Petrol and Diesel: How Government Taxes Keep Retail Prices High

“…The current spike has been particularly severe as petrol and diesel prices have unremittingly soared by around 29% in less than a year. In Delhi, the capital city, retail prices of petrol and diesel went up from a low of ₹69.6 and ₹62.3 per litre in mid-April 2020 to touch a high of ₹89.9 and ₹80.3 by mid-February 2021,” observed an EPW editorial from February 2021, highlighting the most recent instance of rising fuel prices in the country.

What determines the prices that consumers pay for petrol and diesel? And why do the prices rally from time to time? Can fuel prices for consumers actually be much lower than they are?

In this reading list, we dig through the EPW archives for answers to the oil pricing conundrum in India.

How Are Retail Prices of Petrol and Diesel Calculated?

With the fuel price deregulations in India in 2010 and 2014, there is a perception that domestic prices of petrol and diesel are linked with the global crude oil prices. This is not true.

Lekha Chakraborty (2020) wrote:

… the price determination of petrol and diesel in India is not linked to crude oil prices in the international market. Price determination is done through dynamic pricing, termed as “trade parity pricing,” based on the international prices of petrol and diesel (finished products) prevailing in the international markets, and not on crude oil per se. An obvious question here is whether the crude oil prices and the petrol–diesel prices move in tandem in the international market. Not always!

Similarly, an EPW editorial (2018) observed:

In India, fuel is priced as if it, and not crude oil, is imported. Though, in reality, India is a net exporter of fuel, with the export value (at ₹23,858 million) in 2017–18 being almost 32 times the import value of fuel (₹744 million), thanks to the expansion in refinery capacity. But, premised on the misplaced assumption, the calculation of Refinery Gate Price (RGP) and, hence, losses/profits of oil manufacturing companies/refiners assign higher weightage to the import parity price of fuel. This, in turn, implies that whenever international oil prices rise, the oil manufacturers in India make a windfall gain. Concurrently, consumers end up paying a very high price, equivalent to what they would have paid had India been importing fuel instead of crude oil. Thus, the notional losses (profits)—commonly known as “under (over) recovery”—are over(under)estimations of actual losses (profits); though frequently used interchangeably with the latter.

Chakraborty added:

Globally, the market mechanism of ad hoc configurations of demand and supply of crude oil are different from the demand–supply dynamics of petrol and diesel, and, in turn, their pricing behaviour will also be distinctly different. The goi [Government of India] fixes the price of petrol and diesel based on dynamic pricing and trade parity pricing by converting the price from dollars to Indian rupees. The rupee–dollar exchange rate mechanism also affects the pricing of petrol and diesel. This can offset the benefit India can reap from comparatively lower prices of crude oil in the international market, quoted in dollars. The other components to this pricing formula are the cost of inland freight, marketing costs, taxes levied by the centre and the state governments, and the margins (charged by the oil companies) and (the dealer) commissions.

The trade parity pricing approach combined with the government’s taxation policies make it such that the retail prices of petrol and diesel paid by consumers have no connection with global crude oil price movements.

Commenting on the reports of the parliamentary Committee on petroleum and natural gas and the Rangarajan Committee on pricing and taxation of petroleum products, E A S Sarma (2006) wrote:

Elimination of the customs duty differential, coupled with pricing based on export parity, instead of trade parity, would have gone a long way in exposing our oil industry, especially the refining companies, to global competition. The hybrid arrangement of trade parity pricing would be a half-hearted and incomplete move towards a rational pricing strategy.

Government Taxes Create a Lose-lose Scenario for Consumers

The incomplete linkage of global crude oil prices with the domestic retail prices of petrol and diesel is especially relevant when it comes to falling prices of crude oil in the global markets. The beneficial effect of low prices is not passed on to retail consumers due to the incidence of government taxes. 

With consumers being unable to leverage the benefits of low global oil prices in early 2020, an EPW editorial (2020) questioned the purpose of India’s fuel price deregulations (of 2010 and 2014):

In theory, petrol and diesel retail prices in India are linked to the global crude prices, which in effect would mean that if crude prices fall in the international market—as has been the trend since February—then domestic retail prices should come down too. But, in practice, oil price decontrol seems to be rigid/sticky downwards. This happens because every time the (global) prices fall, the government imposes fresh taxes and levies to rake up extra revenues. Eventually, the consumers are short-changed and continue paying either what they were paying previously or end up paying even more. On the other hand, price decontrol enables the Indian fuel retailers to fix the retail prices based on their profit calculations over and above the costs (or prices) at which they source their inputs from the upstream oil companies for whom the price benchmark is derived from global crude prices.

The same taxes ensure that retail prices become even higher when prices in global markets surge—a scenario that would not have been possible prior to deregulation when prices were artificially maintained through the administered pricing mechanism. In the system prior to deregulation, the government faced the burden of high global prices and benefited from low global prices. Whereas with the current deregulated mechanism, the consumers lose out no matter what the global market conditions—they face the burden of high global prices but the benefits of lower prices are lapped up by the government through taxes and do not pass on to them. An EPW editorial (2018) explained:

Fuel price deregulations in 2010 and 2014 should have been meaningful had consumers been able to gain when global prices fell, just as they have to bear the brunt when the prices spike. But, the reality is otherwise. A back-of-the-envelope estimate is that with the addition of excise duty and VAT (nearly 50% of selling price) and dealer commission (at least 9% of the selling price), consumers end up paying double the price that upstream oil retailers charge from the dealers. While this huge burden of government taxes and duties makes consumers pay through the nose when global oil prices rise (currently to a record high of $80 per barrel since September 2014), it also prevents them from leveraging the benefits when prices are low. 

Even when the global crude oil prices had gone negative for a period of time during 2020, the benefits of the sub-zero prices were not felt by Indian consumers. Palanisamy Saravanan (2020) wrote:

India, in spite of importing almost 82% of its oil, is not going to benefit much from the falling global crude oil prices … the government has already increased excise duties and taxes on auto fuels to supplement its revenue collections, which prevents any sharp decline in retail prices. So, the common man is not going to benefit from the falling crude oil prices, and price of petrol and diesel will not go down in the foreseeable period. 

Identifying government taxes as the reason behind the incomplete transmission of pricing, Chakraborty (2020) wrote:

… low international prices per se do not translate into lower prices for petrol and diesel in India as long as the centre and states levy exorbitant taxes on these products. The interstate variation in the prices of petrol and diesel is also significantly explained by the differentials in taxes imposed. 

Proportion of Taxes in Petrol and Diesel Prices

Most goods and services, and even intermediate goods that form part of the production process, are subject to taxes by the centre, state governments or both. What sets the taxes on petrol and diesel apart are the high rates of taxation and the sheer scale of tax revenue involved. An EPW editorial (2021) noted:

Oil is closely associated with high taxes the world over. Numbers for the G7 countries show that for every litre of oil sold, around one third is crude oil price, 18% is industry margin and 50% is taxes. In some countries like the United Kingdom and Italy, taxes are 60% of the retail prices. Clearly, petrol and diesel taxes in India, which are around two thirds of the retail price, are on the higher side both in comparison with rich countries and also with most of our neighbouring countries.

After the government announced, on 5 May 2020, the “steepest ever hikes” on excise duties on petrol and diesel, an EPW editorial (2020) had calculated:

… the government is now collecting around 260% taxes (excise duty and value added tax) on the base price of petrol and 256% on diesel according to estimates by the CARE ratings, with its taxes and levies forming around 69% of the retail prices of fuel in India—the highest rate of fuel taxation globally.

And there has been a consistent increase in the fuel tax rates, as well. According to the EPW editorial from 2021:

Six years ago, in late 2015, just a year and a few months after the current National Democratic Alliance government was sworn in, the petrol prices charged by oil companies to retail pumps in Delhi were ₹28 per litre, almost the same as in early January 2021. However, the retail price of petrol has now gone up by 37%, from ₹61 to ₹84 in this period. The reason is that excise duty levied by the central government on petrol has gone up by an astounding 73% during these six years, while value added tax levied by the states has increased by 53% during the same ­period. 

The revenue windfall from the increase in taxes is also significant in actual terms. An EPW editorial (2018) highlighted:

Recall that between November 2014 and January 2016, concurrent to a period when prices of the Indian basket of crude oil fell to never cross $60 per barrel, the government had raised excise duties nine times, leading to a hike in duty on (normal) petrol by roughly 150% to ₹19.48 per litre and that of (regular high-speed) diesel by 330% to ₹15.53 per litre. This helped the government’s excise mop up ₹2,42,000 crore in 2016–17 against a mere ₹99,000 crore in 2014–15. Moving away from administrative prices has definitely benefited the public exchequer.

To elucidate the scale of the tax revenue from petrol and diesel, the 2021 editorial explained:

The recent estimates for 2019–20 show that the total direct and indirect taxes levied by the centre and the states on the oil sector are a huge ₹5.5 lakh crore, which is around 17% of the total taxes collected in the country and are about 3% of the gross domestic product. 

While the high taxes on petrol and diesel have been “a money-spinner for both the centre and states,” the 2021 editorial examined the differential revenues accrued by the centre as compared to the states, in recent years:

… trends from 2014–15 show that the share of oil taxes levied by the central government has gone up from 52% to 60% now, while that of the states has fallen from 48% to 40%, the latter mainly on account of dipping royalties on oil production and in octroi and entry taxes after the coming of the goods and services tax.
 
The actual losses of states in oil taxes are much larger. This is because the central government, which gets more than three fourths of its oil revenue from excise duties, has changed the excise duty structure to squeeze out the state’s share by reducing the share of basic excise duty, which is shared with the states, and mobilising a larger share of oil excise duty through surcharge and cess, which is its exclusive claim. Trends in excise duty collection show that the share of basic excise duty on branded petrol has been reduced from 42.6% in 2016 to just 12.2% now, while that on branded diesel has come down from 62.9% to 21% during the same period. 
 
… Even in the case of custom duty collections, the states get no share of the 3% surcharge on crude oil imports. 

It concluded that “the biggest gainer from the rising retail prices of petrol and diesel has been the centre at the expense of both consumers and the states.”

The Politics of Oil Pricing in India

While one may argue that such high rate of taxation is an imperative for the government to ramp up its fiscal position from the economic meltdown due to the pandemic, one should not lose sight of the fact that fuel prices have, time and again, been used as a route to garner easy revenues for political expediency.

—wrote an EPW editorial (2020) in the aftermath of the excise rate hikes of May 2020. 

What makes the pricing policy of petrol and diesel politically tricky? The contradicting considerations of revenue and appeasement of the electorate.

Terming fuel pricing in India “more a political statement than an economic exercise,” an EPW editorial (2018) observed:

It is unlikely that the government will be willing to sacrifice these easy revenues, especially in the wake of the 2019 general elections. On the one hand, with a depreciating rupee its oil import bills are burgeoning and, on the other, its tax revenues have not been settled fully as the goods and services tax (GST) is still a work in progress. At this juncture slashing down duties/taxes will mean fiscal adjustments by foregoing some of its pet welfare schemes. Many of the Bharatiya Janata Party (BJP)-governed states, which have waived off farm loans as a populist policy, can barely reduce VAT as the waiver has to be supplanted by revenue from elsewhere.

Explaining the flipside as well, it added:

Governments, however, dread fuel price hike in view of a discontent electorate. But, freezing the daily revision of petrol pump prices during pre-poll days (as in Karnataka in April/May 2018) to appease voters is a played-out strategy now, and may not work in the future, with the steep price rise that follows in its aftermath.

Remarking on the ubiquity of oil pricing politics, an EPW editorial (2011) wrote:

The price of petrol is the most convenient occasion for political parties to show their concern for the “common man” and to attack the government for its “anti-people” policies. 

Another element of oil pricing politics is the differential taxation between the centre and states. The 2018 editorial noted:

The persisting upsurge of fuel prices across the country brings home the ruling government’s lackadaisical attitude towards the problems that commoners encounter due to the hikes. In the face of country-wide protests by the Opposition, the central government has shifted the onus of fuel price adjustment on to the state governments. 

What makes oil pricing an easy avenue for politicking in the form of taxation? An EPW editorial (2021) concluded:

The oil sector has been an easy pick for governments mainly because demand for oil is price inelastic and it falls on the ­ultimate consumers making it less distortionary. More importantly, the middle class that bears the immediate brunt of oil price increases, from disproportionate increases in their transport costs, has very little political heft to resist such price hikes. 

The Problem With High Petrol and Diesel Prices

Indian retail markets witness high prices of petrol and diesel from time to time—how does this matter?

Amita Batra and B B Bhattacharya (2009) explained the negative relationship between oil prices and economic activity:

A rise in the price of crude oil gets passed on to the price of petroleum products and as a consequence from the consumer standpoint, the energy bill of the economic agents (households, industry and government) grows, whereas from the production standpoint, companies have to contend with a rise in unit costs. In terms of demand, this slows down consumption expenditures.
 
In terms of supply of goods and services, a rise in the energy price causes a drop in productivity, which is passed on to real wages and employment, selling prices and core inflation, profits and investment, as well as stock market capitalisation.

This assumes greater significance considering India’s high dependence on petroleum products. An EPW editorial (2017) noted:

India is the third largest consumer of crude oil in the world and its demand for oil is growing fast at a time when demand growth is slowing down in older industrialised economies. The global oil industry sees India as the most important export destination for the next two decades. India already imports over 80% of its crude oil requirement. 

How can the problem of high petrol and diesel prices be addressed? An EPW editorial (2011) wrote:

The government looks at every problem from the narrow perspective of decontrol and ending subsidies. Unfortunately, there is also no alternative political perspective with regard to oil and gas policies. Across the political spectrum the obsession is with prices. While these are important and the poor need to be cushioned from the fallout of the excesses of the rich, it also needs to be recognised that corrective policies which discourage personal transport, trucks and groundwater-based agriculture would reduce our dependence on fossil fuels and improve the efficiency of use as well. Can we hope for such a political position to emerge?

An EPW editorial (2001), which argued for deregulation in pricing and free competition in marketing of petroleum products, also noted:

When global oil prices go up, there is no way to insulate the Indian economy from its impact except through greater efficiency in energy use. Holding oil prices down and piling up a huge subsidy burden on that account only creates macroeconomic strain and is detrimental to growth.

Instead, the 2017 editorial contended:

Given India’s growing demand for oil, and its dependence on imports, there is a need for a more immediate strategy to drastically reduce fossil fuel dependence. This makes economic as well environmental sense. 

It added:

The move to alternative, less oil-dependent, transport systems is an important aim that India has adopted partially. A co-benefit of increased investment in non-polluting public transport or limits on personal transportation, for instance, would be a reduction in the pollution load in our cities, already some of the most polluted in the world.

Read More

Oil Prices and Their Legitimacy: Debating the Accuracy of the Brent Benchmark | EPW Engage, 2020

Reckoning Oil’s Worth: The OPEC, Brent Index and How We Calculate Global Oil Prices | EPW Engage, 2019

Policy Options for including Petroleum, Natural Gas and Electricity in the Goods and Services Tax | R Kavita Rao and Sacchidananda Mukherjee, 2015

Shifting the Focus for Oil Security | Chirag Shah, 2007

Day Dreaming on Oil Price | ISG, 1983