Diesel as a fuel has the most versatile usage in India. From domestic to commercial sector diesel is widely used in freight carriers, heavy duty vehicles, SUVs, MUVs and domestic electricity generators. Here is all you need to know about the economics of one of the most widely used petroleum product in India.

What are the factors that influence the price of diesel?

The price of Crude oil: Crude oil price is the most significant aspect that impacts the price of diesel in India. Diesel is a heavy fuel extracted out of crude oil through fractional distillation and as the price of the finished product is primarily constituted by the prices of raw materials, thus, any changes in the prices of crude oil has a direct impact on the price of diesel in India.

Forces of demand and supply: Petroleum is an exhaustible energy resource with limited availability and uneven distribution across the world. Diesel being produced by processing crude oil is also subject to the limited availability thus leaving the product at the mercy of market forces of demand and supply.

A rise in demand or fall in supply spikes the prices of diesel while a fall in demand or rise in supply pulls the prices down.

In the natural course the prices go higher as the population is rising continuously increasing the demand for the fuel with more and more vehicles hitting the road each day.

So why did the fall in prices of crude oil not impact the price of petrol in the country? The answer lies in the other factors that impact the price of the fuel in India.

Taxes levied: Apart from the economic forces controlling the prices of diesel, there are aspects of taxation and state revenues too that decide the cost of diesel before it reaches into the underground tanks of our nearby retail pump stations.

Governments at the central level as well as the state level levy myriad taxes from import and production to sale of diesel. The companies that hold stake in the production and supply of diesel revise and adjust their prices according to the taxation policies to gain marginal returns and recover losses.

Dollar exchange rate: The rupee to dollar exchange rate has a huge impact on diesel prices in India. The US dollar is used as the standard currency for transactions pertaining to oil trade in the world, therefore, any revision in the exchange rate has a direct impact on the prices of the fuel.

Refinery consumption ratio: Based on the level of technology, grade of oil and size of the unit, oil refineries have different consumption ratios against the amount of fuel they produce. The consumption ratio of refineries also determine the price of diesel in the country.

Why is the price of diesel in India different from other countries?

The price of diesel varies from one country to another and there are a plethora of factors causing this variation.

One or a combination of following factors cause the variation in prices between India and other countries-

Existing reserves

Currency exchange rates

Taxation policy

Government subsidies

Market speculation dealing or oil futures

Regulations related to petroleum products

Proximity to resources or conflicts

International agreements and embargos

How can you calculate the retail price of diesel?

The retail price of diesel can be calculated by adding up the price of crude oil, processing costs, profit margins of the oil marketing companies, freight costs, excise duty and the different taxes levied by central and state governments.

So here is the list of costs that sum up to determine the retail price of petrol-

Cost of Crude oil

Processing cost to extract petrol from crude oil by oil marketing companies

Profit margins of oil marketing company and dealers’ commission*

Transportation and freight costs

Excise duty imposed by the central government

VAT (Value added tax) imposed by state governments**

The commission varies a little with the location of fuel pumps. For instance the dealer commission for diesel is Rs 2.56 on an average in Delhi.

Different states impose VAT at different rates thus, the price of diesel varies from state to state.

What is High-Speed Diesel (HSD)?

HSD is normally used as a fuel in medium and high speed compression ignition engines (operating) above 750 rpm) in commercial vehicles, stationary diesel engines, locomotives and pumps etc

It is primarily a middle distillate with boiling point range at 160-400 Degree Celsius and density range of 820-845 Kg/m3 at 15 Degree Celsius.

What is the Bio-diesel policy?

Bio-diesel is a fatty acid containing properties similar to petroleum diesel fuels, which can be a substitute for High Speed Diesel (HSD). Ministry of Petroleum and Natural Gas announced a bio-diesel policy in October 2005 to encourage the production of bio-diesel.

Under the bio-diesel policy, effected from 01.01.2006, OMCs were allowed to blend 5% of bio-diesel (B100) meeting the fuel quality as per BIS with high speed diesel.

The Ministry of Petroleum and Natural Gas announced the National Policy on Biofuels – 2018 with an aim to increase usage of biofuels in the energy and transportation sectors of the country during the coming decade.

Under this policy, an indicative target of 20% blending of ethanol in petrol and 5% blending of biodiesel in diesel is proposed by 2025 and 2030 respectively.

Why do petrol and diesel not come under the GST regime?

Bringing domestic fuels under the GST would effectively mean reducing taxes on them. The highest tax slab under the GST is 28%, while the fuels such as petrol and diesel are taxed at more than 100% as of now.

To understand the politics of taxation of petrol and diesel between the center and the state, we need to understand the difference between the taxation mechanisms of the two.

Central government taxes the fuels at a specific rate using various duties and cess while states use a combination of specific and ad- Valorem rates to tax the fuels. Center shares 41% of its collection with states while states add the whole collection to their respective exchequer.

Both, the Central government, as well as the state governments, do not want to compromise with the present tax collection from petrol and diesel since they form a large part of the state revenue. In addition to that, states do not want the center to hold sole power over the decision of tax rates of petrol and diesel since in the present tax regime they enjoy the benefit of a dynamic rate giving them the liberty to adjust their collection.

Since the revenues of both the Centre and the States will be heavily affected by a lower tax on petrol and diesel, it is unlikely that these fuels will be brought under the ambit of the GST any time soon. Even if these fuels are brought under the GST, there is likely to be a steep rate imposed on them to prevent any loss in tax revenues.