Oil Companies Get ‘Assured Prices’ – Why ‘Hate’ MSP For Farmers?

Our mainstream economists never say a word about the ‘MSP’ that is assured to India’s large oil refineries. Why?

Representational image depicting how economists are against MSP for farmers but continue to support assured prices for big oil companies.

(Photo: Altered by Erum Gour / The Quint)

Pink-paper-pundits tell us that MSP, or Minimum Support Price, is bad economics. But that is only when it goes to farmers.

Our mainstream economists never say a word about the ‘MSP’ that is assured to some of India’s most valuable companies: the large oil refineries who get assured prices for the petrol and diesel they sell to us.

You might find this surprising, especially since we have been told that fuel prices in India have been deregulated, and that the market determines how much we pay at the pump. But that is simply not true. I am not talking about the heavy taxes that the Centre and states levy on petrol and diesel. It is the price at which refineries sell fuel to petrol pumps that itself is a type of MSP.

Before I proceed any further, let me quickly explain what MSP is, to those who don’t know about it:

Every agricultural season, the government announces ‘support’ prices for key crops. If farmers get a better price from traders, the government doesn’t come into the picture. But if traders aren’t willing to pay that much, government agencies are supposed to step in and buy up the produce at MSP rates.

Myth Of Petrol Prices Being ‘Deregulated’ – And The Case Against MSP For Farmers

Textbook economics tells us that when the government administers prices, it disturbs the fine supply-demand balance in the economy. Assured MSP incentivises farmers to produce more even if there isn’t enough demand. It also artificially pushes up food prices.

And, most importantly, since farmers know that they will get a floor-price that increases every year, they have no reason to become more efficient.

So, economists are asking the government to stand firm and not give in to protesting farmers who want MSP to be made their legal right.

But there is complete silence about the market-distorting manner in which petrol prices are decided in India. In fact, we are continuously sold the myth that petrol prices have been deregulated.

In reality, petrol prices are administered through a mechanism called Trade Parity Pricing (TPP), which assures fuel refiners international prices, whatever their actual costs may be.

To understand how this works, think of a can of Coca Cola. There’s a high-end store near my home, which stores Coke imported from the Gulf along with the ones that are made locally. It is meant for expats who want a taste of home, and is priced at four times the Indian variant. But not all of it is the store’s mark-up. The price of Coca Cola is 2.5 times what it is in India, and importing it means adding the cost of shipping and customs duties.

Now imagine if the government allowed Coke to be sold in India at what it takes to import it from Dubai. Because that is exactly what it does when deciding how to price fuel.

What Does Price Of A Litre Of Petrol Depend On? What Is ‘Trade Parity Price’?

The price of a litre of petrol does not depend on how much it costs to produce it here. It is fixed by a formula based on the price of petrol outside India. 80 percent of it is based on the import price of petrol and 20 percent on how much a company would get in the export market. This 80:20 formula is called the Trade Parity Price.

• Our mainstream economists never say a word about the ‘MSP’ that is assured to some of India’s most valuable companies: the large oil refineries who get assured prices for the petrol and diesel they sell to us.
• Textbook economics tells us that when the government administers prices, it disturbs the fine supply-demand balance in the economy.
• But there is complete silence about the market-distorting manner in which petrol prices are decided in India.
• One could argue that the reason why petroleum has to be priced according to international prices – unlike Coca Cola – is because its key component – crude oil – is almost entirely imported.
• A large chunk of petroleum produced by Indian refineries is exported. If the government were to ever ban the export of petroleum, there would be a supply-glut in the domestic market bringing prices crashing down.
• This is regularly done when it comes to what farmers produce.
• No economist ever points to this artificial manner in which big private players in the oil refining business are protected through the government’s petrol pricing policy.

Why Petroleum Is Priced In India As Per International Prices

But India is a refinery-surplus country – we produce more fuel than we consume domestically.

So, how would we calculate the actual cost of import if we don’t really import any petrol? It is done on the basis of a series of imputed costs. The first is the actual price of petrol at a port in the Gulf. The second is the imputed cost of shipping it to India. That includes an imputed cost of insurance, port charges and customs duty.

Right now, if you imported petrol into India, you would have to pay a customs duty of 2.5 percent. So, if a litre of imported petrol cost you Rs 60, you would pay Rs 1.50 as customs duty. Therefore, the Trade Parity Price of petrol includes this 2.5 percent customs duty as an imputed cost. Mind you, the refineries did not pay this customs duty, since they produced the petroleum right here in India, but it is still included as their legitimate cost.

One could argue that the reason why petroleum has to be priced according to international prices – unlike Coca Cola – is because its key component – crude oil – is almost entirely imported.

Indian Refineries Produce Petroleum Products At Relatively Lower Costs: What This Means

However, each barrel of crude oil produces multiple petro-products, such as petroleum, diesel, aviation fuel, kerosene, LPG, naptha, waxes, asphalt etc. This ‘refinery yield’ tends to be more in volume than the total crude being refined. In the US, refinery yield was about 6 percent more in volume than the crude input, in the first six months of 2020.

The cost of production of any of these products depends on how efficient a refinery is. The more complex a refinery the better it is able to produce more valuable products using cheaper crude variants.

Internationally this is measured using the Nelson Complexity Index, which gives a quick snapshot of how low a refinery’s costs are relative to the value of its output. Refineries with a complexity of more than 10 are considered to be very efficient.

Indian refineries are amongst the best in the world when it comes to refining cheaper heavy ‘sour’ crudes.

Reliance’s upgraded Jamnagar refinery is rated as among the most complex in the world. This suggests that Indian refineries are able to produce petroleum products at lower costs than their international counterparts. So, Trade Parity Prices derived from less efficient refineries situated outside India, effectively gives domestic refineries additional margins, over and above what their real costs justify.

As I said earlier, a large chunk of petroleum produced by Indian refineries is exported. If the government were to ever ban the export of petroleum, there would be a supply-glut in the domestic market bringing prices crashing down.

How Big Private Players In Oil Refining Business Are ‘Protected’

This is regularly done when it comes to what farmers produce. For instance, when the price of onions went up last winter, exports were banned. Yet, petroleum exports are never stopped. On the contrary, the Trade Parity Pricing mechanism ensures that domestic prices will be protected even if the export market shrinks.

No economist ever points to this artificial manner in which big private players in the oil refining business are protected through the government’s petrol pricing policy.

We never hear that ‘this goes against the rules of a market economy’. Instead, every time the price of petrol goes up, attention is drawn to the excessive taxes taken by the government.

The taxes, at least, are pumped back into government expenditure on India’s people. The MSP for petrol only fattens corporate profits.

(The author was Senior Managing Editor, NDTV India & NDTV Profit. He now runs the independent YouTube channel ‘Desi Democracy’. He tweets @AunindyoC. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)