Shifting sands: How India's fuel pricing policy evolved over the years

India's progress with decontrol of fuel prices derailed in May 2022-after 12 years, three governments and two reform-driven Prime Ministers-when petrol and diesel rates surged

With the finances of state oil companies, led by Indian Oil, careening in a volatile oil world, the question being asked yet again is whether they will now finally get the ‘full’ freedom to set the prices of diesel, petrol and LPG, or whether the new government at the Centre will continue to ‘influence’ what you and I pay at the pump. 

However, industry and government officials, analysts and state oil companies say that it is unlikely that the price of petrol will be changed daily, based on international prices. But before we try to read the future, it will be instructive to step into the past and study the evolution of India’s fuel pricing policy.
 

India’s progress with the decontrol of fuel prices derailed most recently in May 2022 when petrol and diesel rates surged to Rs 121/litre and Rs 105/litre respectively in Mumbai, and that may have brought in the government, once again, to step in to ‘manage’ the oil economy. In the two years since, the needle on fuel prices has barely moved, barring a tax reduction and a surprising fuel price cut executed amid rising prices. The Indian crude oil price basket rose by $5 per barrel between March and April 2024, but instead of prices going up pump rates of petrol and diesel fell by Rs 2 per litre in mid-March.

“Considering that oil prices are likely to remain at over $75/bbl, it is highly unlikely that the oil marketing companies will get full freedom in the pricing of petrol, diesel and LPG,’’ said Swarnendu Bhushan, co-head of institutional equities, Prabhudas Lilladher. “As we move towards the adoption of greener fuels, for which government subsidies would be necessary, there is also a likelihood that the government may jack up the taxes on petrol and diesel in order to recoup the future subsidies,’’ he added. In the previous decade, fuel price adjustments were considered insufficient to cover rising crude costs. Today, even as global crude rates seesaw, pump prices have been frozen. Between May 2022 and May 2024 (petrol and diesel prices declined by only around 2 per cent in March 2024, otherwise they were flat) the Indian crude basket swung from $116 a barrel in 2022 to around $75 a barrel in 2023 to $84 to barrel this month.
 

Fuel price reforms drive private and foreign investment, something that has dried up this past decade because of investor concerns over what is perceived as the government’s ‘control’ over the country’s $250 billion oil market. Price reforms also weigh in on energy security because India imports nearly 9 barrels of crude for every 10 consumed. 
 

The oil price reforms have been in the making for a long time and still a half-done story. After the discovery of the offshore oil field Mumbai High, India’s dependence on imported crude shrunk to around 19 per cent in 1984-85, down from 66 per cent a decade earlier. But the explosion in population, vehicles and fuel use has hiked the country’s import dependency to 88 per cent in the last fiscal, even as domestic production has declined. 

Atal Behari Vajpayee was the first prime minister to try and decontrol prices, and it was under former prime minister Manmohan Singh that petrol price controls were lifted. Diesel prices were decontrolled during Prime Minister Narendra Modi’s administration in October 2014. But it has been a halfway house with successive governments unable to resist the temptation to interfere everytime prices threaten to become a political hot potato. And managing by ‘stealth’, a ‘nudge and wink’ to government-owned oil marketing firms has meant that the exchequer has it both ways, with no onus to reimburse state oil companies for any losses incurred on selling petrol and diesel unlike the pre-reforms era.
 

The first stab at regulating petroleum product prices was taken in 1948 when the government and Burmah Shell (now Bharat Petroleum) agreed on a cost-plus formula called Value Stock Account, which in turn, was based on import parity prices, according to a report on Energy Pricing in India by H.S. Kimura.
 

In August 1957, the government replaced it with a new agreement based on actual cost plus a reasonable profit. In July 1975, the pricing of petroleum products was brought under the Administered Pricing Mechanism (APM) designed for crude oil, and it was shifted from import parity to cost-plus principles. Until March 2002, fuel pricing under the APM was based on the retention concept, one where oil refineries, oil marketing companies (OMCs), and the pipelines were compensated for cost and return at 12 per cent post-tax on the net worth. But the growing fuel subsidies were a drag on India’s finances. In 1996, a report by Vijay Kelkar, an economist, observed that the APM was found to be increasingly unsuitable for the long-term growth and efficiency of the oil industry. 
 

Finally, the government abolished the APM in a phased manner during the Vajpayee administration. Between 1 April 2002 and 1 January 2004, the prices of petrol and diesel were revised 23 times. But reforms took a back seat in 2004 when the new UPA government began reversing price reforms.
 

Between 2004 and 2010, the government appointed various expert groups to examine the pricing policy of petroleum products and make recommendations for a sustainable policy to ensure the financial health of the oil companies. The Rangarajan Committee (2006), Chaturvedi Committee (2008), and Kirit Parikh Committee (2010) gave recommendations, which included price decontrol and allowed oil companies the flexibility to fix the retail price based on import parity. 
 

Petrol prices were subsequently decontrolled in June 2010, but that did not stop the government’s contribution to the under-recovery burden which reached a record Rs 1trillion in 2012-13, since diesel, LPG and kerosene were still heavily subsidised.

The Modi government lifted price controls on diesel in October 2014, and eliminated subsidies on LPG in the 

early period of the Covid-19 pandemic in 2020. The government also allocated around Rs 12,000 crore towards LPG subsidies in FY 2024-25.

History of Pricing and Energy Reforms
 

1948: Government and Burmah Shell agree on the ‘Value Stock Account’ (VSA) formula based on import parity prices
 

1957: The government decides to revisit the VSA and replace it with a new agreement based on actual cost plus a reasonable profit
 

1975-2002: Petroleum products pricing brought under Administered Pricing Mechanism (APM) designed for crude under cost plus principles
 

1996: Vijay Kelkar report on the Restructuring of the Indian Oil Industry found APM increasingly unsuitable.
 

1997: APM abolished in phased manner

April 2002: Petrol and diesel prices set according to market

2006-2010: Committees appointed to study the pricing policy of fuels. Recommendations include price decontrol and import parity prices
 

June 2010: Petrol prices deregulated
 

2012-13: Assistance by the government to the oil marketing companies (OMC)s reached a record high of Rs 1 trillion
 

2014 October: Diesel prices decontrolled
 

2020-21: LPG subsidies near eliminated
 

May 2022: Diesel, petrol prices frozen after excise tax cuts
 

2023-24: LPG subsidies reinstated
 

2024 March: Diesel, petrol prices cut amid global oil price rise

Source: ‘History of Pricing and Energy Reforms in India', HS Kimura,  Economic Research Institute for ASEAN and East Asia (ERIA) Research project report; government data; company data.