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Oil Sector :Pricing of oil in
India
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INDEX
Sr. No Topic Page No
1
2
3
4
5
INTRODUCTION
1.1 Research Objective
1.2 Research Methodology
1.3 Review of Literature
INDIAN CRUDE OIL MARKET
2.1 Historical Background
2.2 Production of crude oil in India
2.3 Indian Energy Industry Structure
OIL PRICING POLICY IN INDIA
3.1 Facts and Figures3.2 Latest development
FACTORS INFLUENCING OIL PRICES IN
INDIA
ROLE OF GOVERNMENT IN OIL SECTOR
5.1 Policy Initiatives
5.2 Opportunities
1 4
5 12
13 - 17
18 20
21 24
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6
7
8
9
10
IMPACT OF UNION BUDGET
6.1 Background
6.2 Budget Proposals6.3 Budget Impact on Industries
6.4 Budget impact on companies
CRUDE OIL FUTURES
7.1 Introduction
7.2 Benefits of MCX crude futures
GOVERNMENT TAXES ON FUEL
8.1 Subsidy allowed on fuel prices
8.2 Central Excise and custom tariff
8.3 Dealers commission on Petrol and Diesel
8.4 Distributor Commission on LPG
IMPACT OF INCREASE IN OIL PRICES ON
GROWTH AND INFLATION LEVELS IN
INDIA
REAL COST OF PETROL IN INDIA
25 29
30 34
35 42
43 46
47 50
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11
12
13
14
15
16
CHANGE IN PRICE OF CRUDE OIL
PRICE DISCOVERY
Introduction
Indian Condition
The Issue Of Asian Risk Premium : Dubai
Crude Being An Ineffective Marker
Solutions to the problem of Asian Risk
Premium
Need For Supply Chain Efficiencies
Case of other Markets
o a)TOCOM
o b)SIMEX
RECOMMENDATION
CONCLUSION
APPENDIX
BIBLIOGRAPHY
51
52 63
64 70
71 72
73 75
76 - 78
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LIST OF FIGURES
Sr. No Topic Page No
1
2
3
4
5
6
PLAYERS IN INDIAN OIL SECTOR
PROCESSING AND DISTRIBUTION OF OIL
AND ITS FINISH PRODUCTS
PROJECTION OF GDP IN 2050
EVALUATION OF PETROL AND DIESEL
PRICES
CHANGE IN CRUDE OIL PRICES AND ITS
FINISHED PRODUCTS
CONSUMPTION OF DIESEL BY DIFFERENT
USERS
10
11
20
49
51
67
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LIST OF TABLES
Sr. No Topic Page No
1
2
3
4
5
6
7
8
9
10
11
CHANGE IN DUTY STRUCTURE
BUDGET IMPACT ON COMPANIES
INTERNATIONAL OIL PRICE VARIATION
MAXIMUM PRICE VARIATION
SUBSIDARY ON PDS KEROSENE AND
DOMESTIC LPG UNDR SUBSIDARY
SCHEME 2002
SUBSIDARY FOR FAR FLUNG AREAS
UNDER FREIGHT UNDER SUBIDIARY
SCHEME 2002
CENTRAL EXCIZE AND CUSTOM TARIFF
DEALERS COMMISSION ON PETROL AND
DIESEL
DISTRIBUTORS COMMISSION ON LPG
IMPACT OF OIL PRICES
FACTORS FOR PRIC DISCOVERY ON MCX /
NCDEX
27
29
34
34
36
37
38 40
41
42
44
57
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12
13
WORLD OIL DEMAND 2010
AVERAGE ANNUAL USE OF PETROL PER
VEHICLE
59
64 - 65
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ABSTRACT
Oil is vital to the world economy and the world consumption of oil, driven bycountries such as India and China, is set to rise significantly.
Since the horse and carriage gave way to the car as the main method of
transportation oil has been vitally important to the world economy. Its importance has
risen to the extent that in a world suddenly without oil, all the minor and major
distribution systems that allow economic transactions on a more than local basis would
fail and the world economy would collapse.
Many people underestimate the significance of oil and natural gas in modern
civilisation, and mainly associate oil with the petrol or diesel that they put in their cars.
However, the value of oil to our world goes far beyond our personal transportation
choices as many of the everyday items we use are either made from oil or are dependent
upon oil for their production.
The fruit and vegetables on supermarket shelves are highly dependent upon oil -
from the fuel oil used to harvest and then transport these goods around the world, to the
petrochemical feedstock used to manufacture the pesticides and herbicides that maintain
high yields. Even fertiliser is dependent upon large amounts of hydrocarbons for its
manufacture. The whole of our modern food chain is completely dependent on oil,
meaning that the future of agricultural production is vulnerable to depletion of this non-
renewable resource.
Many consumer goods are made of plastic, a material utilising petrochemicals in its
manufacture. Many common medical and pharmaceutical products also have oil as a
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basic constituent. The aspirin, originally processed from the bark of the willow tree, is
now another of these many oil derivatives.
Oil has proven to be such a flexible resource that it now underpins many of the
items we take for granted in the modern world, and any interuption of its supply would be
very serious. In light of the dual challenge of Peak Oil and anthropogenic climate change
it is critical that we develop targeted interventions to ensure that we do not waste
important resources
When the oil price increases, it not only directly raises the cost of fuel/gas for
consumers, but it also raises the costs of all other goods that are transported. These priceincreases will be passed on to the consumer, giving rise to inflation.
With prices rising, workers (and/or unions) will pressure employers for higher
wages to compensate for the increased cost of living. If there is a risk of price increases
translating into a spiral of rising producer costs and wages then central banks is likely to
intervene by tightening monetary policy by for example raising interest rates. The
higher interest rates will then act as a signal to market participants that monetary
authorities will not tolerate higher inflation. (Higher interest rates will lower disposable
income and suppress demand therefore making it difficult for firms to pass on price
increases and/or agree to excessive wage demands).
To come back to your question on the impact on food items, higher energy prices
affect production costs (directly through fuel and fertilizers), as well as due to the higher
the cost of moving food from the farm gate to the market. Obviously, the effect will be
less for commodities with a high value and low weight and vice versa. Estimates suggest
that a 10% increase in energy prices is associated with a 2 to 3% increase in the prices of
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grains and vegetable oils and also that over the longer term, high energy prices tend to
affect food prices through the biofuel channel
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LIST OF ABBREVIATIONS
OPEC : Organization Of Petroleum Exporting Countries
E&P : Exploration and Production
R&M : Refining and marketing
ONGC : Oil and Natural Gas Corporation Limited
IOC : Indian Oil Corporation Limited
HPCL : Hindustan Petroleum Corporation Limited
BPCL : Bharat Petroleum Corporation Limited
CPCL : Chennai Petroleum Corporation Limited
BRPL : Bongaigaon Refinery & Petrochemicals Ltd.
NRL : Numaligarh Refinery Limited
MRPL : Mangalore Refinery and Petrochemicals Limited
IGL : Indraprastha Gas Limited :.
LNG : Liquefied natural gas
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L&T : Larsen and Toubro
IBP : Indo-Burma Petroleum Company
KRL : Kochi Refineries Ltd
RPL : Reliance Petroleum Limited
RIL : Reliance Industries Limited
APM : Administered Pricing Mechanism
GDP : Gross Domestic Product
WPI : Wholesale Price Index
NPL : New Exploration Licensing Policy
LPG : Liquidified Petroleum Gas
FDI : Foreign Direct Investment
LNG : Liquefied natural gas
US : United States
OMCs : Oil marketing companies
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MS : Motor Spirit
HSD : High Speed Diesel
LDO : Light Diesel Oil
MoPNG : Ministry of Petroleum and Natural Gas
PSEs : Public Sector Enterprises
MRP : Maximum Retail Price
CVD : Counter Vailing Duty
RBI : Reserve Bank of India
MCX : Multi Commodity Exchange of India
PDS : Public Distribution System
CVD : Central VAT Duty
VAT : Value-added tax
CDU : Crude Distillation Unit
VDU : Vacuum Distillation Unit
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FCC : Fluid Catalytic Cracking Unit
NCDEX : National Commodity and Derivatives Exchange of India
PSU : Public Sector Undertaking
ATF : Airline Turbine Fuel
IEEJ :Institute of Electrical Engineers of JapanTOCOM : Tokyo Commodity Exchange
SIMEX : Singapore International Monetary Exchange
KM : Kilometer
MVP : Multi purpose vehicle
Bbl : Barrel / liter
MSP : Minimum Support Price
LCVs : Light Commercial Vehicles
SUVs : Sports Utility Vehicles
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IEA : International Energy Agency
NYMEX : New York Mercantile Exchange
PPAC : Petroleum Planning and Analysis Cell
MOSPI : Ministry of Statistics and Programme Implementation
CHAPTER 1
INTRODUCTION
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Oil is the single most important commodity that holds the position of a key factor
in each and every economy of the world. The worlds richest nations are at their current
positions just because of the oil factor. The importance of oil has reached such a level at
which there is no country in the world, which doesnt need oil and its by-products, and if
somehow it doesnt have much reserves of oil to meet their domestic demand, these
nations are ready to import the product at any cost. Many nations have a huge share of
their earnings constituted by oil exports only.
Every industry requires oil to function properly either directly or indirectly as both
crude oil and its by-products serve as their inputs. Crude oil alone bears 60% share to
meet the global energy needs in the current scenario. The reason for this high share in the
primary energy consumption in the world is due to the advantages that oil has over the
other constituents of primary energy such as diverse application, comparatively lesser
harm to the environment, easy handling, lower capital costs and above all higher
efficiency.
Oil units
1 Tonne = 7.33 Barrel = 1.165 Cubic Metres (kilolitres)
1 Barrel = 0.136 Tonnes = 0.159 Cubic Metres (Kilolitres)
1 Cubic Metre = 0.858 Tonnes = 6.289 Barrels
1 Million Tonne = 1.111 Billion Cubic Metres Natural Gas
= 39.2 Billion Cubic Feet Natural Gas
= 0.805 Million Tonnes LNG
1.1 RESEARCH OBJECTIVE
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The report gives the brief background of the pricing of oil and its finished products
in India and proceeds to highlight the short comings of the existing setup and players in
the oil market. The report also tells us that how Government of India, oil companies and
other intermediaries in oil sector decide the oil price in India.
The price discovery which takes place in crude oil futures tells how it is benefited
to the participants and the exchange itself. A comparative study is done between the
countrys commodity exchange with some of the premiere exchanges of the globe and
the researcher has come up with a solution.
Recommendations are given with respect to pricing of petrol and diesel which will
help not only the users but also for India in order to reduce the inflation which is causing
due to increase of crude oil prices globally.
1.2 RESEARCH METHODOLOGY
A ) PRIMARY DATA
The primary data is generate by interviewing the owner of Ravi Auto Services,
Worli and Mr. G. Chandrashekhar, Associate Editor of "The Hindu Business Line"
newspaper.
B) SECONDARY DATA
The sources from which secondary data was collected are:
Books, Journals, Newspapers and Magazines, Internet.
1.3 REVIEW OF LITERATURE
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The International Energy Agency (IEA) in their report PETROLEUM
PRICES, TAXATION AND SUBSIDIES IN INDIA (2009) have studied on
downstream petroleum product pricing in India. The study examines the current pricing
mechanism and taxation and subsidy regime on four key petroleum products (petroleum,
diesel, domestic kerosene and domestic LPG). In the study, the implications of current
arrangements in each of these markets for central and state government revenues and
expenditures, for the countrys macro-economic positioning as well for upstream and
downstream sector development are to be examined in detail.
International Energy Agency: Focus on Asia Pacific report Petroleum product
pricing in India says that there is frequently a black hole of subsidies. Economists and
oil companies complain about the impacts those subsidies have on public finances,
financial performance of oil companies and demand-side management. However, on
closer analysis, the issue of petroleum product pricing in India is more complex than the
one-way flow of subsidies reported in the press.
Stein Tonnesson and Ashild Kolass ofInternational Peace Research Institute,
Oslo (PRIO) 2006 analyzes the strategic implications of India and Chinas growing
consumption of energy, notably of imported oil, and the two countries quest for energy
security. India currently imports roughly 70% and China around 40% of its oil. As the
energy needs of both countries continue to grow, their oil imports are set to increase
substantially. Due to the size of their populations and their rapid economic growth, India
and China face a formidable challenge in their pursuit of energy security. How the two
governments seek to meet this challenge is vital to the future political stability of Asia as
a whole
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Government Of India, New Delhi Report on A Viable and Sustainable
System of Pricing of Petroleum Products : February 2010 - A viable and sustainable
pricing system for petroleum products is a key requirement ofstable, long-term growth of
the economy. Similarly, a financially strong and globally competitive oil industry
provides an enduring platform to strengthen energy security ofthe country. It is therefore
important that oil companies should have the freedom to setprices based on competitive
market conditions. The government needs to extend subsidyto the targeted consumers in
such a manner which does not impinge on the freedom of oilcompanies to set prices in
the market place.
CHAPTER 2
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INDIAN CRUDE OIL MARKET
2.1 Introduction
India is one of the non - OPEC countries much dependent on its imports to fulfill
the domestic consumption demand as it has a much lower level of production. India is a
developing country and the requirement for the oil as a primary energy constituent from
the industries in the country is at its peak. The country has much depended on coal to
satisfy its energy needs in the earlier times but the use of crude oil and gas is taking over
the dominance of coal with the change in time. Oil and gas contribute to around 45% of
the countrys total energy consumption.
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India has around 5.4 billion barrels of oil reserves with it and the domestic
production has increased in the recent past to reach the 0.8 million barrels per day mark.
Mumbai high is the largest oil - producing oilfield in India with a production of 2.6 lakh
barrels per day. The refining capacity of crude oil in India is estimated at around 2.1
million barrels per day. Regarding the consumption pattern of oil in India, it is the 6th
largest consumer country in the world having a consumption of 2.2 million barrels per
day. This leaves the country with a huge deficit in the demand - supply scenario and thus
70% of the consumption is met through imports.
India generally imports Oman - Dubai sour grade crude, Brent dated sweet crude
and Bonny light crude. The country imports over 1.5 million barrels per day that place it
at the 9th position among the largest importers of the world. Though the Indian
production has increased in the recent times, the imports were raised by 5% making due
to the raised Indian demand of around 4.2%. The countries from which India imports
crude oil are:
Venezuela
Nigeria
Sudan
Iran
Kuwait
The Indian oil-refining sector has been regulated by the government historically
and is still dominated. A new private sector has emerged after the loosening of controlby the government. The major units pertaining to the oil sector in India are:
Indian Oil Corporation (Public sector)
Oil and Natural Gas Corporation (Public sector)
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Reliance India Ltd (Private sector)
Essar Oil Refinery (Private sector)
Bharat Petroleum Corporation Ltd (Public sector)
Hindustan Petroleum Corporation Ltd (Public sector)
Mangalore Refineries and Petrochemicals Ltd (Public sector)
2.2 Historical Background
The history of the oil sector in India dates back to the late 19th century, when oil
was first struck at Digboi in Assam in 1889. In the subsequent period, till the 1960s, oil
exploration and production activities were largely confined to the North-Eastern region.
The daily crude oil production then averaged 5,000 barrels per day. The later discovery
of the Cambay onshore basin (in 1958) and the Bombay offshore basin (in 1974)
enhanced the production to the current level of 0.7 mn. barrels per day (mbd). In the
downstream sector, the first refinery was set up at Digboi in 1901.
However, new capacities were added only in the late 1950s - early 1960s by
international majors such as Shell, Caltex, and Esso. Refineries were also set up by
the Government in the 1960s. Although the exploration and production activities were
dominantly under Government control, the nationalisation of both the upstream and
downstream sectors was initiated after the Oil Shock of 1970s and completed on
October 14, 1981. As a result, the international oil companies withdrew from India.
2.3 Production of crude oil in India
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Upper Assam (Assam)
Cambay (Gujarat)
Krishna - Godavari basin (Andhara Pradesh)
Cauvery basin (Tamil Nadu)
Nagaland Arunachal Pradesh
The largest crude oil producing oilfield is the Mumbai high field that produces
around 260000 barrels per day. Among these production centers, major share of
production i.e. 2/3rd share is bagged by the offshore reserves as compared to onshore
reserves. The refining capacity of crude oil in India is over 2.1 million barrels per day.
The refining sector in India is held by both public and private sector, public sector being
the dominating one.
2.4 Indian Energy Industry Structure
The Indian oil sector has historically been a regulated one dominated by
Government undertakings. However, with the Government loosening its control, new
private sector players are now gaining presence. Unlike the international oil majors
which have integrated operations along the energy value chain, the Indian oil sector
has companies operating in three distinct sub-segments: Oil & Gas Exploration and
Production (E&P), Oil Refining and marketing of refined products (R&M) and,
Distribution of Natural Gas.
Figure no. 1 : Players in Indian Oil Sector
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ONGC is the major player in the Indian E&P sector. Other players include Oil
India Ltd., Reliance Industries, Indian Oil Corporation, Gas Authority of India Ltd.,
British Gas, Essar Oil, Videocon, Cairn Energy, Hindustan Oil.
Figure no. 2 : Processing and Distribution of oil and its finished
products
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Exploration Company: Niko Resources, Gazprom, Energy Equity, Geoenpro
Petrol Ltd., Geopetrol International, Enpro India Ltd., Hardy Oil, Tata Petrodyne,
Gujarat State Petroleum Corporation, Selan Exploration Technologies Ltd., L&T, Joshi
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Tech., Interlink Petroleum, Mosbacher, Tullow Oil, Phoenix, Okland International,
Premier Oil and Geo Global Resources.
Government Controlled Companies: ONGC, OIL, IOC, HPCL , BPCL and
GAIL. CPCL, BRPL and IBP have now become subsidiaries of IOC. KRL and NRL are
now subsidiaries of BPCL.
Joint Sector Companies: MRPL used to be a joint sector company with equal
stake of HPCL and Aditya Birla Group.
Private Sector Companies: Reliance Petroleum Ltd. (RPL) - which has now
been merged with parent Reliance Industries Ltd. (RIL), Gujarat Gas.
CHAPTER 3
OIL PRICING POLICY IN INDIA
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Crude influences the economy in many ways. Not only it directly affect the
manufacturing industry but also affects ones personal disposable income in real terms.
India is almost a free market economy now, unlike even a decade back. The Indian oil
industry has been deregulated, the oil prices decontrolled. The poor common man
wonders whats in store for him next.
3.1 Facts and Figures.
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First, with about 80% import dependence, we cannot afford to divorce domestic
retail prices from international oil prices. Buying crude at high prices and selling products
processed from that very crude at artificially low retail prices is just not sustainable.
Prices have to reflect costs.
Second, price volatility in international oil markets is today a norm, rather than the
exception. There are just too many factors influencing oil prices Organisation of
Petroleum Exporting Countries (OPEC) decisions; conflicts in the Middle East; US crude
stock levels; the harshness of the European winters; and so on.
Third, the erstwhile - administered pricing mechanism (APM) protected the Indian
consumer from the ups and downs in the global markets through the oil pool. The pool
absorbed the volatility and kept retail prices stagnant. In April 2002, however, the APM
for the oil industry was dismantled.
The oil pool is now defunct. Save the government directive to oil companies to
hold price lines for some time, the common man would have already been fully exposed
to the vagaries of the global oil markets. Lastly, it must be borne in mind that the said
directive, is at best, temporary.
Distilling the facts, it follows, that eventually domestic retail prices will start
reflecting international oil prices. In fact it does reflect the same. The best way to analyse
the system is to consider it in two distinct segments refining and marketing, even while
considering prices offered by one single company. The refining division would procure
crude from international markets; process it; and transfer products to the marketing
division at the refinery gate. Margins in the refining industry are embedded in the
inherent crude and product price differentials in international oil markets. The transfer
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price for products at the refinery gate thus reflects international product prices, what is
typically referred to as the import parity price of that product. Deregulation to this effect,
i.e., affecting refinery purchases and receivables at import parity prices, actually took
place way back in April 1998 itself.
This refinery gate price, essentially, becomes the base price for the final consumer.
Added to this are distribution costs; excise duties; sales tax and other local levies; and
finally the marketing margin. The only variable element in this entire list of mark ups is
the marketing margin, and hence, it becomes one of the most crucial elements in price
fixation in a deregulated environment. Under the APM, marketing margins were decided
by the government in relation to the net worth of the companies, and reimbursed through
the oil pool. An important point to note is that the margin was fixed and was not adjusted
from a month-to-month basis as done for the refinery gate product prices. (Actually there
are daily variations in prices in international oil markets, but in India these were averaged
out over a period for simplification and administrative).
It is this system which changes with the now announced full deregulation of the
industry. In deregulated environment, market prices would be driven by competition. In
mature markets in the West for instance, pump prices of one company differ from that of
another. Oil companies for market share through aggressive stands on marketing
margins. In addition, there are weekly/fortnightly price revisions. In times of high oil
prices, oil companies moderate the impact of high international prices by taking a squeeze
on their margins.
The long and short of it the Indian consumer should reconcile himself to frequent
price adjustments (either way, upwards and downwards). As international oil markets
become tight, global prices would rise, and so would domestic retail prices. The common
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man may be on the short-end of it on account of market sentiments alone. The oil
companies would play their role in moderating the price fluctuations to some degree by
contracting/expanding their marketing margins. Under the APM, they enjoyed guaranteed
returns. Now, the common man on the street is their bread maker and they will go all out
to appease him. Of course, the bottom line of the game is still profits.
3.2 Latest development:
Even as global petro-product prices continue to be northward bound, retail
consumers back home will remain insulated from the volatility in globalprices.
The government has formulated a price band for auto fuels petrol and
diesel within which oil marketing companies will be free to revise prices
automatically.
Though the mechanism talks about a band within which prices will be revised
every fortnight, retail prices of petrol and diesel are unlikely to see much of a
change in the coming days. Since global prices have remained firm, oil
companies are currently selling petrol and diesel close to the top end of the
band.
The moving price band will be based on the average of the global prices in
the immediate past three months and the past one year. Oil companies will
have the limited freedom to revise prices (both upwards and downwards) up
to 10% of this mean price.
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CHAPTER 4
FACTOR INFLUENCING CRUDE OIL PRICE IN INDIA
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The petroleum sector has a major influence on the inflationary trend in a country
like India. This is because in India (like in many other developing countries), the total oil
consumption in relation to GDP is relatively high as compared with many developed
countries in North America and Western Europe.
A high level of oil consumption in relation to output implies high oil intensity.
China, South Korea and Mexico are the other most oil intensive nations with oil
consumption to GDP ratios of 0.26, 0.2 and 0.31 respectively, during 1998. Japan and
four major European countries (France, Germany, the UK and Italy) are the least oil
intensive. The last decade and a half has shown a marginal change in oil intensity across
nations.
In the case of India, because of a high level of oil intensity (in relation to GDP), the
energy sector (Fuel, Power, Light & Lubricants) has a significantly higher share of
14.23% in the Wholesale Price Index (WPI), which is a measure of inflation in the
country. This figure implies that for every 10% rise in the prices of products in the energy
sector, the inflation (as measured by WPI) would go up by 1.4 percentage points.
The office of the Economic Adviser to the Government of India, Ministry of
Commerce & Industry, has replaced the old series of WPI (Base: 1981-82=100) by a
new series with a base 1993 94 = 100 for the Wholesale Price Index with effect
from the week ending 1st April, 2000. As per this new base, the share of Fuel, Power,
Light & Lubricants is 14.23% in WPI as compared to 10.66% earlier. This is due to
the structural change in the economy since 1981-82.
Intensity of traffic is steadily increasing in India. Demand from this section of the
is a major determinant of oil price. This sector consumes a very high amount of oil,
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considering all the major modes of transportation. It in turn, further demonstrates the
importance of the petroleum sector in the Indian economy. In the case of the railways,
petroleum accounts for around 7% of the total revenue earning traffic. The POL traffic
using the railways more than doubled to 36.2 million metric tonnes during 2000 - 2001
from 14.95 million metric tonnes in 1980 - 81. Similarly, petroleum accounts for around
38% of the total port traffic in India, and in volume terms, the traffic more than trebled to
107 million metric tones during 2000 - 01 from 34 million metric tonnes in 1980-81.
Since India is a growing economy with GDP expected to grow at 8 10% per
annum, demand from the manufacturing sector is expected to grow manifolds. In fact
development economist predict that by 2050 India will be the third largest economy in the
world .
Figure no. 3 : Projection of GDP in 2050
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CHAPTER 5
ROLE OF GOVERNMENT IN OIL SECTOR
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India is one of the top 10 oil - consuming countries in the world. Oil and gas
represent over 40 per cent of the total energy consumption in India. The consumption of
petroleum products in the country is on the rise and demand already far exceeds domestic
supply. Therefore, the country has to depend largely on imports.
The countrys existing annual crude oil production is peaked at about 32 million
tonnes as against the demand of about 110 million tonnes. With inadequate crude
production, the country is heavily dependent on imports. Crude is the single largest item
on Indias import list. Estimates show that the demand is likely to grow at a faster pace
over the next decade if India is to maintain the GDP growth target of 8 per cent. This
implies larger imports unless new domestic oil reserves are found. With this in view, the
government announced the New Exploration Licensing Policy (NELP) in 2000. With a
view to ensure long-term energy security, the government is also building oil and gas
equity abroad.
5.1 Policy Initiatives
The deregulation of the petroleum sector has been completed on schedule (March
2002) with the government completely dismantling the administered pricing
mechanism for all petroleum products except kerosene and LPG. As a result, the
petroleum product prices will be market determined and the marketing companies
will be free to set prices.
The government offers both off - shore and on - shore exploration blocks under the
NELP for Indian and foreign private participants. Several exploration blocks have
already been given out in the first two rounds of NELP. Currently the third round
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NELP III of bidding out blocks is on. A total of twenty-seven blocks, covering
eleven on land, seven shallow-water offshore and nine deep-water offshore have
been offered by the government for exploration. So far, contracts with private
investors have been signed for 47 blocks in the two rounds of licensing. The recent
Reliance discovery of major natural gas reserve has given a major impetus for new
explorations.
The government allows 100 per cent foreign equity in private refining ventures.
However, FDI in refineries promoted by public sector companies is restricted to 26
per cent. Foreign equity participation in petroleum product marketing has been
capped at 74 per cent. Foreign equity investment in oil and gas pipeline projects is
currently restricted to 51 per cent.
The government has allowed private companies to market petroleum products in
the country provided that the private company either produces 3 million tonnes or
more per annum of crude or has invested over US$ 400 million in the countrys oil
and gas related infrastructure sector.
In order to improve the viability of stand-alone refineries, the government has
linked them to the major public sector oil companies.
5.2 Opportunities
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Entire gamut of exploration & production, refining, transportation & distribution
and retail marketing activities present opportunities for FDI:
Production sharing contracts for oil and gas exploration under NELP.
Supply of crude oil.
Supply of gas.
LNG import and transportation.
Setting up refineries.
Marketing petroleum products including LPG.
Setting up of petroleum infrastructure like storage facilities, pipelines, etc.
Retail marketing of transportation fuels.
As part of its divestment strategy, the government is likely to privatise some of the
major public sector oil companies in the near future. At least a change the equity structure
is very much in the offering. This provides a good investment opportunity for
entrepreneurs looking at investing in this sector, or entering the petroleum retail market.
The country has traditionally operated under an Administered Pricing Mechanism
for petroleum products. This system was based on the retention price concept under
which the oil refineries, oil marketing companies and the pipelines are compensated for
operating costs and are assured a return of 12% post-tax on net worth. Under this concept,
a fixed level of profitability for the oil companies is ensured subject to their
achieving their specified capacity utilisation. Upstream companies, namely ONGC, OIL
and GAIL, are also under retention price concept and are assured fixed return.
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The administered pricing policy of petroleum products ensured that products used
by the vulnerable sections of the society, like kerosene, or products used as feed stocks
for production of fertilizer, like naphtha, may be sold at subsidized prices.
Gradually, the Government of India moved away from the administered pricing
regime to market determined, tariff-based pricing. Free imports are permitted for almost
all petroleum products except petrol and diesel. Free marketing of imported kerosene,
LPG and lubricants by private parties is permitted. It is contemplated that in a phased
manner, all administered price products will be taken out of the administered pricing
regime and the system will be replaced by a progressive tariff regime in order to provide a
level playing field for new investments in a free and competitive market.
CHAPTER 6
IMPACT OF UNION BUDGET 2004-05 ON OIL SECTOR
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6.1 Background
Crude oil prices remained volatile during FY04 and 1st quarter of FY05 mainly
due to geopolitical tensions such as Iraq war, strike by workers in Venezuela and
Nigeria, lower level of inventory held by US and higher demand from China.
Although APM was dismantled w.e.f April 1, 2002 oil companies have rarely
priced end products on commercial basis. Increasing price of crude during FY04
had adverse impact on oil companies in India as end fuel prices were not reset toreflect the increase in prices of crude. On June 15, 2004, the retail price of petrol
was hiked by Rs.2/litre, diesel by Rs.1/ litre and LPG by Rs.20/cylinder. Also,
excise duty on petrol was reduced by 4% to 26% and diesel by 3% to 11%.
Post APM, two Regulatory Commissions; one for upstream sector and one for
downstream sector were proposed to be set up. This was to ensure availability of
products in far flung places as well as to avoid price shocks and monopolistic
behavior of oil companies. These Commissions have not yet been set-up.
Petroleum Regulatory Board Bill, 2002 which incorporates the framework for
regulatory bodies, is pending in Lok Sabha.
In September 2003, GAIL and ONGC were asked to share subsidy burden on
account of sale of kerosene and LPG by public sector oil marketing companies
(OMCs) to retail consumers. In a three-way split, the Government decided to
transfer one-third of the subsidy burden to ONGC and GAIL, another one-third
through overpricing other products such as petrol and diesel, and the remaining to
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be borne by the OMCs. It is estimated that total subsidy burden on account of
under pricing for FY04 stood at Rs.8,200 crore. ONGC and GAIL share was
estimated to be at Rs.2,400 crore.
6.2 Budget proposals
Survey & exploration of minerals have been brought under the service tax net.
Service tax rate has been increased from 8% to 10%.
Education cess of 2% on income tax, corporation tax, excise duties, custom duties
and service tax to be levied. Credit on education cess on duties paid on Motor
Spirit (MS), High Speed Diesel (HSD) and Light Diesel Oil (LDO) will not be
allowed.
Total expenditure of Ministry of Petroleum and Natural Gas (MoPNG) for 2004
-05 is proposed at Rs.3573 crore as against revised estimate of Rs.6903 crore of
2003 - 04.
Equity support of Rs.14,194 crore and loans of Rs.2,132 crore to entral Public
Sector Enterprises (PSEs) in six sectors, including petroleum, is budgeted.
Excise duty on gas stoves with an MRP not exceeding Rs.2,000 per unit has been
reduced from 16% to 8%.
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Existing Counter vailing Duty (CVD) exemptions on LNG to continue. Excise duty
of 16 % on LNG has been done away with.
Table no. 1: Changes in duty structure (%)
6.3 Budget Impact on Industries
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Levy of service tax on survey and exploration activities would have an adverse
impact on companies in the exploration and production sector.
Reduction in budgetary allocation for MoPNG is likely to increase the subsidy
burden to be borne by oil marketing companies. Further, there is no clarification on
continuation / withdrawal of the three way split scheme for sharing of subsidy
burden on LPG and Kerosene introduced during FY04.
Education cess of 2% is likely to increase the retail price of selected petroleum
products marginally. Further, cess paid on MS, HSD and LDO will not be availableas credit for payment of cess on the final products.
Reduction in excise duty on LPG stoves is expected to increase penetration,
particularly in the rural segment. This is expected to increase consumption of LPG.
Table no. 2 : Budget impact on companies
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CHAPTER 7
CRUDE OIL FUTURES
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7.1 Introduction
The Indian government has now permitted oil companies in India to hedge against
commodity price risks while importing crude and petroleum products. This initiative has
been taken by the Indian government in a bid to protect the economy from the volatility
of international crude prices. All oil companies having underlying exposures in crude and
petroleum products will now be allowed to import and hedge future prices against the
drastic volatility of the prices in the hydrocarbon sector. This has almost become a
necessity for a country like India, which imports 70 percent of its petroleum requirementand needs to be protected against such price movements in the International oil markets.
Oil companies such as the Indian Oil Corporation (IOC), Reliance Petroleum and
MRPL are expected to be the beneficiaries of this move from the government. The
hedging facility is to be subjected to detailed guidelines to be issued by the RBI and is
expected to make Indian producers more efficient and enable them to compete in the
International markets. The immediate beneficiaries of the decision will be the Industry
experts opinion that hedging instruments which are used for other commodities like sugar
etc. are like insurance, both for the buyer and the seller, while the buyer can protect his
interests by locking future physical deliveries at prices quoted at present, the seller too
can protect his interest by contracting sales at a price which may fall in the consequent
months.
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The volatility in the International Oil markets can be gauged by the fact that oilprices have been roller coasting during the period December 1999 and April - May 2000.
The prices in December stood at a historic low of barely $10 a barrel while by April -May
it moved up to over $31 a barrel. In August 2004 it was hovering around $44/ barrel). Oil
companies have gained or lost significantly due to the lack of price risk hedging
instruments and have been unable to protect their future interests.
The hedging mechanism is based on a benchmark crude for which price quotes are
available. Exchanges that trade in oil futures has their own crude benchmarks.
In the oil futures market, the quotes are usually for a period of about six months
and the buyer of the future needs to take a position for a particular quantity to be
physically delivered at a particular point of time. The advantage for the buyer would be
that if prices moved up by the time that the physical delivery of the product takes place,
the buyer is compensated with an adjustment and a settlement with the difference being
paid back. The buyer thus is able to hedge against an increase in the prices of crude and
petroleum products. In the case wherein there is a fall in the prices of crude and
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petroleum products then the sellers interest is protected as the delivery is made on the
agreed price by the buyer.
For the Indian market the relevance of the permission by the government allowing
oil companies to hedge against price risks in the crude and petroleum products markets
lies in the facts that :
Large crude buyers such as the Indian Oil Corporation, Reliance Petroleum and
MRPL will be able to improve profitability.
The impact of the volatile international oil prices can be tamed by being able to
hedge against price hikes using oil futures. Lastly this will enable the Indian oil
companies to gear up to competition from global oil players such as Morgan
Stanley and Citibank who are poised the enter the Indian markets.
7.2 Benefits of MCX crude futures
While energy futures markets in the US and Europe trade many times their
underlying oil production and consumption, the need for active energy futures
instruments still exist to a large extent in the Asia - Pacific.
Safeguard mechanisms
The MCX crude Futures will allow oil producers, refiners, traders and consumers
to manage their crude oil price risk with greater precision and without concerns for
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market price. As on date, even the prices of crude bi - products are allowed to vary
+/- 10% keeping in line with international crude price, subject to certain
government laid down norms / formulae. All these facilitates a future trade in crude.
Table no. 3 : International oil price variation
Table no. 4 : Maximum price variation
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CHAPTER 8
GOVERNMENT TAXES ON FUEL
8.1 Subsidy allowed on fuel prices
Subsidy on PDS Kerosene and Domestic LPG effective 1.4.2002 is met from the
fiscal budget and has been fixed on a specified flat rate basis for each Depot /
Bottling Plant based on the difference between the cost price and the issue price per
selling unit. The scheme has provided that both the cost price and issue price
would be revised by the companies based on the changes in corresponding prices inthe international market. However, this mechanism could not be implemented by
the companies on account of sharp rise in LPG prices in international markets since
2004 and consequent Government direction to modulate price increases. The
subsidy scheme has been extended till 31.3.2014.
The average subsidy during 2002-03 on PDS Kerosene was Rs.2.45 per litre & on
domestic LPG at Rs.67.75 per cylinder. The flat rate subsidy was reduced by 1/3rd
each year during 2003-04 and 2004-05. Since then the subsidy rate for Domestic
LPG and PDS Kerosene has been maintained at the 2004-05 level (i.e. 1/3rd of
2002-03 level), i.e. 82 paise per litre for PDS kerosene and Rs.22.58/cylinder for
domestic LPG. The Government has made a provision of Rs. 2900 crore towards
subsidy on these products in the fiscal Budget for 2010-11.
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Table no. 5 : Subsidy on PDS Kerosene & Domestic LPG under Subsidy
Scheme 2002
Table no. 6 : Subsidy for far - flung areas under Freight Subsidy Scheme
Year PDS Kerosene Domestic LPG Total
2002-03 2098.0 2398.0 4496.0
2003-04 2657.0 3635.0 6292.0
2004-05 1147.0 1783.0 2930.0
2005-06 1057.0 1605.0 2662.0
2006-07 970.0 1554.0 2524.0
2007-08 978.0 1663.0 2641.0
2008-09 974.0 1714.0 2688.0
2009-10 955.6 1814.4 2770.0
2010-11 930.6 1973.6 2904.3
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Table no. 7 : Central Excise and custom tariff
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Particulars
CUSTOMS CENTRAL EXCISE
Basic
Customs
Duty
Additiona
l Customs
Duty
(CVD)
Additi
onal
Custo
ms
Duty
Basic
Cenvat
Duty
Special
Additio
nal
Excise
Duty
Additiona
l Excise
Duty
Crude Petroleum
NIL + Rs.
50/MT as
NCCD
Nil+Rs.2500/MT
as Cess+
Rs.50/
MT as
NCCD
Petrol
2.5%
Rs.6.35/ltr
. +
Rs.6.00/ltr
SAD
Rs.2.00
/ltr.
Rs.6.35/l
trRs.6/ltr
Rs.2.00/ltr
.
Petrol (branded)
Rs.7.50/l
trRs.6/ltr
Rs.2.00/ltr
.
High Speed Diesel2.5% NIL
Rs.2.00
/ltr.Nil
Re.2.00/ltr
.
High Speed Diesel(branded)
Rs.3.75/Ltr
Re.2.00/ltr.
LPG
Domestic Nil Nil Nil
Non -
Domestic5.0% 8.0% 8.0%
Keros
ene
PDS Nil Nil Nil
Non PDS 5.0% 14.0% 14.0%
Aviation TurbineFuel
Nil 8% 8%
Napht
ha
Non-
Fertilizer5.0% 14.0% 14.0%
Fertilizer Nil Nil Nil
Bitumen &
Asphalt
5.0%
14.0%
14.0%
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Table no. 8: Dealers commission on Petrol and Diesel
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Table no. 9 : Distributor Commission on LPG
Effective date Petrol Diesel
1-Apr-04 707.0 425.0
21-Jun-05 778.0 467.0
1-Aug-05 848.0 509.0
1-Mar-07 894.0 529.0
16-May-07 1024.0 600.0
23-May-08 1052.0 631.0
27-Oct-09 1125.0 673.0
7-Sep-10 1218.0 757.0
1-Jul-11 1499.0 912.0
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CHAPTER 9
Effective date LPG
14.2 Kg. 5 Kg.
As on 01-April-04 16.71 8.60
1-Mar-07 19.05 9.81
4-Jun-08 20.54 10.58
30-Jun-09 21.94 11.30
1-Jul-11 25.83 13.30
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IMPACT OF INCREASE IN OIL PRICES ON GROWTH AND
INFLATION LEVELS IN INDIA
The impact of high oil prices on the oil-importing countries can vary, depending on
the level of development and the energy intensity of the economy, as also on the
degree of oil import dependence.
The Government is committed to ensuring high economic growth of the country, to
eradicate poverty and to remove socio-economic imbalances. The experience of
countries like Japan, Taiwan and South Korea has shown how high growth can
eliminate poverty and transform a developing country into a developed one. The
two issues that need to be addressed are:
(i) Sustainability of high growth with moderate inflation.
(ii) Inclusive nature of growth, which means the aam admi should share the
benefits of high economic growth.
Table no. 10 : Impact of oil prices
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International
Oil price per
barrel ($)
Increase in
International
Oil Prices (%)
Extent of fall in
manufacturing
Sector growth
(%)
Extent of fall
in GDP
growth (%)
Extent of
increase in
WPI (%)
50 38.9 2.1 0.4 1.5
60 66.7 9.7 1.9 3.
70 94.2 16.9 3.4 5.7
80 122.2 24.5 4.9 7.9
140 126.1 29.7 7.3 7.2
In the last two years, the Indian economy grew by over 9% per annum, with
moderate inflation. Last year, the growth rate was 9.6%, the highest in the last 18
years. Today, India is again poised to achieve double-digit growth.
However, sustenance of this high growth faces the difficult challenge posed by
rising oil prices in the international market. Indias dependence on oil imports,
which is around 75% today, is expected to touch 90% in the next two decades.
Indias gross oil import bill, which stood at nearly one lakh thirty one thousand
crore rupees (Rs.1,31,000 crore) in 2004-05, is expected to be more than double
during 2007-08.
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High international oil prices are exerting an upward pressure on domestic prices of
petroleum products. The price of petrol on 31 January 2008 was 43.52 per litre in
Delhi. If the entire burden of rise in international prices is passed on to the
consumer, the price of petrol in Delhi would rise by Rs.8.70/litre. Similarly, the
price of Diesel would rise by Rs.9.60 and PDS Kerosene by over Rs.19 per litre.
Each cylinder of domestic LPG would be costlier by Rs.335. Obviously, full
increase in domestic prices in line with rise in international oil prices would have a
cascading effect on the entire economy. It would bring hardship for the common
man.
To protect the interests of the aam aadmi, consumer prices of PDS kerosene
have not been revised since March 2002. The retail price of LPG has not been
increased since November 2004. The prices of petrol and diesel have remained
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unchanged since February 2007. This has led to Oil Marketing Companies
incurring huge under-recoveries on sale of the four petroleum products. These
under-recoveries are projected to exceed Rs.71,000 crore in 2007-08.
Considering the inflationary impact of rising petroleum prices, Government policy
has been to equitably share the burden among the Government and oil PSUs so that
impact of price rise on the people is minimized. While upstream oil companies,
namely ONGC, GAIL and OIL, have been sharing a part of the burden of rising
international oil prices on the oil marketing companies since 2003-04, the
Government has issued special oil bonds to the oil marketing companies.
The burden-sharing mechanism put in place by the Government has insulated the
Indian economy from the inflationary consequences of high oil prices but this can
not be sustained in the long run. To ensure Indias energy security, our oil PSUs are
required to invest about Rs. 2.5 lakh crore in expansion and upgradation plans,
during the XI Plan period. Therefore, a holistic approach is required, which
includes rationalization of costs, including taxes and duties on petroleum products,
and moderate increase in retail prices, keeping in mind the capacity of the
consumer to pay.
CHAPTER 10 :
REAL COST OF PETROL IN INDIA
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India has taken steps to de-regularize the petrol prices and increase diesel prices. In effect
petrol and diesel prices are raised. Even after the hike in the four sensitive petroleum
products, government of India still has to under recover 53,000 crore rupees or $11.3
billion. At current international prices the under recoveries of the oil marketing
companies would translate to Rs.17.92 per litre on Kerosene, Rs.261.90 per cylinder
on Domestic LPG and Rs. 1.5per liter fordiesel.
When compared with Indias neighboring countries, the prices of petrol and diesel are
higher but the cost of kerosene and LPG are much lower.
The consumer price of Kerosene in Indias neighboring countries :
1. Rs.35.97/litre in Pakistan
2. Rs.29.43/litre in Bangladesh
3. Rs.21.02/litre in Sri Lanka
4. Rs.39.24/litre in Nepal.
The consumer price of LPG in Indias neighboring countries :
1. Rs.577.18/ cylinder in Pakistan
2. Rs.537.37/ cylinder in Bangladesh
3. Rs.822.65/ cylinder in Sri Lanka
4. Rs.782.84/ cylinder in Nepal
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In April 2010, the cost of a liter petrol in Delhi was 47.93 rupees per liter. But as per
the government of India, if it was market determined then it should be 54.61 rupees per
liter. Not sure how the figure of 54.61 was arrived at but at 47.93 per liter the actual cost
of petrol is 26.34 rupees per liter before all the taxes.
Here is the breakdown of the taxes charged by the government in various forms. From the
time it is refined to the time it reaches the consumers.
1. Excise duty : 14.35 rupees per liter
2. Customs duty : 7.5 percent
3. Sales tax or VAT : 20 percent.
Figure no. 4 : Evaluation of petrol and diesel price
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The total taxes amount to 45 percent of the final cost of the petrol . With a
26.34 rupees per liter of petrol if we add all of the taxes it comes to 47.93 rupees per liter,
the cost of petrol in Delhi before the recent hike.
The crude in international market is now at $72.35 per barrel. If barrel is taken to be
158.99 liters then the cost of crude would be some 46 cents which would mean the crude
cost is 21 rupees. And the cost of refining crude should be added up to. The cost of
refining is hard to find out and looking at the difference it should be around 5.34 rupees
per liter of petrol. I somehow find that hard to believe and I thought the cost of refining
would be much higher. Crude goes through a lot to become petrol. Crude Distillation Unit
(CDU), Vacuum Distillation Unit (VDU), Fluid Catalytic Cracking Unit (FCC), Hydro-
cracker, Coker unit, Lube Unit are the several things which crude goes through to become
petrol or diesel.
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If a barrel of crude oil in International market is $140, as it was in 2008, and if the
petrol prices were left to the market fluctuations then the cost of petrol in retail market
would be 70 rupees per liter. This was exactly the rate at which Shell sold petrol in
2008. Shell is the lone private retailer along with Reliance. Both Shell and Reliance had
shut down many of their shops as they couldnt compete with the government owned oil
marketing companies which were absorbing the shocks. This has done two things. It kept
private sector out of the competition and it has shielded people from price hikes and falls
and inherently made them oblivious to the consumption control. Indias oil
subsidies are 0.4 percent of Indias total budget in 2008.
CHAPTER 11
CHANGE IN PRICE OF CRUDE OIL
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Figure no. 5 : Change in crude oil prices and its finished products
CHAPTER 12
PRICE DISCOVERY
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12.1 Introduction
A futures market facilitates offsetting the trades without exchanging physical goods
until the expiry of a contract. As a result, futures market attracts hedgers for risk
management, and encourages considerable external competition from those who possess
market information and price judgment. While hedgers have long-term perspective of the
market, the traders and arbitragers, prefer an immediate view of the market. However, all
these users participate in buying and selling of commodities based on various domestic
and global parameters such as price, demand and supply, climatic and market related
information. These factors, together, result in efficient price discovery.
12.1.1 Background of Pricing Mechanism of Indian Energy Sector
Prior to the Dismantling of Administered Price Mechanism (APM) in 2002 the
Government used to fix the prices of petroleum products therefore the consumers were
shielded against the vagaries of International price fluctuation. In 2002 when APM was
dismantled Oil companies (Producers & Refiners both) as well as consumers became
exposed to the Crude Oil fluctuations in the international market. Therefore the need was
felt to hedge this exposure through trading on Commodity Derivative exchanges .
12.1.2 Advantages /Benefits of Energy Commodity Trading on Indian Exchanges
Traditionally the advantages of trading commodities have Price Discovery and
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development of supply chain. Another significant advantage is the Cover from Forex
Exposure Risk because the futures are rupee denominated which is a clear gain over to
trading at Nymex where the players had to look for Forex hedging.
12.1.3 Factors Required for Price Discovery
Presence of players in large numbers and in full spectrum is a very important
factor. In economic terms there should be enough number of buyers and sellers to make it
a Perfect Competition market condition. We need Hedgers for getting the long term
perspective in the market. Again Speculators (also termed as Traders or Punters) are
important for bringing in the immediate picture and trends from the knowledge they are
carrying. Finally Arbitragers are also need to correct any positions of Arbitrage.
12.1.4 Some of the Important Players in each segment can be
Hedgers :
Oil PSUs like IOCL, HPCL, BPCL
Other Petrochemical Companies who use Petroleum Products
Railways, Shipping Companies, Airlines etc
Speculators :
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Investment Banks, Brokerage Houses, Foreign Institutional Investors etc
Individual Investors (Transporters, Industrialists, Traders etc)
12.1.5 Other important factors required for price discovery at MCX/NCDEX are:
Market should have enough Volatility to attract hedgers and speculators.
Introduction ofFull Range of Crude Oils.
Use ofAppropriate Marker to avoid Price Premiums.
Availability of Refined product futures to provide forCrack Spread Hedging.
Contracts to be made tailored to meet market Requirements.
Regulatory guidelines & Suitable Accounting Standards and Tax policies.
12.2 Indian Conditions
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a. Non-Availability of Full Spectrum of Players :
The PSUs are still reluctant to trade on MCX and NCDEX because of:
No Middle East crude futures on MCX/NCDEX.
Non availability of Refined Product Futures (Like ATF, Naphtha, Fuel Oil).
Limited trading hours of the MCX/NCDEX exchanges.
At present MCX operates from 10 a.m. to 11.30 p.m., this is an anomaly as the
domestic exchange is trading in global commodities.
b. Lack of full Range of Crude Oils Traded on MCX & NCDEX.
c.Lack of Appropriate Marker to any Price Premiums vis--vis any other trading
Markets.
d. Crack Spread Hedging not available because futures for Refined products like
ATF, Naphtha, Fuel Oil etc) are not available for trading. Although prices of Crude Oil
and petroleum products are generally expected to vary on same scale but sometimes they
may behave otherwise. In that situation a Crack Spread arises. E.g. When prices of
Refined products like Petrol have not increased or decreased with same percentage as the
prices of the Crude Oil. Here to hedge his risk on the refined product a refiner has to have
a double hedge in mutually opposite senses. e.g. He may need to have a Long Hedge in
Crude Oil and a Short Hedge in Petrol .
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e. Contracts to be made tailored to meet Indian Requirements.
f. Regulatory guidelines for Hedge Funds/Speculators and Hedgers:
As per the guidelines the Oil companies cannot indulge in any sort of speculation
and are allowed only to hedge their risk. The oil companies can presently hedge only
imported crude oil, petroleum products export and refinery margins arising out of
imported crude oil. Unfortunately Freight cost and counterparty risk are still not allowed
to be hedged as yet. The positions permitted are Long on crude and short on products and
crack margins. What is still wanted from RBI is Suitable accounting standards and tax
policies to distinguish hedging from speculative contracts. But some of the good steps
have been making the Board of companies responsible for their trading
Table no. 11 : Factors for Price Discovery on MCX/NCDEX:
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12.3 The Issue Of Asian Risk Premium : Dubai Crude Being An
Ineffective Marker
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Formula prices of Arabian Light crude for the Asian market have been higher than
those for European/U.S. markets by $1 - 1.5 per barrel over the period of ten years or so.
This differential has an adverse impact on the economic competitiveness of the countries
involved. On the other hand, the formula prices of Arabian Light crude for the European
market had been almost identical with those of the U.S. markets. The price for European
stations is linked to the average spot price of North Sea Brent crude; and that for US
supplies to WTI crude. Prices for supplies to Asia are linked to a 30-day spot average of
Oman and Dubai crude during the month of delivery.
Major reason attributed for the above is lack of strong trading markets in Asia.
Again the production of Dubai crude was more than 400,000 b/d in the latter half of the
1980s, but began decreasing in the 1990s to drop to the current level of merely 170,000
b/d. It is difficult to determine the price of Dubai crude on spot trading at present because
of the decline in Dubai production.
Table no. 12 : World Oil Demand 2010
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12.4 Solutions to the problem of Asian Risk Premium
12.4.1 Case for Greater Asian Bargaining power for a better Price
Marker
As evident from the following table growth in Asia led by China, India and
other South East Asian nations has led to a total change of position. Gradually since
the1980s growth has been led by Asian nations. Only Asian demand growth is 15% for
China whereas OECD countries are generally stagnant . This can be used to bargain a
better crude marker for Asia as the markers have been decided by the OPEC on the basis
of consumption and buying power.
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We can solve for the problem of a viable marker by choosing a new marker for
Asia. Yoshiki Ogawa in his paper of November 2002 titled Proposals on Measures for
Reducing Asian Premium of Crude Oil (The Institute of Energy Economics, Japan) has
suggested use of the following as the alternatives Daqing Crude of China, Arabian Light,
Price Index of Middle East Crude, Oman Crude, IPE Brent, Average of the current
formula prices for the European and the U.S. market. Of these only the last three have
been considered as viable yet temporary alternatives. Finally the point that is brought
home is that all Asian Nations have to work towards developing the Asian markets into
effective trading hubs on the lines of Simex of Singapore and Tocom of Japan.
12.4.2 Making Effective Price Discovery in Asian Markets by developing
them
Despite the size and importance of Asian market, pricing of oil in the continent is
dependent on less-than-satisfactory crude pricing markets, namely Tapis, Minas andDubai, making market signals not very efficient. No market except TOCOM figures in
the list of top 10 commodity exchanges of the world Therefore the need is for the Asian
countries to come together to develop stronger markets with following characteristics:
It is important for the success of Trading Markets that the governments should
deregulate the markets .It is anomalous in India that despite the dismantling of
APM prices of high consumption products like Petrol , Diesel, LPG are still highly
regulated.
Price Transparency is high.
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Trading is done in variety of Contract types like Cargoes, Barges etc
Final product price is formed of both Spot and Future trading and Crude Oil
Product prices should affect each other leading to real price discovery.
12.5 Need For Supply Chain Efficiencies
It is a pity in Asia that despite using the Middle East Crude in huge quantities the
cost of transportation and storage is very high. Transportation cost between the Middle
East and rest of the Asian countries is still to be reduced. This is one of the structural
factors leading to relatively higher crude oil prices for the Asian market. Another
facilitating factor here can be building storages in large- demand countries to ensure that
there is no shortage of fuel even during disruptions and emergencies.
12.5.1 Case of other Markets
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a) Lessons form the experience from Japans Biggest Commodity
exchange Tokyo Commodity Exchange, TOCOM.
In 1999 the first energy contracts, gasoline and kerosene, were listed on TOCOM
these products proved tremendously successful with the local trading community. They
are domestic commodities and dont have any equivalent or mirror markets overseas. The
trading style is to forcefully push a market, a technique that is less successful with
international commodities, where arbitragers quickly move the markets back to
equilibrium. In India although price of Petrol , Kerosene etc are presently determined by
the government but if we wish the Indian commodity markets are to succeed in real terms
and attain global hues then all the products including these along with popular Crude
varieties have to be trade .
Following regulations have been advocated at TOMCO especially for regulating the trade
done by speculators through brokers.
i. Margins are to be deposited fully and directly with exchanges. MCX in India
has kept the margin value at 5%.
ii. Segregation of clients funds at brokers must be reinforced.
iii. Stricter Surveillance of broker fund management is to be implemented.
iv. A centralized clearing system is to be made possible.
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v. Margin calculations to be rationalized , reflecting real time market risk.
b) Lessons from Singapores Commodity exchange Simex
Spot market at Singapore developed as a result of excess supply which is a key
ingredient for the development of a spot market. Spot trading started off with players
trading based on refinery posted prices up to late 1980s. After that increased arbitrage
opportunities to Asia and the surplus production in Singapore speeded up the
development of spot trading. Later on the factors that facilitated growth of futures trading
were arrival of western traders and the establishment of independent storage facilities.
Supply Chain efficiencies in terms of storage and transport emerged as Singapore
is situated along major Asian and trans-Pacific trade routes. Singapore gradually
developed storage facilities of about 87.77-mil bbl which is very competitive by world
standards. Good storage capacity allows players to capture contango and allows players to
optimize trading positions. Finally Singapore governments Hands-Off policy has really
paid in developing a competitive market.
RECOMMENDATION
A] Petrol
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Petrol is largely an item of final consumption. Its price, therefore, has a very small
impact on inflation due to forward linkages.
Table no. 13 : Average annual use of petrol per vehicle
Type
of
Vehicle
Average
Distance
Covered
annually (KM)
Fuel
Efficiency
(KM/Litre)
Litres/
Vehicle/
Year
Monthly Fuel
Cost at price
on 1.1.10 in
Delhi (Rs)
Two Wheelers
(Petrol)
6300
(10000)
73.0 86 320
Three Wheelers
(Petrol)
35000
(40000)
34.0 1,029 3835
Cars(Petrol)
8000(15000)
13.5 593 2210
Cars
(Diesel)
8000
(15000)
14.0 571 1566
MPV
(Diesel)
7800
(37000)
8.7 897 2461
Bus
(Diesel)
55000
(60000)
4.1 13,415 36802
Heavy Trucks
(Diesel)
55000
(35000)
3.6 15,278 41913
Light Trucks
(Diesel)
20000
(40000)
4.5 4415 12112
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A two-wheeler consumes, on an average, 86 litres of petrol per year, for which the
owner spends Rs. 320 per month (Rs. 510 in Delhi). The fuel expenditure of car
owners is much larger at Rs. 2210 per month (Rs. 4140 in Delhi). Motorizedvehicle owners are largely well-off persons belonging to the upper two/three
deciles of the population. There is no reason to subsidize this class of consumers.
Full price pass-through at US $ 80/bbl will increase the retail price of petrol by
around Rs.7/litre. The additional expenditure of a two-wheeler owner would be
only Rs. 50 per month (all-India average). Even for two-wheeler owners in Metro
Cities who drive more (around 10000 KM per year), the increase on fuel
expenditure will be around Rs. 80 per month. Even if the crude price increases to
$120 compared to the present price of around $70/barrel, the retail outlet price of
petrol, assuming the current tax regime, will increase by Rs. 23/litre (i.e.,
Rs.20/litre on the basis of rise in indicative selling price of petrol from $70/bbl to
$120/bbl of crude price + Rs.3/litre on account of the current price being below the
estimated indicative selling price) and the additional expenditure , assuming no
reduction in use, will be around Rs. 160/month on a two-wheeler user and less than
Rs. 1000/month on a private automobile user (at all-India level)
If higher petrol prices lead to less driving, more fuel efficient vehicles and an
efficiency increase by 20%, the additional cost would be that much less.
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The cost increases can be borne by motorized vehicle owners and recommends that
petrol prices should be market-determined both at the refinery gate and retail
levels.
B] Diesel
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The consumption of diesel by different users in 2008-09 has been shown in Figure.
Trucks accounted for 37% and buses 12% of total diesel consumption in 2008-09.
Agricultures share was 12%.
Figure no. 6: Consumption of diesel by different users
The burden of diesel price increase on agriculture depends on where it is used. In
2008-09, 12 % of total diesel went to agriculture (i.e., to tractors, thrashers, tillers,
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harvesters, pump sets etc.). The cost of diesel in agriculture would be accounted for
by the Government while fixing the Minimum Support Price (MSP) for major
crops. Therefore, any increase in the cost of diesel will be reflected in the price and
will not adversely affect farmers. However, those who use diesel relatively more
may not get fully compensated by MSP. Higher diesel price will induce them to use
less diesel which may reduce over-use of ground water prevalent in many parts of
the country. Of course, higher diesel price resulting in higher MSP will increase
subsidy for PDS, but it would be much less than the reduction in under-recovery on
diesel.
Trucks and LCVs consume around 40% of diesel. It is reported that with industrial
revival and higher economic growth, the truck owners generally raise their rentals
in consonance with growth. Therefore, long distance charge for a round trip
between Delhi and Mumbai for a 9-tonne truck is more than Rs. 40000 today
whereas its diesel consumption works out to around Rs. 22000. Higher diesel price
would encourage fuel use efficiency as well as greater use of railways for freight
movement. Railways consume around 1/4th as much diesel per net tonne kilometer
as trucks.
Even assuming that the truckers, power generators, industrial users etc.(other than
the passenger car owners) are able to pass on fully the additional cost of diesel, an
increase of Rs. 4 per litre would mean an increase of around Rs. 20,000 crore in
their cost of diesel which would be around 0.4 % of GDP in 2008-09. This should
be compared with the inflationary impact of subsidies, which would be similar.
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Car owners who drive diesel vehicles, including Sports Utility Vehicles (SUVs),
should be able to bear the additional cost. There is no economic or social reason to
subsidize them.
Thus the price of diesel should also be market determined both at the refinery gate
and retail levels.
With deregulated oil prices, once households and firms clearly see that
international factors drive domestic petroleum product prices, and when monetary policy is seen to emphasize price stability, households and firms would be
relatively relaxed. When there is a temporary shock to oil prices, they would be
much less likely to react to short-term fluctuations in prices through wage
Hikes or increases in product prices. Thus, in OECD countries, from 1979
onwards, where central banks have shifted into de facto or de jure inflation
targeting, the great commodity inflation from 2002 onwards did not pass through
into broad-based inflation in the 2002-2008 period.
Petrol and diesel used in cars, including SUVs, are for final consumption. The
higher excise duty on petrol compared to diesel encourages use of diesel cars.
While greater fuel efficiency of a diesel vehicle should not be penalized, a way
needs to be found to collect the same level of tax that petrol car users pay from
those who use a diesel vehicle for passenger transport. An additional excise duty on
a diesel vehicle corresponding to the differential tax on the petrol should be levied.
At the present excise rates, the additional excise duty paid by a petrol vehicle
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owner who on an average drives 8000 KM/year and gets an average mileage of
13.5 KM/litre is around Rs.10000 per year. The present discounted value at 10%
discount rate over the 10-year life of a vehicle would be around Rs. 67,500, and at
5% discount rate it would be Rs. 81,000. An appropriate discount rate would be the
rate on Government bonds. An additional excise duty calculation based on the
following model, adjusted for the existing differential, if any, in excise duty
between petrol-driven cars, and diesel-driven cars, should be levied on diesel car
owners.
At the present rates and a discount rate of 5 per cent, an additional excise duty of
Rs. 80,000 should be levied on diesel driven vehicles. Some persons may still opt
for a diesel vehicle if they expect to drive much more than an average petrol
vehicle owner does
CONCLUSION
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Indias imports of oil are increasing. Our import dependence has reached 80 per
cent and is likely to keep growing. At the same time 2008 saw an unprecedented rise in
oil price on the world market. Oil price volatility has also increased. Though future oil
prices are difficult to predict, they are generally expected to rise. Given our increasing
dependence on imports, domestic prices of petroleum products have to reflect the
international prices.
The Government has not permitted public sector oil marketing companies to pass
global prices to domestic consumers. We have examined the impact of the formula-based
prescriptive pricing of major petroleum products devised by the Government from time to
time, particularly since 2002. The present system of price control on petrol and diesel in
particular has resulted in major imbalances in the consumption pattern of petroleum
products in the country, and has put undue stress on finances of the PSU oil marketing
companies as well as of the Government. It has also led to withdrawal of private sector oil
marketing companies from the market. This has affected competition in the domestic
petroleum product market.
Intervention through price control necessitates that someone bears the financial
costs. The issue therefore is to assess the costs and incidence of the burden of alternative
mechanisms on different groups in the society. On whom the burden falls depends on the
policy and the instruments used.
A viable long-term strategy for pricing major petroleum products is required. A
viable policy has to be workable over a wide range of international oil prices and has to
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meet the various objectives of the government. It should limit the fiscal burden on
government and keep the domestic oil industry financially healthy and competitive.
The petrol is largely an item of final consumption. An analysis of the trend of
petrol consumption by the automobile owners reveals that increase in prices of petrol can
be borne by motorized vehicle owners. Accordingly, we recommend that petrol prices
should be market determined both at the refinery gate and at the retail level.
Petrol and diesel used in cars, including SUVs, are for final consumption. The
higher excise duty on petrol compared to diesel encourages use of diesel cars. While
greater fuel efficiency of a diesel vehicle should not be penalized, a way needs to be
found to collect the same level of tax that petrol car users pay from those who use a diesel
vehicle for passenger transport. An additional excise duty, based should be levied on
diesel car owners.
The researcher examined that implications of increase in retail price of diesel on
various groups of consumers and do not find any compelling reason to subsidize them.
Therefore, we recommend the price of diesel should also be market determined both at
the refinery gate and at the retail level.
APPENDIX
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Interview
A) Ravi Auto Services, Worli, Mumbai 30.
1. What is the retail price of fuel made up of?
A : The price of fuel at the retail station comprises the product cost, central government
excise and taxes, State government taxes and operating costs and margin.
2. Who controls pump prices In India?
A : In India there is no regulated pricing as the Administered Pricing Mechanism was
dismantled in 2001. However, the artificially low pump prices of petrol and diesel do
not reflect the realities of the high crude and refined product prices. The low prices are
subsidized by the present government through the issuance of oil bonds, which are
given exclusively to public sector fuel retailers in India.
For us ,the pricing decision is influenced by a number of factors including:
cost of bringing the fuel to the retail site (product and distribution costs)
cost of running the service station (e.g. salaries, rent, utilities)
3. Why have fuel prices increased compared to previous years?
A : The cost of crude oil and refined product have risen and therefore fuel prices have
increased. The cost of crude oil and refined product are influenced by a number of
factors, such as increasing oil demand, limits in refining capacity, seasonal demand for
product and extreme weather events that have affected refineries or fuel supplies.
4. Why do fuel prices vary in different countries?
A : The price of fuel in different countries is affected by:
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Cost of buying finished product in the country
Government excise and tax rates
Government subsidies for fuel
Currency fluctuations
5. How does the US exchange rate affect fuel prices in my country?
A : Since the world's major crude oil market is generally traded in US dollars, any
variation between a country's exchange rate and the US dollar will impact the cost of
buying crude oil in that country.
B) Mr. G. Chandrashekhar, Associate Editor of "The Hindu Business
Line" newspaper.
1. With fluctuation in the international oil prices, how the price discovery takes
place in India?
A : India is a large importer of crude (159 million tons worth $ 80 billion in 2010); there
is n
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