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The Oil Fool Account... - Views on News from Equitymaster
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  • Apr 6, 1997

    The Oil Fool Account...

    What the Government gets..
    CommodityLitres per
    Barrel (Rs)
    Price (Rs)
    Revenue (Rs)
    Petrol 37 24.0 888
    Diesel 49 5.6 441
    Kerosene 35 4.0 140
    Residual 59 7.0 413
    Total/Average 180 10.5 1,882

    .....what it pays.....
    Crude oil US$ 21 Rs 752
    Refining, transport, commissions US$ 4 Rs 143
    Total cost US$ 25 Rs 889

    ....and what it makes!
    Revenues/barrel: US$ 52.50
    Costs/barrel: US$ 25.00
    Profit/barrel: US$ 27.50
    Profits on imports of 200 million barrels: US$ 5.50 bn
    Profits on total consumption of 550 million barrels: US$ 11.00 bn

    For the past six months journalists have been giving us screaming headlines of an imminent hike in oil prices. The Oil Pool Account, we are told, has a deficit of Rs 16,000 crores and the government needs to raise oil prices once again. Worse, we have been warned, oil prices in the international markets have been on the rise. The price of one barrel of crude oil was US$ 18 in August, 1996 but went as high as US$ 25 by January, 1997 - an increase of 40% in 5 months.

    Reports of the galloping oil price increases in the international markets probably made most of you cringe in your seats and feel guilty about the fact that the poor government was bearing all those cost increases. At times many of you were probably on the verge of voluntarily writing a cheque to the Oil Pool Account - a contribution to the burden the government was bearing on behalf of us consumers. It seemed obvious that, if the government had to cover the deficit in the Oil Pool Account and pay this huge increase in global oil prices for crude, then the only option was a hefty increase in oil prices for us consumers.

    The facts, though, are startlingly different from the myth of an Oil Pool deficit that the press has bashed into our brains. Based on the numbers in the charts, I think the government should actually REDUCE oil prices by 30% from US$ 52.5 per barrel to US$ 35 per barrel. The charts summarise how the government (and all the oil companies put together) are fleecing us poor consumers and why we should resist the government's need to raise oil prices.

    A barrel of oil in the international markets costs about US$ 21. Typically, a refinery makes US$ 1.5 per barrel as a profit when it buys the crude, processes it, and sells it on to the distributors and petrol pumps. The typical costs of distribution, marketing, and financing the movement of oil from its crude stage to the end product stage is probably another US$ 4 per barrel. This means that a consumer in India who buys every single kind of product that comes out of a refined barrel of oil should pay US$ 25 for every barrel of end product.

    Now lets see what we in India pay for oil products. One barrel of oil generates 180 litres of end products like petrol (37 litres for every barrel of crude oil), diesel (49 litres), kerosene (35 litres), and residual products like tar and aviation fuel (59 litres of total residual products). Now, if I take all these products and work out a revenue stream based on what consumers pay, I get a fairly startling number of US$ 52.5 per barrel. If I am paying US$ 52.5 per barrel and the international price to consumers in other parts of the world is US$ 25 per barrel, that means that someone is making a profit of US$ 27.5 per barrel. As far as I am concerned the government should be reducing the price of petroleum products, not increasing it!

    But why is the Oil Pool Account showing a deficit? Because the government charges excise duties, import duties, and sales tax on these products which go directly to its pocket and not necessarily through the Oil Pool Account. Actually, there are many Oil Pool Accounts some at the crude oil level in which producers of crude oil and their immediate buyers and importers maintain a set of accounts, then there are accounts at the refinery level, and there are also accounts for different products depending on whether they are being sold at the subsidised price or not.

    But that, as far as we consumers are concerned, is all double- speak and gobblygoog. We are paying US$ 52.5 for every barrel of oil purchased. If I was allowed to import the same oil products from anyone in the world, I would be paying only US$ 25 per barrel - half the price! Saying that the Oil Pool Account has a deficit is like telling us consumers that the government has a bulging left pocket from all the money its making on import duties, excise duties, and sales tax that it levies on oil but it has a hole in its right pocket! Data suggests that the money in the left pocket is a lot more than the money that slipped through the hole in the right pocket - by a phenomenal US$ 11 billion every year (Rs 39,600 crores)!

    Oil prices in this country do not need to be raised. They need to be reduced. From US$ 52.5 per barrel to maybe US$ 35 per barrel - implying that I am paying the government a 30% tariff on the existing international oil prices as opposed to the 100% tariff that I am paying today. Obviously, the loss of tariffs due to this US$ 17.5 per barrel reduction in oil prices will blow a hole in the government's budget and will result in a shortfall of over Rs.34,650 crores (US$ 17.5 x 550 million barrels of annual oil consumption) in the government's revenue side. But maybe the government should raise this money from somewhere else.

    Like imposing more taxes on cigarettes and liquor. Oil is essential to a country's economic development and cheaper oil will mean a more efficient economy. Cigarettes and liquor add to the country's health costs and are certainly not "essential" for international competitiveness of economies. The tax on bidis was imposed with the same philosophy: discourage smoking but if you still do it, pay for it! The ideal situation would be for the government to do away with its continuous need for money altogether but, at this stage, that is unrealistic. In any case the total collection from indirect taxes on the alcohol and cigarette industry is about Rs 4,000 crores - only 10% of the government's collection on petroleum products. More reason for the government to reduce prices on petroleum products and increase taxes on alcohol and cigarettes.

    Luckily for us poor consumers, better political sense has prevailed in the Ministry of Finance about the awkwardness of a oil price during the budget session and, apparently, it has been deferred for a few months. Meanwhile, a collapse in international oil prices back to the US$ 19 per barrel levels has also removed most of the hysteria about "mounting deficits" although the press still makes us worry about the "existing deficit" of Rs 16,000 crores.

    The funny thing is that whoever was responsible for planting stories in the press about rising oil prices in the global markets failed to tell us that the rise was expected and was a momentary spike largely due to the "winter effect" - cold weather in USA and Europe (which are the largest consumers of oil) always tends to cause a seasonal effect on global oil prices. None of our newspapers told us about this small important fact when they went about creating their hysteria of a case to raise oil prices. Now, the betting is that the government will raise the price of oil products after the budget is passed in Parliament - sometime in May or June.

    But don't let them. We are already paying too much for oil and it is about time oil consumers stopped being the scapegoat. If the government is running short of money they should spend less or, in the short term, fleece someone else.



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