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Why the Price of Petrol is Racing Towards Rs 100 Per Litre

If there are two things that get people of this country interested in economics, they are the price of onion and the price of petrol racing towards Rs 100 per kg or litre, respectively.  Currently, the price of petrol is racing towards Rs 100 per litre in large parts of the country. In fact, in some parts, it has already crossed that level.

So, what’s happening here? Let’s take a look at this pointwise.

1) Take a look at the following chart, which plots the average price of the Indian basket of crude oil since January 2020.

Source: Petroleum Planning and Analysis Cell.
*February price as of February 18, 2021.

What does the above chart tell us? It tells us that as the covid pandemic spread, the price of oil fell, falling to a low of $19.90 per barrel in April 2020. It has been rising since then. One simple reason for this lies in the fact that as the global economy recovers, its energy needs will go up accordingly and hence, the price of oil is going up as well.

The other reason has been the massive amount of money that Western central banks have printed through the beginning of 2020. Oil, as it had post 2008, has emerged as a hard asset of investment for many institutional and high-networth investors, leading to an increase in its price. As of February 18, the price of the Indian basket of crude oil stood at $63.65 per barrel, having risen by close to 220% during the current financial year.

2) Now let’s look at the average price of the Indian basket of crude oil over the years.

Source: Petroleum Planning and Analysis Cell.
* Up to January 2021.

What does the above chart tell us? It tells us that the Narendra Modi government has been very lucky when it comes to the price of oil, with the oil price on the whole being much lower than it was between 2009 and 2014.

In May 2014, when Modi took over as the prime minister, the price of oil averaged at $106.85 per barrel. By January 2016, it had fallen to $28.08 per barrel.

Even after that, the price of oil hasn’t touched the high levels it did before 2014, in the post financial crisis years, which also happened to be the second term of the Manmohan Singh government.

A major reason for this lies in the discovery of shale oil in the United States. In fact, as Daniel Yergin writes in The New Map – Energy, Climate and the Clash of Nations: “In the autumn of 2018, though it was hardly noted at the time, something historic occurred: The United States overtook both Russia and Saudi Arabia to regain its rank as the world’s largest oil producer, a position it had lost more than four decades earlier.” This has been a major reason in the lower price of oil over a longer term.

The question that then crops up is why hasn’t petrol price in India seen low levels? The answer lies in the fact that between 2014 and 2021, the taxes on petrol, in particular central government taxes have gone up dramatically.

In short, the central government has captured a bulk of the fall in oil prices. Now when the oil price has gone up over the course of this financial year, the high-price of petrol has started to pinch.

3) Take a look at the following table. It plots the price of petrol in Delhi as of February 16, 2021 and in March 2014.

Source: https://iocl.com/uploads/priceBuildup/PriceBuildup_petrol_Delhi_as_on_16_Feb-2021.pdf
and https://www.ppac.gov.in/WriteReadData/Reports/201409231239065062686Snapshot_IOGD_MAR.pdf.

The above table makes for a very interesting reading. As of February 16, the price of petrol charged to dealers was Rs 32.1. Over and above this, the central government charged an excise duty of Rs 32.90 per litre on petrol. Add to this a dealer commission of Rs 3.68 per litre, and we are looking at a total of Rs 68.68 per litre.

On this the Delhi state government charged a value added tax of 30% or Rs 20.61 per litre. This leads to a retail price of petrol of Rs 89.29 per litre. Given that the state government charges a tax in percentage terms, the higher the price of petrol goes, the more tax the state government earns. The vice versa is also true.

Let’s compare this to how things were in March 2014. The price of petrol charged to dealers was Rs 47.13 per litre, much lower than it is today. On this, the central government’s tax amounted to Rs 10.38 per litre. The dealer commission was Rs 2 per litre.

Adding all of this up, we got a total of Rs 59.51 per litre. On this, the Delhi state government charged a value added tax of 20%, which amounted to Rs 11.9 per litre and a retail selling price of petrol of Rs 71.41 per litre. Interestingly, the state government’s tax was more than that of the central government at that point of time.

4) The above calculations explain almost everything. In March 2014, the price of petrol at the dealer level was higher than it is now, but the retail selling price was lower. Both the central government and the state government have raised taxes since then.

The total taxes as a percentage of dealer price now works out to 167% of the dealer price. In March 2014, they were at 47.3%. It is these high taxes which also explain why petrol prices in India are higher than in many other countries.

Of course, a bulk of this raise has come due to a rise in taxes charged by the central government. As mentioned earlier, the central government has captured a bulk of the fall in price of oil.

5) The calculation shown here will vary from state to state, depending on the value added tax or sales tax charged by the state government and the price at which petrol is sold to the dealers. States which charge a higher value added tax than Delhi will see the price of petrol reaching Rs 100 per litre faster than Delhi, if the price of oil continues to rise.

6) Of course, the governments can bring down the price of petrol by cutting taxes. In fact, four state governments have cut taxes providing some relief to oil consumers. But any substantial relief can be provided only by the central government. The trouble is that tax collections have fallen this year. Only the collection of excise duty has gone up by 54% to Rs 2.39 lakh crore, thanks to the higher excise duty charged on petrol and diesel.

The interesting thing is that the excise duty earned from the petroleum sector has jumped from Rs 99,068 crore in 2014-15 to Rs 2.23 lakh crore in 2019-20. The government has become addicted to easy revenue from taxing petrol and diesel. This year its earnings will be even higher than in 2019-20.

7) The central government also fears that if it cuts the excise duty on petrol and diesel, the state governments can step in and increase their value added tax, given that like the centre, they are also struggling to earn taxes this year.

Also, what needs to be kept in mind here is that the central government doesn’t share a good bit of what it earns through the excise duty on petrol and diesel with the states. This is because a bulk of the excise duty is charged in the form of a cess, which the central government does not need to share with the states.

Let’s take the overall excise duty of Rs 32.90 per litre of petrol currently. Of this, the basic excise duty is Rs 1.40 per litre and the special additional excise duty is at Rs 11 per litre. The road and infrastructure cess is at Rs 18 per litre (also referred to as additional excise duty) and the agriculture and infrastructure development cess is at Rs 2.50 litre. Clearly, the cess has a heavier weight in the overall excise duty.

8) One reason offered for the high price of petrol is low atmanirbharta or that as a country we have to import more and more oil than we did in the past. In 2011-12, the import dependency was 75.9%. This jumped to 77.6% in 2013-14 and has been rising since. In April to December 2020, this has jumped to 85%.

The explanation offered on this has been that oil companies haven’t carried out enough exploration activities in the past. Let’s take a look at the numbers of ONGC, the government’s biggest oil production company (or upstream oil company, as it is technically referred to).

The total amount of money spent by the company on digging exploratory wells in 2019-20 stood at Rs 4,330.6 crore. This had stood at Rs 11,687.2 crore in 2013-14. Over the years, the amount of money spent by ONGC on exploration has come down dramatically. This explains to some extent why the crude oil production in India has fallen from 37.8 million tonnes in 2013-14 to 30.5 million tonnes in 2019-20, leading to a higher import dependency.

Of course, not all exploration leads to discovery of oil, nevertheless, at the same time unless you explore, how do you find oil.

The reason why ONGC’s spending on exploration has fallen is primarily because the company has taken on a whole lot of debt over the past few years to finance the acquisition of HPCL and a majority stake in Gujarat State Petroleum Corporation’s (GSPC) KG Basin gas block. The money that ONGC borrowed to finance the purchase of HPCL from the government was used by the government to finance the fiscal deficit. Fiscal deficit is the difference between what a company earns and what it spends.

The borrowing has led to the finance costs of the company going up from Rs 0.4 crore in 2013-14 to Rs 2,823.7 crore in 2019-20. The cash reserves of the company are down to Rs 968.2 crore as of March 2020 from Rs 10,798.9 crore as of March 2014.

All this explains why the price of petrol is racing towards Rs 100 per litre. At the cost of sounding very very very cliched, there is no free lunch in economics. Somebody’s got to bear the cost.

It will be interesting to see if the central government continues to hold on to the high excise duty on petrol and diesel (whatever I have said for petrol applies for diesel as well, with a different set of numbers) leading to  a high petrol and diesel price and lets these high rates feed into inflation in the process.

Keep watching this space.

Propaganda 101: What the Indian Right has learnt from Big Tobacco

The Indian economy as measured by the gross domestic product (GDP) contracted by 23.9% during April to June 2020 in comparison to the same period in 2019. This contraction was huge.

But soon journalists, economists, corporate honchos and analysts, who are close to the current dispensation, started telling us that, so what if India has contracted by 23.9%, the American economy contracted by 32% during the same period. The point being that if India was in trouble, America was in bigger trouble. How did this lessen our trouble they didn’t bother to explain.

There was an even bigger problem with the 32% American contraction figure. It was wrong, when compared to India’s 23.9% contraction. The way India calculates GDP contraction (or growth for that matter) and the way America does it, are different.

So, what was the American contraction if we used the Indian method? It was 9.1% year on year and not 32% as was being suggested. (For those interested in the fifth- standard maths behind this, I suggest you Google it. It has been explained by multiple people, including me).

Also, none of the people who sincerely believed that the American economy had contracted by 32%, bothered to sit back and think the negative impact this would have had on the world at large.

Data from the World Bank suggests that in 2019, the American GDP (real GDP adjusted for inflation), had stood at $18.3 trillion.
This was around 21.7% or somewhere between a fourth and a fifth of the global GDP. Now imagine the American economy contracting by a third (which is what a 32% contraction almost means) year on year. This would have led the world into a second Great Depression.

America is the world’s largest source of consumer demand. If that demand contracts by a third, the global economy would have been in an even worse situation than it currently is. This simple thought did not occur to anyone who went around town telling people that the American economy had contracted by 32% and hence, had done much worse than the Indian economy. Or maybe it did occur to them, and they simply chose to ignore it.

The Indian GDP numbers for April to June were declared on August 31. This was almost four weeks back. The social media is still buzzing with this issue.

Do the people who spread the story of the US economy contracting by 32% to counter the Indian economy’s contraction of 23.9%, not understand basic fifth standard maths? Because a simple understanding of fifth standard maths would have told them very clearly that the US economy had contracted by 9.1%, if the contraction is calculated in the Indian way.

Obviously, this bunch of people is a smart lot and I don’t think there is any problem with their understanding of fifth standard maths. So, what were they up to then? They were basically borrowing a simple idea first used by Big Tobacco Companies in the 1950s.

In the early 1950s, research which linked the smoking of cigarettes to incidence of lung cancer, started to come out. Big Tobacco Companies met at the Plaza Hotel in New York, just before Christmas in 1953. Scientific research which was being published was making them look very bad. And they had to do something about it.

What did they do? As Tim Harford writes in How to Make the World Add Up: Ten Rules for Thinking Differently About Numbers: “They muddied the waters. They questioned the existing research; they called for more research; they funded research into other things they might persuade the media to get excited about, such as sick building syndrome or mad cow disease. They manufactured doubt. A secret industry memo later reminded insiders that ‘doubt is our product’.”

How did muddying the waters help Big Tobacco? It basically created confusion in the minds of smokers. Was the research linking smoking to lung cancer, right? Was there enough evidence of it? Aren’t correlation and causation two different things? These were the questions that the smokers were suddenly asking themselves.

As Harford writes: “Smokers liked smoking, were physically dependent on nicotine, and wanted to keep smoking if they could. A situation where smokers shrugged and said to themselves. ‘I can’t figure out all these confusing claims’ was a situation that suited the tobacco industry well.”

Big tobacco wasn’t trying to tell smokers that smoking was safe. They weren’t so blatant about it. All they were trying to do was to ‘create doubt about the statistical evidence that showed they were dangerous’.

The muddying of waters to create doubt has been a standard part of propaganda since then. It’s propaganda 101. As Harford summarises it: “Their answer [that of Big Tobacco companies] was – alas – quite brilliant, and set the standard for propaganda ever since.”

Something very similar happened in case of the Indian economy contracting by 23.9%, as well. The fact that the Indian economy contracted by close to a fourth, was something that the sympathisers couldn’t deny. It was official government data. And of course, that this contraction was bad for the average Indian, couldn’t be denied either.

But the waters could be muddied by getting the American angle in. The message was that so what if the Indian economy has contracted and Indians are suffering, the Americans are suffering more.

The sad part of all this is that many educated Indians fells for this spin. But that’s the thing with propaganda, even the educated fall for it.

This piece originally appeared in the Deccan Herald on September 27, 2020. 

The US Economy Contracted by 9.1% and not 32%. India’s Economy Contracted by 23.9%.

Summary: I had absolutely no plans of writing this. But given what has been happening on Twitter and WhatsApp since the morning, I was forced to write this. Please read and share widely.

There is a full-fledged controversy raging on the internet where people have said that the economy of the United States, as represented by its gross domestic product (GDP), contracted by 32%, during April to June 2020. This was worse than India’s contraction of 23.9%.

This comparison is totally wrong. The way the United States reports GDP growth/contraction is different from the way India does. Let’s try and understand this in detail.

In April to June 2020, the US economy contracted by 9.1% in comparison to January to March 2020. This is a quarter on quarter comparison. This figure is then annualised.

How do we annualise it?  We do that by assuming that the US economy will continue to contract by 9.1% quarter on quarter, over the next three quarters (basically we compound in a negative direction, since the economy is contracting). Let’s understand this through a simple example.

So, let’s say during the January to March 2020, the size of the US economy or its GDP was $100. In April to June 2020, this contracted by 9.1%. The size of the economy came in at $90.9 ($100 – 9.1% of $100).

In July to September 2020, the economy will contract further by 9.1% to $82.63 ($90.9 – 9.1% of $90.9).

In October to December 2020, the economy will contract further by 9.1% to $75.11 ($82.63 – 9.1% of $82.63).

In January to March 2021, the economy will contract further by 9.1% to $68.27 ($75.11 – 9.1% of $75.11).

Hence, by the end of one year, the economy has contracted from $100 to $68.27 or by 31.73%, which is nearly equal to 32%.

This is how the GDP growth/contraction numbers in the US get reported. Hence, by this logic, on an annualised basis, the US economy contracted by close to 32% in the period April to June 2020, in comparison to January to March 2020. But this figure can’t be compared with the Indian figure.

The Indian system is different. The GDP during a particular quarter is compared to the GDP during the same quarter in the last year. In the Indian case, the GDP contracted by 23.9% during April to June 2020, in comparison to April to June 2019 (and not January to March 2020, as is the case with the US). The Indian comparison is a year on year one and not a comparison with the previous quarter. The US comparison is a quarter on quarter comparison which is then annualised.

If the US were to report the GDP growth/contraction in the same way as India, its GDP during April to June 2020 contracted by 9.1% in comparison to the GDP between April to June 2019. The Indian economy contracted by 23.9% during the same period. That’s the right comparison.

This is the right way of looking at things and not how they are being misrepresented on the social media, even by experienced economists.

The United States is Helping China Buy Gold

gold

In June 2015, China declared having bought 604.34 tonnes of gold. It’s last declaration before this had come in April 2009, when it had declared to having bought 454 tonnes of gold.

It couldn’t have bought such a huge amount of gold all at once given the limited supply of the yellow metal. Between April 2009 and June 2015, China regularly bought gold. It only declared it all at once in June 2015. The country had followed a similar strategy before April 2009, as well. It had last declared having bought 99.5 tonnes of gold in December 2002.

Hence, even though China has been buying gold all along, it has chosen to do so quietly, instead of going public with it. The reason for this was fairly straightforward. Gold is a thinly traded commodity, and hence, it makes sense for China to keep accumulating gold at a slow and regular pace, without making its intentions public and driving up the price.

Having said that since June 2015, there has been a change in strategy. Between July 2015 and February 2016 (the latest data that is available) the country has been making monthly declarations of the purchases it has been making.

These purchases vary from a minimum of 9.95 tonnes in February 2016 to a maximum of 20.84 tonnes in November 2016. Officially, China now has 1,788.4 tonnes of gold. It is the sixth largest gold owner in the world.

 

Tonnes% of reserves**
1United States8,133.575.3%
2Germany3,381.069.0%
3IMF2,814.0 
4Italy2,451.868.3%
5France2,435.663.2%
6China1,788.42.2%
7Russia1,447.015.1%
8Switzerland1,040.06.8%
9Japan765.22.4%
10Netherlands612.559.4%
11India557.76.2%

Source: www.gold.org

While in absolute terms 1,788.4 tonnes of gold sounds quite a lot, when it comes to gold as a percentage of reserves, the country still needs to catch up with other countries. As can be seen from the above table, China’s gold hoard as a percentage of its reserves is the lowest among the top eleven hoarders of gold.

While officially China may have 1,788.4 tonnes of gold, experts who are in the know of such things, suggest, that China has more gold than it is currently showing.

As James Rickards writes in The New Case for Gold: “The most interesting case is China…We know from various reliable sources including mining production and import statistics that their actual gold stock is close to 4000 tonnes. I’ve spoken to refineries and secure logistics firms—people who actually handle physical gold—in addition to official sources, and included their information in my estimates. On the whole, there is enough credible information available to support this estimate at a minimum. It is also entirely possible that China has considerably more than 4000 tonnes.”

So what this means is that the Chinese government’s real gold hoard is at least 2.2 times its official one.

In fact, Rickards in his book The Death of Money explains how China has gone about accumulating gold over the years. The country buys gold through secret agents based out of London. These agents are known to be very disciplined, and they buy gold whenever the gold price falls significantly. The gold these agents buy is paid for by the State Administration for Foreign Exchange (SAFE), one of China’s sovereign wealth funds.

The gold bought by SAFE is later transferred to the People’s Bank of China, the Chinese central bank. China also buys gold from mines directly. During April to June 2013, when the price of gold had reached a low of $1,200 per ounce, the country bought 600 tonnes of gold directly from Australia’s Perth Mint.

Also, China is now the largest producer of gold in the world. The disadvantage with China’s gold production is that it does not really have any big gold mines and a lot of gold that it produces comes as a by-product in the mining of other base metals. The Chinese government buys gold from the mines within China but does not report these buys. These reasons also explain why China’s gold hoard is actually significantly bigger than what it is telling the world.

In fact, China’s gold hoard maybe more than 4000 tonnes because Rickards seems to have made this estimate in July 2015, when China’s official gold hoard was at 1,658 tonnes. Since then, the number has officially risen to 1,788.4 tonnes.

The question is why is China buying gold? As Rickards explains in The New Case for Gold: “China’s acquisition of more than three thousand tonnes of gold in the past seven years represents almost 10 percent of all the official gold in the world…China is trying to acquire enough gold so that when the international monetary collapse comes and the world has to recut the deal, China will have a prime seat at the table. Countries like Canada, Australia, and the United Kingdom, with small gold-to-GDP ratios will be seated away from the table.”

Currently, the global financial system revolves around the dollar. Given that so much of it has been printed (or rather created digitally) in the last few years, there is the threat of the current financial system collapsing due to high inflation.

When the time for the new financial system comes around, China wants to be in the driver’s seat along with the United States, Germany and Russia, countries which have a significant amount of gold.

It needs to be mentioned here that China owns a significant amount of US treasury securities. These are bonds issued by the US government to finance its fiscal deficit or the difference between what it earns and what it spends. As of end February 2016, China owned $1.25 trillion of the total $6 trillion worth of treasury securities owned by foreign investors.

As I mentioned earlier, the United States has printed a huge amount of dollars over the last few years. This has led to a situation where the chances of a high inflation scenario remain. If something like this were to happen, then the value of the Chinese investment in US treasury securities will fall.

Hence, there is a quid pro quo which is currently at work. As Rickards writes: “The compromise between the Fed’s desire for inflation and China’s desire to protect its reserves is for China to buy cheap gold. That way, if inflation is low, China’s gold won’t go up much, but the value of its paper Treasury reserves is preserved. If the United States gets the inflation it wants, China’s Treasuries will be worth less, yet its gold will be worth much more. Having Treasuries and gold is a hedged position that protects China’s wealth.”

As Ricakrds further points out: “What remains is a strange condominium of interests where the [American] Treasury and China are in agreement that China needs more gold and the price cannot be too high or else China could not easily afford all it needs…The United States is letting China manipulate the market so China can buy gold more cheaply. The Fed occasionally manipulates the market as well so that any price rise isn’t disorderly.”

The question is when will this manipulation end?

The column was published on the Vivek Kaul Diary on April 22, 2016

Shale vs crude: Why oil prices are on a free fall even as Opec members suffer

oil
The latest price of the Indian basket for crude oil was at $35.72 per barrel. It has fallen by 16% over the last one month and by 33% since end December 2014.
Yesterday, the Brent crude oil was selling at $37-38 per barrel. Lower quality oil is selling at even below $30 per barrel. As Amrbose Evans-Prtichard writes in The Telegraph: “Basra heavy crude from Iraq is quoted at $26 in Asia, and poor grades from Western Canada fetch as little as $22. Iran’s high-sulphur Foroozan is selling at $31.”

What has led such low levels of oil price? Over the last one year, the Organization of the Petroleum Exporting Countries(OPEC), an oil cartel of some of the biggest oil producing countries in the world, has been flooding the market with oil in order to make the shale oil being pumped in the United States, unviable. Pumping shale oil is an expensive process and is not viable at lower oil price levels.

In fact, the oil ministers of the OPEC countries met in early December and they pretty much decided to continue doing things the way they have been up until now, over the last one year. In the past, any likely slowdown in oil prices was met with oil production cuts within the OPEC. That hasn’t happened over the last one year and isn’t happening now either.

As the International Energy Agency(IEA) points out in its monthly oil report for December 2015: “OPEC’s decision to scrap its official production ceiling and keep the taps open is a de facto acknowledgment of current oil market reality. The exporter group has effectively been pumping at will since Saudi Arabia convinced fellow members a year ago to refrain from supply cuts and defend market share against a relentless rise in non-OPEC supply.”

The rise in the supply of non-OPEC oil has primarily happened on account shale oil being pumped in the United States and to some extent in Canada, over the last few years. In order to make companies pumping shale oil unviable, OPEC has been relentlessly pumping oil. As the IEA monthly report points out: “OPEC supply since June has been running at an average 31.7 million barrels per day, with Saudi Arabia and Iraq – the group’s largest producers – pumping at or near record rates. Riyadh has held supply above 10 million barrels per day since March to satisfy demand at home and abroad while Iraq, including the Kurdistan Regional Government (KRG), is doing its level best to keep production above the 4 million barrels per day mark first breached in June.”

Also, as oil prices have fallen, OPEC and non-OPEC oil producing countries have had to pump more and more oil, in order to ensure that their governments have some money going around to spend. As the Russian finance Anton Siluanov told Ambrose. “There is no defined policy by the OPEC countries: it is everyone for himself, all trying to recapture markets, and it leads to the dumping that is going on.”

Further, sanctions against Iran are likely to be lifted early next year and more oil will then hit the international oil market. The Financial Times quotes an oil trader as saying: “It seems the Iranians are fulfilling the requirements for the lifting of sanctions faster than expected.” said one London-based oil trader.

The IEA monthly report expects the extra oil from Iran to add 300 million barrels to the already swelling oil inventories. In fact, the November 2015 oil report of the IEA had put the total global stockpiles of oil at 3 billion barrels.

So how long will this last? Given the number of factors that impact the price of oil, predicting which way it will head, has always been tricky business.  As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of Prediction: “Take the price of oil, long a graveyard topic for forecasting reputations. The number of factors that can drive the price up or down is huge—from frackers in the United States to jihadists in Libya to battery designers in Silicon Valley—and the number of factors that can influence those factors is even bigger.”

Nevertheless, it seems that one year down the line the Saudi strategy of driving down the price of oil, in order to drive down non-OPEC oil production seems to be working. As the IEA oil report points out: “There is evidence the Saudi-led strategy is starting to work. Lower prices are clearly taking a toll on non-OPEC supply, with annual growth shrinking below 0.3 million barrels per day in November from 2.2 million barrels per day at the start of the year. A 0.6 million barrels per day decline is expected in 2016, as US light tight oil – the driver of non-OPEC growth – shifts into contraction.”

Also, it is worth pointing out here that oil exporting countries are having a tough time balancing their budgets. The fiscal deficit of Saudi Arabia has touched 20% of its gross domestic product (GDP). Fiscal deficit is the difference between what a government spends and what it earns. As Evans-Pritchard puts it: “Opec revenues have collapsed from $1.2 trillion a year in 2012 to nearer $400 billion next year.”

Hence, it is safe to say that the OPEC strategy of driving down the price of oil is hurting the member countries. Given this, the price of oil cannot be at such low levels for much long. But at least in the short run, the oil price will continue to stay low.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on December 15, 2015