101 Series – The Politics and Economics of Oil Prices
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This article shall try to educate the readers about the economics of the oil prices and also the politics behind it in India. It shall also compare the approaches of the two main political parties the BJP and Congress in managing their prices and which approach can better manage inflation.

Before getting into the details, there are some basic aspects that need to be understood:

1.       Oil refining process: Petrol and Diesel are not found in nature as such. Crude oil is infact mixture of various petroleum products like petrol, diesel or kerosene. Crude is separated into fractions through a fractional distillation.

If petrol, diesel and kerosene are produced simultaneously, it essentially means the cost of producing these items must be shared equally. In simple terms, prices of each these commodities must be same.

Of course there are various factors and usage patterns based on which differential costing is done. For e.g. diesel prices are kept lower because diesel is used to carry goods and any increase in its prices directly impacts inflation. Likewise kerosene is generally used by the poor and hence prices are kept lower.

The problem occurs when the difference becomes too large as has happened at this moment. The huge difference between petrol and diesel is fueling demand for diesel cars, which may not be as environmentally friendly as the petrol ones. Similarly huge price difference between petrol and kerosene fuels adulteration of petrol.

2.       Oil taxation in India: Roughly 50% of the cost of petrol in India is constituted by taxes.

Let us say the cost price of petrol is Rs 25 per litre. Then the selling price in India would Rs 50, the difference going into the govt. coffers in the form of taxes. Now if the cost price increases to Rs 30, then the selling price would be Rs 60. So basically govt. is now getting Rs 30 in the form of taxes. It is profiteering at the expense of aam aadmi.

The key question is

‘Why are taxes on oil high?’

There are two types of taxes – direct and indirect. Direct taxes are taxes that are applied directly on the income of individuals and corporates. Indirect taxes are applied at the time of sale of any article, like sales tax.

Less than 3% of people in our country pay income taxes. Since our economy is not developed, there are enough opportunities for people to hide their income and thus evade tax. This is why most of the Govts tax collection is through indirect taxes.

Each and every citizen consumes oil in some form or other. This can be in the form of using public transport or private. Additionally each and every good that we consume are essentially transported and thus consumes oil. So every one rupee increase in diesel prices means increase in prices of goods.

Oil (Petrol, Diesel, etc) is thus a cash cow. Since everyone uses oil, taxation on oil means a steady source of revenue for the Govt. In fact states get 1/3rd of their revenue from taxation on petroleum product.

Taxation on oil is not the problem, but profiteering at aam aadmi’s expense is surely criminal. Moreover the tax rate on petroleum products must be reduced progressively while instituting reforms to expand the tax base at the same time. There has to be an attempt at reforming the system so that tax collections are efficient and there is no black money, something that the present Govt. has failed to do.

3.       Profits made by Oil Companies: It is often alleged that oil companies are making profits and prices must of petroleum products must not be increased. So the key questions is:

Should oil companies generate profit? Why can’t they serve the people?

The business of business is to do business. Every business must be self-sufficient and it must not only be able to pay its bills but also generate at least decent profit.

What happens if a business ceases to generate profit?

Let us take a classic example – Indian Railways. Indian Railways today is going through a bad time and running into losses. Losses mean that it has no money to start new trains or building new railway lines. Since railways form a key infrastructure, no expansion means less growth. Less growth means less people are lifted out of poverty. What’s worse Indian Railways cannot invest in key areas such as train safety. So the obvious question, are Indian people really gaining by this subsidy in train fare?

Why can’t Govt pump money into Railways?

Of course it can, but where would this money come from. Govt. has limited money. It would obviously mean cutting down on something else like education or health, something that is not desirable. So it is prudent that Indians pay a fare price to the goods and services they consume.

Should oil companies make profit?

The answer is obviously yes. Oil is important commodity as it drives the economy. Any oil shortage can bring the world economy to a grinding halt. As Indian economy grows, its appetite for oil also increases. India would need to augment its refining capacity, i.e. build more refineries. It would need to purchase oil fields across the world. It would need to invest in oil exploration within our own country.

All this would consume money. This is why Oil companies need to generate profits. Failure to invest in these would pose serious risks to the long term growth story.

Comparison of BJP vs Congress approaches

Before comparing the approaches of BJP and Congress we must bear in mind one basic factor – the enormous increase in world crude prices.  International Crude Oil price hovered between $24 and $36 per barrel during the NDA time. The present international price is around $110-120 per barrel. Hence the comparison must factor in this increase.

Would the BJP have done anything different? After all, it was the BJP that deregulated the oil prices

BJP is a centre-right party and believes in free market economics and capitalism. It is the more reform oriented party amongst the BJP and Congress. It was BJP which deregulated the petroleum products in 2002.

Congress on the other hand is a centre-left party that believes in populism, not fully committed to reforms and shies away from taking politically tough decisions.

Deregulation: Difference in Approaches

Deregulation meant that prices of petroleum products would be determined by market forces and Govt. would not have any role in determining the prices.  Key differences between the 2002 deregulation and the current one are:

  • BJP had not just increased the prices but also decreased their prices whenever the world prices reduced. On the other hand, presently the prices are being revised only upwards.
  • The 2002 deregulation was not just limited to petrol but was also applicable to diesel.
  • BJP reduced taxes on petroleum products – Between 1998-2004, there were times when the BJP did not increase the petroleum prices despite increase in the world prices. They did so by reducing taxes on petroleum products. As opposed to this, the present CONGRESS Govt. has not reduced the taxes and oil companies are reporting losses. Govt. has been issuing oil bonds to the oil companies.
  • BJP adjusted the prices immediately whether upward or downward – Had those policies been continued, it would have meant that prices would have increase by small amounts as and when world crude prices increase.  The small increases are easier for the market and people to swallow. As prices would have increased in small amounts, the wages would have adjusted accordingly.
  • Congress dismantled the deregulation in 2004 – After coming to power in 2004, the Congress dismantled the deregulation. After burning its hand and realizing that deregulation was in fact the right policy, it has now deregulated petrol prices. The big problem is the world prices are now roughly 3 to 4 times the value they were in 2004. This has meant huge increases in petrol prices in India in a very short time. Markets cannot adjust to such huge increases in such a short time. As a result, we are witnessing huge inflation.
  • The average Inflation during the NDA regime was around 3-4% while it is at 10% currently.

Spending the Tax revenues

Another key difference between the BJP and the Congress is how they spent the tax revenues collected from the tax levies on petroleum products.

In its six years, BJP invested huge amount of money in building roads and highways. The rate of highway development during the NDA era was 11 kms per day as opposed to less than 6 kms per day at present. Huge infrastructure projects like Golden Quadrilateral, North-South and East-West highways were conceived and executed at lightening pace. These projects cumulatively enable India to save thousands of gallons of crude oil every year.

Similarly, the BJP started the Pradhan Mantri Gram Sadak Yojna in 2000. This was the first integrated scheme aimed at improving rural connectivity. Improving rural connectivity meant that it became cheaper to transport goods and thus meant inflation was reduced. It must be noted that BJP allocated 50% of the diesel cess for rural roads. (Source1, Source2)

Congress on the other hand has hardly invested in improving connectivity across the country. Pradhan Mantri Gram Sadak Yojna  is stuck because of a crippling shortage of funds. The agency implementing PMGSY has “put on hold” clearance to any new projects. There has been no improvement after this year’s budget. (Source)

As has been already mentioned above, BJP reduced taxes on petroleum products as and when required. The reason why they were able to do was because they were able to control the expenses made by the Govt. They were also much more pro-reform and were able to raise money through alternate sources like disinvestment.

Congress on the other hand has not reduced the taxes on petroleum product much. The reason is primarily because it has been spending far too much money than India can afford. It has wasted huge amounts of money in schemes like NREGA. But in spite of the huge cost India is bearing, Congress is going ahead and launching more vote earning policies like Food Security. There is little room left for Congress to reduce taxes on petroleum product. Moreover, it has hardly instituted any reforms and still continues to run loss making companies like Railways and Air India.

Final Thoughts

It is not that PM is not aware of the above mentioned facts. The question is whether he is in control. I have presented all facts and I rest my case. I leave it for the readers to decide how well is our economy is being managed.