Economy of Oil

The prices of petroleum products in India present a fascinating study. The prices of petrol/diesel in India are among the highest in the world, and yet the government keeps on claiming that a huge subsidy is being provided, and that all oil companies are in the red. So it is high time we try to find out the real cost of these petroleum products, and also the truth behind government’s claims.

The basic principal of business is that if, for a firm, the cost of taking its products to the consumer is less than what the consumer pays for that product, the firm will make profit – otherwise it will make loss. So we just need to calculate how much oil companies spend (or need to spend) for getting their products to the filling station, and what the consumers are paying for these products. (For simplicity, we will use approximate averages – which will not have any noticeable impact on the conclusions.)

For oil companies, the input is crude oil – which is refined to yield different products. These products are, in turn, distributed through different channels to reach the consumers. Thus, the costs for oil companies include the cost of crude oil, the cost of refining, and the cost of marketing and distribution. For one barrel of crude oil, the costs incurred by a typical oil company are as following:

     Cost of Crude Oil                 = $100    (actually it is $85)

     Cost of Refining                    = $15      (estimate taken from US data)

     Marketing and Distribution    = $10      (…on the higher side; to be sure)

                      TOTAL              = $125        = Rs50 ×125       = Rs6,250

The next step will be calculating what consumers pay for the refined equivalent of each barrel of crude oil. Through the refining process crude oil is converted into a host of products, including petrol and diesel. Though the actual output of refining process depends on the quality of crude as well as on the refining process, average figures will well serve our purpose. So, the final products and the resultant revenues for 160 liters (one barrel) of crude oil are as following:

      Petrol                   ->       75 liters         (@ Rs68 per liter)         = Rs5,100

      Diesel                   ->       35 liters         (@ Rs43 per liter)         = Rs1,505

      Jet Fuel                ->       20 liters         (@ Rs60 per liter)         = Rs1,200

      Naphtha               ->       15 liters         (@ $1,000 per ton)       = Rs750

      ‘Heavy’ Products  ->      15 liters         (ignored)

                                                                                 TOTAL        = Rs8,555

(Yes, it was a revelation to find that Jet Fuel is cheaper than Petrol in India.) ‘Heavy’ products are petro-chemicals such as lubricants and waxes, which – though not worthless – are ignored in our calculations.

These simple calculations clearly show that the oil companies need to spend only Rs6,250 for delivering their final products to the customers, while the customers are paying Rs8,555 for those products. Under normal circumstances, this difference of Rs2,305 (i.e. almost 37% of costs) would have been the ‘Profit before Tax’ of the company for each barrel of crude oil processed. ‘A mighty profitable business’, I would say; especially when we include the revues from ‘heavy’ products – motor oils, lubricants, grease, aromatic petrochemicals, among others.

But here lies the catch, and also the double-speak of the government. Huge amount of taxes (more than Rs2,305 per barrel) are imposed on petrochemical products, so that the landed cost for oil companies increases beyond Rs8,555. If we assume that the total tax imposed on each barrel of crude oil is, say, α – the final landed cost becomes Rs6205+α, which is more than Rs8,255. Now, the government is FORCED to provide HUGE subsidy to make these products affordable. If this subsidy is, say, β per barrel of crude oil; then                                     6250 + α = 8555 + β

                            or            α – β = 8555 – 6250 = 2305

Hence the taxes [α] are more than the subsidy [β] by an amount equal to Rs2,305 per barrel of crude (equal to the possible Profit before Tax estimated above). Under competitive market conditions, this amount of Rs2,305 should have been shared by the oil companies (as profits), the consumers (as reduced prices), and the government (as taxes). But a distortion is introduced in this scenario by the government through excessive taxation. Now the oil companies make no profit, consumers pay more, and the government make huge money through taxes (while shouting over rooftops about subsidies – which are factually much less than taxes). In fact, for each barrel crude oil imported/produced in India, the government earns Rs2,305 as taxes after deducting the subsidies.

Since India imports approximately 2.5 million barrels of crude oil per day, and produces another 0.8 million barrels at home; for these 3.3 million barrels of crude oil, the government earns more than Rs2,305 × 3.3 million = Rs7.6 billion. We must also remember that since the landed cost of domestically produced crude is much less than that of the imported crude – the profit earned by government is even more. So, even after accounting for all the so called subsidies, the government is making a clean Rs2.7 trillion from taxes on petroleum products each year.

This takes us to another interesting aspect of the story. In US, the price of gasoline (petrol) is approximately $3.0 per gallon – which translates into Rs40 per liter. Thus the fuel for ‘common man and farmers’ in socialist India – Diesel, @ Rs43 per liter – is costlier than petrol in capitalist US.

Long-live our socialism…

(The calculations done above are just of the ‘back of the envelope’ type using approximate values, and the final figures obtained are not cent-percent accurate. But the trends which emerge are correct, and point in the right direction.)