company concedes that this model is flawed, and interestingly, says his company is all for a cost-plus pricing structure with competition between the three oil retailers — Indian Oil, Hindustan Petroleum and Bharat Petroleum.
Comparison with Other Countries
There is yet another myth propagated by government discourse, that the price of petrol and diesel is low in India. A look at the Petroleum Planning and Analysis cell reveals that before the hike, when the price of petrol in India was Rs 63.70/litre, it was Rs 41.93/litre and Rs 45.53/litre in Pakistan and Bangladesh respectively.
BJP’s Crocodile Tears
BJP is now opposing petrol price hike just for the sake of scoring some brownie points over the Congress, rather than for any real concern for the toiling masses of the country. This is evident from the fact that it was the erstwhile NDA government in 2002 which was instrumental in dismantling then prevailing Administered Price Mechanism (APM). By doing this and adopting import parity pricing for petroleum based products, it created the ground for the increase in fuel prices today. Even when crude oil prices didn’t rise that significantly during NDA regime between 1998 and 2004, it was even more brutal in hitting the interests of common man, when it raised the price of petrol from Rs 22.84 to Rs 33.71 (48 %), diesel from Rs 10.34 to Rs 21.74 (a whopping 110%), LPG from Rs 136 to Rs 241.60 (78%), Kerosene from Rs 2.52 to Rs 9.01 (a gigantic 248%).
Pandering to Private Interests
India is dependent on imported crude oil to the extent of 70-75% even to meet domestic needs. Yet, India has promoted surplus refining capacity that exceeds domestic demand by some 35%. The surplus refining capacity through private sector was created on the back of multiple subsidies disbursed selectively even when refining capacity in public sector was more than sufficient. The surplus refining capacity was justified on the pretext of promoting export-oriented refineries. And due to this, indeed, petroleum products out of refining activity in private sector have emerged as India’s largest export in recent years– an activity known for yielding small, and sometimes, negative margins and thus not deserving to be promoted for exports by conventional economic logic. But what India has been exporting is not added value, but the subsidies to the refiners funded by Indian taxpayers. Such subsidies over the years from government exchequer to firms like Reliance have only succeeded in turning public expenditure to private profit.
The recent increase in petrol price and talk of required hike in diesel prices is being done ostensibly to align domestic prices to international prevailing prices. Whose interest would this policy serve? With such an alignment, refiners like Reliance, who are presently earning enormous profits out of exporting petrol and diesel, will be in a position to tap the domestic market as well, without compromising on their profits. It will also service the interests of financial capital further, which has already raised its stake in public sector oil companies due to part-privatisation, in the form of increased dividends and capital profits which comes with higher profitability. For example at present, private interest in ONGC, GAIL, BPCL, HPCL is around 30.77%, 42.66%, 45.07%, and 48.89% respectively. Who will bear the burden of this shift in policy? It will be the working masses of the country, already reeling under high inflation, who will have to bear the brunt by paying higher prices on petroleum products for the sake of serving interests of financial capital and private refiners.