So I was reading this article by Ajay Shah about administered pricing for petroleum. He does an excellent (though it gets a bit technical in terms of statistics) analysis about what could go wrong if the government were to free pricing of petroleum products. He mostly argues in favour of deregulation, and that is a view that I completely endorse.
One of the big fears about deregulation that he mentions is the fear that volatility in retail prices of petroleum products might increase, and he argues that this is a good thing and is much better than the government artificially hiding the prices and subjecting the junata to major price shocks once in a while. While I agree with him on this, I don’t think prices will change frequently in the first place.
While I was reading this article, I started thinking about the neighbourhood Sri Ganesh Fruit Juice (yeah there are a dozen of those in every neighbourhood in Bangalore) center. About how the guy keeps the price of orange juice constant throughout the year, despite the price and availability of oranges themselves fluctuating wildly across seasons. Yeah he might do minor adjustments such as changing the proportion of water but he can’t do too much of it since he needs to maintain quality.
The basic funda here is that customers want certainty. Every time they go to the shop for their fix of orange juice, they want certainty in the prices. Even if you are on an average cheaper, you will lose customers if your price is more volatile than your competitor’s. Of course there are occasions when you can’t help it and are forced to change your price – and on these occasions your competitors are also likely to do the same. But as far as possible, you try your best to decouple the price of orange juice from the price of orange which is pretty volatile.
Now I don’t know if the volatility in crude oil prices is more than the volatility in orange prices (it’s likely to be) but considering that oil companies are supposed to be more sophisticated than your neighbourhood juice shop guy, I would expect similar behaviour from them – of keeping retail prices of petroleum products as stable as they can. Of course they are likely to follow long-term trends but they are surely not going to pass on the short-time noise in prices to the customers.
So this fear of increase in volatility of retail prices is unfounded, assuming of course that the oil marketing companies are good businesspeople!
4 thoughts on “Orange Juice and Petrol”
Then I am sure you will have an explanation for why petrol price in US fluctuates on a daily basis. So much so that the first thing that you notice in front of any gas station is this huge board displaying that day’s price.
I guess it boils down to expectation. The Ganesh Fruit Juice centers have built up this expectation among their customer base that they will keep the juice price constant. Also, minor variations in price of juice become too complex to manage (Rs. 8.47 per glass?). So the prices have to be in round figures, that is why we don’t see too much fluctuation in those prices. There is no such restriction for petrol prices. You can keep changing the price per liter by a few paise without inconveniencing your customers.
the cost of oranges would not make up for a considerable percentage of fruit juice’s selling price .. Max twenty percent i guess .. Whereas for a petrol outlet the logistics , rent and labor cost make up a small percentage of his selling price and petrol the most thus forcing the petrol outlet guy to change the prices ..
one thing that both you and Ajay Shah have missed out is to consider correlation without considering degree of effect. It is true that crude and petrol prices have high correlation, but you need to distinguish between the two.
In Spain (where one of our investee companies is in the light distillates trade) crude contributes to ~25% of the pump price of petrol and diesel. The rest of it is taxes and other inputs such as labour and return on capital. The pump price in Madrid today is EUR 1.058 = Rs. 67.7. I would imagine the pump price of petrol today in India is not too different, which would lead me to conclude that crude contributes to only ~25% of the pump price in India as well. i.e. a 20% change in crude price leads to a 5% change in pump price of petrol – not the end of the world. So I don’t think India should worry too much about this, at least not more than necessary.
@ Mohan (in addition to SKimp)
Crude prices are more of a worry in countries like USA. The pump price in USA yesterday was 2.8 USD per american (not imperial) gallon, i.e. 0.739 USD per litre, i.e. Rs. 34 per litre. Which means crude contributes to ~50% of the pump prices in USA which explains why there is more fluctuation in pump prices in USA.
Just a housewife’s view – Consumers of orange juice can make do without, in case the prices fluctuate madly – consumers of petrol and petroleum products do not have any alternative. So the petrol companies will pass on all fluctuations (and more) to the consumer, while the fruit juice stall owner will go out of business very soon if he does that!