Petrofied - 101

 After a descent amount of research on the eve of India being peTROLLed (yes that's what exactly I want to call the day dated 23rd, May 2012 which co-incidentally happens to be my birth date too and thus providing me less reasons to be in a mood of jubilation) I happened to come across this artifact on the world wide web, which I am not sure if it's as correct as voiced, but then it has some amount of truth. (The Amount is more than those TROLLs/MEMEs floating around on the facebook pages).

The Petrol Price has been hiked by over 10% overnight, and as usual, specious arguments about “loss making Oil PSUs”, “sharp depreciation in Rupee” and “Government cannot subsidize the Rich for their petrol cars” are spouted to justify this humungous hike! A quick 101 (yes that's how the build up courses are named in my firm) on the building blocks of the street price of petrol would debunk each of these specious arguments to smithereens!

The Cost Breakup

The Indian basket of Crude Oil is at about USD 100 today (NYMEX is at USD 90.71, Brent is at USD 107.17 and WTI at USD 89.60 Source: http://www.bloomberg.com/energy/ and Indian basket is usually at 5-7% discount bracket to Brent). At today’s exchange of INR 56 per USD (the worst ever!), the crude works out to INR 5600 per barrel, which is still 6% cheaper than the highest price of INR 5900 recorded in August 2008.

Now lets us have a look at the model which translates to cost per litre of petrol !!

A barrel of Crude produces approx. 150 litres of Petrol or its equivalent. (This is a broad generalization and depends on type of crude, efficiency of the refinery and other processes involved, but is a reasonably good approximated estimate, based on expert inputs).

The total of all other costs involved in converting crude to Petrol – which includes transport of crude and refined products, cost of refining, reasonable refining margin for the refinery, fuel used by the refinery, dealer commission etc. is approx. USD 12, which works out to INR 672 per barrel. (USD 1 = INR 56)

Now, this totals up to a final cost of petrol, at your nearest petrol bunk, at INR 42 per litre! YES, it is a little less than INR 42 per litre, shorn of all taxes. [(5600+672)/150]. This morphs to INR 77 – 81 per litre, adding taxes at different levels under various heads – Basic Excise duty, Additional Duty, Special Additional duty, Cess, Additional Cess and lastly, the exorbitant State Sales Tax – adding up to INR 35-40 per litre of Petrol. These are the taxes and duties that the Governments, both centre and state, happily splurge on populist policies with an aim of making every citizen a beggar of Government doles!

So after the cost setup time to glance at some myths and yes they  can be debunked.

Myth 1 – “Oil PSUs’ losses have to be arrested”

The first and the most common myth “Oil PSUs are loss making?” In the real sense? If they stop paying their sales tax and excise duty, won’t they be rolling in cash? The real issue is the warped duty and pricing structure! The unintended adverse side-effects of this warped duty and pricing structure are

a. Oil PSUs now shy of investing money for creating new refining capacity

b. Much needed resources for exploring fresh oil sources are deprived

c. Investors run for safety (Niko Resources pulled out of India citing this yesterday!)

d. Corporate Governance takes a severe beating – all these Oil PSUs are listed companies, and minority shareholders like you and me are taken for a royal ride!

All these are crippling India’s natural geographical advantage of being closer to Middle East, and distant countries like Singapore and Indonesia are happily creating fresh refining capacities!

Myth 2 – “Sharp Depreciation of Rupee”

The depreciation of Rupee, by about 10% in the recent months from INR 51 per USD to INR 56 per USD has been MORE THAN OFFSET by the almost 20% decline in the global crude oil prices from USD 120 per barrel to USD 100 per barrel. Moreover, the sharp depreciation in the exchange rate is, in all probabilities, an over-reaction of the market to the global turmoil and it can be reasonably expected that RBI would intervene to soothe the nerves of the market which will have a sobering effect on the Rupee. So, the rupee depreciation is NOT a justifiable reason for hiking petrol price today. And as a matter of fact I have not seen petrol pricing down once the rupee becomes stronger. So pricing = f(rupee) is definitely not a well defined monotonically increasing function. If yes, well I would be interested in the domain and range of such a function.

Myth 3 – “Government cannot continue to subsidize the rich”!

This is the unkindest cut of all! As we saw just now, at the cost price of INR 42 per litre and a selling price of INR 70 per litre (before this overnight hike!), who is subsidizing whom? After today’s hike, the total taxes work out to whopping 83% on the basic price.

At this price, even diesel is NOT a subsidized product as the cost is exactly the same at INR 42 per litre for it. (the refining process yields all final products at almost same cost), which is sold at INR 44-46 per litre. So, they should spare us these sermons on “Government subsidizing the rich for their cars and two wheelers!”