Why is Petrol price high in India - An Analysis (Part 1)

The global crude prices have fallen more than 70% in the last few months from a high of $147/barrel in July to a low of $36 in mid Dec. This is a 5yr low for the crude price. In most countries that have market linked pricing the price of gas at the petrol pumps has come down by a similar margin. However in India there has hardly been any movement in price. Whatever hike the Govt implemented in mid-year (Rs.5/lt for petrol, Rs.3/lt for Diesel, Rs.50/cyl for LPG) has been rolled back partially (Diesel was reduced by Rs.2/lt only and LPG price has not be revised). The objective of this article is to analyze why the petrol price in India is still high despite crude prices being at 5yr lows.

As part of my research I checked out the following aspects. I will be detailing each of these below:

• Crude price movement in 2009 & Average crude basket price in India
  
• Pricing components of Petrol price in India
  
• Comparison of pricing components in India with pricing components in US
  
• Gross Refining Margins of OMC’s
  
• Profit/Loss of Govt owned Oil Marketing Companies(OMC’s) which control a 80%+ market share
• Govt policy- Administered Pricing Mechanism(APM)/De-regulation of oil industry

Crude price movement in 2009 & Average crude basket price in India

While the price of crude has reduced drastically over the last six months if you notice the attached chart(Source: CBS Marketwatch) a big chunk of the reduction has come in Q4, 2008 only. The price came below $100/barrel in early October, below $60 in November and below $50 in early Dec. Technically price has been below $100/barrel for a little over 2 months now. This needs to be taken into consideration for the timing of price roll-back. We will come back to this later in this article.

One more factor that needs to be considered is the Exchange rate. US Dollar has appreciated by close to 20% this year against Indian Rupee. While the crude price has gone down the OMC’s will be paying around 20% higher price in Indian Rupee terms due to the exchange rate.

India imports around 70% of our crude from outside and the rest 30% is produced locally thru upstream oil companies like ONGC, Oil India ltd etc. The crude sale price of these upstream oil companies is fixed and they sell oil to OMC’s at $55/barrel irrespective of international crude price. So the average price of crude basket of OMC’s will be lesser than market price of crude as around 30% of the crude is purchased at $55 fixed price. As an example if the market price of crude is $140 the average Indian crude basket price will be $114.5 (average of 70% crude at $140 & 30% crude at $55). The average monthly crude basket price for IOC for last several yrs (Average price of imported crude only) can be found here:

http://www.iocl.com/Products/CrudeOilPrices.aspx

You could use this to arrive at average crude basket price for IOC overall.

Pricing Components of petrol price in India

The pricing of the petrol in India is pretty complicated. I have detailed the same in the below table:

Based on the attached calculation the price of crude is only around 36-40% (based on how you calculate) of the total price that we pay at the pumps. There are way too many levels where we are taxing this needs to be simplified. Secondly there is lot of fixed price components in this. This needs to be changed to variable component as a % of crude or petrol cost so that it can vary relative to crude price. The current fixed pricing structure is beneficial for Govt whereby irrespective of crude price changes Govt get fixed revenue(easy for budgeting). At higher crude prices the overhead is reasonable/comparable to global standards however at lower crude prices the overhead is really high.

Comparison of pricing components in India with pricing components in US

In order to see how our petrol taxation compares globally I wanted to compare the various price components of petrol in India with US. Refer the attached chart for details.

Though the refining cost in India seems to be much lower than US in the attached chart in actual it is similar. Here refining cost if represented as a % of the price of petrol and petrol price in India is much higher than US. Hence the numbers looks skewed. In the same context our distribution costs are much higher than US.

At $65/barrel the average price per gallon of petrol in US is $2.6 & average price per gallon in India is $4.1 (arrived at based on above table). The gas price in US is around 35% cheaper than in India. Due to fixed rate structure of duties/tax on petrol price in India the gap will become bigger as the crude price goes below $65 and will become smaller as crude price goes above this mark.

To be continued. In the next part I will be covering about GRM, profit/loss analysis of OMC's, APM/de-regulation and my prediction on if and when gas prices would be reduced in India.

2008 Economy & Stock Market Highlights

2008 will go down as a record year in the history. Most analysts and economists were predicting a slowdown in the economy and a soft landing earlier this year. However no one was even in the ballpark w.r.to the actual events. The complete world was taken by shock with the magnitude of the financial mess and global recession/slow down. There was unprecedented volatility in global stock markets, commodities like oil, Gold etc, Currencies, interest rates and a whole bunch of key economic fundamentals. This is expected to be the worst recession (some are even calling it depression) since the great depression in 1929. Almost all developed countries and key emerging/developing countries like China, Russia, Brazil, India etc are impacted in this global crisis.

Some of the key highlights/statistics from an economic perspective are listed below

ü All major stock markets down from their record highs in Oct 2007

o Dow is down almost 40-45% from its peak

o NASDAQ is down by around 45%

o S&P 500 is down by 40%

o BSE Sensex is down 55-60%

ü S&P 500 market has lost $6.17 trillion dollars in Market cap in the last year

ü S&P broad market index which has around 11,000 stocks in developed and emerging markets has lost around $17.7 trillion YTD

ü The entire Investment banks segment has been wiped out – Bear Sterns & Lehmann doesn’t exist anymore, Merrill Lynch has been acquired by BoA, Morgan Stanley and Goldman Sachs have converted into commercial banks

ü After Lehmann collapse the entire global credit market was frozen and there were massive money injections from multiple governments (US itself is investing over a trillion dollars this year to re-energize the market)

ü Several large & reputable US financial institutions have failed – Wachovia, Washington Mutual , Fannie Mae, Freddie Mac, AIG etc.

ü 25 US banks have failed so far this year and has been acquired by FDIC

ü US Federal Reserve interest rate is at a 50yr low of 0.25% with today’s cut

ü Oil started our 2008 at little under $100/barrel and reached a peak of $147/barrel in July and dropped to $40/barrel in Dec

ü In the last 15 months Gold which is typically the most stable asset went from <$700/ounce to a peak of $1020/ounce and is now back to $800/ounce

ü US Dollar has bucked a multi-year trend of weakening against global currencies and has appreciated against major global currencies by almost 15-20%

ü The US auto industry is in Doldrums and giants like GM, Ford and Chrysler are on the verge of going bankrupt

o GM’s stock is at a 80 yr low

ü US unemployment rate has gone up to 6.7% and number of unemployed people has increased by around 2.7 million during this year

ü All major global economies are either in recession or in the verge of getting into recession

o Ireland, New Zealand, France, UK, Germany, USA, Japan, Italy, Singapore, Spain to name a few

o China growth is expected to slow to 7.5 – 8 %. This is its lowest since 1990.

o India growth rate is expected to slow to 7.5% (from the 5yr average of close to 9%)

After reading the above the first question that comes to mind is have we seen the worst of this crisis?

I think we are in the middle of this crisis what we have seen so far is the first half of the crisis. There is more of financial crisis that is yet to come, Lay-offs are just starting out and has accelerated in the last 3 months and it will continue thru most part of 2009. There will be budget and spending cuts leading to reduction in customer spending and consequently impacting a wide range of industries etc. To cut to the chase the current scenario will continue thru the first half of 2009 and should start flattening out as we go thru the year. I expect the stock market to be volatile and fluctuate within a band during most of 2009 and start the climb up in 2010.

Is this shake out/recession good for us?

At the outset some of the news we hear and what we see in news would seem scary. However this is part of the economic cycle. The best part of open markets/economy is the self-correction. Companies start becoming inefficient and add lot of fluff over the years. These economic downturns are the times when some of the weak players are eliminated and strong players become more efficient and focused. While we go thru lot of pain in the near term it is good from a longer term perspective. Stock valuations, real estate valuations etc are very attractive now and while there is a little down side to it in the near term over the medium to long term they will start climbing up and this is a good time to start investing.

Stop worrying & start investing!!!