Economy
Why governments are loath to cut fuel prices
Summary
- Even when crude oil prices are falling, governments are slow to cut retail fuel prices owing to the primacy of oil in their own revenues.
Global crude oil prices have fallen sharply in recent weeks. The price of the variant of crude oil that India imports is currently around $73 a barrel. The last time crude oil was this low was around November 2021, just a few months before Russia invaded Ukraine and triggered a surge in oil prices globally. While there is a growing clamour to cut retail prices of petrol and diesel, governments have been slow to respond, given the outsized support that oil provides to their revenues.
In the past five years, the Indian government has been more sensitive on the input side than on the output side. Adjusted for exchange rates, the price of crude for Indian refiners is currently ₹39 a litre. Back in June 2022, it was ₹57. Thus, against a gain of ₹18 on the input side, the price of petrol has been cut by only ₹2 in the past two years. But with several state elections approaching, more cuts may be imminent.
Also read | Mint Primer: Global crude is at $72. Will petrol prices see a cut?
Political considerations aside, the government has little incentive to cut fuel prices on purely economic grounds. Petroleum secretary Pankaj Jain said oil companies may cut prices if global crude prices stay low for an “extended period". A major consideration would have been inflation, which is heavily influenced, directly and indirectly, by fuel prices. Until as recently as June, overall consumer inflation was above 5%, driven by food inflation. But the fuel price component has been negative since September 2023, reducing the incentive to cut prices.
Tax riches
Another economic disincentive for the government to cut fuel prices is the importance of the petroleum industry to India’s public finances. In 2023-24, the industry contributed over ₹4 trillion to the central government in the form of both direct and indirect taxes. That’s around 18% of its total tax revenues for the year, though the importance of that contribution has fallen in recent years.
Also read: Can the drop in crude oil prices spoil the party for MCX?
A cut in fuel prices could, depending on the magnitude, put a dent in central government coffers. Besides tax revenue, dividends from oil companies owned by the government contributed another ₹19,000 crore to it. State governments earned another ₹3.18 trillion in taxes, duties and royalties from oil companies. For states, taxes on fuel and liquor are among the few levers of revenue that remain fully within their control since the migration to GST.
Protecting margins
Healthy margins give oil companies more room for price cuts. Gross refining margin (GRM) is the difference between the sale price of petroproducts (such as petrol and diesel) and the price of crude oil. While the GRM of government-owned oil companies remains well above the benchmark Singapore GRM, that difference is set to fall in 2024-25, according to credit rating firm CareEdge Ratings.
In recent years, India has imported larger volumes of Russian crude at lower rates than crude from other sources, helping refiners make outsized profits. However, the differential between Russian crude and Middle-East crude has narrowed, and is likely to reduce the GRM of Indian refiners. The CareEdge report expects GRM to fall to $6-8 a barrel in 2024-25. In 2023-24, Indian oil refiners reported a GRM of $8-14 a barrel. If GRM falls, expect oil companies to be even more cautious in cutting retail prices.
EV threat?
Beyond short-term movements in global oil prices and the fortunes of oil companies, a major long-term challenge to the fossil fuel industry is electric vehicles (EVs). According to BloombergNEF, EV sales in India grew 39% year-on-year in the first quarter of 2024. Brisk growth could reduce retail sales of petrol and diesel over time. Revenue from fuel taxes, so important to governments the world over, could be hit.
Also read: What fresh EV subsidies tell us about their market
However, this is unlikely to happen any time soon. EVs are still a small share of overall vehicle sales. While EV sales in countries such as India and China have been strong, sales in more developed countries have been subdued. Italy, Japan and Germany reported negative growth in the March quarter. Expect the Indian state, like other governments worldwide, to remain addicted to crude oil—and the revenue it brings.
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