In the last week, our finance minister has announced that there may be no subsidy for the diesel prices for cars. It is one of the news among many news which is coming on its way about the fuel prices in India. Especially in India, fixing the fuel prices is one of the daunting task for the government. Indian govt. gives explanation to the common man for the reason of price hikes which can be understand only by the experts.
There are numerous things involved in the fuel prices, one of the important reason why the crisis comes in India is political influence on the issue. The intention of this article is to explain in the simple terms to understand the jargon used in the oil industry and how the Indian govt. decides the oil prices. If you have any thoughts, please post it in the comments section. Subscribe to our future articles here.
What is Crude Oil?
Crude oil is a naturally occurring liquid composed mostly of hydrogen and carbon. We don’t need any scientific explanation of the term. As we know, in day-to-day life everything revolves around the crude oil and its availability. It is the most valuable commodity in the planet then diamond or gold. If a country has the oil reservoir (the place where oil can be found), then its economy will be in the growth because every country needs the oil. It is the main reason why all the Arabian countries are very rich. There will be lot of geopolitics around it if a country has the oil reservoir. You would have understood the reason why America has captured the Iraq from Saddam Hussein.
What we are using in our life as Petroleum, Diesel,etc. as the end products of the crude oil. A company needs to invest billions of dollar to drill the earth and explore the oil sands. The process is called as Upstream in the oil industry. Once they found the oil sands, they have to take the crude oil and send it to the refineries which needs to extract the specific usable products like Diesel. In India, Reliance Industries has the world class refineries which can extract the any kind of crude oil. The quality of the crude oil can be very based on the geographical location. Not all the refineries can extract from all type of crude oil. Once the products are extracted, it will be sent to the outlets for distribution. This process is called as Downstream in the oil industry.
In the companies perspective, upstream business are more profitable then the downstream. The reason is, once you have the crude oil, it can be sold to any refinery in the world for the extraction. There is no extra expenses for the company. The price of the crude oil is same across the world and denominated in the dollar. The quantity of the crude oil is indicated in the barrels. For example, today’s price of one barrel of crude oil is $86. One barrel equals to 159 liter.
Subsidy for Oil Prices in India
Oil is one of the important product for the people in every country. The transportation and business heavily depend on the oil. It is obvious that any increase in the oil price would directly hit the common man and it will shoot up the inflation to higher level. To avoid that situation, countries normally try to reduce the oil price by giving the subsidy to the oil companies. For example, if a diesel price is Rs.55 per liter, in the market it is sold for Rs.40. In that case govt. needs to pay Rs.15 for every liter sold by the companies. Note that this subsidy is applicable for only the govt. companies (Public Sector Undertakings – PSUs).
In the above section, I have explained about the crude oil prices which is traded in the global market. Think about the situation when the crude oil prices are increased above $110 per barrel which is not the normal condition. In this case, govt. has to shell out the large amount to the companies. It will cause the unexpected loss to the govt. and will lead to the deficit in budget.In this quarter, govt. has to give 150 billion rupees ($3.4 billion) subsidy to the oil companies.
It is the one excuse our govt. is saying to please the people and increase the oil prices. But, there are lot of politics around the issues and many countries are giving the oil cheaper then Indian with subsidy. I need not explain the political conditions, the amount of corruption happening in India and no money for subsidy.
Why the non-govt. companies are not successful in the oil business?
In the above section I have indicated that only govt. companies will get the subsidy. Non govt. companies like Reliance, Shell (UK company) and Essar are running the oil outlets with the huge loss. Shell, which is planning to close oil distribution (downstream) business Indian because it can not get any profit. As we know that companies like Essar and Reliance has closed most of their outlets because of the loss.
Why they are meeting the loss?. Take example of Reliance, it is an integrated company which explore the crude oil then send to its own refinery and distribute it. If the crude oil price is say $120 per barrel, it can easily got more profit then selling it in the outlets. They will have to sell it for lower price then the actual cost of the end products. I hope now you would have understood why only govt. companies are in the oil business.
What is deregulation of Oil Prices in India?
It is said that the oil prices of India is regulated by the govt. of India. The companies can not sell it on the market price. The lost amount will be paid by govt. to the govt. companies as the subsidy. In the recent times, Indian govt. is running out of money and have no clue on how to manage the huge amount needs for the subsidy. The only solution for this problem is to slowly move the process of setting the oil prices by companies itself. Govt. will not involve on the prices. Companies will be given the authority to rise the price when ever they want. This process is known as the deregulation of oil prices.
As of now, petrol is the only product deregulated. Every fortnight, all the oil companies will meet and revise the prices based on the market situation. The darkest truth is that, this will not be suitable for India because in India most of the people are poor and they can not tolerate the high inflation. In the coming days, there is a proposal to deregulate the prices of Diesel and Cooking gas. If it happens, cooking gas price will be Rs.800 per cylinder.
Central and State taxes on Oil distribution
You would be surprise the amount of charges levied on the petroleum and diesel products. The following is the break down of the taxes levied from the oil companies:
- Excise duty : 14.35 rupees per liter
- Customs duty : 7.5 percent
- Sales tax or VAT : 20 percent.
You can read the details in govt. site.
If they want to reduce the fuel prices and contain the inflation, the first step would be to reduce the taxes on the fuel products.
World Economy and Crude Oil Prices
Crude Oil price plays major role in the global economy. It is good to maintain the crude oil price in the reasonable level. When the crude oil price in$85 – $95 is not an issue. If it is increasing above $100 then it will create the inflation problems within countries. Also, if it reaches the higher limit like $140 and above, it will lead to the recession. When economy is recovering and in the growth path, the demand for crude oil price is more. Then price will start increase. If the economy is slowing down, the crude oil price will come down.
Crude oil has the inverse relation with gold prices. Gold is mostly considered as the safe heaven to park the money and keep reserve. When crude oil prices goes down, gold prices will go up. In most of the times, crude oil and dollar would move in the same direction.
Summary
The above sections summarized the details on how the crude oil is taken and marketed by the companies. Then I have explained the fuel price issues in India and how the Indian govt. is handling the issue. The main purpose of the post is to educate the readers to understanding the pricing of oil products. Govt. is not making the loss on subsidy of oils, then what about the huge taxes they levied. Instead they give subsidy, it would be good idea to reduce the taxes and make the Indian people happy. The steep hike in the fuel prices erode the earnings of common man. If you like this article, please share with your friends.
Subscribe to our future articles here.
August 14, 2011 at 12:29 pm
As per the given data , hope approx 50% of what we pay for the fuel is separated as tax.
Really if the govt. has to control the price of fuel why don’t they reduce this tax, rataher playing the drama of subsidy..
August 14, 2011 at 12:30 pm
As per the given data , hope approx 50% of what we pay for the fuel is separated as tax.
Really if the govt. has to control the price of fuel why don’t they reduce this tax, rather playing the drama of subsidy..
August 14, 2011 at 7:10 pm
Hello Penon,
Yes. They must think of reducing the tax and collect the tax from the companies to increase the govt. income. Here its happening reverse.
Thanks,
Krishna
September 16, 2011 at 12:37 am
very well explained……..thanx a lot 4 postin keep up ur good work n post evn more articles
September 18, 2011 at 4:37 pm
dude… very well explained!… just wanted to say thanks!…god Bless u!
keep posting stuffs! 
September 23, 2011 at 9:00 am
nice article… keep posting.
Thanks a lot.
September 23, 2011 at 7:01 pm
Hello Thenmozhi,
Thank you for the comments. Keep reading our articles.
http://www.thinkplaninvest.com/2010/08/what-is-sovereign-debt-problem/
http://www.thinkplaninvest.com/2010/08/2010/06/euro-to-zero/
http://www.thinkplaninvest.com/2010/05/what-is-double-dip-recession/
Thanks,
Krishna
October 28, 2011 at 9:13 am
well explained……..
November 26, 2011 at 6:51 am
Really the corruption is hovering around everywhere.Now what Anna Hazare has to say in this case.All are frauds.Govt is befooling people jus look at the breakdown of tax structure on petrol prices. dey are putting people’s money in their pockets and den spending lavishly rather than taking any austerity measures. Just look at Developed economies like US; India will remain developing if it continued behaving the same way.
November 27, 2011 at 9:55 pm
Yes. Corruption is the main reason why India is still a developed nation. Just look the traffic in the roads, it is all wastage of millions of barrel every day. If we have good infrastructure we could save lot of money in the fuel and reduce the subsidy burden.
Thanks,
Krishna
January 19, 2012 at 2:46 am
thanx a lot!! ur article helped me a lot to understand various concepts.. the language u used is so simple to understand!! thanx again
March 12, 2012 at 1:12 pm
thank you very much for ur article it is very fruitfull to get knowledge about oil prices and govt. systm,,,,..thnks
March 12, 2012 at 6:50 pm
Hi gaurav,
Thank you for the comments.
- krishna
May 1, 2012 at 12:31 am
This government is making us(every Indian) fool.They(oil minister) always say that,they can’t do any thing to control the oil price.
Nothing can be happened of India unless or until these corrupt politician would be sacked from their position & send behind the bar.There is nothing to hear from them except execuses.
May 23, 2012 at 9:06 am
well explained in simple language……thanks for posting such an informative article
May 25, 2012 at 5:33 am
Thank you!!
May 24, 2012 at 12:45 am
What if they reduce both taxes and subsidies? What are the economic implications of the same?
May 25, 2012 at 5:29 am
HI Anindya,
They can not reduce the taxes because it has lot of pressure from world bank to maintain the taxes to repay their loan. It is not easy to reduce the tax unless we are economically sound and repaying the loans from other countries. In the recent days, world is losing confident on India, down trend of rupee value shows that. Politicians has to change their mind and work for the people. Read this article:
http://www.thinkplaninvest.com/2012/05/mystery-of-petrol-price-hike/
Thanks,
Krishna
May 24, 2012 at 10:51 pm
Nice Information.
May 25, 2012 at 5:30 am
Latest article on oil price hike,
http://www.thinkplaninvest.com/2012/05/mystery-of-petrol-price-hike/
Thanks,
Krishna
May 28, 2012 at 4:32 am
hi,
Thanks for the post, I have understood the crude oil price fluctuation in the market and its subsequent impact to the end user. However I have few questions, could you please explain for more understanding. Thanks in advance.
1. Does govt. know how much profit/loss oil company makes after sale?
2. Can govt. control/dictate the profit margin to oil companies?
3. If answer to above questions is yes, can we know the details?
Thanks.
May 28, 2012 at 6:13 am
HI Vinod,
1. Yes. Govt. knows and owns the profit taken by the oil companies. Note that most of the major oil companies in India are public and majority stake is with govt. itself. See the recent new about Indian Oil Company’s profit: http://economictimes.indiatimes.com/news/news-by-company/earnings/earnings-news/indian-oil-net-profit-up-224-at-rs-12670-crore-beats-estimates/articleshow/13597767.cms
They are showing the 224% profit growth. oops!!
2. Yes. govt. can regulate the fuel prices in India. Few months back petrol prices are deregulated, that is the reason now companies are increasing the prices. In the coming days, govt. wants to deregulate the diesel prices. Lot can be done by the govt. In the news they talk like govt. is facing lot of loss due to the oil subsidy, but the fact is different. Oil companies are making the huge margin.
3. The above are the explanations.
Do you have any other doubts?
Thanks,
Krishna
May 28, 2012 at 10:16 pm
Thanks a lot Krishna. No more doubts. And I am glad you replied with such a detailed information. Thanks again. Keep up the good work.
May 28, 2012 at 11:20 pm
HI Vinod,
Thank you for the comments. Keep watching our blog for more updates.
Thanks,
Krishna
June 6, 2012 at 5:10 am
VERY MUCH USEFUL ARTICLE !
THANKS FOR SHARING.
June 15, 2012 at 9:56 pm
Hello Mayuri,
Thank you for reading the article.
Thanks,
Krishna
June 15, 2012 at 9:36 pm
Simple language but very well explained.It was really informative.
June 15, 2012 at 9:58 pm
Hello Shraddha,
Thank you for spending time on reading my article. Share this information for the benefit of your friends.
Also you can subscribe to the future articles here:
http://www.thinkplaninvest.com/subscribe/
Thanks,
Krishna
June 22, 2012 at 2:46 pm
Its indeed a nice & informative article. But, I didn’t understand the meaning of this line – “Crude oil has the inverse relation with gold prices”.
I would be glad if u will clear my doubt.
& yes please do update me with your coming articles.
June 22, 2012 at 6:22 pm
Hello Boski,
It is not always the inverse relation. It means that when crude oil prices decreasing, you would see gold prices increasing. The reason is, if the crude oil prices started decreasing, it implies that economy is weakening. When economy shrinks, everyone starts investing on the gold instead of dollar. So, most of the times it has the inversion relation.
Hope this clears your doubts.
Thanks,
Krishna
June 25, 2012 at 8:48 am
Yes, Agreed
June 26, 2012 at 4:49 pm
Hello Tushar,
Thank you fo the comments.
Thanks,
Krishna
July 10, 2012 at 10:18 pm
Very well written about the Govt. Saga over the Petroleum products
July 10, 2012 at 10:38 pm
Hello Rayees,
Thank you for the comments.
Thanks,
Krishna
September 7, 2012 at 11:20 pm
What i understand from this article is that the government collects the subsidy money from the end users in the form of taxes and they pay it to the oil companies then there is practically no loss to the government and then how a Deficit can occur in their budget