As Prices Rise, Petrol Demand May Adjust Quicker Than Diesel

Consumption of petrol could adjust to the change in prices but diesel consumption is likely to remain high.

(Photo: iStock)

A litre of petrol now costs Rs 86.91 in Mumbai. Diesel costs Rs 75.96.

In Delhi, petrol costs Rs 79.51 a litre, while diesel costs Rs 71.55.

Fuel prices continue to trend from one record high to the next. Despite this, the demand for petrol and diesel has remained mostly inelastic, even though end-consumers are showing some sensitivity to the frequent changes in the price of petrol. Should this trend hold, consumption of petrol could adjust moderately to the change in prices but diesel consumption is likely to continue trending upwards, shows a data analysis by BloombergQuint.

RS Sharma, former managing director of ONGC, agreed with the analysis.

Elasticity in volume consumed is a factor of who bears the brunt of successive price hikes, Sharma said.

Demand for diesel is typically inelastic as most of the rise in price is borne by the end consumer and can be seen to directly impact inflation.

RS Sharma, Former Chairman And Managing Director, ONGC

“There is no such pass through in price of petrol, creating higher responsiveness in consumers to change in price,” he added.

Have Daily Price Changes Impacted Demand?

Petrol was deregulated in June 2010 and diesel in October 2014. Daily price revisions were introduced starting June 2017.

However, the move to daily price changes has not had any significant effect on the demand trends for petrol or diesel, according to analysis of data sourced from the Ministry of Petroleum and Natural Gas.

The Petroleum Analysis and Planning Cell publishes monthly figures for consumption of petrol and diesel. It also publishes the daily retail price of petrol and diesel in metropolitan cities. The average monthly retail price in Delhi was found for purpose of the analysis by BloombergQuint.

(Source: Petroleum Planning and Analysis cell)

The data shows that since the beginning of 2010-11, consumption of petrol has nearly doubled and diesel consumption rose by nearly one-third. Prices have risen from Rs. 38.1 to Rs 71.55 per litre for diesel and Rs. 47.93 to Rs 79.51 per litre for petrol from 1 April, 2010 until 6 April, 2018.

To arrive at the final result, elasticity of demand was computed on an annual basis since month-on-month figures are susceptible to changes from seasonality.

The analysis finally revealed that consumption of diesel is relatively inelastic to price.

In the current period between August 2017 and July 2018, the elasticity to price stood at 0.5. A number below 1 suggests inelasticity, while a number at or above 1 shows greater elasticity. In the case of petrol, elasticity stood at 1.1 in the August 2017 to July 2018 period.

Fuel consumption may prove to be relatively inelastic to small albeit frequent changes in prices, said Aditi Nayar, principal economist, ICRA, explaining the lack of any apparent impact of prices on consumption. Only a large increase in prices beyond a particular threshold could result in a change in consumption behaviour, Nayar said.

Dynamics Of Fuel Demand

Demand is largely inelastic and follows no trend in the short term of less than a year because of our day-to-day requirements and the fixed capital investments already made, said Kirit Parikh, head of the committee on pricing methodology for petroleum products in 2013.

However, over the medium term, there is greater elasticity as private and public investments are made after we take into account price changes, Parikh added.

However, in contrast to developed economies like the U.S., in a fast-growing economy like India, consumption of petroleum products is likely to show a continuous rise despite higher prices.

This is not surprising. Rising incomes, higher automobile sales, improving connectivity and lack of public transport mean that demand for personal automobiles is high and rising.

Higher growth also means stronger industrial activity, which ensures that demand for diesel remains strong.

These trends further intensify on an annual basis, concludes Tirthankar Patnaik, chief strategist and head of research at Mizuho Bank.

To be sure, it is possible to argue that demand growth for petroleum products would have been even stronger at lower prices. However, that counterfactual is tough to prove.

(This story was originally published on BloombergQuint and has been republished by The Quint with permission.)