ECONOMICS FOR

MANAGERS

GREESHMA B
1st SEMESTER
MBA ‘B’ SEC
R19MB063
 Case study : Cashless economy for developing countries:

India is an energy deficient country, importing a significant part of its oil and gas
requirements. Indian gas market is oligopolistic in nature with a large number of
consumers and a few producers. Major producers are fields operated by State Owned
Enterprises (SOEs) or National Oil Companies (NOCs): Oil and Natural Gas
Corporation Ltd. (ONGC) and Oil India Ltd. (OIL) and fields under JVs: KG-D6
[Reliance Industries Ltd. (RIL), British Petroleum and NIKO Resources], Panna-
Mukta & Tapti (British Gas, ONGC, RIL), Ravva (Cairn India, ONGC, Videocon
Petroleum and Ravva Oil), and Hazira (NIKO Resources and Gujarat State
Petrochemical Corporation Ltd.).
Issues Related to Gas Pricing: Gas is Different from Other Commodities. Gas is
different when compared to other commodities. Gas fields are located far away from
consumption points. It has to be transported through pipelines involving huge
investment cost or has to be liquefied, transported and re-gasified (as in the case of
LNG). This requires regasification facility. Transportation cost could account for 20%
to 70% of the total price.
Various Gas Pricing Mechanisms Followed Globally: There are various gas pricing
mechanisms followed in different countries, with most developed nations like US and
UK favoring ‘gas-on-gas competition’ which hinges on demand-supply dynamics.
Trading here takes place in physical or notional hubs like Henry Hub (US) or National
Balancing Point (NBP, UK).
The Demand of Oil and Gas Companies: The OGCs expressed need to increase gas
price/make it market linked in order to increase Exploration and Production (E&P)
activities in India. They complained of lack of incentives to make investment under
the current pricing mechanism.
Rangarajan Committee Recommendation: The Government appointed Rangarajan
panel to suggest appropriate pricing mechanism. The committee submitted its report
in 2012 suggesting a new pricing mechanism to determine sale price of domestically
produced gas.
Mounting Pressure and Future Outlook: There were strong reactions on the decision
from various quarters, law makers and policy experts. The Parliamentary Standing
Committee on Finance demanded a re-assessment of the formula and asked the
government to revisit the decision to raise gas prices.
The Communist Party of India Member of Parliament, Gurudas Dasgupta, urged the
then Prime Minister Manmohan Singh, to reconsider the CCEA decision and debate
with various affected parties before finalizing.

Questions:
I. What is the market structure of natural gas market in India?
2. Should the government let the prices be determined by the market or should it
regulate the prices?
India is an energy deficient country therefore it becomes important to import oil and
gas from other countries. Indian gas market is an oligopolistic market. Gas is different
from other commodity they are usually located in outskirts of city therefore it involves
huge cost to transport to markets which results in increasing the price. The
government appointed committee to look after price mechanism which resulted in
strong reactions in fixing price, therefore fixing a price is a challenging task.

Natural gas is a non-renewable hydrocarbon used as a source of energy for heating,

cooking, and electricity generation. It is also used as a fuel for vehicles and as a
chemical feedstock in the manufacture of plastics and other commercially
important organic chemicals.
Natural gas is sent through small pipelines called gathering lines to processing plants,
which separate the various hydrocarbons and fluids from the pure natural gas, to
produce what is known as ‘pipeline quality’ dry natural gads before it can be
transported.

What is the market structure of natural gas market in India?

For any scarce resource, proper allocation can only occur through well-regulated
markets. This happens when such a resource follows price signals. In the case of
natural gas, India is an oligopoly market. The government, instead of striving for a
more reasonable market structure, has abetted the creation of this oligopoly. It is not
only a question of indulging in corrupt practices to favor one player over another, but
that of a mindset that favours oligopoly. In such a situation, price discovery is
impossible and price distortion a certainty.

In an oligopoly, there are only a few firms in the market. While there is no clarity
about the number of firms, 3-5 dominant firms are considered the norm. So, in the
case of an oligopoly, the buyers are far greater than the sellers. The firms in this case
either compete with another to collaborate together, they use their market influence
to set the prices and in turn maximize their profits. So, the consumers become the
price takers. In an oligopoly, there are various barriers to entry in the market, and new
firms find it difficult to establish themselves.

Price under Oligopoly:

In an oligopoly, the number of sellers is small as against a sole seller under monopoly
and many sellers under monopolistic completion. Principal Characteristics of
Oligopoly The principal features of oligopoly are as under:

(i) Interdependence: Owing to a small number of sellers, the price-output

decisions of one firm are taken note of by other firms and affect their
decisions too.
 (ii) Indeterminate Demand Curve: Since no firm is able to predict the reaction
or behaviour of other firms consequent on price output decision of one firm,
there is uncertainty, and no firm can be sure of the quantity of the
commodity it can sell at a price. The demand curve is thus indeterminate.
(iii) High Pressure Salesmanship: There being only a small number of firms in
the field, there is a tendency for a firm in oligopoly to increase its selling
costs and indulge in advertisement so that it may capture as much of the
market as possible. There is a counter-campaign by the rivals.
(iv) Sticky Prices: In order to avoid adverse reaction by the rivals, there is a
tendency for the firms to avoid changing the price of their products. Hence
comparative price stability rules in the oligopolistic market.

Price Determined under Oligopoly:

Since price-output decisions by one firm affect the decisions of other firms,
nobody can be sure of their reaction. As pointed out above, the demand
curve is indeterminate, and no single price output decision is possible. We
may mention the following functions which price performs:
(i) Price controls consumption: If the price goes up. It is a signal for the
consumers to reduce consumption. The commodity will then be put
only to more urgent uses.
(ii) Price directs production: If the price is low, it warns the producers;
and if it is high, it stimulates production.
(iii) It adjusts the existing supply to demand: If a commodity is in short
supply, the price will go up and reduce demand so that the demand
is equated to supply. If stocks have been accumulated, the price will
fall making demand to come up to the level of the supply. The supply
is cleared.
(iv) Prices of factors indicate the most remunerative channels for them to
flow into: They thus find their most profitable employment. Thus,
price is a powerful regulator of all economic activity in a capitalist
economy.

The nature of the natural gas market is similar to other competitive commodity
markets: prices reflect the ability of supply to meet demand at any one time. The
economics of producing natural gas are relatively straightforward. Like any other
commodity, the price of natural gas is largely a function of demand and the supply of
the product.

When demand for gas is rising, and prices rise accordingly, producers will respond
by increasing their exploration and production capabilities. As a consequence,
production will over time tend to increase to match the stronger demand. However,
unlike many products, where production can be increased and sustained in a matter
of hours or days, increases in natural gas production involve much longer lead times.
In an environment of falling gas prices, the converse will be true. Producers will
respond to lower natural gas prices over time by reducing their expenditures for new
exploration and production. Production decline in existing wells will decrease
productive capacity. At the same time, the lower prices will increase the demand for
natural gas. This, in turn, will ultimately result in upward pressure on gas prices. This
relationship between changes in the price of natural gas and variations in the supply
of and demand for natural gas is sometimes referred to as the “natural gas market
cycle.”

In the short term, and in relation to existing producing wells, the supply of natural
gas is relatively inelastic in response to changes in the price of natural gas. Contrary
to some views, producers do not routinely shut in wells when natural gas prices are
low. There are several economic drivers that provide an incentive for producers to
continue producing even in the face of lower prices.

 First, if production is halted from a natural gas well it may not be possible to
restore the well’s production due to reservoir and wellbore characteristics.
 Second, the net present value of recapturing production in the future may be
negative relative to producing the gas today — i.e., it may be better to produce
gas today than to wait until the future to produce the gas. If a producer chooses
not to operate a well, the lost production cannot be recovered the next month
but is instead is deferred potentially years in the future. There are no guarantees
that the prices for gas in the future are going to be higher than prices today.
 Third, some gas is produced in association with oil, and in order to stop the
flow of natural gas, the oil production must be stopped as well, which may not
be economic.
 Finally, a producer may be financially or contractually bound to produce
specific volumes of natural gas.

Producers and consumers react rationally to changes in prices. Fluctuations in gas

prices and production levels are a normal response of the competitive and liquid
North America gas market. While the price of the natural gas commodity fluctuates,
it is this inherent volatility that provides the signals (and incentives) to both suppliers
and consumers to ensure a constant move towards supply and demand equality.

Because the natural gas market is so heavily dependent on the interaction of supply
and demand, it is important to have knowledge of the factors that affect these two
components.
The government let the prices be determined by the market or should it regulate
the prices?

The government should regulate the price so that they can access control over the
market. Every undertaking to prohibit, regulate, or control monopoly and
restraint of trade must approach the subject from two points of view: structure
and practices. From the point of view of structure, legislation must seek to
prevent concentration of private control of markets into too few hands-that is,
to prevent mergers and other relatively rigid unifications of interest and
management, and to break up existing excessive concentrations. From the point
of view of practices, the aim must be to prevent certain types of concerted action
by agreement or understanding among independent firms whose size.
When the government allows the market to fix the price the following situations
will arise.

Collaborating Oligopolies:

 When two or more oligopolies agree to fix prices or take part in anti-
competitive behaviour, they form a collusive oligopoly. This agreement
can be formal or informal.
 A formal agreement is a cartel and is illegal. The OPEC is a legal cartel
because it is an agreement signed between countries and not individual
firms.
 In an informal agreement, the firms behave as a monopoly and choose
the price that maximizes output.
 Collaborations are unlikely to last as firms have an incentive to cheat.
They all would like the other members to restrict their output to what
everyone agreed but would want to increase their production. However,
if they are a few big firms with similar costs and rising demand, the
agreement is likely to last.

Competing Oligopolies:

 Even if there is no agreement, oligopolistic firms don’t end up changing

their output with changes in cost.
 The assumption is that when a rival firm increases its price, other
companies will not follow, but if a competing business decreases its
price, then others will follow. This behaviour leads to a ‘kink’ in
the demand curve.
Competing excluding price:
The Oligopolistic firms don’t like cutting prices because it leads to a price war,
where firms are continuously cutting prices down. They instead compete
by creating a brand, providing customer service, discounts and coupons, and
product differentiation. However, bigger firms cut prices so low that the
smaller firms can’t compete. Bigger firms force smaller firms out of business.
Then the big firms raise their price up.

Due to these conflicts it is better to let the government to allocate the price in
the market as there will be uniform prices and conflicts between the sellers
will reduce.