The economics of petrol pricing

By: |
February 27, 2021 4:00 AM

The excise rate, levied on a per-unit basis, has been in the range of Rs 18-20 for 2018, 2019 and the first half of 2020.

This break-up in price can be traced back over the last three years.This break-up in price can be traced back over the last three years.

The increase in petrol price has come when the economy is turning a corner and inflation is coming down. Government revenues have also started reverting to normal. The argument for higher levies on petrol and diesel, which could have been justified when the crude oil price was low and consumption declined sharply, is not really strong now.

As usual, there is a discussion on what should be done to ease the prices. The Centre feels that the states should lower their taxes, which is an ad valorem levy. The states feel that the Centre has more legroom as it has already converted taxes into cess, which need not be shared with them. The Centre has pointed to the increasing crude price and made a plea to OPEC to expand output to lower prices.

There are four components to this price: the cost to the dealer, which includes the crude oil price and other processing charges, excise duty charged on per unit basis by the Centre, a dealer commission to the fuel station and a VAT imposed by the state. VAT rates vary across states—being outside the GST ambit—and accounts for a rather wide variation in prices across regions.

This break-up in price can be traced back over the last three years.

The cost to the dealer has three parts: crude oil price in global markets, exchange rate and refining costs, with the first two exogenously determined. As can be seen, this price has varied based on these factors, but has been in the lower range since mid-2019. When the crude oil price was around $65/bbl, the cost went towards Rs 41/litre. But, at present, the crude oil price of around $60/bbl has an associated cost of Rs 32.90, which is comparable to the cost in November 2017 and the two points in 2019. Hence, the argument that the price is high because of global crude oil prices is not convincing.

The excise rate, levied on a per-unit basis, has been in the range of Rs 18-20 for 2018, 2019 and the first half of 2020. In June 2020, the rate was increased by around 65% as consumption had fallen sharply due to the lockdown. The lower crude oil price, hence, did not result in a major gain for consumers as the retail price was maintained at Rs 71-72/litre. Our policy has been that whenever the global price of crude comes down, the government ramps up its revenue collections, giving minimal relief to consumers.

The commission on fuel products has been virtually static, which means that petrol dealers make money only when volumes of sales increase as their income is agnostic to the crude oil price as well as duties paid.

The state contribution to this price rise is interesting. For 2017, the effective VAT rate for Delhi was 27% and remained the same till November 2019. It rose to only 30% in 2020-21. Therefore, the NCT did not increase the rate significantly, but as the tax was on a higher base given the way it is reckoned, there was an automatic gain. Delhi, however, has a low VAT rate. For states where the price is closer to `100/litre, the effective VAT is upwards of 42%.

Now, there can be strong arguments for both the Centre and states to rationalise their taxes. If excise is reduced and the states do not automatically increase their VAT rates, the state part of the price would come down less than proportionately, and the consumer can pay a lower price. On the other hand, if the crude oil price goes up sharply and the tax rates are not changed, the Centre would not benefit while states would gain on the VAT collection as the taxable base rises.

Quite clearly, the economics behind the petrol price determination is complex as the tax rules are very different, being out of the GST framework. For the present, it does look like the government on both sides will remain mostly intransigent in their tax view, which will change only in case the crude oil price increases sharply.

The author is Chief economist, CARE Ratings, and author of Hits & Misses: The Indian Banking Story. Views are personal

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