Crude oil and its economy

1. CRUDE OIL MARKET AND ITS IMPACT ON INDIAN ECONOMY

2. Major Land Mark events in Global Pricing
1948 – 1970: Oil prices remained fairly stable between
(2.5 -3 )$ per barrel from 1948 – 1970.
OPEC established in 1960
1971: US Petro Dollar Scam : The real reason for all
uncertainties in the oil Industry
Arab Oil Embargo 1973:Oil prices quadrupled from $
3 per barrel in 1972 to $ 12 per barrel in the latter half of
1974.
1979-1980 Oil Crisis: Iranian Revolution:
The prices skyrocketed to $ 35 per barrel
Crude oil prices plummeted below $10 per barrel by
mid-1986.
1990 IRAQ KUWAIT Gulf WAR: The price of crude oil
spiked in 1990 with the lower production and uncertainty
associated with the Iraqi invasion of Kuwait and the
ensuing Gulf War.
Peak Oil: Oil prices touched a record peak on 3rd July
2008 touching 145 Dollar Per Barrel

3. Crude Oil Supply Market and Oligopoly
Monopoly is a market structure where a
single organization controls the supply and
pricing in the market.
Oligopoly is a market structure in which a
small number of firms are able to
collectively exert control over supply and
market prices.
The degree of market concentration is
very high. i.e. a large % of the market is
taken up by the number of firms.
Interdependence between firms.
Usually Oligopolistic Players form a
cartel or a union through which they
control the demand and supply

4. Increase in Demand
Developing nations , businesses and individuals
need greater mobility for themselves and their
products.
World vehicle ownership to increase from 122
vehicles per thousand people in 1999 to 144 vehicles
per thousand in 2020, with the largest growth
occurring in developing nations.
Airports are being added . Oil is expected to remain
the primary fuel source for transportation throughout
the world for the foreseeable future.
Transportation fuels are projected to account for
almost 57% of total world oil consumption by 2020.
World population is currently around 6 billion
people, but is expected to grow to approximately 7.6
billion by 2020.
Meaning a huge increase in the demand for
transportation fuels, electricity, and many other
consumer products made from oil and natural gas

5. O.P.E.C
,
A primary example of such a cartel is OPEC
which has a profound influence on the
international price of oil.
 It is collusion of 12 countries producing oil
which came together to ensure stabilized oil
prices, eliminate price fluctuations, safe
guard self interests, have a steady and
secure income for the oil producing countries
ensure fair returns to those investing in the
petroleum industry
Oligopoly market structure offers OPEC an
ability to adjust the price it will sell for & the
volumes to justify their desired price.
Oligopoly firms collaborate to charge the
monopoly price and get monopoly profits.
.

6. Effect on Global pricing- Demand and Supply
In short run, demand is inelastic to price(
i.e as price of oil goes on increasing the
quantity demanded does not decrease to a
certain extent.
Irrespective of what petrol costs you
cannot shift to alternative fuel if price
increases. Or if prices are double you
cannot stop transportation altogether.
Similarly if prices are halved you will not
drive twice as much hence large change in
price has only a small change in demand
Supply of conventional oil is also
inelastic in the short run (i.e even if price
goes on increasing supply will remain fairly
constant).

7. Price elasticity Demand( P.E.D) / Price elasticity of
supply( P.E.S)
e
This is because of lack of substitute products
and limited inventory space (natural reserves).
Actual cost of pumping oil is relatively low,
once the capital cost of putting up rigs is
endured. An oil rig will cost roughly the same,
whether operating at 50% or full capacity. Henc
producers will tend to pump oil at their maximum
sustainable rate.
Point of intersection of the demand and supply
line denote the equilibrium price.
As resources are limited supply curve will shift
to right and price will increase
If there is steep rise in price, demand will
decrease people will opt for substitute goods
and the demand curve will shift towards the right
and equilibrium price will come down.

8. Effect on Transportation Industry
The transport sector is clearly dominant in petroleum product consumption.
Transport sector consumes 50% of total petroleum products
Road transport accounts for an even higher percentage of energy
Consumption

9. Road Transportation…
Over 80% of passengers & about 60% of
freight are transported by road in India.
With the growth in the economy and the rise in
personal incomes there is increasing
dependence on personal modes of transport
such as cars and two wheelers.
The total number of vehicles has increased
more than fivefold, from 21.3 million (including
14.2 million two-wheelers) in 1991 to 109 million
in 2008.
Price hikes in the automobile fuel prices
The transporters had to increase the cost, thus
increasing the prices of basic need such as food
items and other goods
Increase in prices led common man to use
more of public transport and less of personal
transport

10. Effects of oil prices on Automobile and Aviation
Industry
Oil Price hike will curtail the demand for the automobiles
Concessions and bailout packages
AVIATION
5.2 billion dollar losses
1$ increase per barrel of oil costs around 1.26 billion dollars
Growth has slowed down
Accounts to 45% of the operating cost
Benefit not passed on to passengers

11. Calculations of Petrol Prices in India
Basic Price calculation – Considering the
price of crude oil as $96.43 per barell,
cost per barrel in RS will be 96.43*48(1$=Rs48)
= 4628.8 Rupees
One barrel consists of approximately 160 liters.
So Price of crude oil per liter will be 4628.8/160
= 28.93 Rs.
Basic Price: Rs 28.93
Excise duty: Rs 14.35
Education Tax: Rs 0.43
Dealer commission: Rs 1.05
VAT: Rs 5.5
Crude Oil Custom duty: Rs 1.1
Petrol Custom: Rs 1.54
Transportation Charge: Rs 6.00
Total price: Rs 58.90

12. Substitute goods
What seems to be the only way out of this increasingly alarming oil
crisis is for a concerted effort to be made to look for alternative sources
of fuel.
There is a need to identify, on an emergency basis, a plant or plants
from which substitutes for petroleum can be derived.
Alternate fuel
 A. Bio diesel
 B. Ethanol
 C. CNG & COAL
 D. Hydro, Nuclear & Wind Power

13. State of crude oil in India
India is one of the top 10 oil-
consuming countries in the world.
Oil and gas represent over 40 per
cent of the total energy consumption
in India.
The consumption of petroleum
products in the country is on the rise
and demand already far exceeds
domestic supply.
The country’s existing annual crude
oil production is peaked at about 32
million tonnes as against the demand
of about 110 million tonnes. With
inadequate crude production, the
country is heavily dependent on
imports. Crude is the single largest
item on India’s import list.

14. Concept of Administered Price Mechanism
 Govt. introduced APM in 1970 to ensure standard pricing and fair returns to all refining
and marketing companies.
 Under APM, prices in hydrocarbon sector were controlled at 4 stages – Production,
Refining, Distribution, Marketing
 Applied principle of compensating normative cost and allowed pre-determined ROI at
each stage.
Disadvantages-
 Did not encourage efficiency in operations because of cost-plus formula
 Led to insufficient utilization of the country’s resources
 Inadequate incentive for PSU’s to invest in risky but potentially rewarding ventures of
developing oil reserves.
 Investors reluctant to commit large funds because of govt control.

15. Current pricing policies
APM was dismantled in April 2002 and sector moved to
Market Determined Pricing Mechanism.
Disinvestment of HPCL and BPCL
Entry of private and multinational oil companies
Subsidy -
 Subsidies on LPG and kerosene done
through fiscal deficit.
 Subsidy bill for crude oil is more than
50%.
 Govt doesn’t remit the whole amount,
instead issues oil bonds to OMC
Retail prices continue to be regulated by government .
Thus oil companies have limited freedom to revise prices
as per the increase in international oil prices owing to
political pressure , thus creating immediate loss in their
balance sheets.
Subsidies in form of tax cuts, oil bonds and compensation
are draining government resources.

16. Effects of the Global Oil pricing on Indian Economy
Inflation: It is defined as the reduction in
the value of money with passage of time.
In simple terms , any product that we buy
today a particular rate will be available for
a higher amount tomorrow
GDP: Gross Domestic Potential It
represents the total dollar value of all
goods and services produced over a
specific time
Fuel Subsidies: India imports around 75%
of its oil and this is subsidized highly by
the Government to shield the economy
from the global pricing

17. Inflation
The price of oil and inflation are often seen as being connected in a cause and effect
relationship. As oil prices move up or down, inflation follows in the same direction.
The direct relationship between oil and inflation was evident in the 1970s, -cost of oil
rose from $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis.
During the same period the consumer price index (CPI), a key measure of inflation,
doubled from 41.20 in early 1972 to 86.30 by the end of 1980
However, this relationship between oil and inflation started to deteriorate after the
1980s. During the 1990's Gulf War oil crisis, crude prices doubled in six months from
around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in
January 1991 to 137.9 in December 1991. This detachment in the relationship was even
more apparent during the oil price run-up from 1999 to 2005, in which the annual average
nominal price of oil rose from $16.56 to $50.04
In India, the increase in Oil prices directly affects the rate of inflation. When the prices
went to a high of more than $100/barrel in 2008, the inflation also went up to 12.27%
which was the highest for India for any year. Thus because of this phenomenon, there
was increase in prices of all commodities and transportation as well.

18. Gross Domestic Product
GDP = private consumption + gross
investment + government spending + (exports −
imports),
Therefore, when there is a large trade
deficit, the GDP of India decreases.
The Study on this states that an annual
10% increase in Oil Prices decreases the
GDP of a country by 0.9%.

19. India’s Subsidy Bill
The Indian government gives subsides to
the Oil Manufacturing Companies who
import crude oil and manufacture various
petroleum products.
The government does not remit the
whole amount, but issues Oil Bonds which
mature over a period of 10 years.
Thus creating an immediate loss in the
OMC’s balance sheets.
Fuel subsidies as % of GDP are more
than 2 in Indonesia, Malaysia,
Cambodia, Pakistan, Bangladesh and
Nepal. In India it is about 1.5.

20. How is India Combating Price Hike?
The oil price is increased, Revenue loss of Rs 200,000 crore to OMC in 2008-09 fiscal.
Negotiating a cheaper price with O.P.E.C keeping in mind larger imports.
India is considering joining a Central Asian gas pipeline that originates from
Turkmenistan.
China National Petroleum Corporation (CNPC) and India's ONGC, jointly won a bid to
acquire 37% of Petro-Canada's stake in Syrian oilfields for US$573 million.
India is seeking the revival of Iran-Pakistan-India pipeline deal which has currently
reached a deadlock.
Reliance Petroleum Ltd is working on a new 29-million-tonne (5,80,000 barrels-a-day)
refinery which will be housed in a SEZ adjacent to the existing Jamnagar refinery of
Reliance Industries