241448597 Why Petrol Price is Rising in India (1)

8/10/2019 241448597 Why Petrol Price is Rising in India (1)

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Why Petrol Price is Rising in India?By Raman deep Kaur

India is the world’s fourth largest consumer of energy but with low per capita energy consumption. With

the ever increasing number of private vehicles, an overall domestic consumption of petrol and petroleum

product is on rise in India. There was a registered growth of 5% of the same in the year 2011-12 and to

meet the increasing demand, government has to import more and more petrol. If spending of the country

as a whole is considered then 80-90% is done to pay the import bills on petroleum products, which is

accounted as country’s expenditure. Hence more demand of petrol than supply is a leading factor of its

rising price in India.

But rise in petrol price in turn has a rippling effect. As all the commodities are transported across India on

vehicles that run on petrol or diesel, so increase in petrol price results in price rise of these commodities

as well. The greatest sufferer of all this is a common man. He is already bearing the pressure of inflation

and any increase in petrol price will further reduce his actual household income. Today every Indian

spends almost half of his income on food items. If the petrol price in India keeps on increasing then every

food item will get costlier. It will result in less of savings and more of expenditure. This in turn will affect

the real estate, banking and other sectors in India. Eventually, more and more people will be pushed

towards poverty line.

Why India needs to import oil? India does not have enough of oil to meet the growing demand of oil. Near

about 1.4 million barrels of diesels are used per day in India especially by farmers, trucks and industry.

So to meet the growing demand, most of the oil is imported from other countries resulting moreexpenditure. It has been seen that petrol price has increased about 10 times within the period of three

years and still rising. Ultimate result of price hike of petrol is inflation.

Not only this but the condition of Indian currency is also not favorable at present. India is going through

currency crisis where value of Indian Rupee is falling to US Dollar. That is why Oil Marketing Companies

(OMCs) like Indian Oil Corporation (IOCL), Bharat Petroleum (BPCL) are paying more for the same

quantity of crude oil. Due to this, OMCs have lost near about 4,300 crores in the past six months for

selling petrol at low cost.

The price of petrol used to be stable in India but with the deregulation of petrol in 2010, Oil Marketing

Companies can increase the petrol price if large variation in cost is observed by these companies. Oil

marketing companies do so by linking the domestic price of petrol to international market rates.



Why petrol price is rising in India?

Depreciating rupee is one of the major reasons of the increase in petrol price in India. So we must

understand that why rupee is depreciating like a free fall. Economists believe that current euro crisis is

one of the fundamental reasons of depreciating rupee. But if this is the main reason then why other

currencies like Pound, Brazilian Real, etc are not getting affected to that extent. In fact Yen has moved up

against dollar.

So there must be some other reasons as well. Ever increasing fiscal deficit (difference between revenue

and expenditure) is one of the factors leading to currency crisis in India. We spend more than what we

earn. For the year 2011-2012, fiscal deficit was Rs 5,21,980 and for the year 2012-2013 target was to

have it at Rs 5,13,590 crores. Major reasons leading to this fiscal deficit is the financial funding or subsidy

offered on petroleum, food and fertilizer. Cost of subsidy on oil for the year 2012-2013 is estimated to be

Rs 43,580 crores and when the loss suffered by OMCs is also added to it, the total amount stands at Rs

1,14,000 crores.

Present earning of government is less than its expenditure which means that fiscal deficit of government

is increasing. Moreover, fiscal deficit is linked with trade deficit which means more import than export.

Major portion of India’s import is oil. Since import of oil is always paid in dollars, so importers need to buy

dollar by paying rupees. Present currency crisis means more rupees have to be given for the same

dollars leading to more rupees in the market. Applying demand and supply theory, rupee is continuously

losing value and OMC’s have to pay more for the same amount of oil imports.

If the price of oil products is not increased, India will keep on facing this deficit. Price increase will

decrease the demand which in turn need fewer dollars for oil import. Trade deficit will also be lowered

down leading to lesser pressure on rupee-dollar rate. Not only petrol price but the price of diesel, LPG

and kerosene will also be increased to have more prominent impact. This will improve the fiscal deficit of

the government and lead to economic growth.

On the other hand, price rise of petrol can be controlled if the government reduces its revenue from thetaxes on petroleum. 35% of government’s income is generated through petroleum taxes and as there is

no other substitute to this so probably this won’t be done by the government. Hence petrol price for sure

will increase. But indeed Government has to take strong decision as increasing prices will solve one

problem but leads to many other such as poverty, inflating, high cost of living, frustration etc.



How the petrol price is calculated?

Petrol price is calculated on the basis of worldwide supply and demand factors. Foreign suppliers sell

crude oil to Oil Marketing Companies (OMCs) in India at benchmark prices. Delivery price at the refinery

and Brent cr ude’s daily price are considered to calculate actual cost of petrol in India.

One barrel of crude oil contains about 160 litres of oil priced in US dollars. To calculate price, US dollars

are converted to Indian rupee and then divided by 160.

After buying, crude oil is transported to refineries in India. India at present has about 20 refineries. Crude

oil is then separated into various products like petrol, diesel, coal tar, etc in distillation towers of these

refineries. Cost of distillation and refining is added to the price of petrol. Also crude custom levy and

charges from ports to the refinery is added.

Separated petrol is now ready to be stored in the storage tanks of the oil companies. Oil companies now

pay to the refineries and to this added the cost of transporting petrol from refinery to OMC’s tanks. So the

actual price of petrol that a consumer pays includes all the above mentioned cost plus commission of a

dealer, VAT, excise duty, total duties and taxes.

Thus petrol price is the cost price that includes procuring, refining and marketing plus taxes that include

central and state taxes.

Af fect Of Rising Price Of Crude Oil On Stock Market

For the last few years it has been seen time and again that increase in the price of the crude oil had a

direct impact on the stock market. Though it is hard to imagine buy it is fact that a rise in the oilprice has negative effect on the stock prices at the stock exchanges all over the world.

The main reason behind this is the fear of the investors that the profit margin of the companies will

decrease because of the increase in the oil price. As an increase in the oil price directly increases theoperational cost, fuel cost, transportation cost of the companies, it is quite natural that the profitmargin of these companies will decrease. This is the reason that the buyers become susceptible about

the future of the companies that are hugely dependent on oil. This uncertainty restricts the buyers toinvest in these companies and as a result the price of the stocks falls that ultimately has a negative



effect on the overall market scenario. But this phase is temporary as the companies adjust in the price

level to make up for the increased price in the oil and maintain the profit margin.

All said and done this fear for the fall in the profit margin is not practical according to the theory. In

practice the effect of the price increase in the profit margin of the companies takes time. Before thatcould actually happen the companies take adequate measure to avoid the loss.

What are the possible causes and consequences ofhigher oil prices on the overall economy?

November 2007

What a daunting question! With oil prices increasing rapidly in the recent past, it

is hard not to wonder what has caused it and just what effect it might have on

the rest of the economy. Let me begin by discussing the evolution of oil prices

over time.

How have oil prices behaved in recent decades?

Figure 1 shows the history of the price of oil since the early 1950s. The price

shown is the monthly average spot price of a barrel of West Texas intermediatecrude oil, measured in U.S. dollars. The gray bars in this and all the following

figures represent recessions, as defined by the National Bureau of Economic

Research.

http://www.nber.org/








Figure 1. Spot Oil Price ($ Barrel)

As you can see from Figure 1, a long period of oil price stability was interrupted

in 1973. In fact, the 1970s show two distinct jumps in oil prices: one was

triggered by the Yom Kippur War in 1973, and one was prompted by the Iranian

Revolution of 1979. Since then, oil prices have regularly displayed volatility

relative to the ’50s and ’60s.

Figure 2 shows the “real” oil price, calculated by dividing the price of oil by the

GDP deflator. 1 This removes the effect of inflation and thus gives a more

accurate sense of what is happening to the price of the commodity itself. In

essence, the “real” measure allows you to compare oil prices over time in a way

that you can’t when inflation is also part of the change in price. You can see

that real oil prices have varied a lot over time, and large fluctuations tend to be

concentrated over somewhat short periods. You can also see that by the spring

of 2008, as this posting was prepared, the real price of oil has easily exceeded

that of the late 1970s.

http://www.frbsf.org/education/publications/doctor-econ/2007/november/oil-prices-impact-economy#1






Figure 2. Real Oil Price

Why are oil prices rising?

It is likely that both increases in demand and fears of supply disruptions have

exerted upward pressure on oil prices.2 Global demand for oil has been

increasing, outpacing any gains in oil production and excess capacity. A large

reason is that developing nations, especially China and India, have been

growing rapidly. These economies have become increasingly industrialized and

urbanized, which has contributed to an increase in the world demand for oil. In

addition, in recent years fears of supply disruptions have been spurred by

turmoil in oil-producing countries such as Nigeria, Venezuela, Iraq, and Iran

(Brown 2006).

The breathtakingly sharp increase in the price of oil in the last half of 2007 and

first half of 2008 has led many to argue that increased speculation in

commodity markets has played a role, and indeed there is evidence of increased

activity in these markets. However, whether speculation is playing a role in

high oil prices is open to debate (Krugman 2008). It is also useful to remember

that both the demand for and the supply of oil react sluggishly to changes in

prices in the short run, so very large changes in prices can be required to

restore equilibrium if demand should move even modestly out of line with

supply.

As far as the implications of higher oil prices, there are both microeconomic and




http://www.dallasfed.org/research/swe/2006/swe0604e.pdf



http://www.nytimes.com/2008/06/27/opinion/27krugman.html?_r=1&oref=slogin







macroeconomic answers to that question. I will address both of these aspects in

turn.

How do high oil prices affect the economy on a “micro” level?

As a consumer, you may already understand the microeconomic implications of

higher oil prices. When observing higher oil prices, most of us are likely to think

about the price of gasoline as well, since gasoline purchases are necessary for

most households. When gasoline prices increase, a larger share of households’

budgets is likely to be spent on it, which leaves less to spend on other goods

and services. The same goes for businesses whose goods must be shipped from

place to place or that use fuel as a major input (such as the airline industry).

Higher oil prices tend to make production more expensive for businesses, just

as they make it more expensive for households to do the things they normally

do.

It turns out that oil and gasoline prices are indeed very closely related. Figure 3

plots average monthly oil prices from 1990 through early 2008, using the spot

oil price for West Texas intermediate (right scale, thin blue line, measured in

dollars per barrel) and the U.S. retail gasoline price (left scale, thick red line,

measured in cents per gallon). The two series track each other very closely over

time: increases in oil prices are accompanied by increases in gasoline prices. As

shown in the graph, the correlation coefficient (denoted “r”) for the two series is

0.98. Moreover, the monthly changes in oil prices and gasoline prices (notshown) also are very highly and positively correlated.



Figure 3. U.S. Gasoline and Oil Prices

So, when oil prices spike, you can expect gasoline prices to spike as well, and

that affects the costs faced by the vast majority of households and businesses.

What effects do oil prices have on the “macro” economy?

I’ve just explained how oil prices affect households and businesses; it is not a

far leap to understand how oil prices affect the macroeconomy. Oil priceincreases are generally thought to increase inflation and reduce economic

growth. In terms of inflation, oil prices directly affect the prices of goods made

with petroleum products. As mentioned above, oil prices indirectly affect costs

such as transportation, manufacturing, and heating. The increase in these costs

can in turn affect the prices of a variety of goods and services, as producers

may pass production costs on to consumers. The extent to which oil price

increases lead to consumption price increases depends on how important oil is

for the production of a given type of good or service.

Oil price increases can also stifle the growth of the economy through their effect

on the supply and demand for goods other than oil. Increases in oil prices can

depress the supply of other goods because they increase the costs of producing

them. In economics terminology, high oil prices can shift up the supply curve

for the goods and services for which oil is an input.



High oil prices also can reduce demand for other goods because they reduce

wealth, as well as induce uncertainty about the future (Sill 2007). One way to

analyze the effects of higher oil prices is to think about the higher prices as a

tax on consumers (Fernald and Trehan 2005). The simplest example occurs in

the case of imported oil. The extra payment that U.S. consumers make toforeign oil producers can now no longer be spent on other kinds of consumption

goods.3

Despite these effects on supply and demand, the correlation between oil price

increases and economic downturns in the U.S. is not perfect. Not every sizeable

oil price increase has been followed by a recession. However, five of the last

seven U.S. recessions were preceded by considerable increases in oil prices (Sill

2007).4

Is the relationship between oil prices and the economy always the

same?

The two aforementioned large oil shocks of the 1970s were characterized by low

growth, high unemployment, and high inflation (also often referred to as

periods of stagflation). It is no wonder that changes in oil prices have been

viewed as an important source of economic fluctuations.

However, in the past decade research has challenged this conventional wisdom

about the relationship between oil prices and the economy. As Blanchard andGali (2007) note, the late 1990s and early 2000s were periods of large oil price

fluctuations, which were comparable in magnitude to the oil shocks of the

1970s. However, these later oil shocks did not cause considerable fluctuations in

inflation (Figure 4), real GDP growth (Figure 5), or the unemployment rate.

http://www.philadelphiafed.org/files/br/2007/br_q1-2007-3_oil-shocks.pdf


http://www.frbsf.org/economic-research/publications/economic-letter/2005/November/why-hasn-apos-t-the-jump-in-oil-prices-led-to-a-recession












http://www.nber.org/papers/w13368














Figure 4. Oil Prices and CPI Inflation

Figure 5. Oil Prices and Real GDP Growth

A caveat is in order, however, because simply observing the movements of

inflation and growth around oil shocks may be misleading. Keep in mind that oil

shocks have often coincided with other economic shocks. In the 1970s, there



were large increases in commodity prices, which intensified the effects on

inflation and growth. On the other hand, the early 2000s were a period of high

productivity growth, which offset the effect of oil prices on inflation and

growth. Therefore, to determine whether the relationship between oil prices and

other variables has truly changed over time, one must go beyond casualobservations and appeal to econometric analysis (which allows researchers to

control for other developments in the economy when studying the link between

oil prices and key macroeconomic variables).

Formal studies find evidence that the link between oil prices and the

macroeconomy has indeed deteriorated over time. For example, Hooker (2002)

suggests that the structural break in the relationship between inflation and oil

prices occurred at the end of 1980s. Blanchard and Gali (2007) look at the

responses of prices, wage inflation, output, and employment to oil shocks. They

too find that the responses of all these variables to oil shocks have become

muted since the mid-1980s.

Why might the relationship between oil prices and key macroeconomic

variables have weakened?

Economists have offered some potential explanations behind the weakening link

between oil prices and inflation. Gregory Mankiw (2007) suggests increases in

energy efficiency as one explanation. Indeed, as shown in Figure 6, energy

consumption per dollar of GDP has gone down steadily over time. This meansthat energy prices matter less today than they did in the past. Blanchard and

Gali (2007) suggest additional explanations. They find that increased flexibility

in labor markets, monetary policy improvements, and a bit of good luck

(meaning the lack of concurrent adverse shocks) have also contributed to the

decline of the impact of oil shocks on the economy.

Finally, how monetary policymakers treated the economic shocks caused by

rising oil prices also may have played a role in the impact of the shocks on

economic growth and the inflation rate. Specifically, some have arguedpolicymakers tended to worry more about output than inflation during the oil

shocks of 1970s and did not adequately take into account the inflationary

aspect of the oil shocks when fashioning a policy response to them (see, for

example, Clarida, Gali, and Gertler 2000). In the case of the U.S., since

households and firms sensed that the Fed was not going to pay a lot of

attention to inflation, they probably realized that the oil shocks would lead to

http://gregmankiw.blogspot.com/2007/10/where-have-all-oil-shocks-gone.html











substantially higher future inflation and adjusted their expectations accordingly.

By contrast, the Fed in the 2000s is more committed to fighting inflation, the

public knows it, and the result has been that, even though headline inflation has

risen noticeably because of the direct effects of oil and commodity shocks, core

inflation and inflation expectations remain contained.

The lack of major output effects of oil price shocks since the 1970s calls into

question what role they played during the two recessions of that period. In

other words, one possible reason why oil shocks seem to have noticeably

smaller effects on output now than they did in the 1970s is that the world has

changed. Another is that the effects of oil shocks were never as large as

conventional wisdom hold, and that the slow growth of that decade had to do

with other factors.

Figure 6. U.S. Energy Consumption

Endnotes

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