MANAGERIAL ECONOMICS- MID TERM ASSIGNMENT BATCH-2012-14 SECTION- F

STUDY OF OIL INDUSTRY

GROUP MEMBERS -SUNNY SEHGAL -SWAPNIL GARG -VINAY CHHABRA -VINAY GOYAL

RISES IN THE PRICES OF OIL

Oil minister Jaipal Reddy has assured that the government will take measures to soothe impact of steep hike in petrol prices ruling out any rollback and expressed urgency of raising diesel, kerosene and cooking gas rates, which have been frozen for almost one year. "There are suggestions to reduce central and state levies to give relief to consumers and I have spoken about it with the finance minister Pranab Mukherjee. Government (central) and state governments will together arrive at some formula," (25th May , 2012. Economic Times,Rajeev Jayaswal ET bureau) Citing an increase in the world prices of oil, the Department of Energy hinted over the weekend at a possible increase in prices of fuel products this coming week. DOE Oil Industry Management Bureau director Zenaida Monsada said this may thwart bids to further roll back public transport fares, radio dzBB reported Saturday. Monsada was quoted in the report as saying prices of oil in the world market had gone up. Last weekend, Monsada had already noted a possible upward trend of oil prices in the world market. She said last week this was partly due to the US economy recovering. (http://www.gmanetwork.com/news/story/264504/economy/business/doe-hints-at-oilprice-hike-this-coming-week) I. INTRODUCTION

Every now and then there is news of hikes in the prices of petrol, diesel and other crude oil products. This has resulted in hue and cry all over the world and not just in India. In November 2011 the price was in between Rs. 60and Rs. 65 and in June 2012, the price has shot up to as high as Rs. 68.48 per litre. Such high price of petrol has resulted in oppositions from various quarters of Indian segment. A barrel of Crude produces approx. 150 litres of Petrol or its equivalent. (This is a broad generalisation and depends on type of crude, efficiency of the refinery etc. but is a reasonably good estimate, based on expert inputs). The total of all other costs involved in converting crude to Petrol which includes transport of crude and refined products, cost of refining, reasonable refining margin for the refinery, fuel used by the refinery, dealer commission, etc. is approx. USD 12, which works out to Rs. 672 per barrel. Now, this totals up to a final cost of petrol, at your nearest petrol bunk, at Rs. 42 per litre. This morphs to Rs. 77 81 per litre, adding taxes at different levels under various heads Basic Excise duty, Additional Duty, Special Additional duty, Cess, Additional Cess and lastly, the exorbitant State Sales Tax adding up to Rs. 35-40 per litre of Petrol. To analyse the situation it is necessary to study the demand and supply side of oil and what policies can be adopted to stabilize the high prices.

II.

DEMAND AND SUPPLY ANALYSIS

We look at the factors that have affected the demand of oil in India and around the world. Increasing wealth in emerging markets, especially China and India. When economies grow, their energy needs grow. Consumers want cars, air conditioners, refrigerators, and other energy hogs. Thriving economies such as China and India are quickly becoming large oil consumers. China has seen oil consumption grow by 8% yearly since 2002, doubling from 1996-2006. Indias oil imports are expected to be more than triple from 20011 consumption levels by 2020, rising to 5 million barrels per day. Globalization is also another factor that has increased the usage of oil. Transportation is one of the largest consumers of energy in the world, accounting for 58 percent of liquid fuel consumption in OECD countries in 2004. As we move more often, further, and with greater speed, the energy we use in transportation will inevitably increase. Air travel in particular is a heavy user of fuel. As car price were decreasing in price companies such as Tata Nano ($2500), Maruti, Ford Fiesta have been developing micro cars to gain market share. This increase in number of cars demanded had greatly increased the quantity of oil demanded. Here car and petrol were complementary goods.

Industrial Growth:- From April 2012 to May 2012 a 0.80% Yearly growth in industrial sector is recorded in India, compared to 2.80% growth in April 2011 to March 2012. The figure shown here is in terms of production. Therefore higher the production higher will be the demand for oil. Long term demand constraint: Concerns over energy security. While energy demand is typically driven by short-term considerations (e.g., GDP growth, weather, transport needs), long-term concerns over energy security around the world have led to what some might consider an irrational premium paid for energy assets. This is most apparent in the very favourable deals struck by China with host governments in countries around the world to explore for oil & gas, one of the contributing factors to the increasing premium paid per barrel of proven oil reserves in the oil exploration and production industry.

Now we shall look at oil market from the supply side. Low OPEC production margins: Due to the growth in oil demand, most of the worlds surplus production capacity was no longer available. The world oil supply went from a situation of overcapacity to a tight market. It used to be that OPEC, with its cushion of low-cost excess capacity. Higher production costs: The market equilibrium depended on the development of new types of oil that cost more to produce, such as very deep offshore or Canadian tar sands. The inflationary trend in production costs can be attributed to more difficult technical conditions. Prices went up significantly (x1.7) due to the increase in the average selling price (x2.6). In any event, the rise in average cost acted as a drag on the price. The striking rise and fall of the cost of operation of equipment, and to a lesser extent transport inflation in 2008 and 2009, can be attributed to the financial crisis of the period which resulted in a sharp increase in the oil price and consequently a sharp correction due to decreased demand for oil, as most economies were faced with recession. The cost of operating transport equipment has been increasing by over 10 per cent (year on year) since April 2011, peaking at 22.5 per cent in December 2011, the report states. For some months Saudi Arabia has been pumping oil at its fastest rate in 30 years to make up for Iranian crude lost to American and European sanctions, which officially started on July 1st. Plenty of Libyan oil is also back on the market. Oil from Americas shale fields has all but plugged the gap caused by disruptions to supplies from Syria, Yemen and South Sudan. On June 29th,2012 oil markets responded to the latest euro summit with undisguised, and unmerited, glee. The price of Brent crude leapt by 9%, the biggest one-day advance in three years, and has since risen to around $100 a barrel.

III.

WAYS TO REDUCE THE PRICE OF OIL:

The price of oil is directly proportional to the quantity of oil demanded, the supply irregularities and the geopolitical tensions and events. Below are few ways suggested to reduce the dependence and the price of oil. Firstly we need to identify our own natural oil resources in the country so that we can become independent of the international market rates during troubled situations. We need to promote some natural and cheaper alternatives like solar energy etc. Some of the the researched areas are Biodiesel has probably been the most grass roots oil replacement so far. Propane is currently the most used gas alternative in the US with almost propane 200,000 vehicles being driven today. Hydrogen has been hyped in the last few years, but is yet to make a significant impact on the energy industry. Hydrogen is talked about so much because it can easily be made by nuclear and alternative power sources and has no known environmental impact since the exhaust is just water. Ethanol is probably the most well known gasoline alternative. In Brazil sugar is converted to ethanol and nearly half of the fuel sold in ethanol.

Passing Carbon tax: Economists say the most efficient way to reduce demand for any product is to make it more expensive. In short, a carbon tax. For gasoline, let's say an additional $1 or $2 a gallon. Government should focus preparing reserves for petroleum products like US and China. Their daily reserve is around 9 million barrel. This can be used when international market rates are very high. Example that can be quoted in this context is the Obama administration in delaying the approval of the Keystone pipeline becomes apparent.

IV.

REFERENCE http://www.fueleconomy.gov/feg/oildep.shtml http://www.economist.com/node/21558310 http://moneymorning.com/2012/07/21/the-trajectory-is-for-oil-prices-to-rise/ http://money.cnn.com/2007/05/10/news/economy/lower_gas_prices/index.htm http://www.indiabix.com/group-discussion/how-to-deal-with-high-oil-prices/ http://www.careers-india.com/2010/03/31/analysis-of-demand-and-supplydynamics-for-crude-oil-market/ http://www.theteamwork.com/articles/2016-2104-indian-government-monthlyannual-industrial-growth-data.html