Reasons and Implications of Rising Oil Prices for India


INTRODUCTION

The rates of petrol and diesel were raised for the eleventh straight day on 24 May 2018 across the country and the situation is becoming untenable for the survival of a common man, as the fuel prices directly or indirectly affects every sphere of our lives.

The petrol and diesel prices in Delhi from Rs 56.49 per litre and Rs 46.01 a litre, respectively in February 2015, have now touched Rs 76.87 per litre and Rs 68.08 per litre. The global crude oil prices rose from $60.00 per barrel to $80 per barrel during the same period.

It is being argued that the benefits that had accrued due to low global oil prices between 2014 and 2016 were not proportionately passed on to the consumers. In fact, the crude oil prices during 2016 were at its lowest, i.e. in the bracket of $30-40 per barrel.

The government had raised the excise duty on petrol and diesel nine times between November 2014 and January 2016 to shore up finances as global oil prices fell. The same accrued profits of Rs 11.77 per litre on petrol and Rs 13.47 per litre on diesel during that period.

However, the government had slashed excise duty on petrol and diesel by Rs 02/litre last year and again after 2018 Union Budget by Rs 06/litre, but introduced a new Road Cess of Rs 08/litre. Hence, effectively there was no change in the tax imposed on per litre of petrol and diesel.

The global oil prices are believed to continue to follow the current trend of an upwards trajectory during 2018 and the fiscal situation in our country is not conducive enough to provide the common man with any relief.

Factors Affecting Global Oil Prices

Demand and Supply: The price of crude oil, like any other commodity is highly volatile and is largely determined by the equation of demand and supply.

The 14 OPEC countries from the Middle East hold the largest proven reserves of oil in the world. The Organisation of Petroleum Exporting Countries (OPEC) regulates the oil production and it’s pricing.

The global economic growth slowdown has resulted in the reduction of demand of crude oil, especially from emerging economies like China and India that are the major importers of crude oil.

Consequently, OPEC decided to cut down its production with effect from January 2017, which forced the oil prices to rise.

However, excessive increases in crude oil prices brought by production cuts would end up further dampening the demand. The OPEC will be meeting on 22 June 2018 to discuss and possibly revise their earlier decision.

Political and Economic Instability in the Oil Producing Countries: Geopolitical crisis, as is prevailing in the Middle East, is also one of the major factors that determine the fluctuation in oil prices.

The disruption is oil production that was being globally contributed by major oil producing countries of the world due to various reasons like, ongoing conflict in the Middle East, crippling economic sanctions on Russia, re-imposition of sanctions on Iran by US and political instability in Venezuela have begun to create an artificial scarcity of oil in the global market.

In order to counter this threat, oil from countries like, US, Nigeria and Libya is now reaching the global market.

Increased Production of US Shale Oil:Availability of cheap funds and advanced directional drilling technologies has enabled US to extract crude oil from Shale wells.

US has huge Shale oil reserves and by way of perfecting its oil extraction technology, US has managed to extract more oil per well and reduced the break-even for conventional oil by nearly 50%.

President Trump has lifted a 40 year old ban on the export of American oil and hence, surplus oil is likely to flood the global markets.

Thus, by increasing its oil production exponentially, it’s only a matter of time before US starts determining the global oil prices rather than the OPEC.

Increased Interest Rate of US Bonds: The higher rate of interest of dollar denominated bonds is becoming more attractive for investors, thereby increasing the exchange value of dollars against other currencies.

Since, mainly the oil sales worldwide are denominated in dollars, a rise in the dollar means it costs more in other currencies to buy a barrel of oil.

The gradually weakening rupee against the dollar is considered to be a major reason for the continuous rise in oil prices in India.

Implications of Rising Oil Prices for India

Adversely Affect India’s Economic Growth: India imports 82% of its oil requirements and is the third largest consumer of oil after US and China.

Economic Survey- 2018 estimates that for every increase of cost of oil by $10/barrel the corresponding reduction in the GDP is 0.2 to 0.3% points.

The survey has further forecasted that during the FY 2018-19, the price of crude oil is likely to grow at an average of 12%. Hence, the GDP predictions for the 2018-19 may remain difficult to achieve.

Wholesale Price Index (WPI) Inflation will Increase: The cost of fuel is inbuilt into all goods and services purchased. An increase in the global oil price will automatically push the WPI and the Consumer Price Index (CPI) inflation higher.

Hence, the price of every commodity is expected to further rise as the global price of crude oil increases and the cost of living and sustenance is likely to go through the roof.

Current Account Deficit will Rise: The current account deficit (CAD) is a measurement of a country’s trade, where the value of the goods and services it imports, exceeds the value of the goods and services it exports.

India’s FY19 current account deficit (CAD) could be $75 billion or 2.7% of the GDP with oil at $80 a barrel average. It is considered that CAD above 2.5% is not considered sustainable.

Lose the Advantage of Reducing Fiscal Deficit: The gross fiscal deficit (total revenue minus total expenditure), which includes interest payments, stands at 3.2%, of the GDP, has been brought down from 4.5% of the GDP, ever since BJP government came into power in 2014.

In case the Modi government is able to further reduce the fiscal deficit, it will be in a position to provide liberal tax cuts, offer populist schemes and distribute freebees to the common man just before 2019 elections.

However, if the oil prices continue to follow the current trend, this major advantage with the BJP may be lost.

Calculation of Oil Prices for Consumer

The cost of fuel has not been included in the framework of GST by the GoI and tax is levied on it as per the previous taxation regime of excise duty at the centre and VAT at the state level.

The calculation of cost that the end user or the consumer has to pay is explained as follows:

Cost of crude oil assuming @ $72.5/barrel = Rs 31.5/litre.

Cost of fuel after refining (landing, processing, freight charges, etc) = Rs 36.93/litre.

Cost charged to dealer before VAT including Excise Duty @ Rs 19.48/litre and Road Cess @ Rs 08/litre = Rs 56.41/litre.

Cost after commission of Rs 3.62/litre is given to the petrol pump owner = Rs 60.03/litre.

Final retail cost after paying VAT which varies from state to state (about 27% on petrol and 16.75% on diesel) = Rs 76.24/litre.

Note: As per the directions of the government with effect from end 2017, it is mandatory to mix 10% Ethanol with petrol. Ethanol is a natural Fuel, made from Sugar and starch, which mixes well with petrol and also has no PM (Particulate Material) Pollution. The cost of Ethanol is just Rs 40.85/litre. However, the consumer is paying the cost of petrol for the Ethanol mixed in it.

CONCLUSION

The variables that determine the final cost of fuel include international oil price, currency exchange rate, central taxation, state taxation and the dealer’s commission.

The only variable, which is within the control of the government, is the taxation. The central government levies Rs 19.48 a litre of excise duty on petrol and Rs 15.33 per litre on diesel. VAT is imposed state wise, let’s say, Delhi levies VAT on petrol @ Rs 15.84 and Rs 9.68 a litre on diesel. Taxation accounts for one quarter of the total cost of the petrol/diesel that the consumer has to pay.

Just imagine the revenue that the centre and state governments would have collected when the oil prices remained around $40 per barrel for more than three consecutive years. It should have been prudent to create a corpus during that period from which the common man could have been provided relief at this stage.

However, now if the centre government reduces excise duty, it will not be able to meet its target of reducing the fiscal deficit from 3.5% to 3.3% of the GDP in the current fiscal.

Hence, the Centre had asked states to lower VAT, but just four states, namely Maharashtra, Gujarat, Madhya Pradesh and Himachal Pradesh have reduced the rates, while others including BJP ruled states have ignored the call.

JAI HIND