Volatility Pricing of Crude Oil and Its Respondent Factor

The pricing of crude oil in domestic monetary policy has always been efficacious in controlling or keeps in touch with the inflation. The immediate effects of inflation sparse on fuel and other convenient products in relation thereby disrupting monetary policy and often need for change to curb the effects. This present paper refers with world energy consumption for 2011 and India’s historical crude oil consumption. Volatility is measured by employing monthly standard deviation from 2007 to July 2012 and integrating crude oil, CPI to estimate the level of oil price. A study is proposed based on the secondary data. The outcomes of the analysis reveal that oil prices have a significant impact on both economic growth and inflation, when it is measured in local currencies. INTRODUCTION

Since the industrial revolution, the worlds’ appetite for energy from crude oil is at an escalating rate. The rise in prices of oil in the years is a worrying matter and contributed to the volatility of economics and proved its effects by disrupting the energy markets and jolting the responding factors hence a change in respondent is felt needed. Oil is a vital input in the production process of an economy from energy generation to manufacturing process and transporting the output to the market. Therefore volatility in oil prices disrupts the process of the economy from the dealers to the end users. Although industrialized developed countries seem to be more dependent on oil, evidence shows that the demand for oil in developing countries is on an increasing trend (Birol, 2007)- As oil is directly linked to the production process, it can have a significant impact on inflation, employment, and output for an oil price shock can increase inflation by increasing the cost of production (Loungani, 1986). It is always followed and considered effective that the pricing of crude oil in domestic monetary policy to controlling or keeps in touch with the inflation for crude being a primary commodity are always touted as inflation hedging.

The prices of crude oil in the international market have increased steeply. Considering the impact of the price increase on common man and economically vulnerable sections of the society, Government has not increased the domestic prices of sensitive petroleum products in line with international prices. Holding the price-line has taken its toll on public sector oil marketing companies. Oil Marketing Companies (OMCs) namely, Indian Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL), Bharat Petroleum Corporation (BPCL) and IBP Ltd, as a result have suffered losses. Et al. reports of the working group on petroleum and gas. One of the respondent factors affecting the economy with increase in price of crude oil is inflation.

Inflation is a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services. India imports about 80 % of its crude oil and the likely volatility price affects are at the optimum chance for unstable conductivity has always been negative impact on the domestic as well as international economy. The current inflation rate is at 6.75 in June which the monetary controller is on verge of reducing the interest rates to loosen the monetary tightening for growth is recorded to be slow. Past studies have provided contradicting findings with regard to the pricing of crude oil and its respondent factors that is inflation. Therefore there is a need to investigate between these two variables. REVIEW OF LITERATURE

In this contemporary time period energy has become so much part of our day to day life that we can’t derogate the usage of it though researchers are on the lookout for alternative fuel to replace the crude realm but because of certain deficient with cost and other related factors they have failed in their attempt to commercialize the alternative fuel and hence are on the lookout for sustainable change. Further oil price volatility have effects on the basic production input availability and investment costs (supply-side effects), on the terms of trade and wealth transfer from oil consumers to oil producers, on firms’ production structures and unemployment, on monetary policies, on interest rates and inflation, and on consumption opportunities, costs and consumer demand and confidence (demand-side effects), see Hamilton (1983) and Jones et al. (2004).

The findings of these studies are not homogenous, but numerous studies (Hamilton, 2003; Cuñadoand Pérez de Gracia, 2005; Balaz and Londarev, 2006; Gronwald, 2008; Cologni and Manera, 2008; Kilian, 2008; Álvarez et al., 2011) have reported negative effects of oil price fluctuations on economic activity for several net oil-importing developed and emerging countries. Oil price increase will lead to higher cost of productions, as oil is one of the most important production factors (Arouri & Nguyen 2010; Backus & Crucini 2000; Kim & Loungani 1992). The increase cost will be transferred to the consumers, which will, in turn, lead to lower demand and thus consumer spending, due to higher consumer prices; (references -2 –takashi kanamura) which further more is a factor to grim for from dealers to the end users.

In their survey article, Brown and Yucel (2002) provided detailed descriptions for the various reasons why changes in oil prices may be associated with changes in economic activity. They highlight four main channels. First, there is the supply-side effect in which a reduction in the availability of a basic input to production lowers the potential output. Second, the channel may arise from there being income transfers from the oil-importer to the oil exporter countries. Third, the relationship may result from a real balance effect. Fourth, monetary policy may lead to the observed relationship between economic activity and oil prices. However, Brown and Yucel (2002) contend that the supply-side channel best explains why rising oil prices are associated with a slow-down in the growth of output and more inflation.

Nowadays, the majority of the countries have turned the focus of their monetary policy on inflation stability putting an effort to the absorption of any shocks that could cause inflationary pressures – e.g. oil price shocks – (Bernanke et al. 1997; Blanchard & Gali 2007; Lescaroux & Mignon 2008). Furthermore, due to increased productivity, investments and renewable energy sources, firms are able to absorb increased production input costs without the need of price increases (International Energy Agency 2006). As Sadorsky (1999) suggests, changes in oil prices have an impact on economic activity, but changes in economic activity have little impact on oil prices.

He states that oil price volatility shocks have asymmetric effects on the economy and finds evidence of the importance of oil price movements when explaining movements in stock returns. (Sokolov, 2011) one can say that since the consumption of energy resources is closely connected with economic growth [1], then a forced reduction in energy consumption will lead to a decrease in the size of the global economy. Unless using the energy in efficient way is inducted. Although oil has never been one side affect for Andrei Gennadevich Korzhubaev notes that “oil is the energy resource with a global significance, while gas is primarily of regional significance, and coal is of local importance” However in this paper, base price of crude oil is taken from Indian Rupee denominated in dollar which being an oil importing country and the affects of price volatility of crude oil to its responding factor that is inflation. For there is a saying what gets measured gets managed. OBJECTIVES OF THE STUDY

1-To understand the importance of crude oil.
2-To know the volatility of price of crude oil.
3-To elucidate the importance of its inflation.
4-To know about the steps taken by government to adapt to change
5-To give suggestions based on the findings.

THE NEED OF THE STUDY
Despite the alarming rate of the usage of crude energy and the volatility of price of crude oil concerning the import of crude oil and its effect on the respondent factor that is inflation we have never got ourselves to cease its usage.We’ve reached at the stage where energy is accompanied in our basic needs, not to mention of other needs for extravagance. The increase in interest of researchers and energy companies to improve the volatility of crude oil has not succeeded in commercializing the domestic crude oil. The impact was little as to combat the less domestic crude oil production and hence depending heavily on the import of crude oil thereupon affecting the domestic energy market and economy for the cost of the volatility of price of crude oil with inflation responding along with it. Research methodology:

The type of research used is descriptive research and analytical in nature. Data collection:
* This study has been carried from secondary source of data which is collected through CMIE, CIA World Fact Book and data available from oil price official website. Data analysis: Et al takashi kanamura; the volatility in energy markets is not necessarily the same as the volatility in stock markets. For instance, the “inverse leverage effect”, i.e., volatility increases in prices, often appears in energy markets, while the analyses in stock markets illustrate the opposite relationship between the volatility and the prices.

Source: energy statistical yearbook 2012
Along with the developed countries it is pegged the developing countries need for crude oil comes in the forefront of setting their budget. The above table reveals that India is ranked third with a value of 759 as total energy consumption lead by United States with a value of 2225 which was lead by China again a developing country with total energy consumption value of 2648 and lagging just below Russia with total energy consumption of 725 value, Japan with 469, Germany seemingly following with 317value,Brazil with 268 value, Canada with 266 value, South Korea with 257 value and France with 257 value of total energy consumption in the year 2011. India’s historical crude oil consumption (thousand barrels) from 2000-2011 is on accelerating rate as in 2000 it amounts to 2127.438, 2001- 2183.73, 2002-2263.439, 2003- 2346.328, 2004- 2429.616, 2005- 2512.431, 2006- 2690.898, 2007-2800.754, 2008- 2907.647, 2009- 3007.989, 2010- 3116.222, 2011- 3292.215.

In 2002 India’s crude oil consumption rose to 2263.439 against 2183.73 which is 3% rise when Government dismantled the Administered Pricing Mechanism and resorted to issuing oil bonds to reduce loss in lieu of subsidies from 2009 .Inflation still persist in the coming years till 2008 when the recession brought down the oil prices and RBI’s attempt to tighten the monetary policy by hiking its key policy rates for the 13th time since 2010 projecting rise in fuel consumption to 4.9% up from 2.3 % in 2010-2011. Crude oil is the primary input for the cost and affect of a countries production. A sign of volatility will have the economy disrupted.

Because of which the economist have since the first oil price shock in the 1970’s, lagged in 1980’s and the latest price shock to hit the international economy was in 2008 rely on the crude oil price for indicia to keep in touch with the volatility of oil price for oil has never been a primary product of another countries. According to Andrei Gennadevich Korzhubaev notes that “oil is the energy resource with a global significance, while gas is primarily of regional significance, and coal is of local importance” Second objective: To know the volatility of price of crude oil Table- 2: Table showing crude oil price volatility in Mean , SD and CV during 2007 to 2012 (2nd quarter) Year | Mean | SD| Co-efft of Variation|

2007| 71.1275| 12.03409| 16.919|
2008| 97.035| 28.863791| 29.746|
2009| 61.77583333| 13.00562| 21.053|
2010| 79.03166667| 5.020286| 6.352|
2011| 104.0075| 6.16793| 5.93|
2012| 106.11 (2nd quarter)| 9.719268| 9.16|

From the Standard Deviation and Co-efficient of Variation it is inferred that 2008 and 2009 is more volatile but in the year 2010 and 2011 the prices have stabilized after monetary controlling to curb the inflation which has succeeded in keeping the inflation below 7%,data shown in the month of July 2012. (Inferred from table 3) Third objective: to elucidate the importance of inflation

Table- 3: Table showing WPI- All Commodities
| WPI-All Commodities|
Aug-11| 9.78|
Sep-11| 10.00|
Oct-11| 9.87|
Nov-11| 9.46|
Dec-11| 7.74|
Jan-12| 7.23|
Feb-12| 7.56|
Mar-12| 7.69|
Apr-12| 7.50|
May-12| 7.55|
Jun-12| 7.25|
Jul-12| 6.87|

Inflation is said to persist when too much importance is given on purchasing few goods indicating a loss in the value of money. India having exceeding and accelerating demand of crude oil than its capacity to produce in the domestic market have put the economy in the forefront of inflation. The above table showing the India’s WPI inflation from August 2011 to July 2012 shows volatility in the economy surfaced with variability in the inflation. Year 2011 has been quoted as the highest recent inflation recorded with the international market crumbling of debt market which started in Euro zone followed by geo-political tensions in Iran. Which even a threat alone has effect on the oil prices as Iran is one of the major oil exporter among OPEC. But however this years’ July inflation is recorded at 6.87% which is the lowest since 2009 have fuelled hope in the domestic economy for the trade-offs as in Phillips Curve assumed haven’t worked for Indian economy for prevailing high inflation, interest rates and policy inaction with the euro zone debt crisis. According to Cunado and Gracia (2005) examined the impact of oil price shocks on economic activities and inflation in six Asian countries, namely Japan, Singapore, South Korea, Malaysia, Thailand, and the Philippines.

Using quarterly data from 1975Q1 to 2000Q2 they find that oil prices have a significant impact on both economic growth and inflation, and this result is more significant when oil price is measured in local currencies. Fourth objective: to know about the steps taken by the government to adapt to change The volatility of price of crude oil has adverse effects on the government from balance of payment, budget surplus or deficit if the government wants to subsidize the domestic oil price from the international market prices to reduce the effect of the volatility. The Government has enunciated the principle of equitable burden sharing to cushion the impact of high international oil prices on domestic retail selling prices. Thus all stakeholders viz. the Government, oil companies including the upstream PSUs and consumers share the burden of price increase equitably. * Indian Government from 2002 dismantled the Administered Pricing Mechanism (APM) as a free market pricing. While petrol prices have been deregulated since June 2010, prices of diesel, LPG and PDS kerosene are still regulated to insulate consumers against high global crude oil prices.

* On the recommendation of the Prime Minister, an Inter Ministerial Group (IMG), chaired by the Chief Economic Adviser, Ministry of Finance was constituted on 2nd February 2011 to review overall inflation. * RBI has raised its policy rates 13 times to contain aggregate demand to soften inflation. In April 2012 RBI has cut the repo rate by 50 basis points to 8 per cent . Fifth objective: to give suggestions based on findings.

With the crude oil price volatility that has been prevailing in the market for quite long the researcher suggest for; 1. Import of crude oil diversity can be best to minimize the risk and; 2. Finding ways to use the energy efficiently thereby succeeding in change management. SUMMARY

The objective of this study was to infer the price volatility of crude oil in the domestic market, to understand the importance of its respondent factor that is inflation and what the monetary policy have done to curb the inflation. In the overall analysis it was observed that pricing of crude oil has as much as interrelated affects with its other respondent economic factors such as inflation then to just individual affects. CONCLUSION

From the above analysis the researcher concludes that with regard to the volatility of crude oil and its disruptive, harmful affect from the dealers to the end users with regard of the inflation as a factor and to curb these effects energy diversification is prudent to adapt to change and hence efficiency pass-through will prevail in change management. Furthermore the realistic approach to curb the inflation lies in identifying all the factors causing for the price rise.

References:

Cabedo, J. David & Moya Ismael. (2003). Estimating oil price ‘Value at Risk’ using the historical simulation approach. Energy Economic, 25, 239-253. Durai S.R.S & Ramachandran, M. (2007). Core inflation for India. Journal of Asian Economics, 18, 365-383 Ewing, T. Bradley & Thompson, A. Mark. (2007). Dynamic cyclical co movements of oil prices with industrial production, consumer prices, unemployment, and stock prices. Energy Policy 35, 5535-5540 Rafig, Shuddhasawtta, Salim, Ruhul, & Bloch, Harry. (2009). Impact of crude oil price volatility on economic activities: An empirical investigation in the Thai economy. Resource Policy 34, 121-132 Siregar, Y. R. & Goo, Siwei. (2010). Effectiveness and commitment to inflation targeting policy: Evidence from Indonesia and Thailand. Journal of Asian Economics 21, 113-128

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