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Increase in oil prices
Sep 16, 2017

[GS Paper II: (Government policies and interventions for development in various sectors and issues arising out of their design and implementation)]

Why in news?

  • The dynamic daily fuel price revision from June 16, has led to petrol and diesel rates increasing by around 5% in less than three months.
  • In 2012, when India purchased a barrel of crude for around $120, a litre of petrol was sold at around ?65 in retail fuel stations. Today, when the Indian crude basket price has dropped to around $50, the retail price of petrol is well over the ?70 mark. 
  • The government however, has argued that the daily revision of petrol and diesel rates immediately passes on the benefit of any reduction in international oil prices to consumers and avoids sharp spikes by spreading them in small doses.
  • Also, the government has to finance huge infrastructure and social projects which are to be balanced with consumer needs.

Reason

  • Excise duty and value added tax have prevented the benefits of lower international crude oil prices to be passed on to the lower domestic fuel prices. About half the price paid by the Indian end-consumer for petrol goes towards paying these taxes. 

How is the price of crude oil determined?

  • Crude: The revision in the price of fuel corresponds to the change in the global crude oil prices on that day or even the previous day.
  • Rupee/ Dollar Exchange rate: One of the major factors is the rupee-dollar exchange rate. Indian oil companies import crude oil which is quoted in US dollars, but eventually incur the expense in rupees. Thus, even if the price of the crude oil is on the fall but the rupee is also weakening against the dollar at the same time, it may offset the potential gains to oil refiners. On the other hand, strengthening rupee along with weakening crude oil further augments oil refining and marketing companies’ gains, which is currently happening in India. 
  • Demand-supply situation: Among other factors for setting retail fuel prices is the demand-supply situation. Short supply or low output of fuel often leads to a rise in its price; while conversely, an increase in the supply mostly results in the decrease in the price.
  • Logistics: Further, logistics is also one of the other major factors in pricing of retail fuel. Petrol and diesel transported to over longer distances to cities or regions farther from depots would typically be priced higher than at the places nearer to the oil companies’ storage areas. 
  • Pricing mechanism: Daily revision of retail prices of petrol and diesel all across the country would also affect the price of fuel.

Timeline of fuel pricing in India

  • In 2002, petrol and diesel prices were freed for a short period, oil companies had the freedom to manage retail price of diesel on their own and adjust it at periodic intervals to reflect market levels.
  • When oil prices in the international market started to increase post 2004, the deregulation was found to be missing its objective. However, fortnightly revision continued, but the revision was not completely in sync with the required price increase.
  • The government deregulated petrol price in 2010 and diesel price in 2014. It, henceforth, allowed oil marketing companies to decide on the prices of fuel, considering the change in international oil prices and currency exchange rate.
  • From June 16, 2017 the dynamic oil price revision was implemented across India. 

Why daily oil price revision?

  • The petrol and diesel rates in the country are revised every day. The prices are in sync with the prices of oil in international market. 
  • Earlier the rates were revised on 1st and 16th of every month and were based on average international oil price and foreign exchange rate in the preceding fortnight.
  • The oil companies constantly complained of losses and after much deliberations finally dynamic revision was brought in. 
  • This move is believed to crystallise the outlook for oil marketing companies’ (OMC) marketing margin—or the difference between the cost of procurement and the price charged by retailers.
  • Time lag between crude purchase and products sales will collapse, thus allowing prices to reflect cost and avoid artificial distortions.
  •  It may also enhance OMCs’ ability to pass the prices into the economy more effectively.
  • A liberalised retailing regime may also expose the OMCs into an intensive competitive scenario.
  • This move will align the retail pricing of crude products in line with price changes in the international markets, and bring in transparency in the pricing of crude products.

Way forward

  • An alternative tax such as the goods and services tax (GST), would substantially lower the current tax burden on fuels. 
  • A portion of the excise on petrol and diesel can be converted into a cess, whose proceeds would be used solely to fund railways, metro, highways, irrigation, port and other infrastructure projects.
  • However, for a country short of fossil fuel resources, there is a long-term case for restraining consumption and promoting energy efficient production alongside renewable technologies. One way to do it is through taxation, which will also contribute to the exchequer. 


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