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Petrol, Diesel Prices: Let invincible hand do its job.

Date: 10-09-2018
Subject: Petrol, Diesel Prices: Let invincible hand do its job
Retail fuel prices are at an all-time high. Average retail price (Delhi and Mumbai) of petrol was `83.78 and that of diesel was Rs74.38, as on September 7. Petrol prices are up 25% from a year ago, and diesel by 13%. This provided a lot of content to the media to come up with memes, jokes and serious debates alike. While the weight of petrol and diesel prices in CPI basket is low (2.3%) as per the Consumer Expenditure Survey, it is felt much more deeply in our daily routine.

Let’s look at retail fuel prices. Diesel and petrol prices are no longer regulated and are set on a daily basis by OMCs. India imports a major chunk of crude requirements and a small quantity of high-speed diesel. Prices are on set on trade parity basis—taking into account global prices of petrol and diesel, and assuming India imports a substantial chunk of its refined petroleum needs. The retail price in India is a combination of global oil prices, exchange rate and government taxes.

Last year, prices breached $60 mark. These started rising in 2016-end after OPEC and other nations agreed on a deal to restrict output to balance global markets. The sharp rise in oil prices in second half of 2017 was due to hurricanes Harvey and Irma hitting the US and impacting the oil infrastructure in the country. Then there were the geopolitical tensions that added fuel to oil prices, stemming from Turkey and Saudi Arabia. Output from Libya and Nigeria remained volatile.

Global oil prices are up 50% compared to a year ago. Brent crude price breached $70 mark in April 2018 and haven’t come down. Much of the crude oil price rise this year has been a combination of fundamental reasons and investor sentiments. Crude prices have risen driven by higher conformity by OPEC and other cooperating nations to output deal. OPEC and non-OPEC oil exporting nations led by Russia agreed to reduce output by 1.8 million barrels per day since January 2017 to support oil prices and balance markets. This year, the output adjustment went above this level and OPEC conformity touched 152% in May, led by falling output in Venezuela, which was gutted in a crisis. To add, the US announced re-imposition of sanctions on Iran (prohibiting imports of Iranian crude come into force only in November 2018). Despite the market being well-supplied and global crude inventories at healthy levels, these two developments created a perception of decreased supply in future. Saudi Arabia and OPEC agreed to boost oil production to make good for the loss stemming from Venezuela and Iran. Over time, other temporary news developments—fire in a UK refinery, US crude stocks/rig count data points, US-led trade war, and demand outlook in China and other EMEs—further added volatility to oil prices. One should not forget how quickly oil prices can move, especially in the current scenario when prices are driven more by sentiment rather than fundamentals—Brent crude price moved from about $70 to nearly $75 between August 15-23. Ceteris paribus, a sudden and sharp fall in global oil prices can easily bring down domestic fuel prices.

The value of the rupee against the dollar has a crucial role to play in determining retail fuel prices, given that a major chunk of global tradable crude oil is denominated in dollar terms and India imports majority of its crude requirements. The rupee has lost 11% of its value against the dollar over the course of last one year. A weak rupee increases the rupee price of Indian basket of crude oil and, in turn, retail fuel prices. Higher crude prices and a weak currency deliver a double whammy to India.

The final major determinant of retail fuel prices is government taxes. Taxes on fuel in India are perhaps among the highest across the globe. VAT and excise duty make up 45% of petrol’s pump price and 36% of diesel. The government increased taxes on petrol and diesel as global crude prices were falling and remained low during 2014 and 2015. As a result, consumers did not get the full benefit of falling oil prices, while the government was able to add to its kitty. The government hasn’t been very forthcoming in reducing the taxes. However, in April, public sector OMCs were asked to absorb some of the increased burden of higher oil prices.

Where can retail fuel prices head from here? Brent crude price will likely come down from the current levels and settle in the early $70 range in the fiscal. November will be a crucial month for oil markets, as sanctions on Iran oil kick in and OPEC will meet to discuss the future course of action on output deal. There is, as such, no shortage of oil. Data pertaining to drawdown of inventories merely spook short-term investor sentiments amidst other uncertainties and geopolitical developments. In a world of relative calm, oil prices can come down swiftly and with ease. So, a move to, say, $71 a barrel would mean around 8% correction in global oil prices.

With regards to the rupee, the street view is quite broad in the range of 68 to 72. Most analysts believe the rupee to settle in late 60s in the fiscal. Much of the fall is a mix of rub-off from global developments (US rate hikes, trade war, fear of weaker growth in EMEs) and some domestic factors (higher current account deficit, higher inflation). If we assume the rupee to be around 69 to a dollar, that’s a correction of 3-4% from the current levels.

Not taking into account the changes in tax rates, the above numbers suggest a correction of around 10% in retail fuel prices in the months to come. If the government moves to reduce taxes in its pre-election mode, retail fuel prices can come down further. The finance ministry’s revenue collection estimates suggest taxes levied on petroleum products to contribute more than `2.58 lakh crore to the government kitty. A positive way to look at taxes could be to treat them as carbon tax; however, the end to which the collections are put to use can always be questioned.

No doubt, high prices of fuel pinch the consumers, but a lower price arrived at by subsidies or asking OMCs to incur losses is not desirable. Yes, taxes can be rationed to provide some relief. But a sustainable reduction in fuel prices will come only when the currency and global oil prices move in our favour. And this doesn’t seem too distant. So, maybe it’s best to keep calm and let the invisible hand do its job.

Source: financialexpress.com

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