HIKE IN FUEL PRICE AND ITS IMPACT ON

AUTOMOBILE INDUSTRY

POSTGRADUATE DIPLOMA IN MANAGEMENT

MICROECONOMICS
TERM: 1

GROUP NUMBER 8

SUBMITTED ON 09 SEPTEMBER 2016

NAME
1)
2)
3)
4)
5)
6)

REGISTRATION NUMBER

ARIJIT BRAHMA
DIPTANU DEB
MANISH GAURAV TIGGA
PRAJNASMITA DASH
SMRUTI SUDHA BHANJA
SUVAM SAHU

PGDM/2016-18/09
PGDM/2016-18/15
PGDM/2016-18/20
PGDM/2016-18/22
PGDM/2016-18/34
PGDM/2016-18/43

BACKGROUND

SIGNATURE

Efficient, reliable and competitively priced energy supplies are prerequisites for accelerating
economic growth. For any developing country, the strategy for energy development is an
integral part of the overall economic strategy. Efficient use of resources and long-term
sustainability remains core objective of economic planning. Sustainability would take into
account not only available natural resources and issues related to ecological balance but also
established delivery mechanisms, the technological constraints that are prevalent in the
system and immediate compulsion to meet the priority needs of the economy, economic
equity and self-reliance. Simultaneous and concurrent action is, therefore, necessary to ensure
that the short-term concerns do not detract the economy away from the long-term goals.
Realization of high economic growth aspirations by the country in the coming decades, calls
for rapid development of the energy market. The energy resources available indigenously are
limited and may not be sufficient in the long run to sustain the process of economic
development translating into increased energy import dependence. The base of the countrys
energy supply system is tilted towards fossil fuels, which are finite. This has serious longterm implications as the emerging patterns of energy consumption, which is heavily skewed
towards oil and gas, bring to focus many ecological and environmental issues.
India is and shall remain heavily dependent on coal for about half of its primary commercial
energy requirements with the other half being dominated by oil and gas put together. The
Indian hydro carbon industry is currently passing through a challenging phase. Increasing
concern for energy security, increasingly stringent environmental regulations, emergence of
natural gas and soaring crude oil and natural gas prices have thrown up both challenges and
opportunities to the Indian oil and gas industry.
Projected high domestic demand for fuel products is expected to push investments into the
refining sector. India, with 18 refineries, currently has a surplus refining capacity which has
placed India amongst net petroleum product exporter countries. Increasingly stringent fuel
specifications have put pressure on the old and non-compliant refineries to upgrade their
refinery configurations to produce compliant fuels. Exceptionally high fuel prices in the
international market and an almost stagnant domestic crude oil production has caused a drain
on countrys foreign exchange reserves. Besides augmenting domestic reserves, India has
successfully ventured overseas to acquire oil and gas assets and entered into long-term
Liquefied Natural Gas (LNG) contracts as measures for enhancing energy security.

Persistence of high fuel prices and dependence on imported fuel leaves India with some
difficult choices to make. The choice is between (a) passing on the price increase to the
consumer; (b) rationalizing taxes and other levies on petroleum products; and (c) making the
National Oil Companies (NOCs) bear the burden. Although the Government has resorted to a
combination of all above three options in the past, each of these options has its own
drawbacks. In the long-run, the only viable policy to deal with high international fuel prices is
to rationalize the tax burden on fuel products over time, remove anomaly, if any, in the
existing pricing mechanism, realize efficiency gains through competition at the refinery gate
and retail prices of petroleum products, and pass on the rest of the international oil price
increase to consumers, while compensating targeted groups below the poverty line as much as
possible. Major among them are the demands of competing consumer industries, ensuring
competition and open access in the pipeline transportation and distribution networks,
reducing the supply demand gap that exists today.
Energy is essential for living and vital for development. Affordable energy directly
contributes to reducing poverty, increasing productivity and improving quality of life.
Likewise lack of access to reliable energy is a severe impediment to sustainable social
development and economic growth. For any developing country, the strategy for energy
development is an integral part of the overall economic strategy. Efficient use of resources
and long-term sustainability remains core objective of economic planning. Sustainability
would take into account not only available natural resources and issues related to ecological
balance but also established delivery mechanisms, the technological constraints that are
prevalent in the system and immediate compulsion to meet the priority needs of the economy,
economic equity and self-reliance. Simultaneous and concurrent action is, therefore,
necessary to ensure that the short-term concerns do not detract the economy away from the
long-term goals.
There have been several changes in the Indian economy in recent times that have a direct
impact on the automobile industry. Fuel has become an indispensable part of our day-to-day
life, and we cant imagine our life without it. But the fuel prices are increasing day by day
and are eventually going to affect each and everything that we use in our day to day life. One
of those changes includes the reduction in fuel prices while other is the increase in excise
duty. Indian society has certainly taken a lot of relief from the reduction in the fuel pricing
even though the national drop has not matched the global fall. However, that only reduces the
cost of maintenance after buying a vehicle but the price for buying has now increased. Within

three years fuel price has increased ten times and is still increasing. It is nothing but adding
fuel to the fire. Fuel hike directly or indirectly affects all the major sectors like transportation,
textiles, auto, FMCG etc, for manufacturing & transportation.
World fuel consumption use is expected to grow from about 80 million barrels per day
(mbpd) in 2003 to 98 mbpd in 2015 and 118 mbpd in 2030 as per Energy Information
Administration (EIA), International Energy Outlook (IEO) 2006.
To meet the projected increase in world fuel demand, total petroleum supply in 2030 will
need to be 38 mbpd higher than the 2003 level of 80 mbpd. As per the same report India is
expected to consume additional 2.2 mbpd. OPEC producers are expected to provide 14.6
mbpd of the increase. Higher oil prices cause a substantial increase in non-OPEC oil
production23.7 mbpd, which represents 62 percent of the increase in total world oil
supplies over the projection period. In addition, unconventional resources (including bio
fuels, coal-to-liquids, and gas-to liquids) are expected to become more competitive.
Presently, about 45 per cent of primary commercial energy needs are met from oil and gas. Of
this, over 70 per cent of domestic oil consumption is imported mainly from Middle East.
Import dependence is likely to increase considering low accretion to domestic oil and gas
reserves. The case of India is not typical and several oil consuming countries face similar
situation. It is expected that global oil dependence on OPEC will continue to rise with
countries competing for scarce resources.
The automobile sector is a key player in the global and Indian economy. The Indian auto
industry is one of the largest in the world. Due to its deep forward and backward linkages
with several key segments of the economy, automotive industry has a strong multiplier effect
and acts as one of the drivers of economic growth. The well-developed Indian automotive
industry produces a wide variety of vehicles: passenger cars, light, medium and heavy
commercial vehicles, multi-utility vehicles such as jeeps, scooters, motor-cycles, mopeds,
three wheelers, tractors and other agricultural equipment etc. The industry accounts for 7.1
per cent of the country's Gross Domestic Product (GDP). Indias manufacture of 7.9 million
vehicles, including 1.3 million passenger cars, amounted to 2.4 per cent and 7 per cent,
respectively, of global production in number. The auto-components manufacturing sector is
another key player in the Indian automotive industry. In India, the automobile industry
provides direct employment to about 5 lakh persons. It contributes 4.7 per cent to Indias
GDP and 19 per cent to Indias indirect tax revenue.

Fuel prices remain an important determinant of global economic performance. Overall, an oilprice increase leads to a transfer of income from importing to exporting countries through a
shift in the terms of trade. The magnitude of the direct effect of a given price increase
depends on the share of the cost of oil in national income, the degree of dependence on
imported oil and the ability of end-users to reduce their consumption and switch away from
oil. It also depends on the extent to which gas prices rise in response to an oil-price increase,
the gas-intensity of the economy and the impact of higher prices on other forms of energy that
compete with or, in the case of electricity, are generated from oil and gas. Naturally, the
bigger the oil-price increase and the longer higher prices are sustained, the bigger the macro
economic impact. For net oil-exporting countries, a price increase directly increases real
national income through higher export earnings, though part of this gain would be later offset
by losses from lower demand for exports generally due to the economic recession suffered by
trading partners.
Adjustment effects, which result from real wage, price and structural rigidities in the
economy, add to the direct income effect. Higher oil prices lead to inflation increased input
costs, reduced non-oil demand and lower investment in net oil importing countries. Tax
revenues fall and the budget deficit increases, due to rigidities in government expenditure,
which drives interest rates up. Because of resistance to real declines in wages, an oil price
increase typically leads to upward pressure on nominal wage levels. Wage pressures together
with reduced demand tend to lead to higher unemployment, at least in the short term. These
effects are greater the more sudden and the more pronounced the price increase and are
magnified by the impact of higher prices on consumer and business confidence. An oil-price
increase also changes the balance of trade between countries and exchange rates. Net oilimporting countries normally experience deterioration in their balance of payments, putting
downward pressure on exchange rates. As a result, imports become more expensive and
exports less valuable, leading to a drop in real national income. Without a change in central
bank and government monetary policies, the dollar may tend to rise as oil-producing
countries demand for dollar-denominated international reserve assets grow. The economic
and energy-policy response to a combination of higher inflation, higher unemployment, lower
exchange rates and lower real output also affects the overall impact on the economy over the
longer term. Government policy cannot eliminate the adverse impacts described above but it
can minimize them. Similarly, inappropriate policies can worsen them. Overly monetary and
fiscal policies to contain inflationary pressures could exacerbate the recessionary income and

unemployment effects. On the other hand, expansionary monetary and fiscal policies may
simply delay the fall in real income necessitated by the increase in oil prices, stoke up
inflationary pressures and worsen the impact of higher prices in the long run.
While the general mechanism by which oil prices affect economic performance is generally
well understood, the precise dynamics and magnitude of these effects especially the
adjustments to the shift in the terms of trade are uncertain. Quantitative estimates of the
overall macroeconomic damage caused by past oil price shocks and the gains from the 1986
price collapse to the economies of oil importing countries vary substantially. This is partly
due to differences in the models used to examine the issue. Similarly, the boost to economic
growth in oil-exporting countries provided by higher oil prices in the past has always been
less than the loss of economic growth in importing countries, such that the net effect has
always been negative.
Higher oil prices, by affecting economic activity, corporate earnings and inflation, would also
have major implications for financial markets notably equity values, exchange rates and
government financing even, as assumed here, if there are no changes in monetary policies:
International capital market valuations of equity and debt in oil-importing countries would be
revised downwards and those in oil-exporting countries upwards. To the extent that the
creditworthiness of some importing countries that are already running large current account
deficits is called into question, there would be upward pressure on interest rates. Tighter
monetary policies to contain inflation would add to this pressure.
Currencies would adjust to changes in trade balances. Higher oil prices would lead to a rise in
the value of the US dollar, to the extent that oil exporters invest part of their windfall earnings
in US dollar dominated assets and that transactions demand for dollars, in which oil is priced,
increases. A stronger dollar would raise the cost of servicing the external debt of oil-importing
developing countries, as that debt is usually denominated in dollars, exacerbating the
economic damage caused by higher oil prices. It would also amplify the impact of higher oil
prices in pushing up the oil-import bill at least in the short-term, given the relatively low
price-elasticity of oil demand. Past oil shocks provoked debt-management crisis in many
developing countries.
Fiscal imbalances in oil-importing countries caused by lower income would be exacerbated in
those developing countries, like India and Indonesia that continue to provide direct subsidies
on oil products to protect poor households and domestic industry. The burden of subsidies

tends to grow as international prices rise, adding to the pressure on government budgets and
increasing political and social tensions.

STATEMENT OF THE PROBLEM

The global fuel price has been increasing in quite a big number now-a-days. This increase in
global fuel price will give wider impacts towards the sectors related to it, especially in
automobile sector. The price of the fuel has raise to a point where it threatens the growth and
development of the automobile sector.
Given the situation, increase of fuel price will lead to inflation and that means higher cost of
living. It literally increases the price of goods and services so that people have less savings on
their pocket. Unfortunately the group most affected by the increase of fuel price is the middle
class because of higher cost of living and also have maximum buying capacity and usability
share in the automobile industry whether we consider two-wheeler or four-wheeler.

Analysis
Each day approximately 84 million barrels of oil are extracted from the earth and
approximately the same amount is consumed. It can be no other way because of inventory
space is limited, and could not be extended significantly by excess production or indeed
drawn for long by excess demand. Global oil product demand is expected to rise 2.5% but
there is no simple supply number and demand number; there is only demand curve and a
supply curve. And the key to the point is Demand can never outstrip supply.
Microeconomics is the branch of economics that deals with the individual units of an
economy. Here for this case, we can infer the study of supply and demand inside a market is
known as microeconomics (This differs from macroeconomics which is the study of inflation,
unemployment etc.)
If we take a simplified market then it has a demand curve which looks like this:
30

25

20

Price

15

10

0
Demand

The x-axis of the demand curve is the price and y-axis is the demand. There is inverse
correlation between price and quantity demanded. If we pretend this for automobile market,
then, we can see that at lower price levels, people who could not previously afford can buy

them, and those families who have vehicle previously, will spend on a second. Demand varies
with price and the same is true for supply:
18
16
14
12
10

Price

8
6
4
2
0
Supply

If the price will rise so will be the supply. At first it is difficult to understand but we should
understand that supply is elastic, it does grow with price. In the short term higher automobile
prices encourage automobile factories to run on more shifts but longer term, higher prices will
feed into firms capital expenditure decisions: such as buying new machines or ancillaries.
If we put two curve together, the demand and the supply to understand a market:
25

20

15
Supply

Price
10

0
Quantity

Demand

The Market price is the point at which demand meets the supply. That is, there is a price level
where the level of demand is equal to the level of supply. In any normal market condition,
there cannot be enormous inventories of unsold products, or millions of people willing to pay
the prevailing market price and yet unable to do so. An excess of supply, or shortage thereof,
is merely another way of saying clearing price is moving and markets will clear.
The market for the fuel or oil is unusual because in the short term both demand and supply
are highly inelastic. Irrespective what fuel costs our vehicle cannot easily switch to another
fuel. For example ships or airplanes cannot move from diesel or kerosene for their propulsion.
So the result in the short term demand curve looks like this:

1200
1000

800

Price

600
400
200

0
Demand

In other words, a large change in price only has a small impact on demand. Supply of
conventional oil is also relatively inelastic, although for a different reason. The actual cost of
pumping a marginal barrel of oil is relatively low, once capital expenses of prospecting and
building an oil rig has been put in place. An oilfield will cost roughly the same to operate
whether it is producing 50% or full of its capacity. Once it came into operational the producer
will tend to pump at their maximum efficiency but these have costs and oil producers add
these costs unless the price of oil is very high.
As a result of this that the oil market is one where small changes to the supply or demand
curve cause large changes in price.

1200

1000

800
Supply
600

Demand

400

200

Example of change in price of the oil in 1970s

To understand better we have provided an example which is the best explanation of the above
stated theory. In 1973 when US announced support for Israel in Yom Kippur war, the newly
funded OPEC announced it would stop selling of the oil. Because OPEC supplied so much of
the worlds oil, this had effect of changing shape of the supply curve. In other words, for any
given price level there would be less oil supplied.

Supply
Demand -

Price

Quantity
As we can see from chart above, this restricting supply caused the violet supply curve to
move to the left, and as the market must clear, the prices rocketed high and this exactly
happen the price of Saudi oil jumped from $3 barrel in 1971 to almost $40 barrel by 1980.

Short term changes to supply and demand curve

It is not only the sellers in the sellers hand to control the price, When Hurricane Katrina
knocked out the production in the gulf of the Mexico it had similar effect; the supply curve
was shifted to left and prices rose.
The rise of emerging markets has also changed the supply and demand dynamics. Country
like India industrializing its emergent middle class buys cars, and then demand curve moves
to the right. For any given level of price, oil is demanded.

Supply
Demand -

Price

Quantity
As the chart above shows the exactly the same impact on the clearing price of oil as does
reducing supply; the price moves sharply.

Long term implications of supply and demand dynamics

In short term the oil demand and supply is inelastic but in long term it is elastic. Global events
does not cause any long term change in consumer behaviour but if long-term expectation for
oil price rise, then both demand and supply curves will shift.

Impact on Automobile Industry

Three fourth of Indias energy need is met through fossil fuel. According to International
Energy Agency, coal/peat accounts for 40 per cent of domestic energy consumption. Crude oil
and natural gas account for 24 per cent and 6 per cent respectively. Crude oil import to meet
domestic need is mounting by the year. At present almost 80 per cent of crude oil demand is
met through imports. Indias oil import bill accounts for almost one third of the total imports.
Almost 70 per cent of Indias total crude oil imports are from Middle East and North Africa
(MENA) region showing the countrys high reliance on the region for its crude oil needs.

The above data collected from ministry of petroleum, government of India showing import of
crude oil, quantity and average crude prices of last 8 years where we can clearly assess that
with reduction price quantity demanded is more.
The Indian economy imports about 80% of its oil requirements from international markets.
This makes the economy vulnerable to any increases in oil prices in the international markets.
However, the oil prices do not affect the economy homogenously. The services sector is far
less dependent on oil than the industrial sector. In fact, as most of the growth in the economy

is coming from the services sector, the economy and its performance is becoming less
vulnerable to oil price fluctuations. Another reason for the oil-price shocks not being fully
effective in India is the governments administered pricing policies of oil that diffused the
hikes by raising subsidy etc. The obvious shock periods are 1973 to 1974 and 1980, the two
shocks that sent the world into a recession. However, 1990 (the first Iraq war) and the period
around 1999 also show significant oil price hikes.
High inflation has brought down the car market forcing the car manufacturers to come up
with exciting offers to lure customers. But the offers didnt turn out to be successful because
consumers had their own perspectives.
92% of the prospective buyers have a belief that the fuel price will go down in another
three to four months and they wish to wait for their next purchase.
66% have switched over to public transport and quit driving.
87% consumers are in hunt for a fuel efficient car.
38% of the consumers are trading or selling their cars in return of something with
better fuel efficiency.
20% of the prospective buyers are happy driving their two-wheelers.
The list below is the total Petro-Products consumed in barrels per day in India. There may be
some discrepancy between the oil produced or imported and Petro-Products consumed. This
is mainly because of the omission of stock changes.
Petro-Products Production in India
The list below is the total Petro-Products consumed in MMT in India.
Consumption of Petro-Products
Year

(MMT)

% Growth

2003-04

107.751

2004-05

111.634

3.6

2005-06

113.213

1.41

2006-07

120.749

6.66

2007-08

128.946

6.79

2008-09

133.599

3.61

2009-10

137.808

3.15

2010-11

141.786

2.88

Apart from having a devastating effect on the Indian car industry, rising fuel prices have also
wound down the booming airline industry and affected the electric power plants of the
country. When the price of crude oil rises globally, it has a big impact on India and in
particular its automobile industry. India is the fourth biggest user of crude oil in the world,
importing three-quarters of it, at a huge cost. So when the price rises, there is an instant effect
on Indias economy.
A rise in price is transferred to the automobile industries in one of two ways. Either the price
of petrol increases or the government absorbs the price rise, leading to more subsidies to fuel
companies being paid, resulting in a greater fiscal deficit. In turn this indirectly generates a
rise in inflation, and restriction of growth. The other impact is more instantly tangible; the rise
in petrol prices. Even if the public do not abandon car ownership, perhaps because of fears
concerning the reliability of public transport, people are tempted to change to vehicles which
run more efficiently. This particularly affects automobile companies who create larger and
more powerful vehicles.

Conclusive Remarks
The sharp increase in the petrol price has created an alarming situation for the Automobile
Industry. It is witnessing a massive decline in the sale of petrol vehicles. The increasing prices
of petrol has not only adversely touched the life of the common man, but has created a
disturbing situation for the automobile industry itself. The continuous hike in the petrol prices
has cast a shadow on the development of the Automobile industry in India.
This acceleration in the petrol price has put a lot of strain on the demand of automobile cars
and has affected the general growth of the industry. This is the time when the Indian
automotive market is evolving as one of the upcoming consumer market in the world. The top
most automobile manufacturers around the world are keenly exploring the Indian market. The
steep hike in petrol prices has dampened their spirit.
The soaring fuel prices have affected the sales of the automobile cars negatively. The demand
for the luxury cars has receded. This frontal attack on the petrol prices has disappointed the
enthusiastic consumers quest for buying shining new cars. There is a lesser flow of new
consumers in the market. People, in general are hesitating to buy a new car due to the
increased expenditure being incurred on petrol. The consumer is left with fewer options and
ultimately will have to settle for a smaller car. The hike in petrol prices has greatly reduced
the foot traffic in The Automobile showrooms.
The rate hike has a detrimental effect on the consumers who at times have to avail car loans to
invest in a new car. High interest rates and hike in petrol prices are leading to major decline in
the sale sector of the automobile industry. The domestic petrol car sales are considerably
going down. The automobile manufacturers have to diversify now and completely focus on

manufacturing diesel vehicles. As a result, lot of extra expenditure has to be done on research
and in developing new technology for diesel and hybrid technology vehicles.
Volatility in fuel prices affects the growth of the automotive industry all over the world. The
effects of volatility in fuel prices are multipronged. Firstly, the cost of inputs in car
manufacturing increases with the increase in oil prices. Polymers, one of the inputs used in
manufacture of vehicles, are a derivative of crude oil. Bulk commodities, such as steel and
aluminium, are also used in manufacture of vehicles; the transportation cost of which is
influenced by oil prices. Secondly, the oil price has an impact on inflation, affecting the
saving and disposable income of the consumers, thereby affecting the demand for
automobiles. Thirdly, the fuel price influences the overall running cost of the vehicle owners;
there could be switch in demand among the vehicle variants, as also research in use of
alternative fuels. Thus, the volatility in oil prices affects the prospects of the industry.
One of the most important factors that decide the future of Indian economy is the price of
petroleum products. After all a small increase the price of this has got widespread impact on
the Indian Economy. If the price of petrol increases, it increases the transportation cost of
various products, thereby making the companies to increase the price of these products. This
causes inflation in the Indian market and the performance of the economy is affected. Strong
economic growth of India and other developing countries in Asia have increased the demand
of petrol and other related essential fuels, which has resulted in price hike of petrol in India.
The solution lies in finding an alternate source of energy.