Why has India reacted to declining global crude prices by raising excise duties?

The story so far: Till U.S. President Donald Trump’s tweet the past week, on his conversation with Saudi Arabia’s Crown Prince Mohammed bin Salman, Brent crude prices had been declining in an unprecedented manner, touching an 18-year low. Mr. Trump’s assurance that the West Asian kingdom and Russia, major oil producers, would soon announce a production cut sent prices up again. Earlier this year, Saudi Arabia and Russia had fallen out on agreements to cut production which would have kept oil prices up.

What has helped oil prices swing wildly both ways?

Brent crude had tanked about 50% over the month of March and was trading in the region of $26 per barrel till Thursday. Prices jumped, and crude now trading at about $33 per barrel, after the U.S. President’s tweet that a production cut could be ‘as high as 15 million barrels’ per day. To set that in context, when talks on production fizzled out earlier, Saudi Arabia said it would raise its production from 9.8 million barrels per day (bpd) to 12.3 million bpd.

Also Read Centre amends law to enable excise duty increase on fuel

Why does it matter to the U.S. how much oil its competitors produce?

Profits that companies make in selling oil depend directly on the cost of extraction, which is influenced by factors such as the terrain where the oil field is located. There is still a staggering quantity of oil in the world left to be extracted but the cost of extraction is increasing. For example, fracking, which helps extract oil from rocks, and which is a significant source for U.S. extraction firms, does not come cheap. So, a spike in production by Saudi Arabia and Russia typically drives down oil prices, following the traditional concepts of supply and demand. Beyond a certain point, U.S. producers may not be able to withstand declining oil prices, considering their costs. A January 2020 Haynes and Boone’s Oil Patch Bankruptcy Monitor report said that since 2015, when oil prices began to drop save for a few spikes in between, 208 North American producers have filed for bankruptcy involving $121.7 billion in aggregate debt.

But now, if Saudi Arabia and Russia too are considering a production cut to help bring prices back up again, it is a signal that oil prices have gone too low for even these producers to profit from. Significantly, neither of these oil producers has publicly committed to production cuts.

How has COVID-19 influenced prices?

With the virus which originated from Wuhan in China in late 2019 bringing global economic activity to a near-complete halt, demand for fuel is bound to have dropped significantly. This would have had a dampening effect on oil prices. After all, if you do not move out for work or entertainment but only occasionally for grocery shopping, how much fuel would you burn over the period of the lockdown? Even before the virus-induced lockdown, India’s consumption of petrol by volume grew a marginal 2% in February 2020, over April 2019 and diesel consumption fell by 2.2% in the same period.

What is happening to Indian oil prices?

The country’s oil bill may have fallen in the recent past and could remain low if Saudi Arabia and Russia do not behave as the U.S. President expects them to, but Indian end-customers may not benefit. Indian prices of petrol and diesel have remained steady.

Between March 2014 and April 2020, the price per barrel of the Indian crude basket fell from $107 to $21. The average retail selling price of petrol in Delhi has fallen by ₹1.82 from March 2014, to ₹69.59 per litre in February 2020. Of this amount, the portion that goes to the Centre in the form of duties has more than doubled from ₹10.38 to about ₹23.

In March, the Central government reacted to declining international oil prices by raising excise duties by about Rs. 3 per litre on fuel sold in India, such that the end user saw little or no change in the retail price. This was only the latest in a series duty increases over the past few years.

Why the excise duty hike?

Even before the virus-induced lockdown paralysed the economy, the government had been battling a fiscal deficit problem. The nearly four-year-old Goods and Services Tax has not immediately yielded robust collections; consumer demand has fallen and there have been calls to put more money in the hands of the consumer, fuelling expectation of a tax cut. The Centre could not afford a blanket cut in income tax rates but it did offer taxpayers the option of moving to a lower tax slab without deductions or rebates.

With international oil prices declining, the government has used the opportunity to keep end-user fuel prices stable while increasing its own prospects for collection. With consumer inflation being largely influenced by poorer supply of specific food items, and not necessarily by rising fuel prices, the government has chosen to keep Indian end-user fuel prices stable with higher taxes to augment its otherwise-emaciated kitty.

Before the COVID-19 lockdown was announced on March 24, there were reports that the most recent duty hike would give the Centre ₹43,000 crore for the fiscal year 2020-21.