DISCOVER THE COMPLETE EVOLUTION OF PETROLEUM PRICING IN INDIA.

To get a complete idea of the evolution of oil petroleum pricing, we should start from the time of pre-independence period.

EVOLUTION OF PETROLEUM PRICING IN INDIA BEFORE INDEPENDENCE –

In the initial days of 1886, Indian petroleum consumers were completely dependent on American imports because oil in Middle Eastern countries had not been discovered. There was no oil production in the country, and restrictions on oil-carrying ships to use the Suez Canal also added constraints to the Indian oil market.

These oil products include kerosene, Mineral oil, and Batching oil (batching oil is a type of lubricant used by jute manufacturing companies). Later (1904-1905), they also included motor spirit.

When Sir Marcus Samuel convinced the governors of the Suez Canal Company about the advantages, oil tankers were permitted to use the canal. Now, the route to India has become shorter and more viable.

In 1892, the first Russian oil-carrying ship reached the Indian port, and by 1897, Russia got around 60 per cent of the total kerosene imported to India and U.S. imports declined to 20 per cent.

Oil discovery in Assam and Burma also influenced the market.

These reasons created a war in the pricing of oil in the Indian market

1905 AGREEMENT –

From 1905 onwards, the Standard and other smaller companies acknowledged Burmah Oil—Asiatic Group’s superiority in the Indian oil market. That made them strike an arrangement about a price-fixing method with the Burmah oil group.

According to the arrangement, Burmah Oil will inform the Standard company about the Price change in advance. Since the Standard received the information in advance, they will telegram the message to their New York headquarters for permission to increase or decrease the price.

The agreement also divided the whole East market into three divisions.

1. East of 90 East meridian
2. West of 60 East
3. Between 90 East and 60 East

The agreement allows Asiatic oil to supplement Burmah oil’s kerosene supply. It also ensured the Far East market of Asiatic oil outside of the Burmah oil company.

WHAT MADE THESE COMPANIES TO STRIKE AN AGREEMENT?

1. Out of Burmah Oils’ total sales, three-quarters came from the eastern coast of India, and the balance, less than a quarter, came from the West coast of India. The West Coast gave Burmah oil a comparative disadvantage over Russian oil in terms of logistics costs.
2. Royal Dutch Shell became influential in the East.
3. After 1902, Asiatic oil had its base on the western side of India.
4. In 1902, Burmah Oil diluted its capital by issuing more shares and grants for each share. This policy made no allowance for depreciation. This policy forced them to pay a lion’s share of their profit as dividends. It also forced them to avoid creating a fund to defend themselves when there was a price war.
5. A significant share of Asiatic Oil came from Russia, and a strike in the Baku oil field in 1904 affected their business.
6. Dutch East Indies (Indonesia) was Asiatic Oils’Oils’ next supply source. The unreliable production sites created hostile pressure in the Asiatic Oils market.

CREATION OF KEROSENE POOL(1919)

Due to the price wars, four companies created a kerosene pool in India. The contributors were Asiatic Oil, British Burma Petroleum Company, Burmah Oil, and Assam Oil. Another company, Attock Oil, was also associated with the pool but was not a donor. 

Asiatic and Burmah Oil sold the kerosene in the pool. This pooling mechanism brought all the oil companies in British India under Burmah Oil and Asiatic Oil against Standard.

The pooling system adopted the world parity system for pricing. 

PRICE WAR OF 1927 AND THE STORY OF STOLEN OIL

The introduction of oil from the Soviet Union triggered a new price war in 1927. When soviet oil reached Bombay, Asiatic Oil announced a price cut. This price cut triggered Standard Oil to reduce prices. This price war was limited to kerosene of superior grade and not inferior because the latter was included in the pool system, and the price war continued till the middle of 1928.

Now, Asiatic Oil company raised the moral argument – “STOLEN OIL“. Asiatic company objected to the soviet Kerosene imports and raised the reality of prices. The Standard Company purchased oil at very low prices and sold at uneconomic prices in India. Asiatic added that if this practice is permitted, the result will be the destruction of the home industry, higher prices and monopoly of Standard Oil in the future.

These problems, arguments and price wars resulted in the Tariff Board Enquiry.

REPRESENTATION BY OIL COMPANIES TO GOVERNMENT OF BRITISH INDIA

On December 15 1927, seven oil companies went to the government to protect their interests. 

They made the following proposals.

1. Companies requested an extension of the tariff protection rate for motor spirits and oil products. At that time, motor spirit was not protected.
2. A complete ban on Soviet oil dumping due to its uneconomic prices.

The government responded quickly and referred their demands to the Indian Tariff Board. However, the provincial government of Burma immediately granted a temporary exemption to the oil companies producing in India and Burma from the mining rules.

The Burma government recommended increased tariff protection, but the Indian government rejected it.

REPORTS OF TARIFF BOARD

The enquiry report was submitted on June 23 1928. Interestingly, there were two reports

1. The majority report of Dr J Mathai and A.E Mathias.
2. The minority report of P.P Ginwala, the president of the board.

Both reports concluded that the application for protection was premature because no satisfactory case had been pointed out by the oil companies.

Both reports also added that the present production was not likely to be seriously affected by Standard’s competition. Since Standard was not going to start the motor spirit trade within two years, the question of a price war would not rise.

The reports also criticised Asiatic Oil for suppressing compensation for losses in the price war to the members of the kerosene pool.

The minority report recommended the establishment of a domestic oil refining industry.

WHAT ARE THE DIFFERENCES?

The majority report used world parity prices, but the minority report used American parity prices.

The majority report concluded that “dumping” had been established since the biggest seller’s actual selling price of the pool was below the world parity prices.

The minority report, on the other hand, compared “American parity prices” with the prices charged by Standard since it thought that the best test whether there was any “dumping” or not was to take the cost of the biggest importer of kerosene, Standard as the basis and found that had not been established.
Based on this report, the application for protection was rejected by the government of India.

PETROLEUM PRICING IN THE POST-INDEPENDENCE PERIOD

Even though the war ended in 1945, the rationing continued until the second half of 1950.

India and Pakistan were born during independence. Due to a shortage of oil, the government continued a rationing policy. The following problems caused the shortage.

1. Attock oil went over to Pakistan, and its production in Digiboi became part of India.
2. Increase in civilian consumption.
3. Increased demand due to the larger scale of industrial activity.
4. Balance of payments and foreign exchange issues. Even though the government took action to bring oil imports under licence raj, it prohibited oil imports from the dollar area (unfavourable balance of trade). The BOP situation was still unstable.

The net result after partition was a rise in consumption from 2000000 tons of oil to 3000000 tons of oil, and the value of oil imports increased to 833000000 (1953-54) from 309000000 (1947-48).

The primary reason for the increase in value was the result of 

1. High oil prices.
2. High consumptions.
3. The devaluation of currency (1947).

DEVELOPMENT OF REFINERY AND SELF-SUFFICIENCY 

In 1947, the foreign oil companies operating in India requested the government to set up a technical committee to study” at their own expense” the “cost conditions” of a refinery project. Three months later, the submitted report pointed out an estimated annual loss of 20000000RS and advised no to the estimated plan.

Under one condition, these companies were ready to construct refineries in Bombay(Mumbai) and Vizagapatanam. The government must allow them to sell their product at a price 10 per cent higher than the “world parity price.” But the government sensed the danger and rejected their proposal.

Later, companies changed their mindset and agreed to construct refineries without making any cost conditions.

The government of Mohammad Mosaddeque of Iran nationalised a 25000000-ton capacity oil refinery at Abadan of Anglo-Persian Oil Company ( later B.P). The negotiations also failed. This refinery provided 70 per cent of India’s requirements, and the developments in Iran were a serious blow to foreign oil companies, especially B.P., which operated in India.

This Abadan crisis also exposed a serious risk. Any gap between demand and supply at the current price could allow other competitor companies to enter the Indian oil market.
Their new competitor was the state-owned National Iranian Oil Company, which started operations in Calcutta (Kolkatta)in 1951. In case of shortage, the competitor will exploit the situation and topple their market.

India’s government was also thinking of setting up an independent refinery.

These situations influenced the oil companies to change from their old position and build their refineries in India.
Burmah-Shell and Standard Vaccum constructed refineries at Bombay (Mumbai) and Caltex at Vizagapattanam. After 1959, three public-sector refineries were built at Noonmati, Barauni and Koyali.

FACTORS AFFECTING GLOBAL OIL PRICES

1. OPEC countries contribute around 40 per cent of the world’s oil demand and 60 per cent of total petroleum trade internationally. They use a quota system to control prices and the market. In short, prices go up when OPEC cuts down production.
2. Future supply and reserves are significant factors that affect prices. Uncertainty or risk can affect the prices.
3. Oil prices also depend on oil futures contracts. Traders agree to buy or sell oil at a specific date and price in the future.
4. Competition pushes companies to decrease prices. So, closer companies may form cartels to control price loss.
5. Demand by consumers is crucial and affects oil prices.
6. Important geopolitical and economic events and calamities affect oil prices.
7. Weather can affect oil prices. Crude oil prices increase in winter due to the increase in demand. Extreme summer time also affects the cost ( increase due to people who travel for vacation).
8. Exchange rates in USD influence oil prices. A drop in the value of USD tends to increase the price of oil.

HOW DID THE GOVERNMENT CONTROL PETROLEUM PRICING?

After independence, the government decided to interfere effectively with the oil market to avoid future problems.

In 1948, the central government tried to regulate prices using a cost-plus formula based on import parity called the “VALUE STOCK ACCOUNT” procedure.

Even after the independence, the supremacy of Burmah Shell company in oil pricing and the world parity pricing system with the Persian Gulf as the basing point continued.

The purchases made by the government from Burmah Shell came under the Value stock account formula. This new formula was based on the import parity principle with Ras Tanura (Persian Gulf) as the basing point. This new formula covered all significant products except lubricants and greases.

The company maintained separate accounts for each product, which were used to debit the cost of the products sold.

The government’s interference with this method was not very widespread. The companies have to submit a certificate related to price preparation details of VSA to the Director General of Supplies and Disposals of the government of India. But interestingly, the account was not subject to a government audit.

In 1958, the Indian government terminated VSA and asked the chief cost accounts officer (of the government) to submit a report. The chief cost accounts officer submitted a highly critical report. This report observed that Burmah Shell utilised the advantage of the position of a market leader and didn’t exercise proper control on cost.

Later, both the company and government agreed to go on with an ad-hoc price system, and this ad-hoc price management continued until 1961. For this purpose, a price adjustment account will be there, similar to VSA, but it is not permitted to show a balance of more than 2,000,000 rupees.

In 1960, the government appointed an enquiry committee to examine oil prices.

DAMLE COMMITTEE AND PETROLEUM PRICING

In August 1960, a committee on oil prices was constituted under the chairmanship of then secretary to the Ministry of Food and Agriculture, Mr. K. R Damle. This committee studied many issues, particularly the foreign exchange conservation issue, and submitted its report in 1961.

The major recommendations were

1. The committee declared a schedule of maximum prices for all major products, excluding lubricating oil and greases.
2. Did not abandon the import parity principle.
3. The committee considered the growing Soviet competition in the world market and India, with prices 20 per cent to 25 per cent below those offered by the major companies.
4. Requested to continue AFRA rates for calculating ocean freights.
5. Recommended the discounting of Persian Gulf f.o.b prices on a fixed basis- 10 per cent for kerosene, 10 per cent for high-speed diesel, 9.3 per cent for light diesel and 3 per cent for furnace oil. The basis of the discount rates for products was the 8 per cent then allowed by the major companies on the price of imported crude( This is applicable for imports and domestic products and did not differentiate between nearer and distant sources of imports).
6. For lubricating oil and greases, the Damle committee recommended a block control system( Here, the ceiling was fixed for blending charges, packing and marketing costs and profit margins.

COMPANIES REACTION TO THE DAMLE COMMITTEE REPORT

Initially, companies were reluctant to agree on the price ceiling decided by the Damle committee on the grounds that discounts on product prices were not available.

The companies indirectly threatened to stop product imports if the Damle committee prices.

In reality, their claims were not well founded. Rate cuts were widely spread worldwide, especially in Western European markets. Here in India, C.F.P. was selling Western Indian oil at discount rates before 1962. (C.F.P. is the short form of Compagnie Française des Pétroles or French Petroleum Company. Now, this company is known as TotalSA).

The companies also claimed that the product suppliers and marketers in India were organisationally separate, and, in reality, both were part of the same international parent organisation.

Later, companies agreed; interestingly, it took them a year to decide. Technically, the price reduction was not reflected in consumer prices due to taxes( the difference was absorbed by the government using the tax route).

OCEAN FREIGHT AGREEMENTS AND A.F.R.A

CIF and FOB are the two standard terms you will encounter while reading about ocean freight agreements.

CIF- Cost, Insurance and Freight
It is the seller’s responsibility until the crude oil shipment reaches the buyer.
In this case, the seller bears the cost of loading, insurance, and freight charges.

FOB – Free On Board
The buyer is responsible for all expenses and liabilities.
In this case, the buyer bears the cost of loading, insurance, and freight.

Average Freight Rate Assessment, or AFRA, is a classification system created by Burmah Shell (Royal Dutch Shell) in 1947 to standardise crude and refined oil contract terms.
It is determined by a panel of six leading tanker brokers in London. The objective was to achieve freight charge stability. The classification of the oil tanker is based on deadweight tons (ship’s capabilities to carry cargo). For example, General-purpose tankers are used to cover short distances and can hold 70000 to 190000 barrels of oil.

Some countries like France have created freight formulas of their own as an alternative to AFRA, which is based on a combination of long-term and short-term charters.

TALUKDAR COMMITTEE

Since the validity of the ceilings recommendation of the Damle committee was till March 1965, the government of India decided to constitute another committee under Mr T.N Talukdar. The terms of reference of the committee were

1. Define ex-refinery prices of products that refiners produce.
2. Findout the landed price with respect to similar imported products.
3. Determine the marketing and distribution charge.
4. Determine the sales ceiling price of lubes, oils and other specialities.

Technically speaking, this committee extended the concepts put forward by the previous Damle committee ( based on the principle of import parity with a fixed formula)

The report favoured a wide range of discounts: 10 per cent on furnace oil, 12 per cent on motor spirit, 12 per cent on kerosene, 12 per cent on light diesel, and 15 per cent on ATF.

The recommendations were valid till December 1965, and the government appointed a new committee under the chairmanship of Mr. Shantilal Shah.

SHANTILAL SHAH COMMITTEE

This committee recommended discontinuing the import parity principle because, according to them, 90 per cent of the total need was met by domestic production. This committee also failed to forecast a significant shortfall that may come in the future.

The committee also noted the following drawbacks.

1. When the inter-refinery difference is taken, import parity is not considered.
2. The basis of oil price determination in India was West Asian prices. Unfortunately, it did not reflect the domestic cost of production.

The government implemented the recommendation in June 1970 for three years until the 1973 oil crisis. Due to the 1973 oil crisis, the government constituted an oil price committee in 1974.

THE OIL CRISIS OF 1973

On October 7, 1973, a war broke out between Arab countries and Israel. Days later, Aramco sent US president Mr Nixon a memorandum requesting to stop American supply to Israel. They also threatened to cut the oil production if the USA continued its support.

On October 7, OPEC (OAPEC) members decided to cut 5 per cent of production from September, which will be applied each month compared with the previous month. This will continue till occupied Arab territories are restored.

Some countries, like Libya, didn’t approve. Later, they classified countries into three categories: friendly, neutral, and hostile. This embargo created and intensified the 1973 crisis.

OIL PRICE COMMITTEE OF 1974

The oil crisis of 1973 triggered the government to set up a committee under S. Krishnaswamy in 1974. This committee identified the major drawbacks and suggested discontinuing the import parity principle. They recommended an alternate mechanism called the Administered Pricing Mechanism(APM).

This new system introduced retention pricing to overcome overlooked indigenous production costs. Retention pricing allowed refineries to retain, out of the sale proceeds, the crude oil cost, the cost of refining the crude oil, and a reasonable return on investment.

ADMINISTERED PRICING MECHANISM

In short, the process of price fixation of final oil products by the government, along with the retention pricing mechanism, was known as the administered pricing mechanism.

The government implemented APM through the executive wing, the Oil Co-ordination Committee, which is part of the Ministry of Petroleum and Natural Gas.

AIMS OF APM

1. To optimise the utilisation of refining and marketing infrastructure.
2. Minimise cross-haulage of final products.
3. To ensure continuous crude oil availability to refiners.
4. To insulate the domestic market from price volatility.
5. To ensure products are available at subsidised rates.
6. To ensure reasonable returns to companies.
7. To reduce operational inefficiencies.

WHAT ARE THE IMPORTANT FEATURES OF APM?

The wellhead price of domestic crude oil was determined as the weighted average of the cost of production of ONGC and Oil India. A 15 per cent post-tax return on capital employed is added to it. This additional 15 per cent is to compensate for the operating expenses.

Crude oil is priced at a uniform FOB cost, the price of domestic or imported crude oil (irrespective of processed indigenous or imported crude).

All imports were canalised through one route: IOC (Indian Oil Corporation), which was controlled by the empowered standing committee of the central government.

Retention pricing was used to define refining costs and margins and was defined once every three years. Once decided, it remained constant for three years, but some yearly escalations were allowed over the margin.

Product-wise, the uniform ex-refinery price was the weighted average of retention prices of all refineries taken together for that product plus a uniform addition of 25 rupees selling units. Any difference between the retention price and the ex-refinery price was credited to the oil pool account.

Retention pricing was also used to determine marketing costs and margins. The government regulated dealer commissions, which were almost uniform.

Subsidies were provided for Kerosene, LPG, Petrol and Diesel ( for mass transport and agriculture), Furnace oil, and Naptha (for fertiliser).

Petrol, ATF, Diesel, and Naptha(used in other industries) were placed much higher than their cost of production to balance the under-recoveries on subsidised products.

WHAT SITUATIONS WOULD RESULT IN AN OIL PRICE ACCOUNT DEFICIT UNDER APM?

1. If domestic production goes down, the country will be forced to import more crude from the international market.
2. Depreciation of rupee against the US dollar($). This case will increase the import bill in the rupee term.
3. If the crude oil price in the international market rises.
4. A lag in supply from domestic refineries will increase imports.

PROBLEMS OF APM

1. It didn’t generate adequate financial resources for investment in petroleum sectors.
2. Due to the non-revision of petroleum product retail prices, the reimbursements exceed the surrenders to the oil pool account.
3. Prices did not reflect their actual economic cost.
4. Political situations, most of the time, dictated prices.
5. In the upstream sector, APM failed to generate sufficient incentives.

These concerns forced the government to dismantle APM. The decision was announced on November 21, 1997, and planned to be executed in phases from 1998 to 2001.

The timeline for dismantling is as follows.

1. The cost-plus formula would be withdrawn from domestic producers (ONGC and Oil India Limited). Oil products would be given 75 per cent and 77.5 per cent of the weighted average FOB price of actual imports for 1998-1999 and 1999-2000, respectively, and increased to 100 per cent by 2002.
2. All imports and exports of petroleum products except crude oil, liquid natural gas, ATF, petrol and diesel will be decanalised during this period.

SUDARARAJAN COMMITTEE

The government of India constituted an industry study group under Mr U. Sundararajan(then chairman and MD of BPCL) to draft the blueprint of deregulation and create a framework for market-determined pricing mechanism (MDPM).

The following were the committee recommendations.

1. Should enhance the oil recovery from existing fields.
2. Should increase the exploration efforts.
3. Should increase refining capacities and marketing infrastructure.
4. Develop port facilities to support crude oil needs.
5. Promote investment in the hydrocarbon sector.
6. Suggested to introduce MDPM or market-determined pricing mechanism.
7. Suggested removing all import and export restrictions and restrictions on sourcing.
8. The government should allow companies to decide on their respective areas.
9. Ensure fair market competition by constituting a regulatory body.
10. Set up an oil commodity exchange.
11. Suggested to remove sunsides. If the product needs a subsidy, the government should disburse it directly.

PRICING OF CRUDE OIL IN THE POST-APM PERIOD

The price of indigenous crude oil is determined by the crude oil sales agreement (COSA) between the producers and the refineries by benchmarking various indigenous crude oils similar to international crude oils similar to international crude oils. COSA is a type of excise duty imposed on products as per section 136(1) of the Finance Act, 2001. In the case of crude oil, it is calculated on the net quantity of crude oil received by the refining company or gross product produced and supplied from the oil field to the refinery.

The import parity price of crude oil produced by ONGC (ONGC is the largest crude oil producer in India) is calculated by considering the following.

A. FOB prices of the respective market crudes adjusted for Gross Product Worth. Gross Product Worth is the weighted average value of refined products obtained from a barrel of crude oil at the refinery gate and calculated by multiplying the prevailing spot price for each product by its percentage share in the product yield of a barrel. Moreover, it can be used to demonstrate the difference in quality between indigenous and comparable international crude oils.
B. Ocean freight rate.
C. Insurance.
D. Customs duty.
E. National calamity contingent duty.
F. Port charged.
G. Octroi.

INDIGENOUS CRUDE OIL AND ITS BENCHMARKS

ONGC Assam is linked to the average of Nigerian Bonny Light.

ONGC North Gujarat is linked to Arab heavy.

ONGC South Gujarat, Bombay High is linked to the average of Nigerian Boony Light and Quo Iboe.

Oil India is linked to Nigerian Bonny Light of similar quality.

WHAT IS ROYALTY?

The amount levied by the state government under Oilfields Act 1948 and Petroleum and Natural Gas Rules, 1959 on crude extracted from the respective state jurisdiction. It should not exceed 20 per cent of the sale price. From April 1998, the royalty was revised to an ad-valorem rate of 20 per cent of the wellhead price.

CURRENT SCENARIO

Since the government deregulated petrol pricing in 2010 and diesel pricing in 2014, the oil companies can determine the prices and revise them every fortnight. However, starting in June 2017, the prices will be revised on a daily basis.

The union government can levy tax on petroleum product production, while states have the power to levy tax on their sales. They use VAT, Sales tax, instead of GST, which results in price variation from state to state.

STANDING COMMITTEE ON PETROLEUM AND NATURAL GAS

This committee, under the chairmanship of Mr Ramesh Bidhuri, submitted its report on December 2023.

The following are the suggestions.

1. Diversify the imports of crude oils and gas.
2. In 2022-2023, India imported about 87% of crude oil. So, the committee recommended reducing the dependence on imports.
3. Recommended to conduct an audit to determine whether purchases in spot lenders have resulted in cheaper costs. (Spot tenders are generally available at cheaper prices than term contracts.)
4. Suggested to envisage settlement of crude oil imports in the Indian rupee to save foreign exchange.
5. Suggested to explore new short alternate routes for transportation.
6. Recommended to increase the share of crude oil transported through pipelines. At present, about 40 per cent of crude oil is transported by pipelines.

NOTES

What is °API?

The most important physical property of crude oil is the density, typically measured in degrees API. It is a measure of the specific gravity of the crude using a formula developed by the American Petroleum Institute (API) as the following:
Degree API = 141.5/specific gravity – 131.5 (specific gravity is measured at 60°F)
If the degree of API is higher, then the product will be lighter.

Based on degree API, crude oils are divided into three.

Heavy: less than 23° API gravity
Medium: 23–34° API gravity
Light: above 34° API gravity

The light one is easier to refine.

Sweet and Sour crude oils-

Based on Sulphur content, crude oil is divided into Sweet and Sour. Crude oil is considered “sweet” if it contains less than 0.5 per cent sulphur and “sour” if the content is higher than 0.5 per cent. Sweet crude is easier to refine (sulphur is corrosive) and safer to extract and transport than sour crude. Sweet causes less damage to refinery equipment.

In terms of hydrocarbon prevalence, Crude oil is divided into three.

1. Paraffin-based crude oil contains paraffin wax but very few asphaltic materials, suitable for producing lubricant oil and kerosene.
2. Naphthene-based crude oil contains asphaltic materials but very little paraffin suitable for making gasoline and asphalt.
3. Mixed-base crude oil contains a mix of paraffins, naphthenes, and aromatic hydrocarbons. Most crude oil grades belong to this category.

For more info- https://iced.niti.gov.in/energy/fuel-sources/oil/pricing

https://ppac.gov.in/prices/international-prices-of-crude-oil