Last week's fuel price cut will impact margins of oil companies such as Indian Oil Corporation [Get Quote] less severely than it did when prices were last reduced in February 2007, giving the government room for another round of price cuts on automobile fuels before general elections early next year.

"Even after the price cut, the companies will still make profits on the sale of petrol and diesel. This gives some headroom for a further reduction in prices, especially as oil prices are projected to fall further," said an official in the oil ministry. "Oil prices, however, are the key," he added.

The oil marketing companies - Indian Oil Corporation, Bharat Petroleum Corporation [Get Quote] and Hindustan Petroleum Corporation [Get Quote] - are currently making profits of around Re 1 on every litre of diesel they sell and around Rs 10 on every litre of petrol, even after last week's price reduction.

Overall, however, they still lose Rs 5 crore (Rs 50 million) everyday as they continue to sell kerosene and cooking gas at below production costs. This daily loss was expected to double after the prices of petrol and diesel, which partly cross-subsidise cooking fuels, were cut on December 5.

However, this daily loss is significantly lower than roughly Rs 30 crore (Rs 300 million) a day in February 2007, when petrol and diesel prices were last cut. These losses increased to around Rs 50 crore (Rs 500 million) a day after the price cut. At that time, the companies were making profits only on petrol; they were making losses on diesel, which accounts for around 36 per cent of their sales.

The government last week cut petrol prices by Rs 5 per litre and diesel by Rs 2 per litre as oil prices tumbled by more than 70 per cent from their peak in early July.

The reduction negates the Rs 5 per litre increase in petrol prices announced in June this year, but the Rs 2 cut in diesel prices is lower than the Rs 3 per litre price increase in June.

Also, cooking gas prices in June were increased by Rs 50 per cylinder, but the government decided to leave prices of this fuel unchanged in the latest round of cuts.

Then Finance Minister P Chidambaram, who is now the home minister, had said in February 2008, when fuel prices were also increased, that prices of petrol and diesel had been made equivalent to crude oil prices of $66 per barrel. The government has also reduced customs duty on fuels and crude oil, which helped reduce oil companies' losses a little more.

However, the rupee has depreciated sharply against the US dollar which has resulted in losses mounting for the oil companies. The companies pay for the crude oil they buy in dollars and a higher value of the US currency against the rupee results in higher prices.

Earlier this year, a committee headed by Planning Commission member BK Chaturvedi had said the oil companies' retail losses are inflated 10 to 15 per cent as the figures are calculated on an import parity basis.

The companies, thus, account for costs such as customs duty and freight when they calculate the prices of petrol and diesel. However, these companies do not import any petrol and diesel and so that extra costs are only notional.

On their part, the oil companies claim that despite the lower oil prices their losses from kerosene and cooking gas are higher than their gains from petrol and diesel. Also, the three companies together have accumulated losses of Rs 110,000 crore (Rs 1,100 billion) as a result of subsidised fuel prices when oil was over $120 per barrel.

"This loss that we have accumulated for the year is the main concern," IOC's chairman Sarthak Behuria had said earlier this week.