The Real Reason why Fuel prices are on the rise

In today's newsletter, we take a look at why petrol and diesel prices are on the rise once again. This is a must read folks !!!

The Story

The premise is simple. Global crude oil prices have been tanking for a while now and yet, fuel prices in India have remained firm. It’s inexplicable. It doesn’t make any sense. This must be a conspiracy. But wait…

Crude oil isn’t the end product. It’s an intermediary that requires additional refining. You don’t get petrol or diesel, right off the bat. You need to pump crude through a processing facility, hoping to turn it into a consumable product. And herein lies the key distinction.

The price of the end product can vary depending on the complexity involved in processing crude into its desirable constituents.  Consider diesel. It’s heavier, less volatile, and easier to refine compared to petrol. As a consequence, diesel tends to be slightly cheaper than petrol in most countries around the world. We see the same trend in India. But diesel prices trade at a much steeper discount here because of our lopsided tax structure. People use diesel in industries, farmlands, generators, trucks, etc as opposed to petrol which is largely used in personal vehicles. So the government doesn’t tax diesel at much. And as a consequence, diesel has always been more affordable. But that trend seems to be reversing.

On June 24th, for the first time in living memory, diesel was sold at a higher price than petrol. Bear in mind, this only happened in Delhi, but it was still a sight to behold.

But before we get to this bit and explore the price differential here, we need more context.

So let’s start with the Oil Marketing Companies (OMCs) — Entities largely responsible for processing, refining and selling auto fuel. Think Indian Oil Corporation Ltd (IOCL).

The nationwide lockdown has taken a toll on these people. Petrol consumption dived 60% in April. Diesel sales plummeted 55%. But their fixed costs didn’t dissipate as quickly. The companies still had to keep shipping crude oil, pay salaries, run their factories (at low capacity) and spend money even when there aren’t enough consumers buying fuel.

But OMCs were smart. They saw this coming. They stopped revising prices after March 16th. They could see that crude oil prices were trending downwards and they wanted to keep their margins intact. In the process, however, consumers were left hanging. Despite crude oil prices breaching $0 back in April, Indian customers did not get to buy fuel at low prices*. We did not get to benefit one bit.

On the flip side, the central government saw an opportunity to make some money here. After all, tax collections were abysmal. They were already borrowing too much. And they were desperately looking to fund their expenditure through any means necessary. All they had to do was go in and increase the excise on petrol and diesel.

But bear in mind, excise isn’t like your ordinary tax. The consumers don’t get to pay it. Instead, it’s a duty levied on the producers and the sellers. And when the government increased excise on petrol and diesel back in May, the OMCs had to make a choice. Bear the excise duty themselves or pass it on to consumers.

Ideally, you’d think they would just pass it on by hiking prices. But that would have wreaked havoc across the board. After all, the government increased excise by a record ₹10 per litre on petrol and ₹13 per litre on diesel, planning to raise ₹1.6 lakh crore additional revenue. Imagine seeing retail prices increase by this much overnight. Yeah… It’s not a nice look. So the OMCs stood tall and refused to revise prices. They took a hit on their margins and they made peace with it. After all, they are primarily owned by the central government. So they couldn’t increase prices even if they wanted to.

Also, look at those numbers once again. Do you see how the revised excise on diesel is much higher than the excise on petrol? Yeah, that’s been happening for a while now and slowly but surely, diesel prices have been inching upwards. Its the tax structure that’s reducing the price differential between petrol and diesel and now you know why.

But we are not done yet. Remember state governments also have to make some money off of selling petrol and diesel. And once again, we see that most state governments have chosen to increase taxes on petrol and diesel to shore up revenue these past couple months. Now unlike excise, this tax (VAT) is borne by the end consumer. So if you saw fuel prices increase at your next-door petrol station anytime between March 16th and June 6th, it’s probably because your state government chose to ramp up taxes.

Why June 6th you ask?

Well, that’s when OMCs finally decided to start revising prices once again. By then, crude oil prices had started firming up. Oil-producing nations had cut output and the excess supply was slowly being mopped up. And as OMCs started buying crude at higher prices, their margins evaporated rather quickly. Soon they were selling petrol and diesel below cost. They were making a loss on each unit sold. So they had no choice but to start revising prices. And as crude prices started inching upwards, OMCs started pricing their products higher in tandem. And truth be told, they’ll probably keep doing this until they can turn a profit on every litre of fuel sold.

Now obviously, you could debate if there’s anyone to blame here and if the government should roll back the tax hikes. After all the tax component on fuel can be as high as 70%. But in doing so, you have to first understand how we got here and why we got here in the first place. It’s incumbent on you to premise your argument after fully understanding the mechanics of pricing fuel. So if you’ve had a friend or a family member engage in a passionate discussion about petrol and diesel prices this week. Here’s what you need to do to level the playing field. Share this story on WhatsApp, Twitter, or LinkedIn. Ask them to absorb it fully. And then debate.

It’ll be a more fulfilling discussion. We promise you.

Until next time…

*Point of Interest: It was WTI crude futures that broke the $0 mark and India buys a different basket of Oil. However the prices of the Indian basket were also trending downwards just like WTI. Hence the comparison