For two years, the state-owned oil refining and marketing companies have been ripping off buyers of petrol and diesel by charging them Rs 2 extra on every litre of petrol and diesel. In the process, the oil companies pocketed a cool Rs 9,866 crore (Rs 98.66 billion) in 2003-04 and a similar amount the year before.

The Rs 2 extra they charge petrol and diesel buyers is supposed to cover the 20 per cent Customs duty on imported petrol and diesel. But -- here is the catch -- they have neither passed the Customs duty on to the government nor actually imported much petrol and diesel. Almost the entire petrol and diesel consumed in the country is being produced domestically, thanks to excess refining capacity in India.

Had the oil companies passed on the Rs 2 in Customs duty to the government, its Customs revenue from oil products would have doubled.

The companies have been able to rip off buyers of petrol and diesel because of the complex formula for arriving at the retail price of petrol and diesel, which came into effect after the government dismantled the administered pricing mechanism in the oil industry in April 2002.

Oil companies now charge buyers of both petrol and diesel an "adjusted" import parity price. So the 20 per cent Customs duty on petrol and diesel is factored in while arriving at the import parity prices of petrol and diesel -- even if the products are not imported.

To this, the oil marketing companies add the cost of freight up to depots, marketing costs, the marketing margin, state specific irrecoverable levies, excise duty, delivery charges from depots to retail pump outlets, sales tax, other local levies and dealers' commissions.

But in reality, the 20 per cent Customs duty is not passed on to the government. "Yes, we do not pass on this notional Customs duty to the government," admits a senior executive at a public sector oil company. Why? Explains he: "This is only the notional Customs duty for arriving at the import parity price and is not collected from the consumer as Customs duty."

The money is, however, collected from petrol and diesel buyers, even if it is not under the Customs duty head. Had the oil companies not factored in the duty in the retail selling price of petrol and diesel, the cost of petrol and diesel would have come down by around Rs 2 a litre. So the bill for petrol in Delhi should be Rs 31.70 a litre, instead of Rs 33.70 a litre.

During 2003-2004, around 8 million tonnes of petrol and 37 million tonnes of diesel were consumed in the country. At a Customs duty rate of 20 per cent, the revenue from petrol comes to Rs 1,557 crore (Rs 15.57 billion) and from diesel Rs 8,329 crore (Rs 83.29 billion).

The oil companies do make one point. Says the oil company executive: "We pay the government the 10 per cent Customs duty on the crude oil that we use for the manufacture of the two products. The 20 per cent duty on petrol and diesel is the duty protection to domestic refining companies by the government. Once the products are made, this tariff protection works out to around 6-7 per cent, depending upon the product mix of the refinery. If it is removed, we will have no tariff protection."

What this does not account for is the fact that when there are no imports taking place, no protection is required. In any case, one-third of the crude oil is produced domestically and not imported. No Customs duty is paid on this.

• Part II: How Rs 49,000 cr disappeared into govt coffers
• Part III- Why Indians pay $66 a barrel of petro-product