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India is the worlds 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 countrys 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 more
expenditure. 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.
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 Indias 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 OMCs 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 the
taxes on petroleum. 35% of governments income is generated through petroleum taxes and as there is
no other substitute to this so probably this wont 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.
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 OMCs 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.
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 that
could actually happen the companies take adequate measure to avoid the loss.
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 intermediate
crude 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.
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 cant 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.
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?
Ive just explained how oil prices affect households and businesses; it is not a
far leap to understand how oil prices affect the macroeconomy. Oil price
increases 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 to
foreign 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 and
Gali (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.
Endnotes