Reasons and implications of Rising oil prices

Reasons and implications of Rising oil prices

Context

There has been a sharp hike in the prices of petrol and diesel, since the “dynamic” daily pricing model for these fuels was introduced in India.

What has been the trend in fuel prices?

• In the year 2014, the Brent crude price was $ 108.6 per barrel, and petrol cost Rs 73.16 a litre in Delhi.
• In September2017currently, Brent crude was trading at $ 54.2 per barrel, but price of petrol in Delhi was same as 42 months ago, at Rs 70 per litre.
• The dynamic daily pricing model has come in for criticism because the price of petrol has gone up from Rs 63 in July to Rs 70 on September, which is an increase of 11.6%.
• Diesel prices have also surged similarly, and the trend has been identical in other cities as well.

How is the Indian crude basket calculated?

• The Indian basket of crude oil basically represents a derived basket comprising Sour Grade and Sweet Grade of crude oil processed in Indian.
• Prices of petrol and diesel have both been made market-determined. Since then, the Public Sector Oil Marketing Companies (OMCs) are supposed to take appropriate decisions on the pricing of petrol and diesel. This is in line with international product prices and other market conditions such as exchange rate and the demand-supply situation.
• In 2017, the new dynamic daily pricing was introduced.

What does dynamic daily pricing system mean?

• Dynamic daily pricing means the state retailers will reset the price of petrol and diesel each day, rather than wait for a fortnightly revision.
• On a broad view, this move will align the retail pricing of crude products in line with price changes in the international markets. This will bring transparency in the pricing of crude products.
• The companies will change the price of transport fuels every day based on crude price movements. Dynamic pricing is followed in many developed countries.
• We can say therefore say that the retail fuel prices are expected to be more aligned to market dynamics.

What is the positive impact of dynamic daily pricing system?

• This move is believed to crystallize the outlook for oil marketing companies marketing margin,or the difference between the cost of procurement and the price charged by retailer and therefore boost confidence over the overall sustainability of this broad deregulation initiative.
• Shorter time lag between crude purchase and products sales will collapse, thus allowing prices to reflect cost and avoid artificial distortions.
• It will enhance OMCs’ ability to pass the prices into the economy more effectively.
• Global experience shows that the current dynamic pricing of fuel has the potential to attract participation of private players in fuel retailing and several downstream opportunities, thus exposing the downstream and marketing to best practices and modern technology in refining.
• A liberalized retailing regime may also expose the PSUs into an intensive competitive scenario.

What is the negative impact of dynamic daily pricing system?

• Consumers may be affected sometimes, especially if there is a major international event, like a war or riot. Then, the prices may fluctuate a lot. It can become expensive or cheap, depending on the nature of the incident.
• Prices of FMCG goods may also fluctuate dynamically. FMCG prices are directly related to fuel prices. Now, if the fuel prices suddenly increase, then there are chances that FMCG products pricing may also fluctuate, and sometimes daily.

What explains the divergence in the movements of the crude basket and of retail prices?

• With global crude oil prices plummeting to record lows when it took charge, the government resorted to a series of excise duty hikes in the second half of 2015 and the initial months of 2016 on both petrol and diesel to help shore up finances.
• This has helped the Centre realize higher central excise duties primarily through the increased tax on petrol and diesel, which are still outside the ambit of GST.
• In India, the share of taxes in the retail selling prices of petrol and diesel (as on July 16) were 55.5% and 47.3% respectively, with central taxes (essentially excise duty) accounting for the bulk of it.

What other variables are involved?

• The price is determined not only by the movement of crude oil price (the main raw material), but also by the rupee/dollar exchange rate and demand-supply situation in the market.
• While a deficit of the product leads to a rise in its price, an increase in supply will lead to a decrease.
• Over the first nine months of calendar year 2017, the global crude oil price for the Indian basket fell by 0.44% while the price of petrol (in Delhi) came down by 0.3%.
• This is despite the fact that the rupee strengthened against the dollar by nearly 7%, something that would have translated into sharply cheaper imported oil.

How has the government justified the excise hikes?

• The government has defended the higher dutyand said that increased revenue was going into welfare activities of building more roads, and providing irrigation and drinking water facilities.
• Governmenthas said that oil companies would continue to have pricing freedom.
• Government says that one part of the fall in oil prices as a part of proper economic and fiscal planning goes to the consumer.
• The second part is going to developmental activities, particularly national highways and rural roads, because those who consume petrol and diesel drive vehicles on these roads, and they must pay for it.
• The third part is consumed by the states by way of VAT.
• Of what the central government gets, 42% is being passed on to the states.
• And for the fourth and final part, it goes to the oil companies for the reason that when oil companies make international purchases against future purchases, they suffer a huge loss.

Conclusion

The global oil prices are becoming increasingly market-oriented. Thus, dynamic fuel pricing will improve the competitiveness of the economy overall. It would also bring in transparency in fuel pricing and incentivize investments in the oil sector.