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Wednesday, January 28, 2015

Are consumers benefitting from falling oil prices? – a guest post

Oil prices have fallen off a cliff - from above $110 a barrel to less than $50 a barrel in the space of 6-7 months. Part of it was due to speculation. Discovery of huge quantities of shale oil in USA, and development of technology for extracting it at reasonable cost has reduced the dependence on Middle-East oil.

Since most of India’s oil requirements are met by imports, falling oil price has been a boon for our economy – reducing our current account deficit considerably. Reduced prices of petrol and diesel have benefitted consumers – but not to the extent it should have. The government has taken the opportunity to increase excise duty.

In this months’ guest post, Nishit analyses the effect of falling oil prices and increased excise duty to show that consumers are paying at least Rs 8-10 per litre more than what they should. It is probably the government’s way of compensating the oil marketing companies for the past several years of under-recoveries. Does that provide an opportunity to invest in OMCs like BPCL and HPCL?

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The unprecedented fall in oil prices in the international market have reduced pump prices of Diesel and Petrol by large margins. However, consumers are not getting the full benefit of lower oil prices. Let us try and see the reason why.

Brent crude has come down from $115 per barrel in June ’14 to about $50 a barrel, a reduction of 56%. Petrol prices, which were deregulated, have reduced by about Rs 15. (I am taking Mumbai prices as a benchmark just to get average percentage reduction). This reduction constitutes about 19%. The prices have gone down from about Rs 81 a litre to Rs 66.

The Government has increased excise duty on Petrol by about Rs 9 per litre. This constitutes about 11% price drop being absorbed by the Government. If we add up the price reduction and the excise duty hike, the total comes to about 30% reduction from peak prices.

The question which begs to be answered is where is almost 25% of balance reduction going to? Pump prices should be Rs 36 if we take straight linear co-relation. But looking at a complex tax structure, let us add another Rs 10 to the equation. The pump price should be between Rs 45-48. This Rs 10 is being factored in as there is a fixed cost of refining, dealer commission, etc.

Considering everything, consumers are paying at least Rs 8-10 more than they should. Oil marketing companies are hiding behind the fact that they are having to bear inventory losses since they buy at least 6-8 weeks in advance.

This argument can hold for only a short time. If oil prices sustain below $50 a barrel for even a month more, the inventory losses argument will not work.

Also, when prices went up, did consumers get the benefit of inventory profits? Now they are bearing the brunt of the so-called inventory losses!

Another factor is the Rs 9 excise duty. If oil prices go up, will the Government roll back these duty gains so as to cushion the consumer?

The calculations of taxes have been made so complex that it is beyond the understanding of most people.

The real test of the Government would come when oil prices begin to go up again. Right now, in this fiscal, the Government stands to mop up about Rs 20000 Crores from these hikes.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

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