Who is responsible for the hike in Oil prices?

by June 6, 2018 0 comments

Who is responsible for the hike in Oil pricesPublic sector oil companies need to be clear in fixing their price policies and official bodies also need to put up a question whether our oil refineries are proficient in setting standards. Only then one can identify the factors behind the increasing prices of oil.

The spikes in petrol and diesel prices are the focus of attention these days. The official argument is that the oil companies have no other way but to raise the user price to recover their cost of operation due to a higher import price of crude oil in the global market.

The usual argument is that the Government should reduce taxes on these products to give some relief to the consumers. However, the Government is hesitant to do the same for two reasons. Firstly, it would inflate the Budget deficit leading to inflationary impact in the long run. Secondly, the Government will have less money to spend on the social and infrastructural schemes, which does not augur well for the Government in view of the upcoming General Election in 2019.

In sum, the argument goes that Indian consumers pay a significantly higher price for petrol/diesel relative to other countries due to in-built taxes. The implicit assumption is that Indian oil companies are efficiently managed and consumer does not bear high prices due to their inefficiency. Or is there fallacy is this argument? Of course, one can argue that Indian oil companies are Maharatna central public sector enterprises (CPSE) which give dividends year after year to the Central Government. So, how one can argue that they are inefficient and badly managed? Alas, oil is such a commodity that all oil companies worldwide make profits.

Of course, the monopoly of the public sector oil companies ensures that their profits are guaranteed. Unlike other countries, imports of refined petrol or diesel are not allowed by the third party in India so that Indian oil refineries can operate at a near full capacity. So, there is no way to judge whether a private enterprise can sell petrol/diesel at prices lower than Indian oil companies after paying due taxes on the specified commodities.

Like many other countries, India imports crude oil and refines it domestically and sells it to the consumer. The prices paid by the consumer depends on several key factors such as crude oil price, refinery processing, landing cost and other operational costs along with oil marketing companies (OMC) margin, dealer margin, transportation, freight cost and of course the various taxes charged by the Central and State Governments.

While some of the Indian refineries are highly efficient and their cost of processing are comparable to the best in the market, there exist refineries which are inefficient and use obsolete technologies.  The cost of processing in such refineries is high and they are subsidised by the efficient ones. As a result, the cost of processing goes up.

Recently, oil refineries invested a lot in refineries to produce clean fuel. Are they passing this buck to the consumer under the guise of high import price of crude oil?

In the above formula, one thing that is always opaque is how one estimates refinery processing costs. As is well-known, the distillation of crude oil in a refinery produces multiple products grouped into four categories: Light distillates  (LPG, petrol, heavy naphtha), middle distillates (kerosene, automotive and railroad diesel fuels, residential heating fuel, other light fuel oils), heavy distillates (heavy fuel oils, wax, lubricating oils, asphalt) and others. Out of these, only a few products such as petrol, diesel, kerosene, aviation fuel are not allowed to be imported directly by third parties and to be sold to the consumers/end users.

By contrast, there is no restriction on importing other commodities in these chain to the end user. Incidentally, the market price of other commodities does not rise significantly when crude oil prices rise. Obviously, the channel of imports implies that oil companies will land up with unsold stock of these by-products if they tend to raise their price. There is no information regarding the refinery processing price of these other by-products.

Are they proportional to their volume of production? If the Indian refineries are not cost-efficient, it is most likely that the price of other importable by-products are subsidised from the marketing angle and the subsidy is recovered by fixing a higher refinery price for petrol and diesel. Typically, the byproducts from the distillation process of crude oil amounts to 30-35 per cent by volume depending on the type of crude oil.

Public sector oil companies need to be transparent in their price fixation policies. Policymakers also need to question whether our oil companies/refineries are efficient by world standards. Only then, can one identify the ex-post and ex-ante factors behind high domestic oil price.

(The writer is Senior Fellow, National Council of Applied Economic Research)

Writer: Sanjib Pohit

Courtesy: The Pioneer

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