The fuel crisis

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Was spike in demand the major reason for the crisis?

 

As fuel across the country dried up, the natural inclination was to pin blame on the incumbents. The general sentiment would like to see some heads roll within the government, in addition to bureaucrats, however powerful they may be, but politicians because the population feels a greater sense of ownership of political power and hence a greater need to see that power holding itself responsible.

It seems that the minister for petroleum has finally accepted that his domain extends to the provision of petrol to the citizens of Pakistan. This realisation, although late and surprising for the minister himself, has prompted him to accept blame for the current crisis. That the government was caught so completely off guard as the crisis unfolded does not come as a surprise. Flailing, choking, and falling, only to unapologetically get up to repeat the whole exercise in institutional clumsiness on another day, another event.

Out of this choking came a number of responses from the government regarding factors that caused and precipitated the crisis. The response was essentially binary in nature, where two issues were important. First was the boiling over of PSO’s cash flow caused by the circular debt issue, resulting in PSO being unable to honour its import liabilities. This led its suppliers to cut off its oil and break the supply chain. The shutting of an oil refinery comes up now and then but no one seems to take that as the defining point of the crisis’.

Oil is mostly used in machines that are hard to replace in the short term, which is why despite spikes and dips in the price of oil, demand remains stubbornly consistent

The other explanation revolves around an unexpected increase in demand caused by the lowering of petrol prices in October 2014. From October 2014 as of now, the price of oil and related products has gone down by nearly a third. The tenets of supply/demand would suggest an increase in oil consumption, the lending the government’s claim some credibility. However, every good has a unique set of economic characteristics related to supply and demand. Does the fall in price denote a similar rise in demand? Should a price fall of 30 percent result in demand rising by a similar 30 percent? Given the nature of oil and its uses, the percentage demand for oil will rise by less than the percentage price, an economic concept known as price elasticity of demand.

Oil is mostly used in machines that are hard to replace in the short term, which is why despite spikes and dips in the price of oil, demand remains stubbornly consistent. Change in demand only occurs in the long run when people and corporations have enough time to replace their machines with more fuel efficient ones or vice versa. You’ll replace your old car for a new one only after a number of years and certainly not as a monthly response to a change in oil prices.

For most countries, the short term elasticity of oil is less than one, meaning that for each percent change in price, the percent change in demand will be less than one percent. Research conducted by economists at the MIT suggests a price elasticity for oil between the range of -0.034 to -0.077, meaning that a one percent reduction in prices will increase demand by between 0.034 and 0.077 percent. For Pakistan, little research has been conducted on the subject but conjecture would suggest an elasticity that is even lower than the US, since there is a lack of alternatives for transportation, thus resulting in demand being more rigid.

Going by the price elasticity mechanism, the sustained demand for petrol cannot have gone up by more than three percent. Perhaps the explanation lies in the fact that people are still buying petrol according to the same denominations as before. Where once a thousand rupees got you around nine liters in June, the same amount gets you around 12 liters now. In effect, people could have been building up inventories since the decline in oil prices, resulting in an unexpected surge in demand. In this case, demand should settle down back near pre-crash levels.

Going by the price elasticity mechanism, the sustained demand for petrol cannot have gone up by more than three percent

Unlike the scenario above, for demand to sustain our behaviours related to consumption must change to enable demand to stay put at a higher level. The increased demand for hybrid vehicles in recent years was a consequence of higher petrol prices. Similarly, the surge in CNG (Compressed Natural Gas) can also be attributed to higher petrol prices. In both cases, it took consumers some years before they invested in these technologies to counter the higher fuel prices.

The same mechanisms will be at play when prices fall. It will take consumers some time before they acclimatise their consumption patterns to lower petrol prices by perhaps buying less fuel efficient non-hybrid vehicles, driving more kilometers and preferring to live in suburban areas rather than city centers.

Changes at a behavioural level take time and the four month window since prices began falling is certainly not enough for us to attribute the crisis to this phenomenon. That consumers were building inventories through buying the same rupee value of petrol before could be one reason for a spike in demand.

While the spike in demand could have caused the issue to precipitate the fact that the crisis is still not over, yet is first and foremost a governance issue, a candid peak into the incumbent’s style of overly-centralised management of government and its contingent inefficiencies and incompetence.