Draining the price of oil

We all know the significant impact of oil prices on inflation in the economy, but have we considered what drives the price of oil globally? Through elementary economics, we understand that the demand and supply of oil in the global markets would determine the price daily, but it is not that straightforward. Oil is a very contentious and precious commodity. Every oil-producing nation has set a quota on oil production considering the geopolitical scenario before setting the limit. The supply of crude oil is heavily restricted to maintain the prices globally. OPEC(Organisation of Petroleum Exporting Countries) ensures that other countries follow the guidelines. OPEC does not interfere openly, but they have measures that ensure the sanctity of the production limit. Tensions rise with the discovery of crude oil reserves as countries vie for control, making oil prices extremely volatile if determined through just demand and supply interaction. Thus, the price discovery seems to be such that the producers become price takers rather than price setters.

The reversal of roles

Photo by American Petroleum Institute [1]

Let’s delve into the market. The oil market consists of producers, refiners, and consumers. The consumers we refer to comprise end-users, energy companies, and industrial units. The demand function thus includes various parameters that impact the consumer variables. To resolve such an indefinite demand pattern, the refinery may have a contract with the oil producer depending on the benchmark prices of oil. WTI is the benchmark for US oil prices, whereas Brent is the benchmark for international oil prices. Now, these benchmarks operate not only on the current demand but also try to capture the future demand through the trade of futures contracts. In the petroleum industry, dealers heavily rely on Futures due to the long production-to-delivery process and constant demand fluctuations. The future contract specifies the duration or the date of delivery of the commodity, price, the quality of the product, and other specific conditions for execution of the contract. The dealers use futures to secure them from the volatility risk, and at the same time, it assures the producers about the demand and the price they will get for the delivery. It is not a sure-shot measure to mitigate the risk.

Futures incorporate a significant cost, which is the cost of carry. Cost of carry includes risk of transportation, storage, and insurance. A recent incident from which we can learn is during COVID-19, futures of oil went negative. This phenomenon occurred due to the cost of carrying oil becoming so precarious that just releasing the inventory at a loss would prevent a massive failure.

The other major factor that impacts the price is shipping costs, especially in the Asian market where pipelines like the Nord Stream are not available, chartered ships supply the crude oil. Transporting freight comes with inherent risks that can add to the existing risk of fluctuating oil prices affecting their costs.

Do I pay the same?

As a consumer, it’s natural to wonder about the impact of crude oil prices on our daily lives. However, it’s important to understand that the Retail Selling Price (RSP) of petrol is influenced by multiple factors. To begin with, the average price of the Indian Basket crude oil is calculated every two weeks in dollars per barrel. This price is then converted to Indian rupees, taking into account the average exchange rate during that period. In addition, two different taxes, namely the Central Excise Duty (imposed by the Central Government) and the State VAT (Value Added Tax), are levied on the price charged to dealers. The Central Excise Duty is fixed at Rs 21.48 per litre of petrol, while the VAT rate varies from state to state. For example, in Delhi, the VAT percentage is 27%. After imposing the Central Excise, the dealer commission is added to the price. All these components are shifted to the end consumer. It’s worth noting that there may be slight variations in the price across states due to the different VAT rates. Additionally, the price may differ between pumps owned by different OMCs. However, these variations are primarily due to different margins and dealer commissions.

Thus even if crude may be selling at a low rate internationally, your local dealer may not be lowering the price.

Related questions

  • Who owns the most oil

Venezuela is currently the country with the largest proven oil reserves in the world, with an estimated 300 billion barrels of oil.[1]

  • Who is the largest exporter of oil?

Saudi Arabia has consistently been the world’s top oil exporter, with an estimated 11 million barrels per day (bpd) in 2023. The country has the largest oil reserves globally, and its oil production accounts for nearly a third of the global oil supply.[2]

  • Does India export oil?

India exported petroleum products worth $86.21 billion during the first 11 months of the current financial year ending March 2023, which accounts for more than 21 per cent of India’s total commodity exports.[3]

  • How many years of oil is left

The world has proven reserves equivalent to 46.6 times its annual consumption levels. This means it has about 47 years of oil left (at current consumption levels and excluding unproven reserves).[4]

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