Yesterday, the Government of India has taken a bold decision and Diesel and Petrol price Deregulation came into effect – of course, clubbed with a price hike. 
As usual the vote bank politicians on the UPA alliance, opposition leaders and the left have voiced their protest. They claim that they are ‘with the people of India’ and whole lot of other crap. Two of the most politically spoiled states in India – The West Bengal and Kerala – have readily jumped on to ‘celebrate’ the situation with a ‘Hartal’ (strike). But do they even know how pampered the people of India already are how much they are misusing one of the most limited natural resources such as petrol (LPG and diesel as well)?
What does deregulation means?
Decontrolling or deregulating the petrol prices mean that, the government will no longer be subsidizing petrol prices and the prices will be purely linked to the international crude prices. In the case of diesel, though, it will be only partially regulated – the reason being an attempt to avoid sudden spike in inflation.
Why should Petrol cost more?
As all of us know, petrol (or Gasoline) is produced out of crude oil which is a natural resource that’s available in limited quantity. It is a matter of a few years before the crude gets totally exhausted. Although, there have been several crude discoveries in India, we are still dependent on the OPEC (Oil Producing and Exporting Countries) to import crude and refine it to produce petrol, LPG, diesel, aviation fuel, kerosene etc.
Petrol production cost
As of today (26 June 2010), the crude oil costs $79 a barrel (159 Litres). Since this has to be transported to India via the marine route, there is a shipping cost. Let’s say it’s something like 10%. Since the import duty on crude oil was waived sometime back, let us not count that part. Hence by the time the crude arrives in India, it is already costing something like $85 per 159L.
So the petrol refining calculation goes as follows:
Cost of 1 barrel crude: $85 or Rs. 3910.00 (exchange rate of 46)
Quantity of petrol produced from 1 barrel crude: 72L (45.4%)
Since almost 100% of the crude is refined into some product or other, we can calculate the raw material cost of producing 72L or petrol as 45.4% of the price of crude barrel.
Hence 72L petrol’s material cost alone is 3910 * 45.4 / 100 = Rs. 1775.00
Raw material cost of 1L of Petrol = 1775.00 / 72 = ~25 rupees
Obviously, the raw materials alone do not contribute to a product. You need electric power, thousands of paid employees, machinery, maintenance etc to finally produce petrol. So finally when it’s of consumable form, it is costing around 30 rupees in the oil refining spot itself.
Taxes, marketing and distribution cost
The following are the other additional expense before you can consume the petrol at your favorite gas station:
Excise duty
Education tax
VAT
Distribution and transportation cost
Dealer commission
As I understand, all the above added up comes to around 27 rupees per litre of petrol the majority of the cost is towards excise duty, transportation cost and VAT (Isn’t it a pity you have to spend more petrol or diesel to distribute petrol?)
Essentially, one litre of petrol, by the time it reaches the petrol filling stations, is costing you already Rs. 57/- without any profit added to the petroleum marketing companies. Obviously most of these companies are state run companies and hence cannot afford to reap 100% profit. Let’s turn our back on them and tell them that you can make say 20% profit. And if you add that your 1L of petrol should actually cost you around Rs. 68/-
Now, aren’t you really lucky that it’s available below Rs.60/- even with the latest hike in petrol prices?
Subsidy woes
The story is not over yet. One needs to do similar calculations for other products such as diesel, aviation fuel, kerosene and LPG. Unfortunately diesel is the primary thing that fuel public transport and distribution system in India and kerosene – LPG are house hold lifesavers when it comes to cooking purposes. In order to curb the inflation and protect the below poverty line people, the government has to subsidize it big time. A part of this subsidy cost is absorbed by the government while the oil marketing companies bear the other half. This puts some pressure on the government to increase taxes on luxury consumption sectors such as airlines by increasing aviation or jet fuel prices. They are also taxed heavily which is mainly borne by the rich or upper middle class people in India.
Why deregulation of petrol prices is good?
The deregulation of petrol prices will definitely increase the rate of inflation in short term. Virtually there will be immediate price rise in commodities and other consumables. However, for long term I think it is a good move because at the end it will definitely reduce our long term debt and fiscal deficit. Our overall economy will get stabler in this case.
Secondly, this measure will be a boost to the oil producing and marketing companies to recover their losses immediately. Remember, lakhs of people work in these huge companies and they need a life too. Moreover, the government run oil companies will be candidates for disinvestment which means that the government can lower their fiscal deficits further with additional income.
The other advantage is that the inflation, at the moment, is a fake figure. You will get to know the actual inflation and variation of commodity prices only when the petrol prices move according to the international crude prices.
This will also bring in big private players (e.g. Reliance) into the petrol marketing game. Remember that companies like Shell and Reliance used to provide excellent quality of petrol and service until Reliance pumps were forced to close down due to government regulations. This kind of competition will eventually bring in good service, good quality and in the future competitive pricing as well. The immediate woes will be compensated in the mid term – that’s my strong belief.
The government, in the meantime, should try to reduce the excise duties and restructure the VAT to minimize the impact of immediate fuel price rise on inflation and the poor people.
Long term solutions to curb petrol prices
In the long term, there are several viable solutions that needs to be done from the sourcing point to distribution and consumption.
There are possibilities of under sea pipes (just like the one we were planning with Iran for gas sourcing) from the vendor nation to India to reduce shipping cost. This has a very good long term positive impact though initial cost of incorporation is high.
The oil refining companies sourcing and storing mechanism needs to be optimized in a way that when the crude prices are low, we are able to store more. I am not sure, how much of optimization is done in this regard. Since we keep getting new and new governments every few years, they may not go for a long term plan for the same. Please remember that not too long back, the crude prices were at $35 or so per barrel.
There is a scope for improving the internal distribution system as well. Though, India has a huge geographical region, we can still have oil distribution pipes from refineries directly to the regional distribution centers. This needs long term planning.
Final thoughts
I think our citizens (and even people from rest of the world) are misusing petroleum products and this kind of abuse needs to be first controlled via price hikes and then by introducing alternate energy options and technologies to optimize the usage. There is a lot of scope for India to take out those old, fuel inefficient vehicles from our roads. I think the taxation needs to be restructured so that people and families who own more than one vehicle should be taxed more. There can be several other long term steps to improve the overall situation but please remember that at the end of it the petrol will anyhow get exhausted.
And a request to our great politicians who always oppose what the government is trying to implement. If you are really with the people of India, please come up with real practical suggestions to improve the situation. It wouldn’t be too long before you will be stone-pelt by the younger generation for preventing them an opportunity to live in a developed country by 2020.
And my questions to my friends (not the poor) who are earning in thousands and lakhs. How dare you crib about a three rupees rise in petrol while you still prefer to drive to office alone in a 5, 10 or 15 lakh car?. More over I haven’t seen you cribbing while spending 1000 rupees for a dinner or while buying a shirt worth 1500 rupees.
Think long term friends!
Hi Ajith,
This blog is really a very informative about deregualtion in fuel prices in India.
keep posting such article,
Thank You,
Jagadish K
@Jagadish, thank you very much for your compliments. As you know, the IT people have relatively less time for activities like blogging. But I keep it a point to blog about things I like, as time permits.
Thank you for your readership.
Nice post. I am just curious about how they would be deciding the petrol price? If petrol price is purely based on market, then how many times would it fluctuate in a day/ or in a week? Any idea?
@Saurabh, thank you for your comment.
It’s a good question. In my opinion, Indian oil marketers shouldn’t change the crude linked petrol prices the way they do it in the US (where it can even change three or four times a day). Indian companies should adopt a common strategy of revising it every fortnight or so. Anyhow, there will not be huge fluctuation in prices everyday unless there’s a disastrous news breaks or something like that. Also, predictions like the one by Forecasts.org crude forecast can be taken as an indicator for the frequency of change.
Good information ajith
Thanks…….
@Neha, you are welcome.
Very well done Ajith, you covered this topic without leaving any questions behind, was informative and interesting keep up the good work cheers— Prajwal
Thank you very much Prajwal for your comment.
Hi Ajith,
I was trying to figure out the implications of deregualtion on the economy and your article is indeed very useful. Though I’m not complaining about the hike in the larger interest economy, I am certainly concerned about people who do not earn more than a few thousands a month. How do you think will they cope up with this sudden rise. Do you think there could be some other way to keep at least prices of essential commodities down, other that lowering the tax rate as suggested in your article.
@Sarika, there are two main linked issues related to the fuel price hikes. Immediate commodity price increase and then transportation (persona & public). In both cases, there’s no immediate fix unless the govt decides to go down on the excise/VAT structure. However, in the long run I hope to get these things solved as the government fiscal deficit is coming down big time. You saw recently that the 3G auction brought in 70 thousand crores 🙂 and that’s good for the country in the long run.
By the way, I am not an economist nor do I understand macro economic factors very well… It’s purely my views based on my limited knowledge but I have the believe that ‘India 2020’ plan is right on course.
Thanks again. I just heard Arun Jaitley defending their stand of calling a bandh, stating that even when they were in power, deregualtion was proposed, but the global petrol prices were not as high as they are now. So taking this step now when the global petrol prices are already sky rocketting, is a hard blow on the common man. I’m not an economist either :-), but generally interested in such topics, since we are the ones directly affected. Thank you for all the information provided on this topic.
Regards,
Sarika
Excellent information provided on Degularisation of Liquid gold in India.
Thanks a lot Ajith.
its a eye – opener for naive hypothetical politicians who dnt give a shit for India.
Hi.. was going through your blog while trying to get the cost of production for refined products from crude. Can you please tell me the source from where you got the cost of production of petrol. Will be very useful! thanks!
Thanks Sarika, Bikram and Gayatri for your comments.
@Gayatri,
The following is how they actually calculate the price.
The basic price of petrol component of crude is currently priced Rs. 23 (Which ideally should be Rs.25/- based on international crude prices as I mentioned). Every other part is calculated on this basic price.
In union budget 2010, both excise and custom duty on petrol were hiked (Notification: http://indiabudget.nic.in/ub2010-11/bs/speecha.htm) and this caused petrol excise duty to go up to Rs.14.35 and custom duty to Rs. 1.73 (7.5% of basic). The govt also proposed to restore the 5% import duty on crud (This part I am not sure if it was implemented, as I mentioned in the post)
Hence…
Basic price: 23.00 (govt fixed)
Excise duty: 14.35 (earlier it was 13.35)
Edu cess: 0.43 (3% of excise duty)
Custom duty petrol: 1.73 (7.5% of basic)
* Custom duty crude: 1.15 (5% of basic)
VAT: ~7.00 (Varies between 22% and 35% from state to state, assuming 30%. Income for state govts)
Dealer commission: 1.05 (fixed long back)
Transportation charges: 6-8 rupees per litre (as I read in various forums/news paper archives)
The total is around 56 at the current base price and around 59 at a base price linked to the current crude price. Add 20% margin as I mentioned in the post and shipping cost 🙂 to get the actual spend.
However, as I suggested, by restructuring the state VAT and by reducing excise duty, it is possible to bring it down to 50 or so. At the same time, one has to think that, we are paying for a natural resource that’s in limited stocks and fully imported. Lowering the price will increase consumption and subsequently cost/import spending of the government. There has to be a balancing act, at the end.
Thanks for such useful information. Actually I didn’t know about all this but you cleared it to me. Once again thank you! And I also belong to the IT industry and know how much time we could use for such things like blogging etc.
@Durgesh, thank you for stopping by and commenting. Yes, we could always spend a little extra time to spread awareness and thoughts on topics that matter, couldn’t we? 🙂
A very good artical. But I have only few comments over this
The author says that no profit to OMC while the subsidy was there.
Offcourse OMC were selling at lower cost then production on petrol and diesel, But they are getting the financial recovery by GOI and Upstream companies (ONGC and OIL).
The under recoveries on petrol and diesel is just 1% of the total revenue GOI is getting from petroleum products.
Another thing is that, If u see the finalcial statemets of OMC, they were not running on loss as the final figure. They were making huge profit on other refining streams.
They offcourse have the refining marging on petrol and diesel. Then they have marketing marging.
I dont understand if say IOCL, which has the refineries and also a marketing company, why are they keeping marging at two different stages( one at refiney gate and another as marketing margin) for the same product and from the same company.
And we say about the salary of the workers working in OMC. They get more then the average salary from most of the other pvt compaies.
I don’t agree with the statments by the official like ” Burdan of recoveries” . Come on, its jsut the 1% of the total tax revenue over the petroleum perducts. Can’t GOI bear that, instead of passing the same to common man.
At last, I agree that the price deregulation is a good step and the prices should by market determinent for any commodiy to make a competative market.
But the GOI should look into its tax structure on petroleum product and revise the same.
@Nitin, thank you very much for your value adding comment. I really appreciate it.
In my opinion, despite the financial aid from upstream companies and GoI, these publicly listed oil companies are having a combined debt of 1 lakh crore (BPCL 22 thouand crores, HPCL ~25,000 crore and IOC 45K cores). As a listed company, they have to clean up the mess and the government has to support that cause. The Government has to play a balancing act here and I totally agree with you on that by reducing the cess factor a bit. However, that shouldn’t be so entertaining that the consumption goes up. As I maintained, for a limited supply of natural product such as petrol, everyone has to pay a price, at the end.
cheers,
Ajith
Hmm..I would have had respect for your article if not for the last paragraph(how dare you..blah blah) where you took out all your frustration albeit couched in concern for “our long term debt and fiscal deficit”. And man, enough of this “holier than thou” and doing your bit crap. We all know why ppl blog 🙂
All that said, I must give credit to your calc(I trust it to be accurate) although I am sure you have taken a very simplistic view of the whole thing. While talking about long term govt measures, you seemed to have missed out stuff like improving the public transport system. Acknowledged we have something in place but is it good enough for ppl like me who spend 5k on a shirt(that is none of anyone’s bloody business btw – i choose where to spend my money).
And as a tax paying(agreed not by choice thanks to TDS) citizen, I see nothing wrong in expecting more from my govt. Let not my govt keep talking about their helplessness on the crude prices front – let my govt do some “out of the barrel” thinking and reduce my burden on this front – i have every right to expect more!!
Your Excellency,
Since you haven’t provided any name, I should call you that with utmost respect. If the current system is not good enough for you and you don’t even want to pay the taxes willingly, you don’t anyhow deserve to be part of this country. I guess, esteemed people like you should have been born in the US or somewhere.
And by the way, it’s my blog and I will write whatever I want. And about this comment ‘We all know why ppl blog:)’ It would be great if you can elaborate on that? I blog because I want to express my views to the public. Do you have any other definition of the blog?
dear sir,
i m doing mtech from iit delhi and i m doing projet on petrol pump optimization. can you provide me the details of profit margin for the owner of petrol pump, in selling 1 ltr/kg of petrol, diesel and CNG.
thanks
kumar raju
As you probably heard, the petrol pump dealers were supposed to be on strike tomorrow onwards for an increase in their margins. It’s a fixed commission based system since beginning and not % of sale. Per litre sale of petrol they get Rs. 1.49 for petrol and 91 paise for diesel. For CNG, I guess the commission is 87 paise per Kg.
This is awesome.
I am thankful to you Mr.Ajith
good job…….keep it up………..
Excellent Article dude..I was trying to calculate the same.Very informative.
Hi Ajith,
So the basic question is “whether most Indians are willing to shell out more money to buy the fuels ?”. I will giv you the answer and that is “No”. I bet you are not surprised. Sadly it has been a unfortunate characteristic of most of the Indians to focus on shot term goals that can hav negative impact on our future rather than long term benefits. This is a common trait from a constable on the streets to cabinet minister. We will not be able to kick out the habit internally. I think there will be a bleak future when this oil firm’s will suffer bankruptcy and will be unable to buy the oil. The govt may hav to dip into it’s foreign reserves too much for buyin the oil. And it will find itself in catch 22 situation whether to fund oil subsidies or to fund food subsidies. I did not arrive at the conclusion by watching armaggedon Hollywood movies. I arrived at this conclusion by studying our history carefully . Remember the 1990’s when the govt had to surrender it’s gold bullion to pay of the debt. We only had foreign reserves to last two weeks. That was the kick in the ass situation. It took this humiliating incident to our respected ever sleeping politicians to liberalize the economy and push the country to the path of development. We hv only ourselves to blame for this timid ” we will only react when we are cornered” attitude. I will pray that this time it will not be too late for our nation to gain it’s sense.
” I don’t know whether to congratulate or sympathize a man who has come to his senses ” — somebody famous forgot his name 😉
Awesome Reading to say in the most terse manner.Very Informative and to the point.And on the top of that, very pragmatic stand taken on the issue concerned,which I guess, most people either dare not take or don’t have that intellect to comprehend the long term need and goal of the country.
Mr. ajit thanks for the detail study. My one basic question is why we get brent crude which costs around 105 usd(average) as against 83 usd of Nymex crude. Can any body has the answer?
It’s not Nymex but WTI (West Texas Intermediate) traded in Nymex exchange. Brent is more expensive than WTI but then WTI will incur more shipping cost due to longer voyage to transport the same to India. Most refiners in our region prefers Brent.
Very nice article.
My suggestion is that government should identify alternate source of income and reduce the excise duty and VAT on petrol(diesel). Because the crude price will keep on going up and unless Gov take some long term measures,Petrol will be as costly as Gold.
Also, Electric Cars can be a great boon for India (As We don’t need very high speeds and the distance to be traveled is usually under 100 KM/day which electric cars are capable without recharge.) , Government should promote Auto companies making electric cars and should give them subsidies.
-Idris
Dear Ajith,
Appreciate your effort in analysing this imp issue. However, what I fail to understand is that why should there be any under recoveries. As we know the cost of petroleum products are heavily taxed – which increases the selling price and GOI provides subsidies on the increased price (post tax). Can’t the GOi reduce taxes on crude and refining products to lower the actual cost?
Vijay,
Thanks for your comments. As I mentioned in my closure remarks, reducing the VAT and taxes is the short term fix. However, we have not control over the international parameters right?
For example, at the time of publishing this post, the crude price was $79 and USD-INR value at 46. Now (Nov 08, 2011), the former is $109 and USD-INR hovering around 50. So the raw material (before it’s shipped to India) price itself has increased by FLAT 50% percent. i.e. (79 x 46) to (109 x 50) but the retail prices were not completely raised by that percentage yet. So the government has tried to do something, so are the state governments. However, as you rightly said some amount of short term measures can be done to bring the price down to 60s. Beyond that would be really bad for all (because the consumption might increase as well)
It’s a very funny economic problem to solve whereby the resources are not produced in India and in the international market itself, the supply is limited 🙂
In the story above, you mention,
” Although, there have been several crude discoveries in India, we are still dependent on the OPEC (Oil Producing and Exporting Countries) to import crude and refine it to produce petrol, LPG, diesel, aviation fuel, kerosene etc. ”
I wonder why can we need to import crude when it is available locally ……
Hello Ajith,
Thanks for the info. Our blog entry has your blog link.
http://statsvak.blogspot.in/2012/01/from-crude-oil-to-petrol-bunk.html
Comments requested
very well documented ad explained .language was used is lucid and at the same time informative.
nice one !!!
Why don’t express your views on diesel price deregulation also?
MR Ajith…….
very well written!!
and every body should read this!!!
atleast they will come to know abt the actual scenario…
looking forward for some more informative blogs!!
Ajith,first i wish you for your article how petrol rates fix.
As i am business man who deals with lubricants and petrol bunk i didnt know how prices fixing..really thanks for given knowledgeble information.
Hi ajit,
This post is really very good and precise.