What is the issue?
Union government, to reduce the retail prices of petrol and diesel can work on with cost plus formula.
What are the issues with trade parity?
- At present, the government is following the trade parity formula for pricing the fuels, which is based on international markets.
- By this, price for a commodity or service is pegged to another price or to a composite average of prices based on a prior selected period.
- The formula based on trade parity fixes the landed cost of petrol and diesel at a level that is slightly higher because of the inclusion of customs duty in it.
- The logic of an 80 % weight in favour of imports in the formula is questionable, with negligible imports of petrol and diesel taking place at present.
- It also discourages oil refining companies from achieving greater operational efficiency since their cost of petrol or diesel is pre-determined by a formula irrespective of their actual refining costs.
What is cost plus pricing formula?
- It is now necessary to move away from the pricing formula based on trade parity and embrace a cost-plus pricing system.
- Cost plus pricing is a cost-based method for setting the prices of goods and services.
- Under this approach, one can add together the direct material cost, direct labour cost, and overhead costs for a product, and add to it a mark-up percentage (to create a profit margin) in order to derive the price of the product.
- Cost plus pricing is a relatively simple mechanism and easy to understand.
- It will also introduce transparency and help reflect a more reasonable and correct picture of the oil companies’ under-recoveries.
- It, in turn, could help reduce the government’s subsidy bill and even reduce retail fuel prices.
Source: Business Standard