A STUDY OF THE IMPACT OF CRUDE OIL PRICES ON

INDIAN ECONOMY

Thesis Submitted to the Padmashree Dr. D. Y. Patil

University, Department of Business Management
in partial fulfillment of the requirements
for the award of the Degree of

DOCTOR OF PHILOSOPHY
In
BUSINESS MANAGEMENT

Submitted by
PANKAJ BHATTACHARJEE
(Enrollment No. DYP-PhD 076100001)

Research Guide
Prof. (Dr.) R. K. SRIVASTAVA

PADMASHREE DR. D.Y. PATIL UNIVERSITY,

DEPARTMENT OF BUSINESS MANAGEMENT,
Sector 4, Plot No. 10,
CBD Belapur, Navi Mumbai – 400 614.
India.
June 2013
A STUDY OF THE IMPACT OF CRUDE OIL PRICES ON
INDIAN ECONOMY

i
 DECLARATION
I hereby declare that the thesis entitled “A STUDY OF THE IMPACT OF CRUDE
OIL PRICES ON INDIAN ECONOMY” submitted for the award of Doctor of
Philosophy in Business Management at the Padmashree Dr. D.Y.Patil University,
Department of Business Management is my original work and the thesis has not
formed the basis for the award of any degree, associateship, fellowship or any
other similar titles.

Place: Navi Mumbai, India.

Date:

Dr. R. Gopal. Dr. R. K. Srivastava Pankaj Bhattacharjee

(Head of the Department) (Research Guide) (Research Scholar)

ii
 CERTIFICATE
This is to certify that the thesis entitled “A STUDY OF THE IMPACT OF CRUDE
OIL PRICES ON INDIAN ECONOMY ” has submitted by Pankaj Bhattacharjee
is a bonafide research work for the award of the Doctor of Philosophy in
Business Management at the Padmashree Dr. D.Y.Patil University, Department
of Business Management in partial fulfillment of the requirements for the award of
the Degree of Doctor of Philosophy in Business Management and that the
thesis has not formed the basis for the award previously of any degree, diploma,
associateship, fellowship or any other similar title of any University or Institution.
Also certified that, the thesis represents an independent work on the part of the
candidate.

Place: Navi Mumbai,

Date:

Dr. R. Gopal Dr. R. K. Srivastava

(Head of the Department) (Research Guide)

iii
 ACKNOWLEDGEMENT
I am greatly indebted to the Padmashree Dr. D.Y. Patil University, Department of
Business Management which has accepted me for the Doctoral Program and I
also thank Dr. R.Gopal, Head of the Department and Director for providing me
with an excellent opportunity and support to carry out the present research work.

I am grateful to my guide, mentor, philosopher Dr. R. K. Srivastava for having

guided me throughout the research span of time and for providing his
constructive criticism which made me bring my best. I would also like to thank sir
for being there at any point of time without considering his own precious time.

I would also like to thank all my senior ONGCians whose varied ideas and
valuable suggestions have helped immensely in completion of my project and
Dr.Sachin Deshmukh for having supported me throughout the study.

I sincerely thank my mother, mother in-law and my wife for providing me the
necessary motivation for completing this dream project work. I hereby take this
unique opportunity to thank my son Priyanshu for his moral support. I also wish
to place on record my sincere thanks to my revered deity, my late father and late
father in-law who have provided me with the strength and ability to carry this
research out of the best of my ability.

Lastly I also wish to thank all my near and dear ones who have been directly and
indirectly instrumental in the completion of my dissertation.

Place: Navi Mumbai

Date: (Pankaj Bhattacharjee)

iv
 CONTENTS
CHAPTER PAGE NO.
TITLE
NO.
List of Tables
List of Figures
List of Abbreviations
EXECUTIVE SUMMARY
1.0 Introduction 1
1.1 Hydrocarbons 1
1.2 Global Primary Energy Consumption 2
1.3 Properties of Fossil fuels 7
1.4 Character of the deposits of fossil fuels 8
2.0. Literature Review 10-16
2.1. Gap Analysis 16-17
3.0. Statement of the Problem 18-19
3.1. Objectives of the Study 20
3.2. Hypotheses 20
3.3. Defining Variable for the Study 21
3.4 Operational Definition of variables 22
1. Crude Oil Price 22
2. Inflation 23
3. GDP growth 23-24
4.0. Research Methodology 25
4.1. Conceptual Framework 25
4.2. Research Design 26
4.3. Sources of Data 26
4.4. Sample Size and Justification 27
4.5. Econometrics Modeling for the Hypotheses. 28-32
5.0 Global Oil Scenario 33

v
 CONTENTS
CHAPTER TITLE PAGE NO.
NO.
5.1 Classification of Crudes 36
5.2 Structure of Industry and Global Oil Production 39
5.3 Global Oil Consumption 43
5.4. Indian Scenario 48
1. Pre Independence period (1886-1947) 48
2. Post-Independence period (1947-1960) 48
3. Mixed Economy Period (1961-1991) 50
4. Economic Liberalization Period 1991 51
5. Post Liberalization Period 51
5.4.1 Crude Oil and Natural Gas Production in India 52
5.4.2. Refining Capacity and Production 54
5.4.3 Production and Consumption of Petroleum Products 55
5.5. Oil Pricing 58
5.5.1. Historical Aspects 60
5.5.2. History of Oil Price 61
5.5.3. The Seven Sister (1928-1947) 62
5.5.4. The Seven Sister (1947-1971) 63
5.5.5. OPEC set Prices(1971-1986) 64
5.5.6. Development of Market Structure and Type of 65
transactions.
5.5.7. Supply Side –Issues of Peak Oil. 68
5.5.8. Comparative Study and Analysis of Global Oil 69
Reserves
1. Amount of Oil 69
2. Quality of Oil 72
3. Geographical Distribution 72

vi
 CONTENTS
CHAPTER TITLE PAGE NO.
NO.
4. Field-by-Field Analysis 73
5.5.8(a). Demand Analysis; Changing Composition of Global 74
Demand.
5.5.8(b). Consumption Analysis; Changing Pattern of Global 75
Consumption
5.6. Global Oil Demand Projections 78
5.6.1. Production: Non OPEC Supply. 78
5.6.2. Growing Dependence on OPEC 80
5.6.3. Implications of Dependence on OPEC. 81
5.6.4 Supply Issue: Need to offset Production Decline. 82
5.6.5 Impact of Price Elasticity 82
5.6.6 Implication for Oil Prices. 83
5.7. Oil Sector and Energy Development in India. 85
5.7.1. Imports and Prices of Crude Oil. 87
5.7.2. Imports and Exports of Petroleum Products 89
5.7.3. Crude Oil Demand Projection for India. 91
5.8 Role of Crude Oil Prices on Indian Economy. 93
5.8.1 Rise in cost of Imports 93
5.8.2 Widening of Trade Deficit 93
5.8.3 Increase in Oil Under Recoveries 94
5.8.4 Mounting Fuel Subsidy Burden 94
5.8.5 Worsening Fiscal Deficit 94
5.8.6 Reduced Amount For Infrastructure Investment. 94
6.0. Policy Framework for Oil Sector in India. 95
6.1. Institutional Framework. 95
6.2. Upstream Sector. 96
6.3. Intensifying Exploration 98

vii
 CONTENTS
CHAPTER PAGE NO.
TITLE
NO.
6.3.1. History of Pre-NELP Licensing Rounds 99
6.3.2. First Round of Exploration(1980) 100
6.3.3. Second Round of Exploration(1982) 102
6.3.4. Third Round of Exploration(1986) 102
6.3.5. Fourth Round of Exploration(1991) 103
6.3.6. First Development Round(1992) 103
6.3.7. Fifth & Sixth Round of Exploration/ Second 104
Development Round/ First Speculative Survey
Round(1993)
6.3.8. Seventh & Eighth Round of Exploration/ Second 105
Speculative Survey Round(1994)
6.3.9(a) Exploration Rounds 106
6.3.9(b) Analysis of Foreign Investments in Exploration 109
Rounds
6.3.9(c) Speculative Survey Rounds 112
6.3.9(d) Analysis of Foreign Investments in Speculative 113
Survey Rounds
6.3.9(e) Development Round 114
6.3.9(f) Analysis of Foreign Investment in Development 115
Rounds
6.4. New Exploration License Policy (NELP). 117
6.5. NELP Bidding Round 124
6.5.1 NELP-I 124
6.5.1.1. Analysis of Foreign Investment under NELP-I 125
6.5.2 NELP-II 125
6.5.2.1 Analysis of Foreign Investment under NELP-II 126
6.5.3. NELP-III 127

viii
 CONTENTS
CHAPTER PAGE NO.
TITLE
NO.
6.5.3.1 Analysis of Foreign Investment under NELP-III 127
6.5.4 NELP-IV 128
6.5.4.1. Analysis of Foreign Investment under NELP-IV 129
6.5.5. NELP-V 130
6.5.5.1 Analysis of Foreign Investment under NELP-V 131
6.5.6 NELP-VI 131
6.5.7 NELP-VII 132
6.5.8 NELP-VIII 132
6.5.9 NELP-IX 132
6.6. Downstream Sector (Refineries in India) 133
6.7. Policy Framework 136
6.7.1. Product Imbalance 139
6.7.2. The Regulated Era 141
6.7.3. Changing face of Industry: The reform process. 143
6.7.4. Rangarajan Committee Recommendations 148
6.7.5. Chaturvedi Committee Recommendations 149
7.0. Crude Oil Price and Commodity Market 152
7.1. Crude Oil & Petroleum Products 153
7.2. Benchmark Crude 154
7.3. & 7.3(a) Crude transactions , Barter deal 157
7.4. Cargo transactions 157
7.5.; 7.6 Long term Contract ; Price formula 158
7.7. Netback Pricing 159
7.8. Refining Margins 160
7.9. Spot & Future Markets 162
7.9.1; 7.9.2. Spot Market, Forward Market 164-166

ix
 CONTENTS
CHAPTER
TITLE PAGE NO.
NO.
7.9.3. Futures Market & Option Market 167
7.9.4. Analysis of International Crude Oil Prices. 167
8.0 Data Analysis, Interpretations and Model 170
Estimations
8.1 Karl Pearson’s correlation coefficient 170
8.2 Model 1, ( WPI and Crude oil price) 177
8.2.1 The test of Significance of estimated parameters 181
8.2.2 The test of Goodness of Fit, the coefficient of
187
Determination
8.2.3 Analysis of Variance 192
8.3. Model 2, (GDP growth and Inflation) 201
8.3.1 Two variable regression analysis 202
8.3.2 Calculation of standard Error of coefficient 204
8.3.3 ; 8.3.4 “t-test” and Confidence Interval for b1. 205-206
8.3.5 F- test. 207
8.3.6 Calculation of coefficient of Determination 208
8.4 Multivariable regression analysis 212
8.4.1 Test of Multicollinearity 214
8.5 Durbin Watson statistics 219
8.6 Stationarity in time series data 221-236
8.7 Model 3, (Ganger’s causality test) 236-237
8.8 Model 4 (Ganger’s causality test) 237-238
8.9 Model 5 239-242
9.0. Results and Discussion. 243
9.1 Hypothesis 1 243
9.2. Hypothesis 2 245

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 CONTENTS
CHAPTER
TITLE PAGE NO.
NO.
9.2.1. Multivariable Linear Regression Model. 247
9.2.2. Run Test. 248
9.2.3. Test of Multicollinearity 249
9.3. Hypothesis 3 250
9.4. Hypothesis 4 253-254
9.5. Hypothesis 5 255-256
10.0. Summary of Hypotheses, Econometrics and 257-259
Statistical Tools Used and Results.
11.0. Conclusion 260-262
12.0 Managerial Implications 263-267
13.0 Acquisition Dynamics and Vertical Integration 268
13.1 Framework for an acquisition 268
13.2 Policy Environment of India 269
13.3 Target Evaluation 270
13.4 Target Valuation 271
13.5 Due Diligence 272
13.5.1 Conducting due diligence 272
13.5.2 Buyer’s due diligence 272
13.5.3 Limiting due diligence 272
13.5.4 Seller’s due diligence 273
13.5.5 Importance of due diligence report 273-274
13.6 Vertical Integration 275-276
14.0 Limitation of the Study and Future Scope of
277
Research.
References 278-283
Appendix- I (Plots and Diagrams) 284-297

xi
 LIST OF TABLES
TABLE NO TITLE OF PAGE NO.
TABLE
1.0. Primary Energy Consumption by Fuel 4-6
5.0. Distribution and Growth in world proved oil reserves 33-35
5.2. Global Oil Production 40-42
5.3. Global Oil Consumption 43-45
5.3(a) World Crude oil Import and Export data 46-47
5.4.1. Crude Oil and Natural Gas Production in India. 53
5.4.2. Refining Capacity and Production 55
5.4.3. Production and Consumption (indigenous sales) of
56
petroleum products
5.5.8. Estimates of Oil Reserves ( Trillions of Barrels) 71
5.5.8(a). Global Oil Consumption by Region ( Million Barrels
76-77
per day)
5.5.8(b). Changes in demand by Region.( Million Barrels per
77
day)
5.6.1. Non-OPEC production ( Million Barrels per day) 79
5.6.2. Growing dependence on OPEC (Million Barrels per
80
day)
5.6.6. Estimated needs for New Oil Production Capacity.
84
(Million Barrels per day).
5.7. Comparative data of crude oil demand, domestic
87
production and Crude Import.
5.7.1. Imports of crude oil and Average Crude Oil Prices 88
5.7.2. Imports and Exports of Petroleum Products 90
5.7.3. A summary of the projections of Crude Oil Demand 92
for India by various agencies
5.8.2. Widening of Trade Deficit 93

xii
 LIST OF TABLES
TABLE NO TITLE OF PAGE NO.
TABLE
6.3.9(a) Block offered under Pre NELP Exploration Rounds 109
6.3.9(f) Analysis of Foreign Investment in Development
116
rounds
6.4(a). Royalty payment on ad-valorem basis under NELP. 120
6.4(b) Major differences between Earlier Rounds of
121-122
bidding for Exploration blocks and NELP.
6.6. Refineries in India 133-136
7.9.3 Characteristics of Spot/ Forward / Future/ Option
167
Deals.
8.1 Data for Karl Pearson’s correlation coefficient 171-174
8.2 Two variable regression data (WPI &Crude oil price) 178-181
8.2.1 Calculation of Standard error of coefficient 183-186
8.2.2 Calculation of coefficient of Determination 188-191
8.2.4 Interpretation of Regression Model Summary 194
8.2.5 ANOVA table 194
8.2.6 Regression coefficient table 195
8.2.7 Log natural transformation data(WPI & Crude price) 196-199
8.3 Two variable data for correlation(GDP growth and
201
inflation )
8.3.1 Two variable regression analysis 202-203
8.3.2 Calculation of Standard error of coefficient 204
8.3.6 Calculation of coefficient of Determination 208-209
8.3.7 Model Summary 209
8.3.8 ANOVA table 209
8.3.9 Coefficient table 210
8.3.10 Log natural transformation data (GDP growth & 210-211
Inflation)

xiii
 LIST OF TABLES
TABLE NO TITLE OF PAGE NO.
TABLE
8.4.1 Test of Multicollinearity 214
8.4.2 Multivariable regression analysis 215-217
8.4.3 Probability output data 219
8.5.1 Residual data for D W statistics calculation 220
8.6.1 Logarithmic transformation GDP growth data 223
8.6.2 ACF and PACF 224
8.6.3 Variance and Covariance for inflation 226
8.6.3.1 ACF & PACF for Inflation 227
8.6.4 ACF& PACF for first order difference Inflation series 228
8.6.5. Variance & Covariance for Crude oil price change 230
8.6.5.1 ACF and PACF for Crude oil price change 231
8.6.6 ; 8.6.7 ANOVA for Unit root tests time series data 233-234
8.6.8 ANOVA for ADF test for Inflation 234
8.6.9 ANOVA for Unit root test Crude oil price change 235
8.9 Industries Data for regression 240-241
8.9.1 Log natural converted data 241-242
9.1. Results of Regression Analysis, Hypothesis1. 243
9.2. Results of Regression Analysis, Hypothesis2. 245
9.2.1 Results of Multivariable (Three Variable) Linear
247
Regression Analysis
9.2.3 Test of Multicollinearity; auxiliary regression results 249
9.3.0 Results of Stationarity Test of Time Series data. 252
9.3.1 Results of Granger’s Causality Test. 253
9.4.0 Results of Granger’s Causality Test. 254
9.5.0 Results of Regression 255
10.0. Summary of Hypotheses, Econometrics and 257-259
Statistical Tools Used with Result

xiv
 LIST OF FIGURES
FIGURE TITLE PAGE NO.
NO.
1.0. Global Primary Energy Consumption 3
5.4.1. Percentage Growth in Crude oil and Natural Gas 54
Production
5.4.3. Percentage Growth in Production and Consumption 57
of Petroleum Products.
5.7.1. Percentage Growth in Imports of Crude oil and 89
average International Crude oil prices.
5.7.2. Percentage Growth in Imports and Exports of 91
Petroleum Products.
7.9.4 Plot of International Crude Oil Prices 169
8.2 Scatter Plot between WPI and Crude oil price 175
8.2.1 Fitting of Regression line (WPI and Crude oil price) 176
8.3 Scatter plot ( Quarterly GDP growth & Inflation with 202
Fitting line)
8.4 Plot of Inflation and Crude oil price change rate 212
8.6.2.1 ACF plot for time series GDP growth 224
8.6.2.2 PACF plot for time series GDP growth 225
8.6.3.2 ACF plot for time series Inflation 227
8.6.3.4 PACF plot for time series Inflation 228
8.6.4.1 ACF and PACF plots for first difference time series 229
Inflation
8.6.5.1 ACF plot for time series Crude oil price change rate 231
8.6.5.2 PACF plot for time series Crude oil price change 232
rate
ACF plot for time series Crude oil price change rate
A.I - 1.0 Bar diagram of Crude Oil Prices ( Indian Basket) 284
A.I - 2.0 Plot of Indian Crude Basket Price and WPI 285

xv
 LIST OF FIGURES
FIGURE TITLE PAGE NO.
NO.
A.I. – 3.0 Plot of GDP Growth, WPI and Crude Price 286
A.I. – 4.0 Plot of Prices of different grades, API crudes 287
A.I. – 5.0 Plot of Crude oil Consumption and Production of 288
India
A.I. – 6.0 Plot of GDP Growth, Inflation and Crude Price 289
A.I. – 7.0 Scatter Plot of GDP Growth, WPI and Crude oil 290
price change in percent
A.I. – 8.0 Line diagram of GDP growth, WPI & Crude oil price 291
change rate
A.I. – 9.0 A plot of Quarterly GDP Growth and Quarterly 292
Inflation rate
A.I –10.0 A plot of Quarterly Inflation rate and Quarterly 293
Crude oil price rate change
A.I. – 11.0 Plot of GDP growth , inflation & crude oil price 294
change rate
A.I. – 12.0 Oil production by Region at the end of 2011 (Mtoe) 295
A.I. – 13.0 Oil Production Outlook 2030 by Region (Mtoe) 296
A.I. – 14.0 Future Crude Oil Consumption in Million tonnes by 297
Regions

xvi
 LIST OF ABBREVIATIONS

ABV Accreditation in Business Valuation

ACF Auto correlation function
ADF Augmented Dickey-Fuller
AIC Akaike Information Criteria
AOC Assam Oil Company
API American Petroleum Institute
APM Administered Price control Mechanism
ARTC Assam Railway and Trading Company
BAU Business as Usual.
BCS Best Case Scenario
BEE Bureau of Energy Efficiency
BOC Burma Oil Company
BP British Petroleum
BPE Bureau of Public Enterprises
BPCL Bharat Petroleum Corporation Limited
CCEA Cabinet Committee on Economic Affairs
CCGT Combined Cycle Gas Turbine
CO2 Carbon di-oxide
CSO Central Statistical Organization
C&AG Comptroller and Auditor General
CVC Central Vigilance Commission
CS Conditional Subsequent
DD Due diligence
DGH Director General of Hydrocarbons
EIA Energy Information Administration
FCC Fluid Catalytic Cracking
FOB Free On Board or Freight On Board.
FOREX Foreign Exchange

xvii
 LIST OF ABBREVIATIONS

GHG Green House Gases

GJ/t Gigajoules per tons
GJ/m3 Gigajoules per cubic meter
GOI Government of India
HOG High Output Growth
HPCL Hindustan Petroleum Corporation Limited
IEA International Energy Agency
IHV India Hydrocarbon Vision
IOCL Indian Oil Corporation Ltd
IMF International Monetary Fund
IPE International Petroleum Exchange
IRAC Imported Refiner Acquisition Cost
IRADe Integrated Research and Action for Development
JVEP Joint Venture Exploration Program
JVSSR Joint Venture Speculative Survey Round
LNG Liquefied Natural Gas
MBD or mbd Million Barrels per day (MB/d)
MJ/m3 Mega joules per cubic meter
MOP&NG Ministry of Petroleum and Natural Gas.
Mt Million tons
Mtoe Million tons of oil equivalent
MRPL Mangalore Refinery and Petrochemicals Limited
NELP New Exploration Licensing Policy
NOC National Oil Company
NYMEX New York Mercantile Exchange
OECD Organization for Economic Co-operation and Development
OIL Oil India Limited
ONGD Oil and Natural Gas Directorate

xviii
 LIST OF ABBREVIATIONS

ONGC Oil and Natural Gas Corporation Ltd

OPEC Organization of the Petroleum Exporting Countries ( Originally 13
members countries they are Algeria, Angola, Ecuador, Gabon,
Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United
Arab Emirates, Venezuela. Gabon terminated its membership in
1995.
OTC Over The Counter
PACF Partial Auto correlation function
PAD Project Appraisal Department
PIB Public Investment Board
PEL Petroleum Exploration License
PPAC Petroleum Planning and Analysis Cell.
PSE Public Sector Enterprise
PwC Price Waterhouse Cooper
R&D Research and Development
RFO Residual Fuel Oil.
SEBI Securities and Exchange Board of India
SIC Schwarz Information Criteria
Seven Anglo-Persian Oil Company( now BP); Gulf Oil; Standard Oil of
Sisters California(SoCal);Texaco(now Chevron);Royal Dutch Shell;
Standard Oil Company of New Jersey(Esso);Standard Oil
Company of New York(Socony) now(Exxon Mobil)
UNCITRAL United Nations Commission on International Law
URT Unit Root Test
USGS United States Geological Survey
VIF Variance Inflation Factor
WB World Bank
WTI West Texas Intermediate

xix
 EXECUTIVE SUMMARY
Energy is the prime mover of economic growth and is vital to the sustenance of a
modern economy. Future economic growth crucially depends on the long-term
availability of energy from sources that are affordable, accessible and
environmentally friendly.

Efficient, reliable and competitively priced energy supplies are prerequisites for
accelerating economic growth. For any developing country, the strategy to obtain
and meet the energy requirements and energy developments are the integral
part of the overall economic strategy. Efficient use of resources and long-term
sustainability in its utilization is of prime importance for economic development.
Sustainability would take into account not only available natural resources but
also to take care of the related ecological and social aspects to meet the priority
needs of the economy. Simultaneous and concurrent action is, therefore,
necessary to ensure that the short-term concerns do not detract the economy
away from the long-term goals.

Realisation of high economic growth aspirations by the country in the coming

decades, calls for rapid development of the energy market. The energy
resources available indigenously are limited and may not be sufficient in the long
run to sustain the process of economic development translating into increased
energy import dependence. The base of the country’s energy supply system is
tilted towards fossil fuels, which are finite.

India meets nearly 35 per cent of its total energy requirements through imports.
With the increase in share of hydrocarbons in the energy supply/use, this share
of imported energy is expected to increase. The challenge, therefore, is to secure
adequate energy supplies at the least possible cost. Although growth of the
energy sector is moderate and has, to some extent, served the country’s social
needs, it has put tremendous pressure on the Government’s budget. Energy is
essential for living and vital for development. Affordable energy directly
contributes to reducing poverty, increasing productivity and improving quality of

xx
life. In UK, households that spend less than 10% of their income on heating their
homes are officially stated to suffer from fuel poverty. In case of India, there is no
such identification; as a result, some poor do not have access to minimum
energy resources and its utilization for the quality life. Likewise lack of access to
reliable energy is a severe impediment to sustainable social development and
economic growth.

There are major disparities in the levels of consumption of energy across the
world with some countries using large quantities per capita and others being
deprived of any sources of modern energy forms. Energy supply has become a
subject of major universal concern. Volatile oil prices threats to stable energy
supply and energy security.

World primary energy consumption is 12274.6 Mtoe (Million tonnes of oil

equivalent) in 2011, the primary energy consumption varies with availability and
specific utilities of different types of fuels with the various pie, oil: 33.06%; natural
gas: 23.67%; coal: 30.34 %: nuclear energy: 4.88%; hydroelectricity: 6.45%;
renewable: 1.59%. China leads the order of absolute primary energy
consumption with 21.29%, followed by US 18.49%, Russian Federation comes
third with 5.59%, then comes India in Fourth with 4.55%.

Global Oil Scenario:-Crude oil is not distributed uniformly around the globe.
Some regions and countries are well endowed, while others are not. Most of the
proven reserves of conventional oil are to be found in Middle East Countries,
namely, Iran, Iraq, Kuwait, Saudi Arabia and the United Arab Emirates (UAE),
similarly, conventional gas is located primarily in Russia and other Former Soviet
Union (FSU) countries, Iran, Qatar and Saudi Arabia.

The most important aspects of oil business are the locations of production and
the refineries. Oil produced close to major market for refining will require less
transportation and therefore will be more attractive and command a premium
over oil produced further from the market and which has to incur large

xxi
transportation costs to get to the market, but the analysts have focused on two
key qualities of crude oil, namely, the API gravity and sulphur content to explain
inter crude price differentials. Crude oil is considered light, if it has low density or
heavy if it has high density and it may be referred to as sweet if it contains
relatively little sulphur or sour if it contains substantial amounts of sulphur.

The global proven oil reserve is estimated to 1652.6 billion barrels by the end of
2011 as per BP. Almost 48.1% of the proven oil reserves are in Middle East. The
Saudi Arabia has the second largest share of the reserves with 16.1%, whereas
Venezuela ranks first in terms share of reserves with 17.9% and S & Cent
America’s proven reserve of 19.7%.

Global oil production by region varies due to heterogeneous distribution of crude

oil reserves. Global oil production is 3995.6 Mtoe in 2011, i.e. 83.57MB/day
basis. The highest crude producing region is Middle East 32.6%, then Europe
and Eurosia 21%, followed by North America with16.8% , Africa, Asia Pacific
and South and Central America are 10.4%, 9.7% and 9.5% respectively; Country
wise, Saudi Arabia in the highest producer 13.2%, then Russia Federation ranks
second with 12.8%, US ranks third 8.8% followed by Iran 5.2%, China 5.1%,
Canada 4.3%, UAE 3.8%, Mexico 3.6%, Venezuela 3.5% and Kuwait 3.5%
respectively.

Global oil consumption varies from region to region and country to country,
depending upon population, income and total spread of the economy. On region
wise, Asia pacific region is the highest consumers of oil with 32.4% of total share,
then North America 25.3%, followed by Europe and Eurasia 22.1%, Middle East
9.1%; and Africa with 3.9%.

Global oil consumption is 4059.1 Mtoe in 2011 i.e 88.03 MB/day basis. Among
the countries US ranks first in terms of share of crude oil consumption and it is

xxii
20.5% of global consumption followed by China 11.4%, Japan 5.0%, India 4.0%,
Russia Federation 3.4%, Saudi Arabia 3.1%, Brazil 3.0% and Iran 2.1%.

Global oil consumption grew by a below average 0.6million bbls per day or 0.7%
to reach 88.03 million bbls per day. Projected global oil consumption is expected
to register a below average growth over the present levels. Oil is expected to be
the slowest-growing fuel over the next 20 years. Recently published BP energy
reports project incremental demand of liquid fuel about 16 million barrels per day
(Mb/d) exceeding 103 Mb/d in 2030. Growth comes exclusively from rapidly-
growing non-OECD economies. China (+8 Mb/d), India (+3.5 Mb/d) and the
Middle East (+4 Mb/d) together account for nearly all of the net global increase,
Non-OPEC (Organisation of Petroleum Exporting Countries) production, though
showing an upward trend, will not be sufficient to service this incremental
demand emphasising, once again, the continued dependence of the world on
OPEC oil for its energy requirements.

Global oil demand is projected to increase from 86MB/day in 2010 to an

estimated 93.3 MB/day in 2015 and an estimated 107.9 MB/day in 2030 based
on the projection made by US department of energy (2011). Again, as per British
Petroleum(BP) estimate June 2012, the estimated projection of demand of crude
oil at the end of 2030 is 103MB/day, with a view that US and the developed
economy is reducing the consumption of oil and switching over to efficient,
renewable and green energy.

The fuel mix changes slowly, due to long gestation periods and asset lifetimes.
Gas and non-fossil fuels gain share at the expense of coal and oil. The fastest
growing fuels are renewables (including biofuels) which are expected to grow at
8.2% p.a. 2010-30, among fossil fuels, gas grows the fastest (2.1% p.a.), oil the
slowest (0.7% p.a.), as per BP statistical Review, June 2012.OECD total energy
consumption is virtually flat, but there are significant shifts in the fuel mix.
Renewables displace oil in transport and coal in power generation; gas gains at

xxiii
the expense of coal in power. These shifts are driven by a combination of relative
fuel prices, technological innovation and policy interventions. The economic
development of non-OECD countries creates an appetite for energy that can only
be met by expanding all fuels. For many developing countries the imperative
remains securing affordable energy to underpin economic development.

The growth of global energy consumption is increasingly being met by non-fossil

fuels. Renewables, nuclear and hydro together account for 34% of the growth;
this aggregate non-fossil contribution is, for the first time, larger than the
contribution of any single fossil fuel. Renewables on their own contribute more to
world energy growth than oil. The largest single fuel contribution comes from gas,
which meets 31% of the projected growth in global energy.

India ranks fourth in the world in total energy consumption and needs to
accelerate the development of the sector to meet its growth aspirations. The
country, though rich in coal and abundantly endowed with renewable energy in
the form of solar, wind, hydro and bio-energy has very small hydrocarbon
reserves (1.0% of the world’s reserve). India, like many other developing
countries, is a net importer of energy; more than 76 percent of crude oil is being
met through imports. The rising oil import bill ( i.e.140 billion US dollar in 2011-
12) has been the focus of serious concerns due to the pressure it has placed on
scarce foreign exchange resources and is also largely responsible for energy
supply shortages. The sub-optimal consumption of commercial energy adversely
affects the productive sectors, which in turn hampers economic growth.

India’s primary energy mix at the end of 2011 is containing 43.49% of oil, 23.03%
of natural gas, 29.67% coal, 1.30% nuclear energy, 2.35% hydroelectricity and
1.44% renewables. The total primary energy consumption is 559.1 Mtoe (million
tonnes of oil equivalent). India’s burgeoning economy and population of over 1.2
billion has created exceptionally high demand of primary energy. Among the
primary fuels, the fossil fuels are particularly oil and gas dominating and total

xxiv
accounts 66.52% of primary fuels. Currently, transportation fuel accounts for
around 50% of domestic oil consumption, with other major users including
agriculture, industry and power generation. Diesel run electricity generators have
also become increasingly common due to the nations unreliable power supply.
As a result, demand for oil has rapidly increased over the last decades. India is
now the world’s fourth largest oil consumer and the world’s fifth largest oil
importer, as per the BP Statistics Review of World Energy.

Currently India import around 76% to 80% of its oil demand, with this percentage
showing little sign of cooling. It is predicted that the nation’s oil needs would rise
40% by 2020 and the need has only become more acute in recent years. It is
vital for the nation’s energy security that India needs to increase domestic
production and also increase energy efficiency. Increased domestic oil
production would not only make the country more energy secure, it would also
offer significant macroeconomic benefits too.

India is potentially sitting on significant hydrocarbon resources, but reduced

exploration activities means their size and scope has yet to be properly
determined. This is compounded by a lack of encouragement at national level for
a more proactive approach to exploration, which has undermined India’s E&P
sector.

In 2011, India’s proven balance of recoverable reserves was reported at 9.04

billion barrels of oil equivalent, placing the country in an unimpressive 19 th
position worldwide. However, according to a 2012 report by India’s Directorate
General of Hydrocarbons – the regulatory body charged with the promotion and
management of India’s oil and gas resources – in the financial year 2010-2011,
12% of India’s sedimentary basins remain unexplored, with a further 22%
classed as “ poorly explored”. In the near future, production from India’s
underdeveloped onshore and offshore fields is set to increase, as these are yet
to realise their full potential.

xxv
High oil prices have prompted increased investments in the Exploration and
Production (E&P) sector posing new challenges for the sector in the form of
increased cost of operations due to high service costs, exposure to logistically
difficult terrain and shortage of technical manpower. Global refining scenario
indicates very little to negligible addition in capacities in major developed
consuming markets like the USA and the European countries. Developing
countries like the Middle East, China and India are fast emerging as refining
hubs. Needless to say that capacity augmentation in these regions would also
result into possible integration of both the refining and petrochemicals business.

Energy imports are also currently hindering the nation’s economy. The
Government of India currently spends billions of dollars on non-targeted
subsidies, which the IEA claims the nation can ill afford. During the financial year
2011-2012, 54% of India’s trade deficit – which stood at US$189.9 billion –, was
due to oil imports. Because of such a high deficit, the rupee weakened, inflation
soared and there was a drawdown of almost US$13 billion in India’s foreign
exchange reserves. According to PwC report, these events could have been
avoided had India produced an additional 17 million tonnes of oil domestically.
(Source: White paper by Price water house Coopers (PwC), titled “It’s our turn
now –E&P partnerships for India’s Energy Security”). This increase in India’s
domestic production would arrest currency depreciation, contain Inflation and
reduce import bill – resulting higher GDP.

The past decade has seen an unprecedented rise in crude oil prices on the world
oil market. The prices of Brent & WTI (West Texas Intermediate) – the leading
benchmark types of crude crossed $30 per bbl in the early 2004. From then,
crude oil prices increased continuously and touched at $145.29 per bbl on
beginning of July 2008 and then settling at lower level below $40 per bbl by
December 2008, thereafter oil prices oscillating and making the crude oil prices
volatile. The price volatility of crude ranges from $40 to $80 per bbl, during 2009,
$78 to $90 per bbl and $90 to $111.78 are during 2010 and 2011 respectively
and making the world oil market more and more volatile. This volatility and the

xxvi
rising trend of crude oil prices in international markets are sending shockwaves
across the world.

It is indeed difficult to predict what will happen to oil prices over a five year period
but current assessments indicate that oil prices will remain high. This will exert
downward pressure on the economy. India meets nearly 76 percent of its total
crude oil requirements through imports. With the increase in share of
hydrocarbons in the energy supply/use, this share of imported energy is
expected to increase. The challenge, therefore, is to secure adequate energy
supplies at the least possible cost, to meet the country’s social needs; otherwise
high crude oil price will put tremendous pressure on the Government’s budget.

The existing scenario of oil consumption and production of world indicates that
there is more demand for than supply of crude oil in general, except a few
developed economy, for the developing country like India in particular reveals
that the country is able to meet 24% of crude oil requirement and the rests 76%
are to be meet through import. Therefore, there are sometimes demand driven
price rise otherwise price rise due to supply disruption. Under such
circumstances it is very much essential to study the impact of crude oil price on
the inflation and economic growth of our country.

Several researchers have studied the various aspects of Indian economy at

different period of time due to change in crude oil prices. The review of literature
does not reflect the exact impact of crude oil prices on Indian Economy after the
second phase of economic liberalization. Therefore, it is required to understand
the dynamics of petroleum economics and management of crude oil and
petroleum business for the growth of Indian economy.

The objectives of study were:

1. To study and formulate the impact of crude oil prices on the whole sale price
index of Indian economy.

xxvii
2. To study the waves of inflation rate (consumer price index) due to change in
crude oil prices on the GDP growth of Indian economy

3. To examine and understand the direction of causality and to search and

ascertain the causal relation and linkage between differential change rate of
crude oil prices and Inflation , also between inflation vis-à-vis GDP growth of
Indian economy.

4. To study the impact of energy price relative to the productivity of capital and
labor of Indian industries based on the past data.

Methodology adopted:

The research has econometric and analytical areas of research. The econometric
and analytical study of the research has uses secondary data. The source of the
data has been taken from primary reports and publications of varies bodies of the
Ministry of Petroleum and Natural Gas and Government of India; public sector
undertaking annual reports. Economic Data has been collected from the
economic survey (2010-11); Reserve Bank of India data and CSO data. The data
of inflation rate (consumer price index) is collected from the trading economics
data and the Indian basket Price of Crude oil data has been collected from
Petroleum Planning and Analysis Cell (PPAC). Data of world oil has been taken
from British Petroleum (BP) statistics in addition to Journals and periodicals
reliable constitutional and company publications. Historical perspective of Indian
petroleum industry from 1857 has been chronologically brought out to follow the
growth and development of the oil industry especially after 1956 under the public
sector in various phases both in exploration & production and refining by the
Government of India both pre and post liberalization period, also after the
abolition of administered price control mechanism and the resultant data
emanating from the evolution has been considered as a source of this research.

xxviii
Findings of the Study:

1. Our study showed that crude oil price plays a significant role in rising the
Whole sale price index (WPI); crude oil prices have positive impact on Whole
sale price index (WPI), our double log regression model shows that the
crude oil price elasticity of inflation 0.27 and Karl Pearson Coefficient is
positively correlated.

2. Our study showed that “The role of inflation is significant in declining GDP
growth of Indian economy”, Karl Pearson Co-efficient between Inflation and
GDP growth is negatively correlated, the inflation elasticity of GDP growth in
the double log regression model is –0.245, which indicates that increase of
Inflation retards GDP growth.

3. Our multiple regression analysis (GDP growth, Inflation rate and Crude oil
price change rate) estimates that the quarterly crude oil price change
elasticity of GDP growth and quarterly inflation elasticity of GDP growth are
0.01 and -0.21 respectively.

4. On Grangers causality test, our findings are –

(i) “Crude oil price rate change Granger causes Inflation rate” again
“Inflation Granger Causes the crude oil price rate change”. It is
bidirectional causality.
(ii) “Inflation does not Granger cause GDP growth”, it is uni-directional
causality. But, GDP growth Granger causes Inflation.

5. On application of “Cobb Douglas Model”, our finding is –

“A rise in the price of energy relative to output leads to decline in the

productivity of existing capital and labor.” That is with the increase of energy

xxix
 or fuel price relative the derived output leads to diminish the productivity of
existing capital and labour.”

Recommendations

1. Increasing domestic production by attracting investments, both private and

public in the upstream sector through investor friendly E&P investment regime.
To increase foreign investment, the Indian government must first introduce
reforms that encourage foreign and private investor for its trusted international
partners to leverage their skills, expertise and technological capabilities.

2. Taking all steps to increase the production from NOC’s (National Oil
Companies) assets including their maturing field.

3. Equipping domestic refining industry both existing and planned to successfully

meet the quality of producing fuels complying with prescribed environment
friendly specifications for export hub of petroleum products to earn foreign
exchange.

4. Encouraging energy conservation through campaigns aimed at sensitizing the

people about the significance of efficient use of energy.

5. Towards Energy Security: As India’s economy continues to grow, so will its

need for energy security. By adopting various strategies for nonconventional and
green energy and also alternative forms of energy in the form of renewable
energy and nuclear power as a diversification to ensure energy security

Challenges in the nation’s hydrocarbon sector do exist. Yet, they are not
insurmountable. Increased domestic production and investment in nation’s E&P
sector will not only ease worries about India’s future energy security, but also
reduce the nation’s trade deficit and rejuvenate the rupee on international foreign
exchange market.

********

xxx
 Chapter-1
Introduction
Oil is a magic word that always makes news. There is hardly a nation that does
not seek this indispensable natural resource. A country that already possesses
crude oil wants more. They struggle to explore it at almost any cost. The
common man does not know much about this strange „mineral oil‟ although in
almost every country he bears the burden of the cost of exploration of oil or its
import.

Oil or Petroleum is defined in a variety of ways by geologists, chemists, refiners,

engineers and lawyers. There is, therefore, no uniformity or full agreement.
Since, it is a natural product forming a part of rocks, geological definition finds
more general acceptance.

The word petroleum is derived from two Latin words petra means rock and oleum
means oil. Petroleum is loosely called „rock oil‟ or „crude oil‟. It is a generic term
covering a wide range of substances comprising hydrocarbons, which are
naturally occurring molecules of carbon and hydrogen.

1.1. Hydrocarbons

Crude oil is a complex mixture of a large number of organic compounds that vary
in appearance and composition from one oil field to another. Crude oil is
classified as paraffinic, naphthenic, aromatic or asphaltic based on the
predominant proportion of hydrocarbon series molecules which dictate their
physical and chemical properties. Theories vary regarding the origin of crude oil
though the general consensus is that most of the deposits have resulted from the
burial and transformation of biomass over geological periods during the last 200
million years or so. In terms of quantities, therefore, the total amount of oil and
gas residing in the earth‟s subsurface is certainly finite. While it is recognized
that some of these resources have yet to be found, there is considerable
uncertainty about the magnitude of the “undiscovered resources”. The most

1
widely used estimates of total amounts of crude oil to be found in the earth‟s
subsurface are those of the US Geological Survey 2000, 2007, 2009 and IEA,
2004 which deals primarily with conventional Oil and Gas. There is no universally
agreed definition of what is meant by conventional oil or gas, as opposed to
nonconventional. Roughly speaking, any source of hydrocarbons that requires
production technologies significantly different from mainstream in currently
exploited reservoirs is described as non-conventional.

1.2. Global Primary Energy Consumption

The global primary energy consumption at the end of 2011 is equivalent to

12274.6 Million tonnes oil equivalent. The share of oil is the largest at 4059.1
Million tones oil equivalent; i.e. oil : 33.06%; followed by coal: 30.34 %, natural
gas: 23.67%; hydroelectricity: 6.45%; nuclear energy: 4.88%; renewable: 1.59%
respectively. The demand for natural gas in future will increase as industrialized
countries take strong action to cut CO2 emissions.

World primary energy consumption is projected to grow by 1.6% p.a. over the
period 2010 to 2030, adding 39% to global consumption by 2030. The growth
rate has declined from 2.5% p.a. over the past decade, to 2.0% p.a. over the next
decade, and 1.3% p.a. from 2020 to 2030. Almost all (96%) of the growth is in
non-OECD countries. By 2030 non-OECD energy consumption is 69% above the
2010 level, with growth averaging 2.7% p.a. (or 1.6% p.a. per capita), and it
accounts for 65% of world consumption (compared to 54% in 2010). OECD
energy consumption in 2030 is just 4% higher than in 2010, with growth
averaging 0.2% p.a. to 2030. OECD energy consumption per capita is on a
declining trend (-0.2% p.a. 2010-30).

The International Energy Agency (IEA) defines energy security primarily in terms
of stable supplies of oil and natural gas. A broader definition of energy resource
portfolio and supply of energy services for the desired level of services that will

2
sustain economic growth and poverty reduction. Energy security covers many
concerns linking energy, economic growth, environment and geopolitics.

Figure 1.0.Global Primary Energy Consumption

Hydro- Renewables
electricity 1.59%
6.45%

Nuclear 4.88%

Oil 33.06% Oil

Gas
Coal
Nuclear
Coal 30.34%
Hydro-electricity
Renewables

Gas 23.67%

Source: BP Statistical Review of World Energy June-2012.

The above figure shows the breakup of various constituents of primary energy
consumption (Million tonnes of oil equivalent, Mtoe) worldwide.

The primary energy consumptions of various countries and regions of the world
are shown in table 1.0. It may be seen that India‟s absolute primary energy
consumption is only 4.55% of the world, 21.29% China‟s, 18.49% USA‟s, 3.89%
Japan‟s consumption.

3
 Table 1.0. Primary Energy Consumption by fuel

Consumption by fuel*
Million
tonnes oil Natural Nuclear Hydro Renew- 2011
equivalent Oil gas Coal energy electricity ables Total

US 833.6 626.0 501.9 188.2 74.3 45.3 2269.3

Canada 103.1 94.3 21.8 21.4 85.2 4.4 330.3
Mexico 89.7 62.0 9.9 2.3 8.1 1.8 173.7
Total North
America 1026.4 782.4 533.7 211.9 167.6 51.4 2773.3

Argentina 28.1 41.9 1.1 1.4 9.0 0.4 81.9

Brazil 120.7 24.0 13.9 3.5 97.2 7.5 266.9
Chile 15.2 4.7 5.3 - 4.7 1.0 30.9
Colombia 11.7 8.1 4.3 - 10.9 0.2 35.1
Ecuador 10.5 0.4 - - 2.2 0.1 13.2
Peru 9.2 5.6 0.8 - 4.9 0.1 20.7
Trinidad &
Tobago 1.7 19.8 - - - ^ 21.5
Venezuela 38.3 29.8 2.0 - 18.9 - 89.1
Other S. &
Cent.
America 53.7 4.7 2.4 - 20.4 2.0 83.3
Total S. &
Cent.
America 289.1 139.1 29.8 4.9 168.2 11.3 642.5

Austria 12.5 8.5 2.5 - 6.9 1.6 32.0

Azerbaijan 3.6 7.3 ^ - 0.6 ^ 11.5
Belarus 9.0 16.5 ^ - ^ ^ 25.5
Belgium 33.7 14.4 2.1 10.9 ^ 2.1 63.3
Bulgaria 3.5 2.6 8.4 3.7 0.6 0.3 19.2
Czech
Republic 9.1 7.6 19.2 6.4 0.6 1.1 44.0
Denmark 8.3 3.8 3.2 - ^ 3.4 18.7
Finland 10.5 3.2 3.3 5.3 2.8 2.6 27.7
France 82.9 36.3 9.0 100.0 10.3 4.3 242.9
Germany 111.5 65.3 77.6 24.4 4.4 23.2 306.4
Greece 17.2 4.1 7.3 - 1.0 0.9 30.5
Hungary 6.5 9.1 2.7 3.5 0.1 0.7 22.6
Republic of
Ireland 6.8 4.2 1.3 - 0.2 1.1 13.6
Italy 71.1 64.2 15.4 - 10.1 7.7 168.5
Kazakhstan 10.2 8.3 30.2 - 1.8 - 50.5
Lithuania 2.7 3.1 0.2 - 0.2 0.1 6.4
Netherlands 50.1 34.3 7.8 0.9 ^ 2.7 95.8

4
Norway 11.1 3.6 0.6 - 27.6 0.4 43.4
Poland 26.3 13.8 59.8 - 0.6 2.2 102.8
Portugal 11.6 4.6 2.6 - 2.8 2.8 24.4
Romania 9.0 12.5 7.1 2.7 3.4 0.2 34.8
Russian
Federation 136.0 382.1 90.9 39.2 37.3 0.1 685.6
Slovakia 3.7 5.6 3.3 3.4 0.9 0.1 17.1
Spain 69.5 28.9 14.9 13.0 6.9 12.7 145.9
Sweden 14.5 1.1 2.0 13.8 15.0 4.1 50.5
Switzerland 11.0 2.6 0.1 6.1 7.4 0.3 27.6
Turkey 32.0 41.2 32.4 - 11.8 1.3 118.8
Turkmenistan 4.9 22.5 - - ^ - 27.4
Ukraine 12.9 48.3 42.4 20.4 2.4 ^ 126.4
United
Kingdom 71.6 72.2 30.8 15.6 1.3 6.6 198.2
Uzbekistan 4.4 44.2 1.3 - 2.3 - 52.2
Other Europe
& Eurasia 30.3 14.9 20.8 2.0 19.7 1.4 89.1
Total Europe
& Eurasia 898.2 991.0 499.2 271.5 179.1 84.3 2923.4

Iran 87.0 138.0 0.8 ^ 2.7 0.1 228.6

Israel 11.1 4.5 7.9 - - ^ 23.5
Kuwait 19.0 14.6 - - - - 33.6
Qatar 8.0 21.4 - - - - 29.4
Saudi Arabia 127.8 89.3 - - - - 217.1
United Arab
Emirates 30.5 56.6 - - - ^ 87.2
Other Middle
East 87.5 38.4 - - 2.3 ^ 128.1
Total Middle
East 371.0 362.8 8.7 ^ 5.0 0.1 747.5

Algeria 15.6 25.2 - - 0.1 - 40.9

Egypt 33.7 44.7 0.9 - 3.1 0.3 82.6
South Africa 26.2 3.8 92.9 2.9 0.4 0.1 126.3
Other Africa 82.9 25.1 6.0 - 19.8 0.9 134.7
Total Africa 158.3 98.8 99.8 2.9 23.5 1.3 384.5

Australia 45.9 23.0 49.8 - 2.4 2.2 123.3

Bangladesh 5.0 17.9 1.0 - 0.3 ^ 24.3
China 461.8 117.6 1839.4 19.5 157.0 17.7 2613.2
China Hong
Kong SAR 18.1 2.7 7.7 - - ^ 28.6
India 162.3 55.0 295.6 7.3 29.8 9.2 559.1
Indonesia 64.4 34.1 44.0 - 3.5 2.1 148.2

5
Japan 201.4 95.0 117.7 36.9 19.2 7.4 477.6
Malaysia 26.9 25.7 15.0 - 1.7 ^ 69.2
New Zealand 6.9 3.5 1.4 - 5.7 2.0 19.4
Pakistan 20.4 35.2 4.2 0.8 6.9 ^ 67.6
Philippines 11.8 3.2 8.3 - 2.1 2.3 27.7
Singapore 62.5 7.9 - - - ^ 70.4
South Korea 106.0 41.9 79.4 34.0 1.2 0.6 263.0
Taiwan 42.8 14.0 41.6 9.5 0.9 1.2 109.9
Thailand 46.8 41.9 13.9 - 1.8 1.6 106.0
Vietnam 16.5 7.7 15.0 - 6.7 ^ 45.9
Other Asia
Pacific 16.7 5.2 19.1 - 8.8 0.1 49.9
Total Asia
Pacific 1316.1 531.5 2553.2 108.0 248.1 46.4 4803.3

Total World 4059.1 2905.6 3724.3 599.3 791.5 194.8 12274.6

of which:
OECD 2092.0 1386.1 1098.6 487.8 315.1 148.0 5527.7

Non-OECD 1967.0 1519.5 2625.7 111.5 476.4 46.8 6746.9

European
Union 645.9 403.1 285.9 205.3 69.6 80.9 1690.7

Former
Soviet Union 190.6 539.6 169.8 60.2 54.6 0.4 1015.1

* In this Review, primary energy comprises commercially traded fuels including

modern renewables used to generate electricity.
^ Less than 0.05.
Notes: Oil consumption is measured in million tonnes; other fuels in million
tonnes of oil equivalent.
Source: BP Statistical Review of World Energy June-2012.

6
1.3. Properties of fossil fuels
Oil has the highest energy density of all fossil fuels, about 40-45 GJ/t or 35-
40GJ/m3, with some variation due to gravity and sulphur content.

Coal, by contrast, has only about 20-30 GJ/t, varying largely depending on the
ash content, which for hard coal can be as high as 40% and even higher for
lignite.

Gas, which has methane as its main component, has only one thousandth of the
energy density of oil under-atmospheric pressure, i.e., 35-45 MJ/m3, with a lower
value depending on the share of components higher then methane, typically
ethane, propane and butane.

It is possible to increase the energy density of natural gas by putting it under

pressure, e.g., by a factor of 100 if pressurized to 100 bar, but this still leaves a
differential in energy density in the order of 10 compared with oil. It is also
possible to liquefy natural gas by cooling it down to minus 162 degrees Celsius.
The energy density of liquefied natural gas (LNG) is about half that of oil, but the
technology necessary to liquefy, ship and re-gasify LNG is much more costly
than that for handling oil.

Noxious components like sulphur, which can occur in all three fossil fuels, need
treatment to protect the environment. Handling the ash contained in the coal
requires substantial additional equipment for the combustion process and
depositing the ash is a costly operation.

The use of coal is so far confined to boilers alone or combined with steam
turbines (except for transforming it into a manufactured gas by a process of
hydration), while gas and oil are easy to handle and can also be used in internal
combustion engines (cars) and in gas turbines.

Oil and coal can be transported and stored in vessels without entailing high
specific costs, making it easier to establish marketplaces for oil and coal trading.

7
The high energy density of oil, combined with easy handling storage and
transportation, make it suitable for small applications like cars.

This does not apply for coal and only to a lesser extent for gas. Due to its
gaseous aggregate and low energy density, and unless it is transported as LNG,
gas requires a fixed pipeline infrastructure for transportation and distribution
establishing a physical trading infrastructure of gas is more difficult because of its
high specific costs.

Gas has a substantial advantage on GHG emissions; the CO2 emission factor
from burning fuel oil is about 35% higher and, for coal about 55% higher than for
gas. In addition, gas and oil can be used in gas turbines and in CCGTs, where
the exhaust heat of a gas turbine process is used to run a steam turbine with a
substantially higher electric efficiency (more than 55%) of the combined process
than a standard coal-driven steam turbine, which has a maximum electric
efficiency of 45%.

Oil can always replace gas, at the price of a higher CO2 emission factor, while
gas can replace oil but is not well suited to fuel individual cars. All three fossil
fuels can be used for power generation, gas and gas oil performing similarly,
while burning heavy (residual) fuel oil causes more handling problems and
burning coal required a different treatment and substantial higher investment
than for oil or gas.

1.4. Character of the deposits of fossil fuels:

Oil and gas fields are subject to hydraulic communication; production from one
part of a structure leads to a pressure reduction for all of the structure with
repercussion for overall recovery. It is, therefore, common practice to unitise
deposits that stretch across the borders of several licenses and to have oil or gas
fields under a uniform operating regime, even the very large ones. By contrast,
large deposits of solid minerals like coal can be produced at several places in
parallel, without interference with each other. However, there are usually

8
economies of scope and scale stemming from a coordinated development of
large coal deposits.

At large onshore oil fields with good production characteristic the drilling of
additional wells to add production capacity is often not very costly. In such cases
spare capacity can be kept in reserve or created at relatively short notice. As
access to extra oil-tanker capacity is usually possible, large oil producers can
react quickly to fluctuations in demand. By contrast, spare production for gas
capacity is not expensive for large onshore fields, but the spare infrastructure to
bring it to the market is very costly because of the low energy density of gas. For
coal, spare production capacity would be costly because of the substantial idle
equipment and the need to have enough qualified workforce at hand, while extra
shipping capacity may be available on the mass freight-ship market, subject to
competition with other users.

The consequence is that oil storage downstream is minimized except for

strategic stocks, while, for gas, storage close to the market is usual for seasonal
storage to avoid unnecessary capacity in the pipeline, and for coal many power
plants have a coal stock close to the plant.

******

9
 Chapter-2
Literature Review
Oil prices matter to the health of an economy, despite a consistent fall in global
oil intensity; crude oil remains an important commodity and events in the oil
market and continues to play a significant role in shaping global economic and
political development. Crude oil is the world economy‟s most important source of
energy and is therefore, critical to economic growth.

The price of crude in global market is essentially driven by supply and demand.
The performance of world economy in general and the world‟s largest economies
such as US, Japan and recently China have a significant impact on the demand
for crude oil and vice versa. The various method developed by IMF, World
Bank(WB) and OECD have estimated that 10 dollar increase in crude oil prices
would lead to a decline of world production of goods and services by 0.5%. The
world economic growth and world oil demand are moving in tandem and there is
high correlation between world economic growth and demand for oil. It is
essentially the supply that drives the prices of crude oil.

Many researchers agree in opinion that no other economic event in post-World

War II era generated as much attention as the series of oil price shocks, mainly
produced by OPEC countries. No studies were necessary to see the clear
relationship between oil prices and main economic indicators. Nevertheless, this
issue was new and researchers posed such a question as the numerical impact
of oil shocks and their correlation with the policy conducted by government in
order to predict the best instrument to cope with the negative impacts caused by
oil price increases. Since then a large number of studies have reported a
correlation between increases in oil prices followed by economic downturns.

Hamilton (1983) investigated the impact on the US economy. His evidence

suggests that crude oil prices have a strong relationship with the US business
cycle and tends to highlight cost-push inflationary effects, while the research of

10
Berndt and Wood (1975,1979) as well as Wilcox‟s (1983) indicates the
complementarily between energy prices and capital in the US economy is rather
strong, both before and after 1973. Hence, oil price rise lead to shocks may have
a stronger effect than generally believed. These results were later extended by
Mork (1989) and Hooker (1999) who argued that asymmetric and nonlinear
transformations of oil prices restore that relationship, and thus the economy
responds asymmetrically and nonlinearly to oil price shocks.

Later Hamilton (2000) reported clear evidence of nonlinearity-oil price increases

is much more important than oil price decreases. An alternative interpretation
was proposed based on the estimation of a linear functional form using
exogenous disruptions in petroleum supplies as an instrument. His study shows
that oil shocks play a crucial role in determining macroeconomic behavior
because they disrupt spending by consumers and firms.

Hamilton extended his research work (2003, 2005, and 2009) and has presented
empirical evidence suggesting that oil price shocks have been one of the main
causes of recessions in the United States. Others, including Barsky and Kilian
(2004), argue that the effect is small and that oil shocks alone cannot explain the
U.S. stagflation of the 1970s. Taking a more intermediate position, Bernanke et
al. (1997) argue that an important part of the effect of oil price shocks on the U.S.
economy results not from the change in oil prices per se, but from the resulting
tightening of monetary policy. In the same line of research, Blanchard and Gali
(2007) present evidence showing that the dynamic effect of oil shocks has
decreased considerably over time, owing to a combination of improvements in
monetary policy, more flexible labor markets, and a smaller share of oil in
production. Their results indicate that a 10 percent increase in the price of oil
would, prior to 1984, have reduced U.S. GDP by about 0.7 percent over a 2–3
year period, while after 1984 the loss would be only about 0.25 percent. In
contrast to the extensive literature on the impact of oil prices on the U.S.
economy, there has Outside the U.S., studies of the relationship between oil
prices and the macro-economy have almost exclusively been confined to other

11
OECD members, with results suggesting that they tend to be affected in broadly
the same way as the U.S. but less strongly.

Rasche and Tatom (1977 and 1981) explain that energy price shocks alter the
incentives for time to employ energy resources and alter their optimal methods of
production. Energy -using capital is rendered obsolete by any energy price
increase and the optimal usage of the existing stock is altered and production
switches to less energy- intensive technologies. The reduced capacity output of
the economy is usually referred to as decline in potential or natural output.

The authors state that domestic aggregate demand is affected due to a change
in net imports of oil. The direction and extent of effects depends on the country‟s
net oil export status. Net oil exporting countries experience an increase
(decrease) in aggregate demand when oil price rise (fall). The effect on net oil
importing countries is exactly opposite. Net oil exporting countries like Canada
and the UK receive a boost to aggregate demand and output/ employment from a
spike in oil price.

The impacts on productivity tend to work in the same direction regardless of the
oil trade status of the country. An increase in oil prices has a negative impact on
productivity. The theories suggest that energy price shocks should affect the
productivity of capital and labor resources.

Rati Ram and David Ramsey (1989) also took a production function approach
(Cobb-Douglas specification) to estimating the elasticity. Their estimates for the
United States are somewhat unique in that they distinguish between privately
owned and publicly owned capital. A relative energy price variable is also
incorporated and the estimation period is from 1948 to 1985. They obtained
statistically significance energy price – GNP elasticity estimates that ranged
between -0.074 and -0.069, depending on the disaggregation of public capital.

12
Micha Gisser and Thomas Goodwin (1986) estimated equations involving real
GNP, general price level, unemployment rate and real investment. They
regressed each of those variables independently on contemporaneous and four
lags of M1money supply, the high employment federal expenditure measure of
fiscal policy and the nominal price of crude oil.

BAIC Economic Review Autumn 2006 (The business and industry advisory
committee to the OECD), it has shown that the world economy slows down
based on the BAIC Member Survey and at that time it was anticipated that the
OECD –wide real GDP growth to drop from 3.1 % to 2.6% in 2007 and risk for
growth was associated to oil price.

Hyun Joon Chang of Korea Energy Economics Institute in his paper “The Impact
of Oil Price Increase on the Global Economy” discussed the impact of an oil price
increase of $5 per bbl on global economy (IMF -2000).

In the case of oil price increases, there will be a transfer of income from oil
consumers to oil producers. On an international level, the transfer is from oil
importing countries to oil exporters, and oil exporters tend to expand demand
only gradually. It will affect income redistribution of the global economy.

Also, when oil prices increase and energy input prices rise, there will be a rise in
the production costs in the economy, depending on degree of competition of the
markets. As the oil intensity of production in developed countries has fallen over
the past three decades, the cost side impact of increases in oil prices can be
expected to be less than in past oil price increases. In developing countries,
however, where the oil intensity of production has declined less, the impact may
be closer to that in the earlier period.

There will be a demand side impact of oil price increases. When oil prices rise,
consumers are likely to delay or postpone their purchasing durables such as
automobiles. This demand side impact leads to relative increase in inventories to
sales and then decline industrial production.

13
Finally, depending on expected duration of price increases, the change in relative
prices creates incentives for suppliers of energy to increase production and
investment, and for oil consumers to economize.

The impact on developing countries seems to be at least as large as for many of

the industrial countries. Oil exporting countries suffered seriously from the oil
price decline in 1997-98 are expected to benefit substantially with recent oil price
increases. On the other hand, there is a negative impact on oil importing
countries, especially as dependency on oil has not fallen to the same extents as
in industrial countries. Oil price increases affect developing countries very
differently. Oil exporting countries such as UAE have a large current account
surplus while many oil importing countries are expected to be adversely affected.
The oil price increase would add to its current account deficit by 1.25 percent. A
number of countries also face additional pressures from weak non-oil commodity
prices, and have limited access to capital markets, which will further increase the
adverse impact on domestic absorption.

In major emerging market economies, the results vary widely by region,

depending on the relative size of oil importing to exporting countries. Asia
experiences the largest negative impact on growth. Latin America, emerging
Europe and Africa are less adversely affected by the oil shock. Among the oil
importing countries, the largest impact on GDP growth and the balance of
payments is expected to be in India, Korea, Pakistan, Philippines, Thailand, and
Turkey. The oil price increases will affect China‟s economic recovery, yet the
direct impact of oil price hikes on China‟s economy should be much less than
that on most Asia-Pacific countries as the ratio of net oil imports to domestic oil
consumption is much lower than the Asian average. The ratio for China is 22
percent, but 100.2 percent for Japan and 61.4 percent for the rest of Asia Pacific.
Also, oil occupies only 26.6 percent in China‟s primary energy consumption,
much lower than other Asian countries, which are heavily dependent on oil.

“Analysis of the impact of high oil prices on the global economy” by Economic
Analysis Division, International Energy Agency reports in “Energy Prices and

14
Taxes”, 2nd Quarter 2004, wherein it has shown that the vulnerability of oil
importing countries to higher oil prices varies markedly depending on the degree
to which they are net importers and oil intensity of their economies. According to
the results of a quantitative exercise carried out by the IEA in collaboration with
the OECD Economics Department and with the assistance of the International
Monetary Fund Research Department, a sustained for10 per barrel increase in oil
price from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP
in the first and second years of higher prices. Inflation would rise by half a
percentage point and unemployment would also increase. The OECD imported
more than half its oil needs in 2003 a cost of over $260 billion-20% more than
2001. Euro-zone countries, which are highly dependent on oil imports, would
suffer most in short term, their GDP dropping by 0.5% and inflation rising by0.5%
in 2004. The U.S would suffer the least, with GDP would fall 0.4%, with its
relatively low oil intensity compensating to some extent for its almost total
dependence on imported oil. In all OECD regions, these losses start to diminish
in following three years as global trade in non-oil goods and services recovers.
This analysis assumes constant exchange rates.

The adverse economic impact of higher oil prices on oil-importing developing

countries is generally even more severe than for OECD countries. This is
because their economies are more dependent on imported oil and more energy-
intensive, and because energy is used less efficiently. On average, oil-importing
developing countries use more than twice as much oil to produce a unit of
economic output as do OECD countries. Developing countries are also less able
to weather the financial turmoil wrought by higher oil import costs. India spent
$15billion, equivalent to 3% of its GDP, on oil import in 2003. This is 16% higher
than its 2001 oil import bill. It is estimated that the loss of GDP average 0.8% in
Asia and 1.6% in very poor highly indebted countries in the year following a $10
oil-price increase. The loss of GDP in Sub-Saharan African countries would be
more than 3%.

15
World GDP would be at least half of one percent lower – equivalent to $255
billion- in the year following a $10 oil price increase. This is because the
economic stimulus provided by higher oil –export earnings in OPEC and other
exporting countries would be more than outweighed by depressive effect of
higher prices on economic activity in the importing countries. The transfer of
income from oil importer to oil exporter in the year following the price increase
would alone amount to roughly $150billion. A loss of business and consumer
confidence, inappropriate policy responses and higher gas prices would amplify
this economic effect. For as long as oil prices remain high and unstable, the
economic prosperity of oil-importing countries-especially the poorest developing
countries-will remain at risk.

World Economic Outlook April-2007 reports there is a global macroeconomic

implications of a supply induced oil price hike and persistent productivity shocks
with low oil capacity.

In fiscal 2010, the India‟s import bill for crude oil was $100.08billion, which of
7.12% higher in volume than fiscal 2009, crude oil import bill increased to around
$ 20.527billion. That means there was a jump of 25.8% in crude oil import bill for
fiscal 2010 from previous fiscal 2009 i.e. $79.553billion.

2.1. Gap Analysis

Crude oil prices played a critical role in substantially reducing economic growth in
any economy whether it is developed or developing economy.

Worldwide demand for crude oil arises from demand for the refined products that
are made from crude; and changes in crude oil prices are passed on to
consumers in the prices of the final petroleum products.

When the prices of petroleum products increase, consumers use more of their
income to pay for oil-derived products, and their spending on other goods and
services declines. The extra amount spent on those products is basically go to
foreign oil producers as India is net importer of oil.

16
Oil is a vital input for the production of a wide range of goods and services,
because it is used for transportation in business of all types. Higher oil prices
thus increase the cost of inputs; and final product price increases cause inflation,
if the cost increases cannot be passed on to consumers, economic inputs such
as labor and capital stock may be reallocated. Higher oil prices can cause worker
layoffs and the idling of plants, reducing economic output in the short term.

In a net importer of oil economy like India, higher oil prices shrink foreign
reserves of the economy, affect the purchasing power of the economy in terms of
International trade. The increased price of imported oil forces the businesses to
devote more of their production to exports, as opposed to satisfying domestic
demand for goods and services, therefore cause inflation, even if there is no
change in the quantity of foreign oil consumed.

Higher oil prices cause, to varying degrees, increases in other energy prices.
Depending on the ability to substitute other energy sources for crude the price
increases can be large and can cause macroeconomic effects similar to the
effects of oil price increases.

Thus, though energy is the prime mover in an economy, the demand and supply
gap of crude oil must be bridged through import to meet the country‟s
requirement, hence, crude oil price is an important parameter in determining
reserve position and trade balance and finally balance of payment.

Inflation is also an important area arising with the increase of crude oil prices,
with the increase of inflation, capacity to purchase is reduced and expenditure
increases, saving decreases, ultimately slows down the business and economic
activities thus slows down GDP growth.

******

17
 Chapter-3
Statement of the Problem
Crude oil price is an important parameter for refining industries, which has a
bearing on economy, because it is vital input for productivity. There is a vast gap
in demand and production of crude oil in India. National oil companies are able to
produce 23-24% of India‟s total requirements of crude oil. The production of
crude oil from public sector enterprises in India has been decreasing due to old
and the maturity of the fields.

India is not self-reliance on crude oil production; therefore, it is necessary and

inevitable to import the crude oil to bridge the gap between demand and supply.
The increase in international crude oil prices will make import costly and raise the
Indian crude basket price. Therefore, both international crude oil price rise and
import dependency on crude oil are the problematic area that may damage the
Indian economy.

It is estimated that the import dependence of India associated with crude oil is
expected to 94% by the end of 2030. Therefore, the trouble water in Indian crude
oil demand and supply management is the rise in international crude oil prices
followed with the extent of the increase in crude oil requirement with respect to
feasible higher GDP growth 8% to 9%. The import dependence of India
associated with crude oil is from 76% in 2011-12 to 80% by the end of twelfth
plan (2012-17). As crude oil prices are rising globally and imports will be
expensive, it is necessary to understand the consequences of crude oil price rise
on the economy.

Therefore, there is an urgent need to look holistic picture of whether the changes
in Indian crude basket prices have any implication on Inflation and GDP growth,
or is there any link between Indian crude oil basket price change and Inflation or
Inflation is the cause of concern for slowdown of GDP growth, what should be

18
our strategy to meet the growing demand of crude oil for economic growth. It is
against this backdrop that we attempt, in this study, to critically analyze the
impact of the change in crude oil prices on Indian economy. Therefore, there is
an urgent need to look at holistic picture of investment in Brown field and Green
field projects in petroleum industry, use of new technologies in the area for Oil
and Gas business.

The desire of the study is to understand, how the increase in Indian basket price
of crude due to raise in international crude oil prices impact the economic
indicators like inflation and GDP growth. The essence of the study is to garner
the understanding of the causal relationship with the phenomenon of complexity
of historic facts in crude oil prices and social reality of economic development
and economic growth. The study is essential for both – knowledge and to help in
solving problems of businesses arising out due to inflation, predicting the future
price signal in relation to the business environment and economic growth.

No similar research initiative has been undertaken in India that has focused on
causal study and the impact of Indian crude basket price on the economic
indicators like the inflation and GDP growth of the economy.

The import requirement of crude oil is 73 – 76 % of total demand, which is equal

to 141.9MT for the year ending 2011-12 and growing annually at the rate of
2.9%. To meet the demand, the crude oil is being imported from gulf countries
through long term contract and international tie up is essential to avoid any
supply shock. The Indian basket of crude comprising of the composition
represents average of Oman & Dubai for sour grades and Brent (Dated) for
sweet grade in the ratio of 67.6:32.4 from 1st April'2010.

19
3.1. Objectives of the study:
Based on the secondary data, literature review and the gaps identified, the
following objectives of study were framed. The objectives of study are as
follows:-
• To study and formulate the impact of crude oil prices on the whole sale price
index of Indian economy.
• To study the waves of inflation rate (consumer price index) due to change in
crude oil prices on the GDP growth of Indian economy.
• To examine and understand the direction of causality and to ascertain the
causal relation and linkage between differential change rate of crude oil prices
and Inflation , also between inflation vis-à-vis GDP growth of Indian economy.
• To study the impact of energy price relative to the productivity of capital and
labor of Indian industries based on the past data.

3.2. Hypotheses

Hypothesis: 1

H01 : Crude oil price plays an insignificant role in rising WPI of

Indian economy.
H11 : Crude oil price plays a significant role in rising WPI of
Indian economy.

Hypothesis: 2

H02 : The role of Inflation is insignificant for declining GDP growth of Indian
economy.
H12 : The role of Inflation is significant for declining GDP growth of Indian
economy.

20
Hypothesis: 3

H03 : Crude oil price rate change does not Granger cause inflation.
H13 : Crude oil price rate change Granger causes inflation.

Hypothesis: 4

H04 : Inflation does not Granger cause GDP growth.

H14 : Inflation Granger causes GDP Growth.

Hypothesis: 5

H05 : A rise in the price of energy relative to output does not lead to decline in
productivity of existing capital and labor.

H15 : A rise in the price of energy relative to output leads to decline in

productivity of existing capital and labor.

3.3. Defining Variable for study:

Independent Variable: Crude oil price

Dependent Variable : Inflation, GDP growth.

21
3.4. Operational Definition of Variables

1. Crude oil price:

Crude oil prices measure the spot price of various barrels of oil, most commonly
either the West Texas Intermediate or the Brent Blend. The OPEC basket price
and the NYMEX Futures price are also sometimes quoted. West Texas
Intermediate (WTI) crude oil is of very high quality, because it is light-weight and
has low sulphur content. For these reasons, it is often referred to as “light, sweet”
crude oil. These properties make it excellent for making gasoline, which is why it
is the major benchmark of crude oil in the America. WTI is generally priced at
about a $5-6 per barrel premium to the OPEC Basket Price and about $1-2 per-
barrel premium to Brent.

Brent Blend is a combination of crude oil from 15 different oil fields in the North
Sea. It is less “light” and “sweet” than WTI, but still excellent for making gasoline.
It is primarily refined in Northwest Europe, and is the major benchmark for other
crude oils in Europe or Africa. For example, prices for other crude oils in these
two continents are often priced as a differential to Brent, i.e., Brent minus $0.50.
Brent blend is generally priced at about a $4 per barrel premium to the OPEC
Basket price or about a $1-2 per barrel discount to WTI.

The OPEC Basket Price is an average of the prices of oil from Algeria, Indonesia,
Nigeria, Saudi Arabia, Dubai, Venezuela, and Mexico. OPEC uses the price of
this basket to monitor world oil market conditions. OPEC prices are lower
because the oil from some of the countries has higher sulphur content, making
them more “sour”, and therefore less useful for making gasoline. The Indian
basket of crude comprising of the composition represents average of Oman &
Dubai for sour grades and Brent (Dated) for sweet grade in the ratio of 67.6:32.4
from 1st April'2010.

22
2. Inflation
In economics, inflation is a rise in the general level of price of goods and
services in an economy over a period of time. When the general price level rises,
each unit of currency buys fewer goods and services. Consequently, inflation
also reflects erosion in the purchasing power of money – a loss of real value in
the internal medium of exchange and unit of account in the economy. A chief
measure of price inflation is the inflation rate, the annualized percentage change
in a general price index (normally the consumer price index) over time.

Inflation's effects on an economy are various and can be simultaneously positive

and negative. Negative effects of inflation include a decrease in the real value of
money and other monetary items over time, uncertainty over future inflation
which may discourage investment and savings, and if inflation is rapid enough,
shortages of goods as consumers begin hoarding out of concern that prices will
increase in the future. Positive effects include ensuring central banks can adjust
nominal interest rate (intended to mitigate recession), and encouraging
investment in non-monetary capital projects.

There are two type of inflation- namely Whole sale price index (WPI) and
Consumer price Index (CPI). The WPI can be interpreted as an index of prices
paid by producer for their inputs. CPI is the money outlays required to purchase a
given basket of consumption goods and services.

3. Gross Domestic Product (GDP) growth or Economic Growth

The term GDP refers to the monetary value of the gross output produced by the
nationals of a country in the domestic economy. The change in a nation's Gross
Domestic Product (GDP) from one period of time (usually a year) to the next. The
economic growth rate shows by how much GDP has grown or shrunk in raw
dollar or rupee amounts or in the currency of that country. It is considered one of
the most important measures of how well or poorly an economy is performing.

23
Thus,
Economic growth rate = {(GDPyear2– GDPyear1) / GDPyear1 } * 100
The GDP growth rate is the most important indicator of economic health. If it's
growing, so will business, jobs and personal income. If it's slowing down, then
businesses will hold off investing in new purchases and hiring new employees,
waiting to see if the economy will improve. This, in turn, can easily further
depress the economy and consumers have less money to spend on purchases. If
the GDP growth rate actually turns negative, then the economy of the country is
heading towards a recession.

*******

24
 Chapter- 4
Research Methodology
4.1. Conceptual Framework: Crude oil is the fundamental building block
among the primary energy which dictates the overall energy mix in terms of its
utility as basic input for economic growth. Oil is often thought of first fall back
energy resource. Its price is the basic unit for all economic activities like
agriculture, manufacturing, project evaluation directly or indirectly, for calculating
price of manufacturing articles, product prices, transportation cost, service
industry etc., even in pricing other forms of energy. Therefore, crude oil price
increase is viewed throughout the world as it has a bearing on all the prices of
final goods and services of the economic activities of the world. No economies in
the world, whether exporters or importers are de-coupled from the impact of the
increase of crude oil price. Crude oil price increase can be treated as the source
affecting the economy, it may be treated as the epicenter of earthquake in an
economy, which has the potential to cause catastrophe to any economy and can
damage the business activities, in worst condition, it can bring down to business
and economic recession.

As oil price increase can influence the economy through two important routes.
First, with the increase of oil price in world market, i.e. Brent, WTI, Nigerian
Forcados, Dubai, Arabian light, Iranian light etc., the Indian crude basket price
will also rise. This price hike pass on to domestic refining petroleum product
price, ratcheting up domestic price levels, in turn WPI. In India‟s WPI, for
instance, the weight of mineral oils (comprising POL price mainly) is 6.99% (base
year1993-94) and it is increased to 9.36% (base year 2004-05). Second, Higher
oil price would raise the variable cost of industry. So, industries would seek to
raise their product price to protect their profit margin. Thus, overall product price
level of all the commodities on all the sectors of the economy will increase; hence
raise the consumer price index level i.e. the inflation rate. The Inflation rate has a
bearing on GDP growth. Higher crude oil prices would also impact balance of

25
payments significantly. In sum, oil price changes affect several domestic
variables, occasion „economy-wide‟ effects and are a politically sensitive
ingredient for parliamentarians and policy makers.

This is a quantitative and analytical research. Data analysis is done mainly by

statistical and econometrics methods (deductive process) to find out correlation
between the dependent and independent variables, also empirical relationship of
the variables based on the objective and hypotheses followed with Granger‟s
causality tests.

4.2. Research Design:

Research design is a blue print of the study conducted, which includes steps of
data collection, sample selection, process of data and finally interpretation of the
data. The period of study is important in collecting the secondary data.

4.3. Sources of Data:

Secondary data sources have been used to collect information about the Indian
crude basket prices, whole sale price index, Inflation rate and GDP growth.
Information collected from Secondary data sources include Central Statistical
Organization (CSO) data of Indian Economy, RBI reports, Indian Economic
survey reports, Petroleum Planning and Analysis Cell (PPAC) data, reports and
websites.

For deriving relationship between crude oil price and inflation (WPI) for our log-
log natural base regression model, WPI and Crude oil price data pertains from
2000 to 2009 have been used. Data on WPI has been taken from CSO data and
the crude oil prices have been taken from Petroleum Planning and Analysis Cell
(PPAC) data. Gross Domestic Product (GDP) growth rate (base year 2004-05)
has been used from Reserve Bank of India data source and publications. Data
for inflation rate has been used from trading economics statistics.

26
4.4. Sample Size and Justification
The fundamental purpose of study is to examine whether crude oil price affect
inflation, if so, whether rate of change in crude oil price affect inflation rate and
GDP growth and what is the extent of impact. And finally it relates to the issue of
causality test. Our study period is from financial year 2000 -2009 for the
hypothesis 1, data have been collected on monthly basis for both crude oil price
and whole sale price index (base year 1993-94=100) with sample Size 124. This
period is important because so many events have taken place around the world
like soaring international crude oil price from $24 ( Jan-2000) and touched to
$147.27 per barrel( 11thAug 2008). Disruption caused by Hurricane Ivan in 2004,
US government had announced on September 24, 2004 that it was prepared to
lend some stocks from Strategic Petroleum Reserve (SPR). Traders felt that the
supply was too small and hence the price would tend to rise. As a result, the
Crude basket price of India went up to $39.21 in 2004 from previous year price of
$27.97, followed with bad monsoon in 2004. There was devastating hurricane
Katrina in 2005 in the history of US and thereafter hurricane Rita was the fourth-
most intense Atlantic hurricane ever recorded and the most intense tropical
cyclone ever observed in the Gulf of Mexico. Rita caused $12 billion in damage
on the U.S. Gulf Coast in September 2005, followed by OPEC supply shock,
Subprime crisis and bankruptcy of Lehman brothers, fear of terrorist attack on oil
installations in various oil producing countries had added a premium to oil prices
etc. and most important event in Indian context is the second phase of reform
and the dismantling of the Administered Price Mechanism (hence forth referred
to as APM) from 1st April 2002, Oil companies have given the freedom to buy
crude oil and sell their products at market determined prices.

Quarterly data were also collected for crude oil price change of India basket,
inflation and GDP growth base year ( 2004-05) of new series from 2005-06 to
2009-10 for carrying out the study with sample size 20.

27
Further, Yearly data have collected from 1992-93 to 2008-09 (base year 1993-
94) to examine whether a rise in the price of energy relative to output leads to
improve or decline in productivity of existing flow of capital and labor for the study
with sample size 17.

4.5. Econometrics Modeling for the Hypotheses:

The principal statistical tools considered for data analysis are using the Karl
Pearson’s Correlation Co-efficient, followed with econometrics modeling of
regression and causation. Correlation means a statistical relationship between
sets of variables none of which has been experimentally manipulated i.e. (crude
oil price and WPI), (Inflation and GDP growth).Therefore, Correlation means a
relationship between un-manipulated variables. It measures the strength of linear
association between two variables. Karl Pearson’s Correlation Co-efficient is
used to study correlation between two variables crude oil price and WPI, also
Inflation and GDP growth. Often in practice, correlation is followed by regression.
The tacit assumption being, if we have established that two variables are linearly
or log linearly related then we may predict one based upon the knowledge of
other. The purpose of regression is also to study the model relationship between
variables, describing the relationship between the explanatory and response
variable and has been addressed using the modeling framework and followed by
Granger‟s causality tests.

Model-1

In an attempt to determine, the influence of crude oil price on the inflation of

Indian economy. The following time series regression equation was fitted.
Yt= a + bX + et ---------- (1)
Where
Yt denotes the WPI (base year 1993- 94)
„a‟ denotes constant quantity, i.e. the intercept of the line on Y- axis.

28
„b‟ denotes the co-efficient of X.
„X‟ denotes the crude oil price. (monthly Indian basket price).
„et‟ is residual term of the model.
The data used for the variables were from April‟2000 to July‟2009.

For deriving the elasticity co-efficient, the double log regression model was used.
The above equation was converted into natural log – linear form. One attractive
feature of double log model or log – log model is that the slope co-efficient “b”
measure elasticity of Y with respect to X, that is percent change of Y for a given
(small) percent change in X. Thus Y represents quantity of WPI increased and X
its unit price; „b‟ measures the elasticity (Gujarati, 1995). The double log
regression model was estimated using excel software package.

Model-2

In an another attempt, to carry out the quantification of expected influence of

inflation on GDP growth, we have the econometric model which is depicted as
follows-
YGDP = a1 + b1 XInflation+ et ----------(2)
Where,
YGDP represents the GDP growth, XInflation represent the CPI Inflation rate, „a1‟
represent the intercept and „et‟ denotes the residual term.
The data used for the variables are quarterly data for both Inflation rate and GDP
growth with base year (2004-05).
The equations (1) and (2) are converted into natural log-linear form or double log
regression model for deriving the elasticity co-efficient of the dependent
variables. Here the independent variable is crude oil price in equation (1) and
WPI is the dependent variable and in equation (2) Inflation is the independent
variable and GDP growth is the dependent variable respectively.

29
Model-3

In a separate attempt, all the variables are taken systematically i.e. GDP growth,
Inflation rate and Rate of change of crude price, all variables are in percent, data
are collected on quarterly basis with base year 2004-05 for prediction of GDP
growth by linear regression to study the hypotheses 1 and 2 by linear model. This
is a Multivariable Linear Regression Model - or – Three Variable Model.
YGDP = β1 + β2Xinfla. + β3Xrate of change of crude oil price.
On a priori reasoning let us assume that the GDP growth is dependent on
inflation rate and rate of change in crude oil price. The linear regression model is
estimated using excel data analysis software package. The output residuals are
analyzed, if there is the existence of auto correlation, also DW statistics and Sign
test followed by Auto regression and stationary.

Model-4.

Granger (1969) proposed a time – series data based approach in order to

determine causality. In the Granger-sense x is a cause of y if it is useful in
forecasting y. In this framework “useful” means that x is able to increase the
accuracy of prediction of y with respect to a forecast, considering only past
values of y.

The Granger causality Test:

The Granger causality test assumes that the information relevant to the
prediction of the respective variables, GDP growth and inflation rate, inflation rate
and rate of change in crude oil price are contained solely in the time series data
on these variables. The test involves estimating the following pair of regressions.

(i) Yt (infla). = Σni=1αi X t-i (rate of change in crude oil price) + Σnj=1 βjYt-j(infla) + u1t

30
 (ii) X t (rate of change in crude price). = Σni=1λiX t-i.(rate of change in crude oil price) +
Σnj=1 δjYt-j(infla) + u2t‟
Similarly,

(i) Yt (GDP). = Σni=1αi X t-i ( infla) + Σnj=1 βjYt-j(GDP) + u1t

(ii) X t (infla). = Σni=1λiX t-i.(infla) + Σnj=1 δjYt-j(GDP) + u2t‟

Where, disturbance terms u1t, u2t are uncorrelated.

Based on the estimated OLS coefficients for the two sets of equation different
hypotheses about the relationship between rate of change in crude oil price and
inflation also the relationship between GDP growth rate and inflation can be
formulated.

Model-5.
The “Cobb-Douglas” production function is applied for estimating the output of
Indian industries. The real output of industries depend upon the capital and
labour as well as energy resources. The “Cobb-Douglas” production function may
be written as

y= A ert ha kb Ec ------------ equation (1)

Where y = is output,

h = labor measured in man-days

k = Capital input or capital employed in the business,

E = flow of energy.

A = a scaling factor; t = year;

r = is the trend rate of growth of output due to technological change;

31
a,b,c = are the output elasticities of respective inputs.

Now, if enterprises maximize economic profits, they employ energy at a rate

where the value of additional product obtained from employing more energy
equals its price. The demand for energy from equation above can be written as

E = c.Y. ( pe / pd )-1 ----------equation (2)

Where, pe is the price of energy and pd is the price of output of the business
enterprise. The (pe / pd) is the relative price of energy, the relative price of energy
measured by the ratio of whole sale price index of fuel, related products like
power, light and lubricants to the wholesale price index and expressed in percent
with respect to base year.

On simplification of the equations (1) and (2) with energy demand, the model
reduced to ln(y/k) = α + β ln(h/k) + γ ln(pe/pd) +δ.t -------- equation(3)
Where, α = (1/1-c)ln A*, and A*=A.(c)c ; which is the intercept of the regression
equation,
β = a/(1-c) ; γ = (-c/1-c); δ = (r/1-c) are the regression coefficients.
The equation (3) is the reduced form of productivity model that is applied for
Indian industries in relation to rise in energy price.

****

32
 Chapter-5
Global Oil Scenario
Crude oil is not distributed uniformly around the globe. Some regions and
countries are well endowed, while others are not. Most of the proven reserves of
conventional Oil are to be found in the Middle East Countries, namely, Iran, Iraq,
Kuwait, Saudi Arabia and the United Arab Emirates (UAE). Similarly,
conventional gas is located primarily in Russia and other Former Soviet Union
(FSU) countries, Iran, Qatar and Saudi Arabia. Since these reserves are often
not in the same regions as the markets they serve, considerations of security and
diversity of supply are among the important factors to be placed in the balance in
decisions over squeezing more crude oil from deposits in other regions closer to
home or over developing non-conventional crude oil.

Table 5.0. Distribution of World proved Oil reserves

Oil: Proved
reserves at end 2011

Thousand Thousand
million million Share R/P
tonnes barrels of total ratio
US 3.7 30.9 1.9% 10.8
Canada 28.2 175.2 10.6% *
Mexico 1.6 11.4 0.7% 10.6
Total North
America 33.5 217.5 13.2% 41.7

Argentina 0.3 2.5 0.2% 11.4

Brazil 2.2 15.1 0.9% 18.8
Colombia 0.3 2.0 0.1% 5.9
Ecuador 0.9 6.2 0.4% 33.2
Peru 0.2 1.2 0.1% 22.2
Trinidad &
Tobago 0.1 0.8 0.1% 16.7
Venezuela 46.3 296.5 17.9% *
Other S. & Cent.
America 0.2 1.1 0.1% 22.1
Total S. & Cent.
America 50.5 325.4 19.7% *

33
Azerbaijan 1.0 7.0 0.4% 20.6
Denmark 0.1 0.8 w 10.0
Italy 0.2 1.4 0.1% 34.3
Kazakhstan 3.9 30.0 1.8% 44.7
Norway 0.8 6.9 0.4% 9.2
Romania 0.1 0.6 w 18.7
Russian
Federation 12.1 88.2 5.3% 23.5
Turkmenistan 0.1 0.6 w 7.6
United Kingdom 0.4 2.8 0.2% 7.0
Uzbekistan 0.1 0.6 w 18.9
Other Europe &
Eurasia 0.3 2.2 0.1% 15.2
Total Europe &
Eurasia 19.0 141.1 8.5% 22.3

Iran 20.8 151.2 9.1% 95.8

Iraq 19.3 143.1 8.7% *
Kuwait 14.0 101.5 6.1% 97.0
Oman 0.7 5.5 0.3% 16.9
Qatar 3.2 24.7 1.5% 39.3
Saudi Arabia 36.5 265.4 16.1% 65.2
Syria 0.3 2.5 0.2% 20.6
United Arab
Emirates 13.0 97.8 5.9% 80.7
Yemen 0.3 2.7 0.2% 32.0
Other Middle
East 0.1 0.7 w 37.1
Total Middle
East 108.2 795.0 48.1% 78.7

Algeria 1.5 12.2 0.7% 19.3

Angola 1.8 13.5 0.8% 21.2
Chad 0.2 1.5 0.1% 36.1
Rep. of Congo
(Brazzaville) 0.3 1.9 0.1% 18.0
Egypt 0.6 4.3 0.3% 16.0
Equatorial
Guinea 0.2 1.7 0.1% 18.5
Gabon 0.5 3.7 0.2% 41.2
Libya 6.1 47.1 2.9% *
Nigeria 5.0 37.2 2.3% 41.5
Sudan 0.9 6.7 0.4% 40.5
Tunisia 0.1 0.4 w 15.0
Other Africa 0.3 2.2 0.1% 27.0
Total Africa 17.6 132.4 8.0% 41.2

Australia 0.4 3.9 0.2% 21.9

Brunei 0.1 1.1 0.1% 18.2

34
China 2.0 14.7 0.9% 9.9
India 0.8 5.7 0.3% 18.2
Indonesia 0.6 4.0 0.2% 11.8
Malaysia 0.8 5.9 0.4% 28.0
Thailand 0.1 0.4 w 3.5
Vietnam 0.6 4.4 0.3% 36.7
Other Asia
Pacific 0.1 1.1 0.1% 10.4
Total Asia
Pacific 5.5 41.3 2.5% 14.0

Total world 234.3 1652.6 100% 54.2

of which: OECD 35.7 234.7 14.2% 34.7

Non-OECD 198.6 1417.9 85.8% 59.7

OPEC 168.4 1196.3 72.4% 91.5

Non-OPEC £ 48.7 329.4 19.9% 26.3

European Union 0.9 6.7 0.4% 10.8

Former Soviet
Union 17.2 126.9 7.7% 25.8

Canadian oil
sands: Total 27.5 169.2

of which: Under
active
development 4.2 25.9

Venezuela:
Orinoco Belt 35.3 220.0

Source: BP Statistical Review of World Energy June-2012.

35
5.1. Classification of Crudes

Crude oil differs in two important respects, the quality of crude and the location of
the production. The exact composition of the mixture will determine the mix of
the products that can be obtained from crude oil by refining and the case at
which it is refined. Hence, the crude oil, which yields a large proportion of more
valuable products and which can be treated by a large number of the world‟s
refineries, will command a premium over those which produce a larger proportion
of lower value products or which can be processed by only a limited number of
refineries. Similarly, on the aspects of location of production, Oil produced close
to major markets for refining will require less transportation and therefore will be
more attractive and command a premium over oil produced further from the
market and which has to incur lager transportation costs to get to the market
(World Bank, 2005). Historically analysts have focused on two key qualities of
crude oil, namely, the API gravity and sulphur content to explain inter crude price
differentials.

The petroleum industry generally classifies crude oil by the geographic

location it is produced in (e.g. West Texas Intermediate, Brent or Oman), its API
gravity (an oil industry measure of density), and its sulfur content. Crude oil may
be considered light if it has low density or heavy if it has high density; and it may
be referred to as sweet if it contains relatively little sulfur or sour if it contains
substantial amounts of sulfur.

The geographic location is important because it affects transportation

costs to the refinery. Light crude oil is more desirable than heavy oil since it
produces a higher yield of petrol, while sweet oil commands a higher price than
sour oil because it has fewer environmental problems and requires less refining
to meet sulfur standards imposed on fuels in consuming countries. Each crude oil
has unique molecular characteristics which are understood by the use of crude
oil assay analysis in petroleum laboratories.

36
The type of crude oil that are traded on the international market have steadily
increased over the past few years, partly as a response to the desire to diversify
sources of supply and partly because increasing global demand has encouraged
production in less well-known oil producing areas.

According to The International Crude Oil Market Handbook, 2004, published by

the Energy Intelligence Group, there are about 161 different internationally traded
crude oils. They vary in terms of characteristics, quality, and market penetration.
Two crude oils which are either traded themselves or whose prices are reflected
in other types of crude oil include West Texas Intermediate and Brent.
Comparing these two crude oils with EIA‟s Imported Refiner Acquisition Cost
(IRAC), the OPEC Basket, and NYMEX futures is important to understand the
differences among the various types of crude oil that are often referred to in the
press and by analysts. Generally, differences in the prices of these various crude
oils are related to quality differences, but other factors can also influence the
price relationships between each other.

West Texas Intermediate (WTI): WTI crude oil is of very high quality and is
excellent for refining a larger portion of gasoline. Its API gravity is 39.6 degrees
(making it a “light” crude oil), and it contains only about 0.24 percent of sulfur
(making a “sweet” crude oil). This combination of characteristics, combined with
its location, makes it an ideal crude oil to be refined in the United States, the
largest gasoline consuming country in the world. Most WTI crude oil gets refined
in the Midwest region of the country, with some more refined within the Gulf
Coast region. Although the production of WTI crude oil is on the decline, it still is
the major benchmark of crude oil in the Americas. WTI is generally priced at
about a $5 to $6 per-barrel premium to the OPEC Basket price and about $1 to
$2 per-barrel premium to Brent, although on a daily basis the pricing
relationships between these can vary greatly.

Brent: Brent Blend is actually a combination of crude oil from 15 different oil fields
in the Brent and Ninian systems located in the North Sea. Its API gravity is 38.3

37
degrees (making it a “light” crude oil, but not quite as “light” as WTI), while it
contains about 0.37 percent of sulfur (making it a “sweet” crude oil, but again
slightly less “sweet” than WTI). Brent blend is ideal for making gasoline and
middle distillates, both of which are consumed in large quantities in Northwest
Europe, where Brent blend crude oil is typically refined. However, if the arbitrage
between Brent and other crude oils, including WTI, is favorable for export, Brent
has been known to be refined in the United States (typically the East Coast or the
Gulf Coast) or the Mediterranean region. Brent blend, like WTI, production is also
on the decline, but it remains the major benchmark for other crude oils in Europe
or Africa. For example, prices for other crude oils in these two continents are
often priced as a differential to Brent, i.e., Brent minus $0.50. Brent blend is
generally priced at about a $4 per-barrel premium to the OPEC Basket price or
about a $1 to $2 per-barrel discount to WTI; although on a daily basis the pricing
relationships can vary greatly.

NYMEX Futures:- The NYMEX futures price for crude oil, which is reported in
almost every major newspaper in the United States, represents (on a per-barrel
basis) the market-determined value of a futures contract to either buy or sell
1,000 barrels of WTI or some other light, sweet crude oil at a specified time.
Relatively few NYMEX crude oil contracts are actually executed for physical
delivery. The NYMEX market, however, provides important price information to
buyers and sellers of crude oil in the United States (and around the world),
making WTI the benchmark for many different crude oils, especially in the
Americas. Typically, the NYMEX futures price tracks within pennies of the WTI
spot price, although since the NYMEX futures contract for a given month expires
3 days before WTI spot trading for the same month ceases, there may be a few
days in which the difference between the NYMEX futures price and the WTI spot
price widens noticeably.

Many players are involved in the Oil and Gas production chain, from the owners
of the subsurface resources to financing organizations and on to operators,
drillers, equipment manufacturers, facility constructors, service providers and

38
engineering companies. The producing companies are generally classified into
the following three main groups: the international majors, the independents and
the major resources holders. The international majors are one of the largest
integrated companies in the world, the independents are the ones that have a
presence in just one segment of the industry, say for example, only in E&P
segment or only marketing and finally major resource owners are the one with
large reserves of crude oil.

5.2. Structure of the Industry and Global Oil Production

The oil industry is commonly viewed by the public as a monolithic entity. The
global petroleum industry is made up of many different actors engaged in
different segments of the business. Crude oil exploration & production
(henceforth referred to as E&P), gathering (generally called upstream sector),
refining or manufacturing of intermediate and final products such as petrol, diesel
and ATF, chemical feedstock, lubricant, and waxes (generally called downstream
sector), refined product distribution and storage facilities such as pipelines and
terminals, marketing and retail operations such as petrol stations, among others,
constitute the functional characteristics of the global petroleum industry. The
petroleum industry (Chazeau and Kahn, 1959) is what it is very largely because
of the peculiarities of its raw material. Petroleum is a fluid, both as captured from
the hidden recesses of the earth and as it passes through processing into final
uses. It is concealed in the earth and all advances in modern scientific
techniques have been incapable of eliminating the high element of gamble in its
quest. It is a raw material of almost infinite potentialities some of will be lost
forever if care is not taken, some can be secured simply while others can be
tapped only with costly special equipment. And finally oil is an exhaustible
resource, the total quantity of which is not clearly known.

The global proven oil reserve was estimated to 1652.6 billion barrels by the end
of 2011 as per BP. Almost 48.1% of the proven oil reserves are in Middle East.
Saudi Arabia has the second largest share of the reserve with 16.1%, Whereas

39
Venezuela ranks first in terms share of reserve with 17.9% and S & Cent
America‟s proven reserve of 19.7%.The oil industry is not a scientific pursuit but
a commercial venture. It is largely profit oriented and hence is carried out by
individuals, companies or countries for their own needs and for commerce. The
vagaries of the industry are because of several factors which are beyond the
control of the industry, even though some powerful cartels and syndicates can
influence the trend of production or prices from time to time. The pattern of world
oil production is given in table:-5.2.

Table 5.2. Global Oil Production

Change
Oil: 2011 2011
Production * over share
Million tonnes 2008 2009 2010 2011 2010 of total

US 304.9 328.6 339.9 352.3 3.6% 8.8%

Canada 155.9 156.1 164.4 172.6 5.0% 4.3%
Mexico 157.6 147.4 146.3 145.1 -0.8% 3.6%
Total North
America 618.5 632.1 650.6 670.0 3.0% 16.8%

Argentina 34.1 33.8 32.5 30.3 -7.0% 0.8%

Brazil 99.2 106.0 111.7 114.6 2.5% 2.9%
Colombia 32.0 35.8 41.9 48.7 16.3% 1.2%
Ecuador 27.4 26.3 26.3 27.1 2.8% 0.7%
Peru 5.5 6.6 7.2 7.0 -2.8% 0.2%
Trinidad &
Tobago 6.6 6.6 6.3 5.9 -6.5% 0.1%
Venezuela 154.1 149.9 142.5 139.6 -2.0% 3.5%
Other S. &Cent.
America 7.0 6.7 6.6 6.7 1.4% 0.2%
Total S. & Cent.
America 366.0 371.9 375.2 379.9 1.3% 9.5%

Azerbaijan 44.7 50.6 50.8 45.6 -10.3% 1.1%

Denmark 14.0 12.9 12.2 10.9 -10.1% 0.3%
Italy 5.2 4.6 5.1 5.3 3.9% 0.1%
Kazakhstan 72.0 78.2 81.6 82.4 0.9% 2.1%
Norway 114.2 108.8 98.6 93.4 -5.2% 2.3%
Romania 4.7 4.5 4.3 4.2 -1.5% 0.1%
Russian
Federation 488.5 494.2 505.1 511.4 1.2% 12.8%

40
Turkmenistan 10.3 10.4 10.7 10.7 - 0.3%
United Kingdom 71.7 68.2 63.0 52.0 -17.4% 1.3%
Uzbekistan 4.8 4.5 3.6 3.6 -1.8% 0.1%
Other Europe &
Eurasia 20.6 19.9 19.2 19.2 0.3% 0.5%
Total Europe &
Eurasia 850.8 856.8 854.2 838.8 -1.8% 21.0%

Iran 213.0 204.0 207.1 205.8 -0.6% 5.2%

Iraq 119.5 120.0 121.4 136.9 12.8% 3.4%
Kuwait 135.8 121.0 122.7 140.0 14.1% 3.5%
Oman 35.9 38.7 41.0 42.1 2.8% 1.1%
Qatar 60.8 57.9 65.7 71.1 8.2% 1.8%
Saudi Arabia 513.5 462.7 466.6 525.8 12.7% 13.2%
Syria 19.8 19.9 19.1 16.5 -13.7% 0.4%
United Arab
Emirates 142.9 126.3 131.4 150.1 14.2% 3.8%
Yemen 14.9 14.4 14.2 10.8 -24.0% 0.3%
Other Middle
East 1.5 1.7 1.7 2.2 32.0% 0.1%
Total Middle
East 1257.6 1166.6 1190.9 1301.4 9.3% 32.6%

Algeria 85.6 77.8 75.5 74.3 -1.6% 1.9%

Angola 93.5 89.1 92.0 85.2 -7.3% 2.1%
Chad 6.7 6.2 6.4 6.0 -6.7% 0.1%
Rep. of Congo
(Brazzaville) 12.2 14.2 15.1 15.2 1.0% 0.4%
Egypt 34.6 35.3 35.0 35.2 0.3% 0.9%
Equatorial
Guinea 17.2 15.2 13.6 12.5 -8.1% 0.3%
Gabon 11.8 11.5 12.5 12.2 -2.0% 0.3%
Libya 85.3 77.1 77.4 22.4 -71.0% 0.6%
Nigeria 105.3 101.5 117.2 117.4 0.2% 2.9%
Sudan 23.7 23.4 22.9 22.3 -2.6% 0.6%
Tunisia 4.2 4.0 3.8 3.7 -2.5% 0.1%
Other Africa 8.1 7.7 7.1 10.9 52.7% 0.3%
Total Africa 488.3 463.0 478.5 417.4 -12.8% 10.4%

Australia 24.4 22.6 24.6 21.0 -14.5% 0.5%

Brunei 8.5 8.2 8.4 8.1 -3.8% 0.2%
China 190.4 189.5 203.0 203.6 0.3% 5.1%
India 36.1 35.4 38.9 40.4 3.9% 1.0%
Indonesia 49.0 47.9 48.3 45.6 -5.6% 1.1%
Malaysia 32.1 30.6 29.8 26.6 -10.9% 0.7%
Thailand 13.3 13.7 13.8 13.9 0.8% 0.3%
Vietnam 15.4 16.9 15.5 15.9 2.1% 0.4%

41
Other Asia
Pacific 14.7 14.2 13.6 13.0 -5.1% 0.3%
Total Asia
Pacific 383.8 379.0 396.1 388.1 -2.0% 9.7%

World Total 3965.0 3869.3 3945.4 3995.6 1.3% 100%

of which: OECD 863.7 864.0 868.1 866.7 -0.2% 21.7%

Non-OECD 3101.3 3005.3 3077.3 3128.9 1.7% 78.3%

OPEC 1736.6 1613.6 1645.9 1695.9 3.0% 42.4%

Non-OPEC £ 1601.3 1611.1 1641.3 1640.1 -0.1% 41.0%

European Union
# 105.4 99.0 92.7 80.9 -12.7% 2.0%

Former Soviet
Union 627.1 644.6 658.2 659.6 0.2% 16.5%

* Includes crude oil, shale oil, oil sands and NGLs (the liquid content of natural
gas where this is recovered separately).
Excludes liquid fuels from other sources such as biomass and coal derivatives.
^ Less than 0.05.

£ Excludes Former Soviet Union.

# Excludes Estonia, Latvia and Lithuania prior to 1985 and Slovenia prior to
1991.

Source: BP Statistical Review of World Energy June-2012.

42
5.3. Global Oil Consumption

World crude oil consumption in the energy mix is the basic premises on which
the demand estimates are made. The crude oil consumptions are driven by
consumption of petroleum products; in turn crude oil consumption dictates the
demand of crude oil in the mix. The crude oil consumption pattern is given in
table-5.3 below.

Table 5.3 Global Oil Consumption

Oil: Consumption * Change 2011

2011
over share
Million tonnes 2008 2009 2010 2011 2010 of total

US 875.8 833.2 849.9 833.6 -1.9% 20.5%

Canada 102.5 97.1 102.7 103.1 0.4% 2.5%
Mexico 91.6 88.5 88.5 89.7 1.3% 2.2%
Total North America 1069.9 1018.7 1041.1 1026.4 -1.4% 25.3%

Argentina 24.7 23.7 25.9 28.1 8.2% 0.7%

Brazil 107.9 108.0 118.0 120.7 2.3% 3.0%
Chile 16.8 15.6 14.8 15.2 2.8% 0.4%
Colombia 10.7 10.6 11.4 11.7 2.4% 0.3%
Ecuador 8.7 8.9 10.3 10.5 2.6% 0.3%
Peru 8.0 8.1 8.5 9.2 9.0% 0.2%
Trinidad & Tobago 1.8 1.7 1.7 1.7 -3.5% w
Venezuela 33.3 34.8 36.9 38.3 3.8% 0.9%
Other S. & Cent.
America 56.7 54.5 53.5 53.7 0.4% 1.3%
Total S. & Cent.
America 268.5 266.0 281.0 289.1 2.9% 7.1%

Austria 13.3 12.8 12.9 12.5 -3.6% 0.3%

Azerbaijan 3.6 3.3 3.2 3.6 11.9% 0.1%
Belarus 8.3 9.4 7.3 9.0 22.8% 0.2%
Belgium & Luxembourg 36.8 32.2 33.5 33.7 0.7% 0.8%
Bulgaria 4.6 4.2 3.8 3.5 -6.4% 0.1%
Czech Republic 9.9 9.7 9.1 9.1 -0.5% 0.2%
Denmark 9.5 8.5 8.4 8.3 -1.7% 0.2%
Finland 10.5 9.9 10.4 10.5 0.9% 0.3%
France 90.8 87.5 84.4 82.9 -1.7% 2.0%
Germany 118.9 113.9 115.4 111.5 -3.3% 2.7%
Greece 21.3 20.1 18.7 17.2 -7.9% 0.4%
Hungary 7.5 7.1 6.7 6.5 -3.1% 0.2%

43
Republic of Ireland 9.0 8.0 7.6 6.8 -10.4% 0.2%
Italy 80.4 75.1 73.1 71.1 -2.7% 1.8%
Kazakhstan 11.1 9.0 9.5 10.2 7.6% 0.3%
Lithuania 3.1 2.6 2.7 2.7 0.8% 0.1%
Netherlands 51.1 49.4 49.9 50.1 0.3% 1.2%
Norway 10.4 10.6 10.8 11.1 3.5% 0.3%
Poland 25.3 25.3 26.7 26.3 -1.5% 0.6%
Portugal 13.6 12.8 12.5 11.6 -7.3% 0.3%
Romania 10.4 9.2 8.7 9.0 4.4% 0.2%
Russian Federation 129.8 124.8 128.9 136.0 5.5% 3.4%
Slovakia 3.9 3.7 3.9 3.7 -5.3% 0.1%
Spain 78.0 73.6 72.1 69.5 -3.7% 1.7%
Sweden 15.7 14.6 15.3 14.5 -5.3% 0.4%
Switzerland 12.1 12.3 11.4 11.0 -3.0% 0.3%
Turkey 31.9 31.6 30.2 32.0 5.8% 0.8%
Turkmenistan 5.1 4.6 4.8 4.9 3.9% 0.1%
Ukraine 14.9 13.4 13.0 12.9 -0.8% 0.3%
United Kingdom 77.9 74.4 73.5 71.6 -2.6% 1.8%
Uzbekistan 4.5 4.2 4.3 4.4 0.7% 0.1%
Other Europe &
Eurasia 32.3 30.5 30.4 30.3 -0.4% 0.7%
Total Europe &
Eurasia 955.5 908.5 903.1 898.2 -0.6% 22.1%

Iran 91.0 91.9 89.8 87.0 -3.1% 2.1%

Israel 12.2 11.5 11.2 11.1 -0.8% 0.3%
Kuwait 17.8 17.5 19.0 19.0 0.2% 0.5%
Qatar 6.2 6.2 7.4 8.0 8.3% 0.2%
Saudi Arabia 106.1 115.4 123.2 127.8 3.7% 3.1%
United Arab Emirates 29.6 27.5 28.9 30.5 5.6% 0.8%
Other Middle East 78.7 80.2 84.7 87.5 3.2% 2.2%
Total Middle East 341.6 350.3 364.3 371.0 1.8% 9.1%

Algeria 14.0 14.9 14.8 15.6 5.3% 0.4%

Egypt 32.6 34.4 36.3 33.7 -7.2% 0.8%
South Africa 25.3 24.7 26.1 26.2 w 0.6%
Other Africa 78.1 80.3 83.4 82.9 -0.6% 2.0%
Total Africa 150.1 154.2 160.6 158.3 -1.4% 3.9%

Australia 42.5 42.2 43.4 45.9 5.7% 1.1%

Bangladesh 4.6 4.8 4.9 5.0 2.2% 0.1%
China 376.0 388.2 437.7 461.8 5.5% 11.4%
China Hong Kong SAR 14.6 16.6 17.9 18.1 1.0% 0.4%
India 144.1 153.7 156.2 162.3 3.9% 4.0%
Indonesia 58.7 60.6 65.2 64.4 -1.1% 1.6%
Japan 220.9 198.3 200.3 201.4 0.5% 5.0%
Malaysia 27.1 26.5 26.7 26.9 0.7% 0.7%
New Zealand 7.2 6.9 7.0 6.9 -1.5% 0.2%

44
Pakistan 19.3 20.6 20.5 20.4 -0.2% 0.5%
Philippines 12.3 13.1 12.2 11.8 -3.6% 0.3%
Singapore 52.0 56.1 60.5 62.5 3.3% 1.5%
South Korea 103.1 103.7 106.0 106.0 -0.1% 2.6%
Taiwan 45.1 44.3 46.3 42.8 -7.5% 1.1%
Thailand 44.2 45.6 45.8 46.8 2.2% 1.2%
Vietnam 14.1 14.1 15.1 16.5 8.9% 0.4%
Other Asia Pacific 15.7 15.9 16.0 16.7 4.5% 0.4%

Total Asia Pacific 1201.6 1211.2 1281.7 1316.1 2.7% 32.4%

Total World 3987.3 3908.9 4031.9 4059.1 0.7% 100.0%

of which: OECD 2208.9 2097.8 2118.0 2092.0 -1.2% 51.5%

Non-OECD 1778.3 1811.1 1913.9 1967.0 2.8% 48.5%

European Union # 705.6 667.7 662.8 645.9 -2.6% 15.9%

Former Soviet Union 187.2 178.0 180.4 190.6 5.7% 4.7%

* Inland demand plus international aviation and marine bunkers and refinery
fuel and loss. Consumption of fuel ethanol and biodiesel is also included.

^ Less than 0.05.

# Excludes Estonia, Latvia and Lithuania prior to 1985 and Slovenia prior to
1991.

Note: Differences between these world consumption figures and world

production statistics are accounted for by stock changes, consumption of non-
petroleum additives and substitute fuels, and unavoidable disparities in the
definition, measurement or conversion of oil supply and demand data.

Source: BP Statistical Review of World Energy June-2012.

45
Saudi Arabia is the largest oil producer in the world (at the end 2011 as per BP).
With almost one-sixth of world proven oil reserves, some of the lowest production
costs, and an aggressive energy sector investment initiative, Saudi Arabia is
likely to remain the world‟s largest net oil exporter. Russia is another major world
oil producer, sometimes surpassing even Saudi Arabia production. Although the
United States ranks third in terms of oil production, it only ranks eleventh in terms
of proven oil reserves. Table 5.3(a) indicates the World Crude oil Import and
Export to different countries.

Table 5.3(a). World Crude oil Import and Export data

Oil: Imports and exports 2011

Million Tonnes Thousand barrels daily

Crude Product Crude Product Crude Product Crude Product
Imports Imports Export Exports Imports Imports Export Exports
s s
US 445.0 114.8 1.0 122.1 8937 2400 21 2552
Canada 26.6 12.7 111.7 26.8 533 265 2243 561
Mexico - 32.7 67.5 6.2 - 684 1356 131
S. & Cent.
18.7 62.6 139.0 46.5 375 1308 2791 972
America
Europe 464.2 132.2 12.9 86.4 9322 2764 259 1806
Former
† 5.1 319.3 108.9 ‡ 107 6413 2276
Soviet Union
Middle East 10.7 11.4 879.4 100.0 214 239 17660 2090
North Africa 21.0 20.6 72.3 22.9 423 430 1451 478
West Africa † 11.8 224.1 7.4 ‡ 246 4501 154
East &
Southern 2.4 11.6 16.6 0.3 48 243 334 6
Africa
Australasia 26.8 16.6 14.2 8.0 538 346 285 168
China 252.9 75.2 1.5 29.8 5080 1571 30 623
India 169.7 8.2 0.1 41.8 3407 171 1.5 873
Japan 177.3 44.5 † 13.9 3560 930 0.6 290
Singapore 55.1 97.6 0.7 87.1 1107 2040 14 1822
Other Asia
224.4 133.2 34.3 82.6 4505 2785 690 1727
Pacific
Total World 1894.7 790.7 1894.7 790.7 38050 16530 38050 16530
Note: Bunkers are not included as exports. Intra-area movements (for example,
between countries in Europe) are excluded

46
 * Includes changes in the quantity of oil in transit, movements not otherwise
shown, unidentified military use, etc.
† Less than 0.05.
‡ Less than 0.5.

Source: BP Statistical Review of World Energy June-2012.

If the production continues at today‟s rate, many of the present top ranking
producers such as U.S, Russia, Mexico, Norway, China and Brazil will have their
oil field largely depleted, and so will have much smaller share in the oil market in
less than 20 years. At that point of time, world will have to depend mostly on
Middle East for oil.

The non-Middle East Countries‟ overall reserves-to-production ratios are much

lower than the Middle East Countries (about 22 to 40 for non- Middle East and
about 90 for the Middle East producers).

Apart from the above conventional oil reserves, an estimated 800 to 900 billion
barrels of unconventional oil reserves comprising of oil sands (or tar sands) and
heavy oil are located in Canada and Venezuela. The R/P ratio for unconventional
oils is very large expected to be 300 by 2020.

***

47
5.4. Indian Scenario.
1. Pre Independence period (1866-1947): The exploration of hydrocarbon is
commenced in 1866 when Mr.Goodenough of McKoillop Stewart Co. drilled a
well near Jaypore in upper Assam and struck oil. Mr.Goodenough, however,
failed to establish satisfactory production. By 1882 the Assam Railway and
Trading company (ARTC), a company registered in London in 1881, with an
objective to explore the rich natural resources of Upper Assam, acquired rights
for exploration over about 30 sq. miles in the same area. Sub-surface oil
exploration activities started in the dense jungles of Assam in North-East India.
The first commercial discovery of crude oil in the country was, however, made in
1889 at Digboi. In 1893, rights were granted to the Assam Oil Syndicate which
erected a small refinery at Margharita to refine the oil produced at Margharita. A
new company known as Assam Oil Company (AOC) was formed in 1899 with a
capital of £ 310,000 headquartered at Digboi to take over the petroleum interests,
including the Makum and Digboi concessions and the rights from Assam Oil
Syndicate. A 500 BPD refinery was set up in Digboi in 1901, supplanting the
earlier refinery at Margharita.

In 1921, UK based Burmah Oil Company (BOC) which had a successful oil
exploration record in Burma, bought all the shares from ARTC and was
appointed commercial and technical managers of AOC. By 1931, crude oil
production has gone up to about 250,000 tonnes per annum and exploration
activities were spread all over the Assam-Arakan region. Meanwhile another
field was discovered at Badarpur in the Surma Valley and because the
discovering party lacked the capabilities to exploit the find, BOC provided
technical know-how, financial backing and managerial support.

2. Post-Independence Period (1947-1960): After independence, the

Government of India (GoI) realized the importance of oil and gas for rapid
industrial development and its strategic role in defense. Consequently, while
framing the industrial Policy Statement of 1948, the development of petroleum
industry in the country was given top priority.

48
While BOC and AOC continued development of Digboi oil field and intensified
exploration activities in the North-East region, the Indo-Stanvac Petroleum
Project (a joint venture between GoI and Standard Vacuum Oil Company of
USA) was engaged in exploration work in West Bengal. In the year 1953, the first
oil discovery of independent India was made at Nahorkatiya near Digboi and then
in Moran in 1956.

In 1955, GoI decided to develop the oil and natural gas resources in the various
regions of the country as a part of development of the Public Sector. With this
objective, and Oil and Natural Gas Directorate (ONGD) was set up towards the
end of 1955, as a subordinate office under the then Ministry of Natural
Resources and Scientific Research. The department was constituted with a
nucleus of geoscientists from the Geological Survey of India (GSI).

In April 1956, the GoI adopted the Industrial Policy Resolution, which placed
mineral oil industry among the schedule „A‟ industries, the future development of
which as to be the sole and exclusive responsibility of state.

Soon, after the formation of ONGD, it became apparent that it would not be
possible for the Directorate with its limited financial and administrative powers as
subordinate office of the Government to function efficiently. So in August, 1956,
the Directorate was raised to the status of a commission with enhanced powers,
although it continued to be under the government. ONGC started it systematic
geo-scientific surveys in areas considered prospective on the basis of global
analogies. A thrust in exploration was concentrated during the early years in the
Himalayan Foothills and adjoining Ganga plains, in the alluvial tracts of Gujarat,
Upper Assam and Bengal Basin. Exploratory drilling was initiated in the
Himalayan Foothills in 1957 with drilling of the first well Jawalamukhi-1 in
Himachal Pradesh. The year also saw drilling activities being taken up for the
first time in Cambay Basin which ultimately resulted in the discovery of oil and
gas in 1958. Meanwhile, Oil India Private Ltd. was incorporated on February 18,
1959 for the purpose of development and production of the discovered prospects
of Nahorkatiya and Moran and to increase the pace of exploration in the North-

49
East India. It was registered as a Rupee Company in which AOC/BOC owned
two-thirds of the shares and the GoI, one-third. In October 1959, ONGC was
converted into a statutory body by an act of the Indian Parliament, which
enhanced powers of the commission further. The main functions of ONGC
subject to the provision of the ACT, were „to plan, promote, organize and
implement programmes for development of petroleum resources and the
production and sale of petroleum and petroleum products produced by it, and to
perform such other functions as the Central Government may, from time to time,
assign to it‟.

3. Mixed Economy Period (1961-1991): On July 27th 1961, the Government of

India and BOC transformed OIL into a Joint Venture Company (JVC) with equal
partnership. ONGC‟s Geo-Scientific surveys and exploratory drilling activities
were also spread out to UP (1962), Bihar (1963), Tamil Nadu (1964), Rajasthan
(1964), J&K (1970),Kutch (1972), and Andhra Pradesh (1978). In spite of limited
success in these areas, ONGC pursued its exploratory efforts and was
successful in identifying hydrocarbons in Cauvery basin and Krishna Godavari
basins in the mid 1980‟s. Offshore exploration was initiated in 1962 through
experimental seismic surveys in the Gulf of Cambay. Detailed seismic surveys
carried out in the western offshore in 1972-73 resulted in the identification of a
large structure in Bombay Offshore which was taken up for drilling in 1974
leading to India‟s biggest commercial discovery, thereby establishing a new
hydrocarbon province. Encouraged by the success at Bombay Offshore,
exploratory efforts were expended systematically in the entire Western Offshore
including Kerala Konkan basin and Eastern Offshore areas leading again to large
discoveries in the Western Offshore (Bassein and Neelam) and substantial
accumulations in the Eastern Offshore (Ravva, PY-3 etc.). ONGC went offshore
in the early 1970‟s and discovered a giant oil field in the form of Bombay High,
now known as Mumbai High. This discovery, along with subsequent discoveries
of huge oil and gas fields in Western offshore changed the oil scenario of the
country. Subsequently over 5 billion tonnes of hydrocarbons were discovered.
The most important contribution of ONGC, however, is its self-reliance and

50
development of core competence in E&P activates at a globally competitive level.
ONGC went offshore in the early 1970‟s and discovered a giant oil field in the
form of Bombay High, now known as Mumbai High. This discovery, along with
subsequent discoveries of huge oil and gas fields in Western offshore changed
the oil scenario of the country. Subsequently over 5 billion tonnes of
hydrocarbons were discovered. The most important contribution of ONGC,
however, is its self-reliance and development of core competence in E&P
activates at a globally competitive level. On October, 14 th, 1961, OIL became a
wholly-owned GoI enterprise by taking over BOC‟s 50 per cent equity and the
management of Digbol oilfields changed hands from the erstwhile AOC to OIL.
For the time PEL‟s outside the North-East, were granted to OIL in Offshore
Orissa (Mahanadi) in 1978, in Mahanadi Onshore (1981), North-East Coast
Offshore (1983), Rajasthan (1983), Saurastra Offshore (1989) and Ganga Valley
areas in UP in 1990.

4. Economic Liberalization 1991: The liberalized economic policy, adopted by

the Government of India in July, 1991 sought to deregulate and de-license the
core sectors (including petroleum sector) with partial disinvestments of
government equity in Public Sector Undertaking and other measures. Following
this, ONGC was re-organized in February 1994 as a limited company under the
companies Act.

5. Post Liberalization: Several committees were set up to examine various

proposals for restructuring and devising strategies to meet the challenge of the
new economic environment. Among the most prominent report was the
Sundarajan Committee Report in February 1995 which favoured de-regulation of
the petroleum industry at one stroke. However, the strategic Planning group on
Restructuring of the Indian Oil Industry, the „R‟ Group, headed by the then
Petroleum Secretary. Dr. Vijay Kelkar, felt the Switchover should be in a phased
manner. Commercial hydrocarbon discoveries were reported by OIL during 1990-
91 in Assam and Rajasthan. During 1993 -1994 ONGC‟s production from
western offshore reached a low of 15.37 MMT, prompting ONGC to enter into

51
Joint Ventures for developing Ravva, Mid & South Tapti, Mukta and Panna fields.
The JV initiative was fulfilled in as much as it increased the production from these
declining fields by 5 MMT in 1994-95; during the same period 5 important
discoveries were made in the Bombay, Krishna – Godavari and Cauvery Basins.
A committee was constituted in 1992 under the chairmanship of P.K. Kaul former
cabinet Secretary, to examine the need for restructuring of ONGC. This
Committee recommended setting up of a body, with the name and style of the
Director General of Hydrocarbons (DGH), for discharging the regulatory functions
of leasing and licensing, safety and environment as also development,
conservation and reservoir management of Hydrocarbon resources. Accordingly,
DGH was set up by a Government Resolution in April, 1993 through which
certain advisory regulatory roles were entrusted but no development role was
assigned.

OIL also went overseas and acquired a 20 per cent participating interest in the
production sharing contract for the Block 4 in Oman through a farm in agreement
with TOTAL – FINA of France. It also involved in the exploration service contract
for the Farsi Block in Iran along with OVL and Indian Oil Corporation Limited.

In 1997 the GoI in order to accelerate pace of exploration efforts in the country
approved the New Exploration Licensing Policy (NELP) by providing a number of
attractive fiscal and contractual terms. The 9th rounds of NELP have been
concluded, out of the 254 blocks awarded under NELP 1-9 rounds, 54 blocks
have been relinquished till date and balance of 181 blocks are active.

5.4.1. Crude Oil and Natural Gas Production in India.

The trend in production of crude oil and natural gas during the period 2003-04 to
2010-11 is in Table-5.4.1 and Figure-5.4.1. The crude oil production has
remained in the range of 33 to 34 MMT during the period 2002-03 to 2009-10.
However, during 2010-11 the production of crude oil increased from33.69 MMT
during 2009-10 to 37.712 MMT due to production from Rajasthan oil fields.
Natural gas production increased substantially from 31.389 BCM in 2002-03 to
52.222 BCM in 2010-11, with some major discoveries by Pvt. /JVC‟s in Krishna
52
Godawari deep water; there was an increase by 11.94% over the year 2009-10 in
production of crude oil in 2010-11.

The Government of India launched the ninth bid round of New Exploration
Licensing Policy (NELP-IX) and fourth round of Coal Bed Methane Policy (CBM-
IV) during October, 2010 to enhance the country‟s energy security. In addition,
overseas oil and gas production in 2011-12 is likely to be about 7 MMT and 2
BCM per annum respectively.

Table 5.4.1. Crude Oil and Natural Gas Production in India

Year Crude Oil % Natural %

Production Growth Production Growth
(MMT) (BCM)

2002-03 33.044 - 31.389 -

2003-04 33.373 1.0 31.962 1.83
2004-05 33.981 1.82 31.763 -0.62
2005-06 32.190 -5.27 32.202 1.38
2006-07 33.988 5.59 21.747 -1.41
2007-08 34.118 0.38 32.417 2.11
2008-09 33.508 -1.79 32.845 1.32
2009-10 33.691 0.55 47.496 44.6
2010-11 37.712 11.94 52.222 9.95

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

53
Figure -5.4.1. Percentage Growth in Crude Oil & Natural Gas Production

50 44.6

40

30

20
9.95
10
1.83 1.38 2.11 1.32
-0.62 -1.41
0
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
-10

% Growth of Crude Oil Production - % Growth of Natural Gas Production -

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

5.4.2. Refining Capacity & Production

There has been a considerable increase in refining capacity over the years as
may be seen in Table-5.4.2. Domestic refining capacity has increased by over
2.48% to reach 183.386 Metric Million Tonne Per Annum (MMTPA) in 2010-11
as compared to 177.968 MMTPA in 2009-10. The refining capacity has touched
in 2011-12 at 213.06 MMTPA. It is expected that refinery capacity by the end of
2012-13 would reach 215.06 MMTPA (including private refiners).

The Refinery production (crude throughput) was 206.154 MMT during 2010-11
which marks net increase of 83.15.% over that produced during 2002-03 (112.56
MMT) and increase of 6.94%over 2009-10 (192.768 MMT) as depicted in Table-
5.4.2.

54
 Table-5.4.2. Refining Capacity & Production

Refining % Growth (Crude % Growth

Capacity Refinery Throughput)
@ Productio (MMTPA)
Year (MMTPA) n
2002-03 114.67 112.559
2003-04 116.968 2.00 121.84 8.25
2004-05 127.368 8.89 127.416 4.58
2005-06 127.368 0.00 130.109 2.11
2006-07 132.468 4.00 146.551 12.64
2007-08 148.968 12.46 156.103 6.52
2008-09 148.968 0.00 160.772 2.99
2009-10 177.968 19.47 192.768* 19.9
2010-11 183.386 3.04 206.154* 6.94
st
@ = As on 1 April of the Year.

*Includes other inputs by RIL Refineries.

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

5.4.3. Production and Consumption of Petroleum Products

There was an increase of 5.78% in production of petroleum products, including
fractioners, during 2010-11 compared to the year 2009-10. The indigenous
consumption of petroleum products increased by 2.88% during 2010-11
compared to the previous year. During the year 2010-11, net consumption of
petroleum products was 141.785 MMT against total production of 192.532 MMT.
It may be mentioned that the consumption data does not include data in respect
of RIL SEZ Refinery as it is presumed that all products have been exported and
not consumed domestically. Year-wise production and consumption of petroleum
products during 2003-04 to 2011-12 are depicted in Table-5.4.3. and Figure-
5.4.3. below. It is evident from Table-1.2.8, that production and consumption of
petroleum products are substantially higher than 2003-04.

55
 Table-5.4.3.

Production and Consumption (indigenous sales) of Petroleum Products

Year Production % Growth Consumption of % Growth of

of Petro Production Petro Product** Consumption
Product * of Petro (MMT) of Petro
(MMT) Product Product

2002-03
106.51 104.126
2003-04
115.783 8.71 107.751 3.48
2004-05
120.819 4.35 111.634 3.6
2005-06
121.935 0.92 113.213 1.41
2006-07
137.353 12.64 120.749 6.66
2007-08
146.99 7.02 128.946 6.79
2008-09
152.678 3.87 133.599 3.61
2009-10
182.012 19.21 137.808 3.15
2010-11
192.532 5.78 141.786 2.88
*= include LPG production from Natural Gas.
**=excludes refinery fuels includes import also.

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

56
 Figure-5.4.3:

Percentage Growth in Production & Consumption of Petroleum Products

25.00

20.00 19.21

15.00
12.64

10.00 8.71
7.02
5.78
4.35 6.66 6.79
5.00 3.87

3.48 3.6 3.61

0.92 3.15 2.88
0.00 1.41
2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

% Growth Production of Petro Product

% Growth of Consumption of Petro Product

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

57
5.5. Oil Pricing
To begin with, it is necessary to distinguish between pricing mechanisms and the
underlying forces which determine prices, or, in other words, to distinguish
between how prices are determined and what determines prices. The first is
about the organization of trade, exchange and marketplaces, including access,
and the ways prices are negotiated, communicated and made public. This does
not necessarily give an insight into what influences decision-making by buyers
and sellers, nor about the resulting market balance and price level.

The price mechanism for a commodity can lead to a transparent and liquid
market (as for crude oil) without any pressure for lower prices. However, the
underlying structure of oil and gas trade will have an influence on pricing
mechanism: a prominent question is the role of long-term contracts compared to
liquid markets. As oil and gas are special commodities, it is useful to look at the
range of economic paradigms, as well as the historical development of oil and
gas markets, in order to find ways to interpret the developments of oil and gas
pricing.

Price signals are visible to both producers and consumers and both sides follow
them with their decisions on production (output) and consumption to optimize
their profit or overall benefit. This not only presumes clear and visible signals but
also the capacity and the willingness to transform these signals into action. This
is put into question once demand reaches a certain inelasticity because
consumers may have little choice for a given time horizon and it may then
depend on the incentive on the producers side to compete with each other for a
larger share in the market. Those incentives may be distorted in the case of high
enough market concentration, but also as a function of risk perception or simply
by the investment time-lag needed to adjust the production level, or eventually by
regulatory or technical bottlenecks.

Price is signal from the market. It represents scarcity of the commodity in the
market. When the price rises, demand is reduced to a level where supply

58
matches demand (and vice versa). It also indicates a foresight of supply and
demand, as expectations are factored in both supply and demand curves.

Price is also a key signal for an efficient allocation of capital. A higher price
relative to cost signals the need for new investment in production capacity, as the
price signals a potential reward to investors. On the other hand, a low price
discourages investment. It is worth noting that the oil and gas sector competes
for capital with investment opportunities in other sectors. Therefore, a certain
level of returns is needed to attract capital.

Oil and gas have many characteristic that distinguishes them from other
commodities, such as:

i. The high uncertainty linked to resource development and the high

specificity of investment all along the energy chain from production to
consumption,

ii. The character of a natural resource,

iii. The finiteness of the resource exacerbated by the high concentration

of reserves in about a dozen countries,

iv. The involvement of two decision makers on the production side:

producing company and resource owner.

v. The often highly inelastic demand for energy and its interaction with
concentration and capacity restriction on the supply side, and

vi. Market imperfections such as unavoidable externalities.

By market imperfection, it is meant that when market mechanisms alone do not

allocate resources correctly, the occurrence is called „market imperfection‟ or
„market failure‟. The word „failure‟ does not mean an economic collapse or a

59
breakdown in the market. The term is normally applied to situations where the
inefficiency is particularly dramatic.
Market imperfections typically occur due to:

(i) Imperfect competition arising from monopoly,

(ii) Price distortion caused by lack of information,

(iii) The existence of externalities (e.g., environment ,climate, health ) and

(iv) Non-rivalry and non-excludability of public goods (e.g., national

security, fire-fighting) in which non- market institutions are more
efficient than private companies.

Energy markets are often characterized by

(i) Imperfect Competition

(ii) The existence of externalities and
(iii) The presence of public goods.
Price distortion caused by lack of information is increasingly excluded by the
development of liquid markets and transparency initiatives by governments.
By the laws of physics, energy cannot be recycled (contrary to mineral
resources)and the burning of fossil fuels inevitably produces CO2, with negative
externalities as a greenhouse gas. Security of supply of energy-especially for
electricity but also for oil and gas –has the character of a public good.
Internalizing of externalities is addressed by Pigou taxes i.e. pollution tax (which
try to assess the negative externalities and charge them as a tax on the player
causing it).

5.5.1. Historical Aspects

Current emerge energy markets development of their resource base is a

fundamental feature. Oil production has a limited life span; its production over

60
time can be illustrated by the so-called Hubbert‟s curve, a bell-shaped
distribution, initially proposed by M. King Hubbert in 1949 in relation to US oil
production based on statistical methods.

Many seek to utilize Hubbert‟s curve in order to predict the end of the current oil
era (peak oil debate / theory). But, as on a global basis the peak of the curve
has moved up and to the right because exploration activities and new
technologies have expanded the resource base (and proven reserves).

5.5.2. History of Oil Price

Until the beginning of the 1970‟s energy and Oil market development was
described by the ascending branch with accelerated growth of Hubbert‟s curve.
Production growth was based on the discovery of major new low-cost oil fields
primarily in the Middle East. The international market was closed to any
outsiders; first split between the Seven Sisters under the 1928 Achnacarry
Agreement and by the end of the 1960‟s increasingly dominated by OPEC,
especially after re-nationalization of their resources in the mid-1970‟s following
the end of colonialism in the 1960‟s. However, the embargo in 1973 / 1974 and
the oil price increases in 1973 /1974 and 1979 / 1980 triggered investment in oil
outside of OPEC, the development of new technologies, oil substitution by other
energies especially in power generation, more efficient energy use, and
substitution of energy by other productive resources, firstly by capital. This finally
led to the decrease of absolute volumes of world oil consumption in the early
1980‟s and to the oil price collapse in 1985 / 1986, to more competitive structures
and finally to a liquid oil market.

The development of the oil market, its contractual structure and pricing
mechanisms can be divided in four major time-periods from a historical
perspective. Different forms of oligopolistic pricing dominated during the first
three periods: prior to the 1970‟s, at the first two stages it was the oligopoly of
international oil companies (with the strong back-up of their home states), at the
third stage-it was the oligopoly of 13 major producer states (OPEC). It was only

61
after the oil price collapse in 1986 that pricing set by an oligopoly was substituted
by exchange – based pricing.

5.5.3. The Seven Sisters (1928-1947)

Prior to the 1970‟s the vertical value chain for internationally traded oil was
almost under the full control of the Seven Sisters. They received their oil mostly
through long-term concession agreements with host (mostly developing)
countries and exported it under long-term contracts (the trade arm of concession
agreements) either to affiliates in their home countries (up to 70% of total oil
export) or to independent non-integrated downstream companies. Transfer
pricing dominated during this period. Posted prices (de facto the transfer prices
of international oil companies) were established by the majors as a basis to
calculate the royalties to be paid to host states and thus were understated since
the international oil companies had their centers of profit in their respective home
states. This helped to expand oil consumption, especially in competition with
other energies, like coal, for electricity production. Competition happened in the
end-user markets, but for crude oil itself a free market played only a very limited
role (3-5% of world oil trade), used to fine-tune the volume balance of supply and
demand, based on the posted prices set by the Seven Sisters.

The Achnacarry agreement of 1928 assigned to each company a specific quota

of oil sales in the segments of the market outside the US. Its central element
was the so-called „one-based pricing formula‟ known as „Gulf referring to Mexican
Gulf which dominated the oil market until 1947. It increased the profitability of oil
operations of the Seven Sisters by establishing a single price formula for all oil
buyers outside the US, calculated as oil price FOB US Mexican Gulf coast, plus
freight rates in force from this coast to the delivery point, independent of the
origin of factual deliveries. According to the agreement each company was to
physically deliver within its quota to markets outside the US, and usually the
companies provide these deliveries from the nearest production area of that
company. Under this system any buyer would pay the same price in the given
location independent of the factual origin of the purchased oil; the savings on
62
freight for deliveries from areas closer to the buyer than the Mexican Gulf, as well
as the difference between the posted price at the factual origin of the purchased
oil and the price FOB Mexican Gulf, was extra profit for the International Oil
Companies.

The Achnacarry agreement was not applicable within the domestic US market as
it would have violated the US anti-trust law. But in accordance with the US
Webb-Pomerene law of 1918, American companies were allowed to act abroad
by means that would have been illegal under the anti-trust law in the domestic
US market.

The Achnacarry agreement allowed oil majors to fix oil prices based on the high
domestic US oil price level and thus provided extra profits due to the exploitation
of the uniquely cheap oil reserves in the Middle East. In the domestic US
market, a great number of small non-integrated American oil producing
companies operated with high marginal costs. In order to keep up a high number
of companies in the domestic market, the US government protect small
producers by regulating domestic prices at the „marginal cost-plus‟ level, thus
providing them with acceptable profitability. That is why the Achnacarry formula,
based on Mexican Gulf FOB oil price, protected both the interests of American
majors and of small and medium-sized American oil companies.

5.5.4. The Seven Sisters (1947-1971)

When, during World War II, the American and British Navies bunkered their ships
from the local refinery in Abadan, in the Persian Gulf, they were to pay the price
equal to the residual fuel oil (RFO) price FOB Mexican Gulf, plus fictive freight
from the Mexican Gulf to Abadan. American and British administrative
investigations after World War II forced the Seven Sisters to change the „one
base‟ oil pricing formula. In 1947 the international oil companies accepted
Persian Gulf as a second base for price calculations. As a modification of the
initial Achnacarry agreement, the „two base‟ oil pricing formula was introduced,
under which freight rates were calculated either from the Mexican Gulf or from

63
the Persian Gulf, but in all cases the oil price used for the calculation was the oil
price FOB Mexican Gulf. Under this new formula the extra profits of the
International Oil Companies were diminished by the deletion of virtual
transportation costs, but the difference between the marginally low production
costs in the Persian Gulf area and marginally high costs in the US (price FOB
Mexican Gulf) remained. Through the transfer pricing mechanism of posted
prices, the companies escaped taxation of their extra profits in the host states
and transferred them to their profit centers in their home states. This formula is
known as „two Gulfs plus Freight‟ (but should more accurately be labeled as
„Mexican Gulf plus two Freights‟). That is why WTI was the marker crude during
both of the two first pricing stages of oil market development.

5.5.5. OPEC set prices (1971 -1986)

In the 1970‟s control over domestic oil economies in the producer countries
(upstream part of the energy value chain-resources, production, sales and selling
prices) was acquired by the OPEC states. The upstream assets of the
international oil companies in the major host (OPEC) countries were nationalized
and formed the basis on which the new National Oil Companies (NOC‟s) were
created. Almost all oil supplied to the world market at this time was no longer
purchased on the basis of intra-or inter-company transactions (barter deals), but
by commercial transactions between independent players at the official selling
prices of the OPEC member-states. These prices began to play the role of world
oil prices. These conditions triggered a disintegration of the previous structure as
more companies entered oil trade operations downstream and upstream. While
during the periods of the Seven Sisters , the only point of competition had been
at the customers downstream, with OPEC dominance, competition also
developed for crude oil supplies.

This stimulated the appearance of new contractual forms in the oil trade and an
increased variety of trade operations. As the share of volumes traded under
long-term contracts diminished, their prices began to be established on the basis
of spot deals. By contrast, volumes traded on the spot market increased
64
significantly. The spot market began to balance supply and demand and began
to be used as a reference point for price levels both for exporters and importers.
It was during the first oil crisis of 1973-74 that the spot market first played its
price-defining role as a reference point for OPEC to set official selling prices.
Spot market volumes developed strongly during the period 1971 -1986: from 5-
8% of the international oil trade at the beginning of the 1970‟s and 10-15% in the
middle of the 1970‟s – to not less than 40-50% in the mid-to-late 1980‟s.

After the introduction of OPEC official selling prices, oil pricing was converted to
the „Persian Gulf plus freight‟ formula. The marker crude for official selling prices
at this time was usually Light Arabian Crude FOB Ras-Tanura, geared (by
regular updating by the OPEC states) to the development of spot market prices.

Sharp fluctuations in spot oil prices stimulated the introduction of risk

management techniques into oil operations. Demand to standardize oil trade
operations (as one of the risk-management instruments) was among the driving
forces for introducing contracts for oil and petroleum products at the existing
commodities exchanges (NYMEX) and for the establishment of specialized oil
exchanges (IPE). Managers from financial markets became involved in the oil
markets, introducing the techniques of financial markets and specialized oil
derivatives (oil futures and options). By the end of the 1980‟s, the current
complex contractual structure of the oil market was in place. It is now the oil
exchange where world oil prices are determined, though all other contractual
forms, determining oil prices at earlier stages, are still present, albeit without their
former dominant role.

5.5.6. Development of World Oil Market Structure and Types of

Transactions:-

The size, scope and complexity of global crude trade are unique among physical
commodities. Currently more than 86.03 million barrels of oil are produced and
consumed every day. Beyond the scale of trade in oil, the strategic importance

65
oil and the crucial role that it plays in the economy make it a commodity like no
other.

The pricing mechanisms in the oil sector, particularly into its commodity-type
pricing mechanism, which has developed since the official selling price system
within long-term oil contracts established by OPEC came to an end in the mid –
1980‟s. Commodity pricing in the oil sector is well established and spot markets
for oil have developed the full range of commodity pricing instruments.
Nonetheless, long term oil contracts still play a significant role, albeit with
different pricing mechanisms compared to previous periods.

The current spot markets have been developed since the early 1970‟s. at the
beginning they were aimed at fine-turning oil demand and supply and covered
not more that 3-5% of international oil trade. In the 1980‟s, rising oil production
from non-OPEC areas went into the spot markets. Key benchmark grades, West
Texas Intermediate (WTI), Brent and Dubai / Oman emerged and served as the
reference for crude of similar qualities and locations. Previously the role was
played by Arabian Light under OPEC‟s official selling price system.

Spot transactions are mainly conducted by telephone or computer network

between two parties. It is an over-the-counter (OTC) market as opposed to an
exchange. Spot markets do not necessarily have trading floors. The term „spot
market‟ applies to all spot transactions concluded in an area where strong trading
activities in one or more trading products take place.

The main spot markets or trading centers for crude oil are Rotterdam of Europe,
Singapore for Asia and New York for the United States. Their benchmarks are:
Brent, Dubai and WTI.

At the same time, futures markets have also developed in Western Countries.
These arose from a desire on the part of oil companies to reduce risk in light of
high price volatility. Developments in information technology, developments in
financial theory and a political climate favoring markets over government
administrative guidance led to the creation of financial derivative markets,

66
including futures and options. The New York Mercantile Exchange (NYMEX) and
the International Petroleum Exchange (IPE) are two major financial markets for
oil. World oil prices are led by these markets.

Long term contracts are still widely used. OPEC countries in the Middle East sell
their crude exclusively to refiners through long term contracts, which usually have
contract duration of one year with renewal clauses. The pricing formulas in the
long-term contracts are linked to benchmark grades. There are no long term
fixed price contracts, which existed between the two oil crises in the 1970‟s and
prior to that time.

Oil prices were hit hard by the Asian financial crisis in 1997 and 1998. They fell
to below $ 10 at the end of 1998. In March 1999, OPEC countries agreed to cut
production, joined by Russia, Norway and Mexico. With the Asian Economies
recovering from the financial crisis, prices increased during 1999. In 2003 and
2004 oil prices rose strongly in view of the war in Iraq and the fear of terrorist
attacks on oil facilities in Middle East. This was also result of under investment in
the international oil industry. Strong demand increases from the US and large
developing countries, which were not followed by a similar expansion of supply,
resulted in further increases in crude oil prices. That attracted speculators, who
moved from financial and currency markets into commodity markets (oil) and
contributed to the rise in prices. International Crude prices reached as high as $
78 per barrel in summer 2006, although they fell from this peak later in 2006.
Again, it went up to $ 147.27 per barrel in July- 2008 and later in fourth quarter
period.

Looking into the oil market, increases in oil consumption are closely linked to
economic growth. Where economies are growing, oil demand growth is taking
place in China, India, the Middle East and the US. Global oil demand is
expanding at around 1 MBD every year.

On the supply side, there is an ongoing debate called „peak oil theory‟. One
school claims that oil production will soon peak and that the consequences for

67
the world economy will be severe. Others consider that the peak oil production
will still be a moving target for some time, as new reserves become recoverable
due to exploration and improvements in technology. The United States
Geological Survey (USGS) considers that there are enough remaining petroleum
reserves to continue current production rates for another 50 to 100 years.
OPEC‟s 11 member countries produced 42.4% of the world‟s production in 2011
but hold 72.4% of oil reserves. OPEC ministers meet every three months to
discuss production levels and take the stock of situation of supply demand
balance sheet.

5.5.7. Supply side: Issue of Peak Oil

Global economy does not want to run out of fossil fuel any time soon. The
economist and analyst are concerned with the upward trend in oil production that
has been evident over the past century and will reach a peak of production and
then decline. Peak production is a source of debate among the participants in
energy market.

Peak oil is the point, when a given oil field reaches its maximum production, after
that starts decline in production, no matter how many new wells are drilled. The
ideas underlying peak oil were developed by a shell geologist, M King Hubbert
(Hubbert, 1956). Back in 1956, Hubbert reviewed the production history of a
number of oil fields in the US. He predicted that US oil production would peak in
the 1970s, and he called the top within a few months. Since then, crude oil
production has been declining in the US, despite the large discovery of oil made
on North Slope of Alaska in the late 1970s.

Applying same methods to global production, proponents of the Hubbert predict

that global production should peak in the next few years (Campbell, 2003 and
Deffeyes, 2002 and 2005).Hubbert‟s curve shows that oil production rises and
falls as a direct function of remaining oil reserves. In other words, production can
increase until the cumulative production uses up half the total reserves in the
field and then production begins to decline. What is critical in the analysis is the

68
half-way point (Campbell,2003). Once half of the oil is used up we have reached
a point of no return and production will decline no matter how much new
technology is applied or additional drilling occurs.

5.5.8. Comparative Study and Analysis of Global Oil Reserves:

According to the International Energy Agency (IEA), the world economies have
extracted and consumed approximately 1 trillion barrels of crude oil over the last
100 years. A reserve is said to be attained Hubert‟s peak when the field has
reached its maximum production and then begins to decline and this is the level
of oil reserve. Current production uses about 31 billion barrels per year. Now,
how much oil is left in the reservoir? Proponent like Kutasovic R. Paul‟s views are
essential to understand the oil left in global oil reserves. If we have extracted half
of all the oil that has ever existed, we are, by most definitions of the peak oil, at
or past the peak. Obviously, a larger reserve base implies a later peak date than
a smaller one. Following are the points borne in mind regarding oil reserves:

1. Amount of oil left to produce

2. Quality of remaining reserves
3. Geographic distribution of remaining reserves
4. Field by field analysis.

1. Amount of Oil

No geologist or analyst knows exactly the quantities of oil that exists beneath the
earth or how much can be extracted. Instead, all the numbers and figures
reported are essentially estimations based on probabilities. In fact, reserve
definitions vary by country to country, making comparisons between them
essentially useless. Reserves in a given oil field are classified in a number of
categories. The news media nearly always uses the proven reserve figures and
omits other categories. By definition, proven reserves are those that can be
recovered with reasonable certainty using current technology and current prices.
These are often classified as p-90 reserves since there is a 90% probability they
will be extracted over the life of the field.
69
The oil field will have additional quantities of probable and possible reserves;
these are recoverable with a probability of over 50% and under 50%,
respectively, from the estimated total volume of oil-in-place in the field. The
probable and possible reserves are undeveloped since they are unprofitable to
produce at current prices and technology.

Finally, there are unconventional reserves, which include heavy oils, tar sands
and oil shale. Processing these reserves is expensive and requires different
production methods. While some consider recoverable reserves to be fixed by
geology, in reality, their accessibility as energy source is more dictated by
technology and oil price changes. In other words, economics is as important as
geology in coming up with reserve estimates since a proven reserve is one that
can be economically developed.

Field delineation and development involves release of wells by geologists and

these wells are drilled by drilling team, followed by production testing. Once
testing of well is done and successful, the oil is flowed to process platform in
offshore field otherwise in onshore field it is flowed to group gathering station.
The processed oil is sent through pipe lines to the refinery for refining the crude
oil.

As technology improves and prices increase, probable and possible reserves are
reclassified as proven. This process often leads to a situation where the level of
proven reserves in an oil field trends upwards over time in spite of the ongoing
extraction of oil from the field. This will occur as the rate of extraction is offset by
the conversion of probable and possible reserves to the category of proven. In
addition, proven, probable and possible reserves represent only a portion of oil in
place in a given field since it is impossible to recover all the oil and gas. The
recovery factor (reserves to oil in place) may change over time in response to
improved technology and higher prices. Table 5.5.8 provides an estimate of
ultimately recoverable reserves (a category that includes proven and probable
reserves from discovered fields) as estimated by various sources.

70
Table 5.5.8. Estimates of Oil Reserves (Trillions of barrels)

Sources Ultimately Recoverable Reserves

British Petroleum 1.6
Campbell 1.0
Exxon 3.2
International Energy Agency 1.3
Nashawi Kuwait University 1.2
Oil and Gas Journal 1.3
United States Geological Service 2.3

Sources : British Petroleum(2011), C. Campbell (2003), Exxon 2010 Annual

Report, International Energy Agency (2008 and 2009), Nashawi (2010), Oil and
Gas Journal (2010), and United States Geological Survey(2000).

Thus, the world supply of oil is not only determined by geology, but also by an
interplay of economics, technology and most critically important in today‟s
environment, geopolitics. Given the above, the concern is not that world will soon
run out of oil in a direct sense. The consensus among most geologists is that
world still have about 7-9 trillion barrels of oil-in-place left. The question, is how
many of those barrels can be recovered and what will be the cost?

Most advocates of peak oil believe about 1 trillion barrels of oil are left. If true,
that will put us at or beyond the peak since about 1 trillion barrels have been
already produced and production must, therefore, decline. Other geologists
estimate ultimately recoverable conventional reserves as high as 3 trillion barrels
with another 2 trillion barrels of unconventional oil. Of course, the higher reserve
figures yield a much later oil peak, with the USGS numbers suggesting a peak
around 2037. A recent study (Nashawi, 2010) by researchers at Kuwait
University estimated that the world could ultimately produce 2,140 billion barrels
of oil, with 1,161 billion barrel remaining to be produced at 2005 end. This
suggests a peaking of production is 2014.

71
Reviewing the other reserve estimates suggests that the claim that oil production
has already peaked seems premature. If the more optimistic assessments hold
up, we should have at least another decade or two of rising production,
especially if production from unconventional reserves increases as expected.
But, even assuming that the peak occurs as late as 2040, a crisis is in the
making and preparation must soon begin for the difficult adjustment process of
finding reasonable options and alternative energy sources.

2. Quality of Oil

Quality of oil reserves is also critical due to its impact on the cost of extracting
and refining oil. The highest quality, light sweet crude, is easy to find and
cheapest to produce and refine. But, most geologists, according to IEA and US
Geological survey, believe that most of the high quality crude oil has already
been discovered and its production in existing oil fields is set to decline.
Replacing it will be one of several lower, heavier grades of crude (often
containing sulfur) that are more expensive to extract and refine. Compounding
the problem, it is getting more expensive to discover such new deposits
worldwide. For example, recent discoveries of large quantities of crude oil
offshore in Brazil and in the Gulf of Mexico involve extremely costly deep water
drilling in waters over 2 miles deep. Furthermore, unconventional energy sources
such as oil sands in Canada and Venezuela are expensive to produce and refine
and have significant environmental costs. All this suggests that oil prices cannot
help but trend upwards in the years ahead as cost of production rises.

3. Geographic Distribution

Finally, most of the world‟s proven reserves are found in OPEC region. The
Middle East accounts for over 48.1% of world‟s reserves based on data of British
Petroleum (June 2012). The rest of OPEC has 34% of reserves with Venezuela,
Nigeria and Libya containing 17.9% and 2.3% and 2.9% respectively. Most of the
OPEC reserves are found in countries with high geopolitical risks. Non OPEC
reserves accounts for 19.9% of the world total with proven reserves in the US

72
estimated at 1.9% of total. Exploration, development and production costs are
much higher in non-OPEC region. Most of the fields in the non-OPEC region are
mature and in decline.

4. Field-by-Field Analysis

The rate of change in output from maturing oil fields is critical in assessing the
point of peak production. The IEA (2008 and 2009) has compiled a database
containing production profiles on the world‟s 798 largest oil fields. This database
includes all 54 of the super-giant fields (proven reserves greater than 5 billion
barrels) and 263 of the 320 giant fields (proven reserves greater than 500 million
barrels). The bulk of global oil production comes from a small number of super-
giant and giant fields. The IEA (2008 and 2009) shows that the 20 largest fields
in the world produce over 19 million barrels per day (mbd) or about a quarter of
the oil produced in 2008. In addition, the percentage of global production from
super-giant and giant fields has grown as a share of total production and
accounted for about 60% of global production in 2008 (IEA, 2008 and 2009)
compared to around 56% in 1985.

The IEA (2008 and 2009) in an intensive field-by-field study found that 580 of the
798 largest oil fields are at peak or past peak in production. Output in 2008 at 16
of the 20 largest oil fields was below their historic peak. Most of the world‟s
largest fields have been in operation for many years and few large discoveries
have been made in recent years except for those in high cost deep offshore
waters.

The average annual rate of decline in these 580 fields is 5.1%. This is equal to
3.6 mbd, based on 2008 levels of global production. The rate of decline can be
slowed through the deployment of new secondary and enhanced recovery
techniques, but this is extremely capital intensive and significantly increases the
cost of producing a barrel of oil. The problem is that once production exceeds its
peak, it is difficult to slow the rate of decline even if large investments are made.
In fact, peak oil analysis suggests that the rate of decline will accelerate once

73
oilfields exceed peak production. A key implication of the analysis is that future
supply must not only meet rising demand, but also offset the loss of capacity
from existing fields as they mature. In fact, loss of capacity will have a more
important impact on future supply needs than the increase in demand.

In summary, what the oil reserve data suggests is that we are not running out of
oil per se, but that we are running out of high quality low cost oil and large-scale
investment in future energy supply is needed to offset large declines in global
production capacity.

5.5.8. (a). Demand Analysis (Changing Composition of Global Demand)

Perhaps, the most important development on the demand side of the oil market
is the rising importance of emerging market economies. Tables 5.5.8(a) and
5.5.8(b) provide historic consumption data for 1980 to 2010 and projections out
to 2030.

The composition of global oil demand is rapidly changing. Mature economies in

the US, Europe and Japan still account for over half of global consumption, but
their share are declining. The share of oil composition in advanced countries has
declined from 62.2% in 1980 to 49.9% in 2010. What is happening is that most of
the growth in the demand for oil is coming from emerging/developing countries.
Due to a combination of rapid economic growth and an expanding manufacturing
and transport sector, emerging economies are quickly cornering a larger pie of
global oil consumption. Growth in manufacturing and vehicle ownership is the
most important driver of oil demand in developing countries.

It is not surprising that the booming emerging economies have posted robust oil
demand. This is especially true of China and India, with the GDPs growth at an
annual average rate of around 10% and 8% respectively, over the past 5 years,
with no reasonable expectation of a slowdown. From the table 5.5.8(a) and
5.5.8(b), the historic oil consumption and demand data, the following
observations on the changing pattern of oil consumption have been made.

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5.5.8.(b). Consumption Analysis (Changing pattern of Global Consumption)

Oil prices rose significantly in the decade of 1970s. Oil consumption responded
to these price hikes with a lag as there was virtually no growth in global oil
demand between 1980 and 1990. Demand in mature economies declined by
400,000 barrels per day over this 10 year period.

Between 1990 and 2000, global oil demand rose by 9.6mbd as economic growth
worldwide was relatively strong. Despite the robust increase in demand, both
nominal and inflation-adjusted oil prices declined through most of the decade and
bottomed out in late 1998.

What was striking in the oil market in the decade of the 1990s was the sharp
contraction in oil consumption in the former Soviet Union from 8.1 mbd in 1990 to
4.3 mbd in 2000.

Global oil consumption grew at a rapid rate between 2000 and 2010 despite the
deep 2007-09 recession. Between 2000 and 2010, demand for oil increased by
9.4 mbd from 76.6 mbd in 2000 to 86.0 mbd in 2010.

Most of growth in oil demand between 2000 and 2010 has been due to growth in
consumption in emerging economies. Between 2000 and 2010, oil consumption
in emerging economies rose by 11.2 mbd accounting for all of the incremental
growth in global demand over this period. In contrast, consumption in advanced
economies declined by 2 mbd.

China alone increased consumption by 4.4 mbd between 2000 and 2010.
Demand in India and the rest of Asia rose by 2.6 mbd from 2000 -10.

The forecast of crude oil demand estimate remains for 2013 at 10 mbd, for Japan
it dropped from 5.4mbd to 4.6mbd and for India 3.75 mbd.

Changes in the price of oil are largely determined by incremental growth in

demand. Emerging economies, given their rapidly expanding consumption, will

75
increasingly account for most of the overall incremental demand growth for oil
and thus become one of the primary determinants of oil price.

Table -5.5.8 (a). Global Oil Consumption by Region (Million Barrels Per Day)

Mature 1980 1990 2000 2010 2015 2030

Economies
US 17.4 17 19.7 19 20.6 21.6
Europe 14.6 14.2 14.6 14.1 14.3 14.8
Japan 4.9 5.3 5.5 4.4 4.3 4.5
Other* 3.3 3.4 5.1 5.4 5.8 6.2
Total 40.3 39.9 44.9 42.9 45.0 47.1
Mature
Former 9.5 8.1 4.3 4.5 5.0 5.5
Soviet
Union
Emerging Economies

China 2.0 2.3 4.7 9.1 11.1 16.6

India 0.7 1.2 2.3 3.3 3.7 5.1

Rest of Asia 4.0 4.1 6.4 8.0 9.1 10.9

Latin 5.0 5.6 6.8 7.8 8.4 9.6

America

Middle East 2.0 3.7 4.9 7.1 7.5 9.0

Africa 1.3 2.1 2.3 3.3 3.5 4.1

Total 15.0 19.0 27.4 38.6 43.3 55.3

Emerging

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Total World 64.8 67.0 76.6 86.0 93.3 107.9

Sources: US Energy Information Administration (EIA 2011) and British Petroleum (2011)
Note: Other consumption in table is oil demand in Canada, Korea and Australia & New Zeeland

Table 5.5.8(b). Changes in Demand by Region (Million Barrels Per Day)

Changes in Projected Changes

Consumption in Consumption
2000-10(mbd) 2010-30(mbd)
Advanced Economies
US -0.7 2.6
Europe -0.5 0.7
Japan -1.1 0.1
Other 0.3 0.8
Total Mature -2.0 4.2
Former Soviet 0.2 1.0
Union(FSU)
Emerging Economies
China 4.4 7.5
India 1.0 1.8
Rest of Asia 1.6 2.9
Latin America 1.0 1.8
Middle East 2.2 1.9
Africa 1.0 0.9
Total Emerging 11.2 16.7
Total World 9.4 21.9

Sources: US Energy Information Administration (EIA 2011) and British Petroleum(2011)

Note: Other consumption in table is oil demand in Canada, Korea and Australia & New Zeland

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5.6. Global Oil Demand Projections

Global oil demand is projected to increase from 86.0 mbd in 2010 to an

estimated 93.3 mbd in 2015 and an estimated 107.9 mbd in 2030 based on
projection made by US Department of Energy (2011). The US Energy
Information Administration (EIA, 2011) forecast is essentially a consensus
forecast is consistent with projection made by the International Energy
Administration (IEA) and most private analysts.

Oil consumption in emerging economies will increased by an estimated 16.7mbd

between 2010 and 2030 and account for most of the growth in global oil
consumption. Oil consumption is expected to increase by 4.2 mbd in advanced
economies over this period. China alone will increase its consumption by 7.5
mbd between 2010 and 2030 accounting for over 34% of the global increase in
oil demand.

Growing vehicle ownership will play a key role in oil demand growth. Of the
projected increase in oil use over 2010-30, 62% occurs in the transportation
sector. Statistical studies by EIA(2010) and IEA (2008 and 2009) indicate that the
demand for motor vehicles rises rapidly once per capita income exceeds $3,000.
A growing portion of the population in China and India is now approaching this
threshold level of per capita income and thus both countries will experience a
significant surge in rates of motor vehicle ownership. In summary, the absolute
size and importance of demand in emerging economies will have a major impact
on price trends in the oil market.

5.6.1. Production: Non-OPEC Supply

We now look at the non-OPEC supply side of oil market. Growth in non-OPEC oil
supplies has played a significant role in the erosion of OPEC‟s market share over
the past three decades. Production surge in Alaska, The North sea, South
America and Mexico and recently in Africa. Many of these oil fields are now aging

78
and production is expected to decline. It is non-OPEC supply that will experience
the impact of peak oil.

Table 5.6.1. – Non-OPEC Production (Million Barrels per day)

2000 2010 2015 2030

US/Canada 11.1 13.3 14.6 18.2
Mexico 3.5 2.9 2.3 1.5
Europe 5.8 4.5 3.5 3.1
Former Soviet 10.7 13.2 14.6 17.4
Union(FSU)
Africa 2.5 2.6 3.0 3.5
Latin America 3.6 4.8 6.2 8.9
Rest of world 9.6 10.4 10.5 10.4
Total Non- 46.2 51.7 54.7 63.0
OPEC (Includes
Unconventional)
Unconventional 1.3 4.8 6.2 11.7
Production
Total Non– 44.9 46.9 48.5 51.3
OPEC less Un
conventional
Total less 34.2 33.7 33.9 33.9
Unconventional
and Former
Soviet Union.

Source: US Energy Information Agency (EIA) Annual Energy Outlook (2011)

Table 5.6.1. provides supply projection for Non-OPEC countries to 2030 based
on EIA estimates. The forecast assumes that conventional production (outside
the Former Soviet Union) stays essentially flat through 2030 as efforts of peak oil
become evident. Oil production increases due to growth in the former Soviet
Union and gains in nonconventional production. The EIA assumes significant
growth in nonconventional production with production increasing from 4.8 mbd in
2010 to 11.7 mbd by 2030. It is important to point out that unconventional
production is capital intensive, expensive to produce and with large

79
environmental impacts. The extreme to which these unconventional resources
will be utilized hinges on the price of crude and the cost of mitigating their impact
on environment. Oil markets will be adversely impacted if either former Soviet
Union or unconventional production falls below expectations.

5.6.2. Growing Dependence on OPEC

Comparing the demand forecast provided in Table 5.5.8(a) with non-OPEC
supply projections in Table 5.6.1, we can calculate the residual demand for
OPEC oil. This is the amount of oil OPEC must produce to close the gap
between global demand and non-OPEC supply. The results are provided in
Table 5.6.2. Most long-term projections of oil supply and demand simply assume
that OPEC production is a residual that will be available to meet market demand.
Table 5.6.2.
Growing Dependence on OPEC (Million Barrels Per Day)

2000 2010 2015 2030

Global 76.6 86.0 93.3 107.9
Demand
Less Non 46.2 51.7 54.7 63.0
OPEC Supply
Need for 30.4 34.3 38.6 44.9
OPEC Oil
Source: US Energy Information Agency (EIA) Annual Energy Outlook (2011)

The need for OPEC oil will grow from 34.3 mbd in 2010 to 44.9 mbd in 2030.
These amounts to a significant increase in OPEC output over a 20-year period.
Most of the production increases will occur in the highly politically unstable
Middle East. Essentially, the above analysis indicates that OPEC countries must
find the equivalent production capacity of another Saudi Arabia over the next 20
years. Such a sizeable expansion in oil production capacity will prove to be a

80
daunting challenge for OPEC producers and will require a huge financial
investment in both oil capacity and the infrastructure to transport it.

5.6.3. Implications of Dependence on OPEC

The growing projected reliance on OPEC production has the following

implications:

1. Oil is a global market, therefore, once non OPEC production peaks and
demand continues to grow, there will be strong upward pressure on oil prices.
2. Despite the two prices shocks in 1973-75 and 1979-1980, oil prices, after
adjusting for inflation, have been essentially flat for the past 40 years with no
clear trend. This is about to change. Over the next few decades, oil prices are
expected to trend upwards and do so well above the inflation rate.
3. The world currently has little surplus oil capacity. According to EIA, spare
global capacity is at its lowest in 30 years. Tight capacity is likely to be an
ongoing characteristic of the oil market in the future, given the expected slowing
in non-OPEC production.
4. With little spare capacity, oil prices will be highly volatile and will respond
quickly to any sudden change in demand or supply.
5. There are major questions as to whether OPEC countries or countries in FSU
will have the required financial wherewithal and technology to expand oil
production to meet global market needs. This will create further uncertainty in the
oil market.
6. Much of OPEC‟s production is in countries with high geopolitical risk. With a
growing reliance on OPEC oil, a speculative risk premium will be a permanent
feature in the oil market.
7. The threat is especially acute in Venezuela, where nationalistic policies could
lead to a sharp drop in foreign investment and in output. At risk are foreign oil
company‟s plans to finance the commercial development of an estimated 235
billion barrels of extra-heavy oil found in the Orinoco Belt.

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5.6.4. Supply Issue: Need to Offset Production Declines

Global oil production must expand over the next two decades not only to meet
the expected increase in demand, but also to offset declining production in
existing oil fields. As we have noted earlier, many of the largest oil fields have
been producing oil for decades and are likely to be close to a production peak
and an eventual decline. The IEA (2008) estimated that oil production from
existing oil production from existing oil fields is declining at an annual rate of
5.1%. Given this rate, the question is how much capacity must be added
between 2010 and 2030 just to offset the production declines.

IEA(2010) data estimated global oil production capacity in 2010 as 85 mbd. With
no addition to reserves, global production capacity will decline to 31.4 mbd by
2030 assuming an annual rate of decline of 5.1%. Thus, gross capacity of 53.6
mbd must be added by 2030 to compensate for declining production in existing
fields. This estimate is probably conservative since the rate of decline is likely to
accelerate over the next two decades.

5.6.5. Impact of Price Elasticity

The key unknown in the above projections is the eventual responsiveness of

global demand and non-OPEC supply to higher prices. In economics jargon, we
are referring to the concept of elasticity of demand for and supply of oil. Elasticity
measures responsiveness of consumption and production of oil to changes in
price. In other words, the coefficient of elasticity measures the extent to which
consumption growth will slow and production will rise in response to higher
prices. Estimates of demand and supply price elasticity for oil vary widely, but
consensus shows that elasticity rises significantly with time as both businesses
and consumers make adjustments in their spending habits and production
decisions. Economic theory predicts that over longer periods, oil demand and
supply should be highly responsive to price (a high level of elasticity). Historic

82
data completely supports this prediction. In fact, the decades of 1970s and 1980s
provided a perfect test of this theory.

Considering with economic theory, the high price of oil in the 1970s was followed
by a surge in non-OPEC investment and production in 1980s. At the same time
following the 1979-1980 price shock, demand for oil stagnated for over 10 years.
Surprising to many analysts, the global economy expanded at a healthy rate in
the 1980s with essentially no growth in oil demand (energy-efficiency improved
dramatically). What the data clearly shows is that in response to the higher oil
price, there was a sharp slowdown in growth in demand for oil in 1980s while its
supply rose. These results are just as predicted by economic theory and indicate
a high value for long run elasticity of demand and supply.

Understanding the concept of elasticity has important implications for the future
outlook of the oil market. Forecast in tables 5.5.8. (a) and 5.5.8(b) assumes that
oil prices rise at a faster rate (not an unreasonable assumption), projection of
future global demand will be considerably lower, and at the same time, higher
production is likely from non-OPEC sources. The global demand and non-OPEC
supply imbalance will be considerably less, as will be the need for OPEC
production. The important point to understand is that higher the oil price, the
more important is the elasticity effect. This means that demand will expand at a
slower rate and supply will expand at a faster rate in response to the higher price
of oil. This, in turn, will limit the extent to which oil prices rise (because of lower
demand and higher supply).

5.6.6. Implications for Oil Prices

The oil market is undergoing fundamental changes. On the supply side, global oil
production is likely to peak in the next few decades. A careful analysis of global
oil reserve data suggests it could occur as early as 2014 or as late as 2040. The
impact on global oil supplies will be dramatic even if peak production occurs at a

83
later date since global production capacity is already falling due to aging of oil
fields.
On the demand side, growth in oil consumption will come entirely from emerging
countries, with little growth in demand in advanced countries. Thus, pressure to
add to oil production capacity is coming from both supply and demand sides of
the oil market. Table-5.6.6. summarizes the amount of new oil production
capacity that must be added globally by 2030 to meet growing global demand
and to offset production declines.
Table 5.6.6.
Estimated Needs for New Oil Production Capacity ( Million Barrels Per
Day).

Additional Oil Capacity need to: 2010-2030

Meet global demand 21.9
Replace loss of capacity due to aging 53.6
of fields
Total 75.5

The results show that oil production capacity must increase by a staggering 75.5
mbd by 2030 to meet demand growth and replace depleted supply. This capacity
increase is more than twice the level of current OPEC production. In fact, as
shown in the above table, the loss of capacity will have more important impact on
future supply needs than the increase in demand. What makes the situation even
more challenging is that peak oil analysis indicates that the rate of decline will
accelerate with the increase in the age of oil fields. If this prediction is correct and
peak production occurs in the next few years, there will be an even greater need
to discover more oil to offset the larger declines in production. Therefore,
Investment in Exploration for New Discovery is essential and prime importance
for getting new field for oil production.
In addition, most new capacity coming on stream will be of lower quality, more
difficult to refine, with higher production costs and located in countries with high

84
geopolitical risk. Given the need to replace a significant and growing amount of
capacity and the growing demand from emerging economies, oil prices should
rise considerably over the next two decades.

5.7. Oil Sector and Energy Development in India:

Energy Security is essential for sustainable economic development. The modern
trend of economic development in the world is characterized by country‟s Energy
Security. In recent years India‟s economic growth has been achieved due to
synchronization of primary energy consumption. Oil contributes about 29.028
percent and gas contributes 9.84 percent of total energy consumption of India,
which is fourth largest energy consumer in the world. Energy is a vital input into
production and this means that if India is to move to the higher growth rate of 9%
that is now feasible, it must ensure reliable availability of energy at competitive
prices.

India is both a major primary energy producer and a consumer. India‟s crude oil
proved reserve at the end of 2011 as per BP statistics (June 2012) is 0.3% of
world reserves. India‟s Crude oil production is 38.9 Million tonnes that is just 1%
of World Crude oil production (i.e. 3913.7 Million tonnes). But, India is consuming
4.0 % of total world oil consumption as per BP annual statistical report (June
2012). However, the per capita energy consumption of India is one of the lowest
in the world. India consumed 455 kgoe per person of primary energy in 2004,
which is around 26% of world average of 1750 kgoe in that year. As compared to
this, per capita energy consumption in China, Brazil was 1147kgoe and
1232kgoe respectively. In the year 2009, the per capita energy consumption of
India is increased to 530Kgoe only.

India is not endowed with large primary energy reserves in keeping with her vast
geographical area, growing population, and increasing final energy needs. The
distribution of primary commercial energy resources in the country is quite
skewed. Whereas coal is abundant and is mostly concentrated in the eastern

85
region, which accounts for nearly 70% of the total coal reserves, the western
region has over 70% of the hydrocarbons reserves in the country. Similarly, more
than 70% of the total hydro potential in the country is located in the northern and
north eastern regions. The southern region, which has only 6% of coal reserves
and 10% of the total hydro potential, has most of the lignite deposits occurring in
the country.

The proven oil reserves of India as on 2011-12 is around 5.7 Thousand Million
barrels or 0.8 Thousand Million tonnes, i.e 0.3% share of total world reserves.
This can sustain the current level of production for the next 22 years. The current
level of production barely caters to 24% of the petroleum products demand and
the balance oil requirements are met by importing the crude. So, products prices
are very sensitive.

Petroleum pricing is fundamental for the operation of efficient energy market.

Petroleum product prices perform the important role of balancing consumer
energy demand with producer supply. The basic objectives of energy pricing are
economic efficiency, social equity and financial viability. Efficiency principle seeks
to ensure regulation of prices in such a manner that the allocation of society‟s
resources to the energy sector fully reflects their values in alternative uses.
Equity principle relates to welfare and income distribution considerations.
Financial principle suggests that energy supply system should be able to raise
sufficient revenues to remain financially viable, so that continuity and quality of
service is ensured and common people and community benefitted from the
energy supply system for sustainable growth and development.

India‟s dependence on oil import is growing. Table-5.7 shows the comparative

data of crude oil demand and domestic production, to sustain rate of 9% GDP
growth, the requirement of crude oil during (2011-12) has been 145 Mt. The
country is forced to resort to imports to bridge the gap between demand and
supply.

86
Table 5.7. Comparative data of crude oil demand, domestic production and
Crude Import.

Year Crude oil demand (XI) plan Crude oil Crude oil
(MMT) production(MMT) import (MMT)
Base case Upper case
2002-03 33.044 81.989
2003-04 33.373 90.434
2004-05 33.981 95.861
2005-06 32.190 99.409
2006-07 33.988 111.502
2007-08 116.4 117.6 34.118 121.672
2008-09 119.1 122.0 33.508 132.775
2009-10 122.0 127.8 33.691 159.259
2010-11 127.0 136.6 37.712 163.594
2011-12 131.8 141.8
Source: Petroleum Planning and Analysis Cell.

5.7.1. Imports and prices of Crude Oil:

Imports of Crude Oil during 2010-11, in terms of quantity was 163.594 MMT
valued at Rs.4,55,909 crores, this marked an increase by 2.72% in quantity
terms w.r.t. 159.259 MMT during the year 2009-10 and an increase by 21.45%
(w.r.t.Rs.3,75,378 crores) in value terms over the year of 2009-10. In terms of
US$, the extent of increase in value of Crude imports was 25.73%. It may be
noted that the imports of crude oil has doubled during this period when seen in
relation to imports in 2002-03.
During this period, the average price of International crude oil (Indian Basket) has
increased from US$ 26.59/bbl in 2002-03toUS$ 85.09/bbl in 2010-11 i.e. an
increase of about 220%. The trend in growth of crude oil imports and crude oil
International (Indian Basket) prices are depicted inTable-5.7.1.and Figure-5.7.1.

87
Table 5.7.1. Imports of Crude oil and Average Crude Oil Prices

Import of % Growth Average Crude oil % Growth

Crude Oil in Import Prices (US$/bbl.) in Crude
(MMT) Crude Oil Prices

Year
2002-03 81.989 26.59
2003-04 90.434 10.30 27.98 5.23
2004-05 95.861 6.00 39.21 40.14
2005-06 99.409 3.70 55.72 42.11
2006-07 111.502 12.16 62.46 12.1
2007-08 121.672 9.12 79.25 26.88
2008-09 132.775 9.13 83.57 5.45
2009-10 159.259 19.95 69.76 -15.77
2010-11 163.594 2.72 85.09 21.97

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

88
Figure-5.7.1 Percentage Growth in Imports of Crude Oil & average
International Crude Oil Prices.
50.00
42.11
40.14
40.00

30.00 26.88
21.97

20.00
19.95 % Growth in Import Crude
12.1
% Growth in Crude oil Prices
10.00 5.23 5.45
12.16
10.30 9.12 9.13
6.00
0.00 3.70 2.72

-10.00
-15.77

-20.00

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

5.7.2. Imports and Exports of Petroleum Products:

It may be seen that despite considerable variations in International prices of

crude oil, imports have followed a steady growth primarily to meet domestic
demand of a burgeoning economy, apart from re-exports of petroleum products.
With substantial increase in refining capacity in India, as seen earlier, exports of
petroleum products have picked since 2002-03 although declined shortly in 2008-
09 due to slowdown in global economy. Exports of petroleum products during
2010-11, in terms of quantity was 59.133MMT valued at Rs.1,96,112 crore,
which marked an increase of 16.01% in quantity terms (w.r.t. 50.974 MMT during
the year 2009-10), and an increase of 36.15% (w.r.t Rs1,44,037 crore) in value

89
terms in Indian rupees over the year of 2009-10.In terms of US$, the extent of
increase of exports in value was 41.12%.The exports of petroleum products, it
may be seen, has steeply increased by 475 % up to 2010-11. Imports of
petroleum products are relatively limited with greater focus on imported crude oil
to utilize domestic capacity as may be seen in Table-5.7.2 and Figure-5.7.2
below:

Table-5.7.2. Imports and Exports of Petroleum Products

Import of % Growth in Export of % Growth in
Petroleum Import of Petro- Export of
Products Petro- Product( Petro-
(MMT) Products MMT) Products
Year
2002-03 7.228 10.289
2003-04 8.001 10.69 14.62 42.09
2004-05 8.828 10.34 18.211 24.56
2005-06 13.44 52.24 23.461 28.83
2006-07 17.66 31.40 33.624 43.32
2007-08 22.462 27.19 40.779 21.28
2008-09 18.524 -9.50 38.902 -4.6
2009-10 14.662 -20.85 50.974 32.15
2010-11 17.337 18.24 59.133 16.01

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

90
Figure-5.7.2: Percentage Growth in Imports & Exports of Petroleum
Products

60.00

50.00 43.32
42.09 52.24
40.00
32.15
28.83
30.00 24.56 31.40
21.2827.19
% Growth in Import of
20.00 16.01
18.24 Petro- Products

10.00 10.69 10.34 % Growth in Export of Petro-

Products
0.00 -4.6

-10.00 -9.50

-20.00 -20.85

-30.00

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

5.7.3. Crude Oil Demand Projection for India.

A summary of the projections by various agencies is given in table 5.7.3. The
projection by IEA and EIA are based on unrealistically low growth rates of GDP
for India. It may be seen the demand for the year 2025 varies from 235 Mt for the
best case scenario(BCS) of India Vision- 2020 to 368 Mt of India Hydrocarbon
Vision-(IHV) 2025. The IRADe-PWC projections exclude Naphtha and their
projection of 347Mt under high growth case (HOG) is comparable to 368 Mt of
India Hydrocarbon Vision.

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 Table-5.7.3.
A summary of the projections of Crude Oil Demand for India by various
agencies

Year Projections by various Agencies

EIA (2004) IEA IHV- India Working Power & IRADe&
(2004) 2025 Vision- Group Energy PWC(2005)
(2000) 2020(2002) Report Division‟s
th
Reference High Low BAU BCS of 10 (Planning BAU HOG
case case case plan Commission)
(2001- Projections
02) (2003-04)
Base 2001 (105 2001 2001 2000 1998- 1997(83 2001-02 2001-02 2003-04 (
year Mt) (105 (105 (102 99 Mt) (108 (108 Mt 109.7 Mt)
Mt) Mt) Mt) (91 Mt)
Mt)

2004- 119 122 115 122 132 121 112 119 124 125 127
05
2009- 139 149 129 145 175 153 135 139 147 162 176
10
2014- 157 194 154 171 226 193 162 164 174 191 212
15
2019- 219 254 189 201 288 245 195 195 207 212 259
20
2024- 264 324 204 230 368 309 235 232 240 260 347
25
2029- 271 276 281 320 465
30

EIA – Energy Information Administration, USA;IRADe – Integrated Research and Action for Development.
IEA – International Energy Agency: BAU – Business as Usual; PWC – Price Waterhouse Cooper;
IHV- India Hydrocarbon Vision 2025; BCS –Best Case Scenario HOG – High Output Growth .
Source : Integrated Energy Policy (Report of the Expert Committee 2006)

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5.8. Role of Crude Oil Prices on Indian Economy:
Crude oil price is an important parameter for oil importing country like India; it has
a bearing on economy, because crude oil is the raw material for refinery. The
domestic production accounts for only 24 to 26% of total country‟s crude oil
demand; rest is to be met by importing the crude. India‟s huge dependence on
imported crude oil makes it vulnerable due to the shocks & disruptions in the
Global Oil Market. Any sharp spike in oil prices in the global market results in an
unfavorable economic situation. The reasons for the same are outlined below.

5.8.1. Rise in Cost of Imports: The first victim of rise in crude oil prices is the
state exchequer. Every increase of $1 per barrel in Indian crude basket prices
pushes up the annual oil import bill by $1.2 billion. The oil import bill of $140
billion is faced by India in 2011-12.( Source: World Oil, August 2012/ vol.233
No.8, p-25). It also leads to a faster depletion of India‟s Foreign Exchange
(FOREX) Reserves.

5.8.2. Widening of Trade Deficit: There is a sharp increase in India‟s trade

deficit. The steep increase in imports due to high oil prices leads to a further
widening of the trade deficit.
Table:-5.8.2.
Year Export (Million $) Import (Million $) Trade balance
(Million $)
2005-06 103090.5 149165.7 -46075.2
2006-07 126414.1 185735.2 -59321.2
2007-08 185295.0 303696.3 -88535.0
2008-09 185295.0 303696.3 -118401.3
2009-10 178751.4 288372.9 -109621.5
2010-11 251136.2 369769.1 -118632.9
2011-12 304623.5 489417.4 -184793.9
Source: RBI Handbook of Statistics of Indian Economy 2011-12, India‟s Foreign
Trade.

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5.8.3. Increase in Oil Under Recoveries: As the pricing of Diesel, LPG &
Kerosene is still under government control; any rise in international oil prices is
not reflected in the domestic market. The inability of OMCs to sell fuel at the
market defined rate results in higher under recoveries. OMC have reported under
recoveries totaling Rs. 1,385,410.00 million for the Financial Year 2012. ( ONGC,
Annual Report 2011-12, P-96).

5.8.4. Mounting Fuel Subsidy Burden: Any hike in price of imported crude oil is
absorbed by the OMCs along with the Upstream Oil Companies & the federal
government. The fuel subsidy bill has witnessed a continuous rise for the past
few years. Government‟s fuel subsidy bill amounts to US $ 9 billion during 2010-
11 (International Institute of Sustainable development, iisd, Fuel Subsidies in
India, 14th Aug 2012).

5.8.5. Worsening Fiscal Deficit: India‟s Fiscal Deficit for 2009-10 stood at 6.6 %
of Gross Domestic Product (GDP). Rise in crude oil prices worsens the situation
as Government has to shell out more money in the form of fuel subsidy to OMCs.
High subsidies are putting pressure on fiscal deficit which has touched 5.9 % of
GDP in 2011-12 and Govt. has targeted to bring it down to 5.1% in 2012-13.

5.8.6. Reduced Amount for Infrastructure Investment: India aims to invest $1

Trillion in infrastructure development during the 12thFive Year Plan (2012-17).
High prices of crude oil (leading to higher fuel subsidy & increase in fiscal deficit)
have the potential to derail the government‟s plans as they eat into the amount of
disbursal available with the government for infrastructure &social development
schemes. A continuous rise in the subsidy bill & worsening fiscal deficit has
forced the federal government to deregulate the petrol prices in the domestic
market while in-principle approval has been given for deregulation of diesel
prices. However, the Government reserves the right to intervene whenever the
situation demands.

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 Chapter-6
Policy Framework for the Oil Sector in India
Ministry of petroleum and Natural Gas (henceforth referred to as MOP&NG) is
concerned with exploration and production of oil and natural gas (including import
of crude oil, Liquefied Natural Gas), refining, distribution & marketing, import,
export and conservation of petroleum products. Activities of the Ministry are
carried through 17 (Seventeen) public sector undertaking, (03) private sector and
(01) one Joint Venture of BPCL and Oman Oil Company. Thus companies under
state dominate oil industry in the country today. These companies follow
government policies and directions and are accountable to parliament. Besides,
the Comptroller and Auditor General (C & AG) verify their books of accounts and
Central Vigilance Commission (CVC) oversees their commercial transactions.
The present pricing structure is influenced by Government policy. Even if one
argues that state is operating a monopoly, it is a public monopoly with all the
attendant control and the accountability in place (GOI,2006b). It is only recent
past that the various activities within the petroleum sector are slowly ceding to
private sector. Exploration and refining of petroleum has seen emergence of
many private players apart from multinational firms; though in marketing of petrol
and diesel very few private players have entered.

6.1. Institutional framework

The Indian petroleum sector can be divided into the following three sub-sectors:

1.Oil and Gas E&P;

2. Petroleum refining; and

3. Marketing

Petroleum Professional and Analyst in finding the business opportunities goes

further and breaks down the petroleum industry into more segments, namely,
exploration of potential oil basins, extraction of crude oil from the oil fields which

95
bear oil, storage, transportation, distribution, and marketing of crude oil; refining
to end product stage; and transportation, storage, and marketing of end products.

The Ministry of Petroleum and Natural Gas (henceforth referred to as MoPNG) is

entrusted with the responsibility of E&P of Oil and Natural Gas (including import
of liquefied natural gas) their refining, distribution and marketing, import, export
and conservation of petroleum products. The activities of the MoPNG are carried
out through two Exploration and Production companies (hence forth referred to
as E&P Companies) i.e. ONGC and OIL and Twenty one Refineries. The country
is not only self-sufficient in refining capacity for its domestic consumption but also
exports petroleum products substantially. The total refining capacity in the
country as on 1.6.2011 stands at 193.386 MMTPA.

The Indian petroleum industry is still largely controlled by PSU‟s though; of late
private players are making inroads into the industry. The Directorate General of
Hydrocarbons, GOI, which acts as the upstream regulator, was established
under the administrative control of MoPNG by a GOI Resolution in 1993 to
promote sound management of the Indian petroleum and Natural gas resources,
having balanced regard to the environment, safety, technological and economic
aspects of petroleum activity, to review the exploration programmes of
companies and to advise the GOI on the adequacy of these programmes. The
downstream sector of the industry was regulated by the MoPNG, until the setting
up of the Petroleum and Natural Gas Regulatory Board (henceforth referred to as
PNGRB) to regulate the refining, processing, storage, transmission, distribution
marketing and sale of petroleum, petroleum products and natural gas excluding
production of crude oil and natural gas. The Board is also responsible for
promoting competition in the industry.

6.2. Upstream Sector

Oil and natural gas also known as hydrocarbons are some of the most important
fossil fuels to meet the energy requirements of the country and support economic
growth. Currently, in India, the share of oil and gas in the primary energy is

96
about 38.8 percent. In spite of several advances in technology, exploration of oil
and gas has been stated, till today, to be a probabilistic discipline with a high
degree of risk of failure. The habitat for oil and natural gas having been
determined by geological events of the remote past, any estimation of resources
is based on various possible hypotheses and models constructed thereon.
Exploration is undertaken based on the some hypotheses and geological models
constructed on the basis of data acquired by exploration companies (GOI,
2005a). India has 26 sedimentary basins, comprising both onland and offshore
areas. Only 19 of the 26 sedimentary basins in India have been taken up for
exploration so far, with acquisition of seismic data and carrying out exploratory
drilling. Of the total sedimentary basin area of India of 3.14 million sq. km., about
1.39 million sq. km area is in the onshore area and 0.39 million sq. km in the
offshore area (up to 200 m isobaths water depth). The deep water area is about
1.35 million sq. km. Most of the basins are under various stages of active and /or
reconnoiter exploration. The sedimentary basins of India have been classified
into four categories as a function of geological knowledge of the basin, presence
and or indication of hydrocarbons and current status of exploration.

In view of the great need to establish indigenous sources of oil, the nucleus of an
organization for oil exploration was set up by GOI towards the end of the First
Plan period. With limited equipment and technical personnel available,
investigations were started in the Jaisalmer area of Rajasthan. The Second Plan
provided for an intensification of the effort and enlargement of the organization,
therefore, the Oil and Natural Gas Commission (now Corporation) was set up in
1956 by an Act of Parliament to explore and exploit hydrocarbon reserves in the
Indian sedimentary basins. The Commission undertook geological surveys,
geophysical investigations and exploratory drilling for oil in Punjab and later in
the region of Cambay and in the Brahmaputra valley in Assam. In 1958, Burmah
Oil also transferred bulk of its share to the GOI, and accordingly a joint venture
company name OIL was formed.

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In April 1956, the GOI adopted the Industrial Policy Resolution, which placed the
mineral oil industry among schedule „A‟ industries, the future development of
which was to be the sole and exclusive responsibility of the state. The Indian
upstream sector, thus, historically, has been under the dominance of PSU‟s.
ONGC and OIL, 33.3 million tonnes produced by the National Oil Companies
(henceforth referred to as NOC‟s) and more recently private and joint venture
companies are engaged in E&P of oil and natural gas in the country.

The domestic production of crude oil has remained between 33.3 and 37.712
million tonnes during 2003 – 2011. Not only has domestic production stagnated,
known oil reserves have also remained in a narrow range with total oil reserves
being of the order of 739 million tonnes in 1990 -91 and estimated to be 800
million tonnes in 2010 – 11. The proven reserve to production (R/P) ratio is
found to be 22 as on 2010-11. We now import 76 per cent of our consumption
and our import dependence is growing rapidly. There has been no significant
increase in known crude oil reserves during the last decade in spite of large
investments in exploration activities except Rajasthan MBA fields (i.e. Mangala,
Bhagyam and Aishwariya) in onshore by Cairn India Limited and KG basin
offshore Gas discovery by RIL. As a result, there is a vast gap between the
demand and domestic availability of crude oil. The import dependence kept on
rising. This raises serious concerns about India‟s energy security and our ability
to obtain the oil we need and the impact of constrained supply on oil prices and
on our economy. All projections show an increase in the gap between the
domestic crude oil production and consumption. In fact, according to International
Energy Agency, (henceforth referred to as IEA) India will be import dependent to
the extent of 94 per cent by 2030.

6.3. Intensifying exploration

It is surprising that though exploration has been a top most priority in the GOI‟s
agenda over the last four decades, the country is facing these dire consequences
of increasing crude oil imports as far as performance of exploration is concerned,

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the gap between import and domestic production is widening. The Third Plan
talked about an intensified programme of mineral exploration and development.
The Sixth Plan, similarly, called for a greatly intensified effort towards both
exploration and development. Similarly, the Seventh Plan pointed out the need
for intensifying exploration as well as for extending exploratory activities to
inadequately explored and unexplored basin. Further, the Ninth Plan envisaged
acceleration of exploration efforts, while the Tenth Plan pointed out that the thrust
area is acceleration of exploration efforts especially in deep offshore and frontier
areas. Both Eleventh and Twelfth plan also have given importance in intensifying
exploration and development effort in both offshore and onshore. Therefore, it
makes a great deal of economic sense to intensify exploration efforts in the
Indian basins, especially in the frontier basins so that their hydrocarbon potential
is fully assessed as early as possible. However, this intervention requires
substantial investments. Fortunately, it has already dawned upon our policy
makers that efforts of the two NOCs needed to be supplemented through
additional investments in the E&P sector from multinationals and Indian
companies.

It was against this background regarding the exploration scenario in the country
that GOI started looking for private capital to complement capabilities of our
NOC‟s. It must be pointed out that the importance of private capital has always
been duly acknowledged earlier. The Third Plan, for instance, had clearly
acknowledged the role of private capital to join the search of oil in India. GOI has
been inviting private investment in exploration of oil and gas in the country since
early 1980. However, initial efforts to attract private investment were limited to
offshore areas only.

6.3.1. History of Pre – NELP Licensing Rounds

The earliest effort at attracting foreign companies to invest was in the mid-1970
under the then Union Minister for Petroleum and Chemicals H.R. Gokhale.
ONGC and OIL were the major players. Except for Carisberg of the US and
Reading and Bates of Canada, the Government could not farm out any of the

99
areas to other parties. The two also eventually pulled out without finding any oil
but made their documentation available to the Government.

Failure to meet reserve accretion targets prompted the Government to involve

the private sector exploration bidding rounds started in 1979, but the early rounds
were not successful. The first four rounds took 12 years to come (1979-91). The
next five rounds came in two years (1994-1995) and succeeded in generating
some interest in the international oil industry. An innovation was also introduced
in the 9th round known as the JV round to reduce the risk for the private investors
by associating ONGC/OIL as partners in these exploration ventures. However,
the rigid decision – making structures of these National Oil Companies (NOC‟s)
created problems of compatibility and reduced the attractiveness of this
innovation.

To raise the interest of foreign companies in the E&P sector, the government
decided to award some small and medium fields for development to the private
and joint sectors, respectively, and came out with two rounds in 1992 and 1993.
These rounds evinced tremendous response from foreign players. Also in order
to upgrade the information on the hydrocarbon potential of India‟s unexplored
sedimentary basins, the GoI offered blocks for geophysical surveys during 1993
to 1995.

The following discussion chronologically traces the various exploration rounds,

Speculative Survey rounds and Development rounds announced by the GOI
during the period from 1980 to 1995.

6.3.2. First Round of Exploration (1980)

In 1980, GOI made a second offer to the international industry. This offer is now
referred to as the First Round as it was the first such invitation in the 1980‟s.
During this round 32 offshore blocks were placed offered to the international
industry. The timing of the offer coincided with two significant international

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developments which adversely impacted the response of the industry. Firstly,
the international market price of crude oil and products started showing signs of
weakness. This was because of the combined impact of the decline in demand
caused by the price rises of the 1970‟s and the addition to worldwide supply
arising from the discovery of new hydrocarbon reserves in non- OPEC countries
particularly Norway, UK, and Mexico. Falling oil prices narrowed the profit
margins of the oil companies compelling them to be more selective in their choice
of new international ventures.

Secondly, China threw open its off-shore acreage to international companies.

The offshore areas of China had excited explorers ever since offshore
exploration had become a technical reality. Its offshore sedimentary basin
offered the possibility of large new discoveries. Thus, when China reversed its
policy of isolation and adopted an open door attitude towards international
exploration there was literally a scramble to take up acreage in the country. In
the process funds which had been previously allocated to India and South Asia in
general were diverted to exploration in China.

Four companies responded to the Government‟s offer for bidding for two blocks.
After negotiations, the Government concluded an agreement in March, 1982 with
Chevron Oil Company of USA. This was a production sharing contract that
stipulated if Chevron had made a commercial discovery. ONGC would have had
the option to take up to 50 per cent equity interest in the project. Chevron was
obliged to sell its share of crude oil to India at the international market price. A
56.375 per cent corporate tax was to be levied on Chevron‟s profits. In addition a
15 per cent royalty was leviable on gross production. Chevron drilled three wells
without success and relinquished its contract area in 1985.

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6.3.3. Second Round of Exploration (1982)
The Second Round was announced in 1982. This time the Government placed
on offer 50 onshore and offshore blocks. Unfortunately the market had weakened
even further by then and no bids were received for the blocks on offer.

6.3.4. Third Round of Exploration (1986)

In March, 1986, GOI announced its Third Round in which 27 offshore blocks
were demarcated and placed on offer. The indicative terms of the production
sharing contract were issued along with the announcement. The Government
followed up the announcement with three presentations in Delhi, London and
Houston during which a delegation from the Government, ONGC and OIL
outlined the main provisions of the proposed contract and provided briefs on the
geophysical and geological activities carried out by the two national oil
companies in the blocks offered.

The framework of the contract offered in the Third Round was also of the
production sharing kind. The detailed terms and conditions were however
different from those offered in the earlier two rounds. Inter alia, the Royalty
charge of 15 per cent was withdrawn and Corporate Tax was reduced from
56.375 per cent to 50 per cent.

Seven companies viz, Shell, Chevron-Texaco, Broken Hill Proprietary Britoil,

Amoco, Albion and International Petroleum Corporation (IPC) made 12 bids for 9
blocks. The bids were evaluated in January‟1987 and the various companies
were called for negotiations in February. In December 1987 four contracts were
signed, three with the Chevron-Texaco group and one with IPC. All four
contracts were for exploration in the offshore east coast.

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6.3.5. Fourth Round of Exploration (1991)
In 1991, due to the Gulf crisis and disintegration of the Soviet Union, the
Government further intensified its efforts and started announcing bidding rounds
at regular intervals.

The Fourth round of exploration for oil and natural gas in India was announced in
1991. Gol invited bids from companies to explore for oil and natural gas in 72
blocks out of which 39 were offshore and 33 were onland. A number of foreign
companies did participate in this round. These companies include Alboin India
Inc., Coplex (India) Ltd., Vaalco Energy Inc., Rexwood-Oakland Joint Venture
and Pan Energy Resources from USA. Nikko Resources Ltd., Canada, Shell
India Production Development B.V., The Netherlands, and Sterling Resources
N.L, Australia.

6.3.6. First Development Round (1992)

GoI came out with the First Round of bidding for development of small and
medium sized oil and gas fields in 1992. These fields were discovered either by
ONGC or OIL but could not be developed on account of financial constraints of
the companies.

A total of 31 small sized discovered fields were offered, out of which 10 were
offshore and 21 onland. Of the above fields on offer, only 3 onland fields were
discovered by OIL while the rest belonged to ONGC. The offshore basins in
which the offered fields were located included the Andaman, Krishna-Godavari,
Cauvery and Bombay basins. Onland blocks were in the Gujarat and Assam
basins.

GoI offered 12 medium – sized fields 6 offshore while 6 onland to be developed

by the companies in joint venture with ONGC/OIL, Offshore fields offered
included the Ravva, Panna, Mukta, Mid and South Tapti and the R-Series.
Onland fields included fields in Arunachal Pradesh, Assam and Rajasthan.

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6.3.7. Fifth & Sixth Round of Exploration / Second Development Round /
First speculative Survey Round (1993)
The Fifth Round of bidding for exploration of oil & natural gas in India was
announced in 1993 in which a total of 45 blocks were offered 29 offshore and 16
onland. Rexwood – Oakaland JV, USA. Command Petroleum Holdings,
Australia, Vaalco Energy, USA participated.

Again in the same year, as part of the continuous round the year bidding scheme
for exploration acreages, GoI announced the Six Round of bidding for exploration
of oil & gas in India. Twenty three blocks from those offed in the Fifth Round of
bidding were offered again in this round. In addition, 23 other blocks were put on
offer making a total of 46 blocks on offer, with 17 of them being offshore and 29
onshore. Among the foreign companies who showed interest under this round
included Samson International Ltd., Amoco India Petroleum Ltd., and Enron Oil &
Gas India Ltd from USA, BHP Petroleum (India) Ltd., Australia and Phonix
Geophysics Ltd., Canada.

In order to upgrade the information available on the hydrocarbon potential of the

unexplored sedimentary basins in the country. Gol announced the offer of blocks
for carrying out speculative geophysical and other types of surveys. In the First
Round, a total of 35 blocks 21 offshore and 14 onshore were put on offer.

Also in 1993, GoI invited offers from companies to participate in the development
of medium sized and small sized oil & gas fields in India. Eight medium sized
and 33 small sized fields were on offer. The medium sized fields were to be
developed in joint venture between the companies and ONGC/OIL while the
small sized fields were to be developed by companies on their own with no
participation by ONGC/OIL. Of the 33 small size fields, 4 were offshore while the
balance 29 was on land fields. Of the 8 medium sized fields 2 were offshore

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Ratna & R-Series and Basin Oil Rim while 6 were on land located in the Cambay
and the Upper Assam basins

6.3.8. Seventh & Eighth Round of Exploration / Second Speculative Survey

Round (1994)
The Seventh Round of bidding for exploration of oil and natural gas blocks in
India was announced by GoI in 1994. A total of 45 blocks were offered out of
which 27 of them were on land and 17 were offshore and 1 on land block
extended in offshore. Under this round companies like Rexwood – Oakland,
Enpro India Ltd., Geo-Enpro Petroleum Ltd., Phoenix Overseas Ltd., and Enron
Oil & gas India Ltd., participated among others.

In the same year the GoI announced the Eighth Round of bidding for the
exploration acreages. A total of 34 blocks were offered out of which 19 of them
were on land and 15 were offshore

GoI announced the Second Round of offer of blocks for carrying out speculative
geophysical and other surveys. In this round a total of 12 blocks were on offer 11
on land and 1 offshore.

JV Exploration Programme / JV Speculative Survey (1995)

The last of this series of rounds was the joint Venture Exploration Programme
(JVEP) for the exploration of oil and natural gas in India announced by Gol in
1995. Under this programme the successful company / consortium was to form
an unincorporated joint venture with ONGC/OIL. A total of 28 exploration blocks
were placed on offer (23 of which were under licence to ONGC and 5 to OIL),
with 10 of them being offshore and 18 onland.

The first two speculative survey rounds were unsuccessful, prompting GoI to
announce a Joint Venture speculative Survey Round in 1995. Under this round
the blocks were offered to carry out speculative geophysical and other type of

105
surveys with the participation of its nominee, the Directorate General of
Hydrocarbons (DGH). A total of 20 blocks were placed on offer with 16 being
offshore and 4 being on land.

6.3.9(a) Exploration Rounds

As discussed in the above section, during the pre-NELP period, a total of nine
rounds of bidding for exploration took were held by Gol including the last Joint
Venture (JV) Round. The first three rounds were announced between 1979 and
1986 while the fourth round was announced in 1991 when India opened its door
for foreign investments in a number of industries. After the Fourth Round, Gol
adopted a system of continuous round the year bidding with exploration blocks
being offered every six months. Under this scheme, the Fifth to Eighth Rounds
of bidding were held during January 1993 to July 1994. Bidding for JVEP was
held in September, 1995.

The exploration blocks under the pre-NELP rounds were identified for offer in
consultation with ONGC and OIL, who were the licensees. Notices were
published in national and international dailies / journals inviting offers for the
identified blocks. Companies were given about five to six months to submit their
bids. The bids were invited under international competitive bidding system.
Information docket / data packages were prepared by ONGC / OIL for each block
on offer.

The main criteria for evaluating of bids were the technical and financial capability
of the bidding company / consortium, work programme and the commercial terms
offered to the government the bids were evaluated by ONGC / OIL / DGH. The
evaluations were considered by the empowered Committee of Secretaries (ECS)
comprising Petroleum Secretary, Finance Secretary and Law Secretary. The
C&MDs of ONGC and OIL also assisted the committee as technical members.
The recommendations of the ECS on the award of blocks were placed before the
Cabinet Committee of Economic Affairs (CCEA) for consideration and approvals.

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The blocks were awarded to the successful bidders after obtaining CCEA
approvals. Successful companies or consortium had to sign Production Sharing
Contracts (PSC‟s) with GOI and ONGC or OIL.

The terms and conditions of the 9th Round of Exploration, which was the JV
Round, were as follows:-

ONGC or OIL was to have a participating interest of 25-40 per cent in the joint
venture, thus sharing exploration costs. In the case of crude oil and associated
gas the contract was on a production-sharing basis for 25 years, from the date of
commencement of the contract (with a possible extension of 5 years). For non-
associated gas, the contract was for 35 years from the date of signing.

The exploration period was for a maximum 6 years divided into 1-3 commitment
phases, with no single commitment phase exceeding 2 years. The company or
consortium had the option to terminate the contract at the end each commitment
phase.

Cost recovery of up to 100 per cent was allowed. The percentage of annual
petroleum production expected to be allocated for recovering costs was required
to be indicated.

Companies had to indicate the minimum exploration work they planned to carry
out in each commitment phase.

The sharing of profit was to be based on a sliding scale tied to post – tax rates of
return or multiples of investment recovered. Multiples of investment recovered
was defined as the cumulative cash flow since the commencement of the project
operations divided by the cumulative investment in the project.

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For Natural Gas, the joint venture had the freedom to make arrangements for
marketing the gas. There were no production signature bonuses. All data
gathered during the course of operation under the contract was the property of
GoI.

If the joint venture opted to proceed to the second commitment phase, It has to
relinquish 30 per cent of the original area of the blocks. Similarly, if it opted for
the third commitment phase, the joint venture had to relinquish a further 40 per
cent of the area. At the end of the last commitment phase, the joint venture had
to relinquish all areas except those in which hydro carbons had been discovered
or a development plan had been prepared. However, negotiations for certain
blocks were allowed.

The joint venture was not required to pay royalty or cess and was exempt from
customs duty on all operations under the contract.

Foreign companies were free to remit amounts due to them under the contract
out of India. Soft loans were available for the exploration of blocks.

No private company in a consortium that had been awarded a block for

exploration could unilaterally withdraw from the consortium. Further government
approval was required for induction of any new player in the consortium.

The companies were required to adhere to the original schedule, and the
government had the right to revoke the contract if the companies did not follow
the schedule.

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 Table-6.3.9(a)

Blocks Offered under Pre-NELP Exploration Rounds

Year Round No of Blocks offered Bid Contracts Signed
Received
Offshore Onshore Total Offshore Onshore Total
1980 One 17 15 32 4 1 0 1
1982 Two 42 8 50 Nil 0 0 0
1986 Three 27 0 27 13 0 0 0
1991 Four 39 33 72 24 2 3 5
1993 Five 29 16 45 15 4 2 6
1993 Six 17 29 46 20 2 3 5
1994 Seven 17 28 45 12 2 3 5
1994 Eight 15 19 34 38 1 3 4
1995 Ninth 10 18 28 22 1 1 2
JV
Round
Given to Chevron in Saurashtra Offshore where 3 wells were drilled. Chevron
exited from the block in 1993.
Source: PetroFed, Paper on “Review of E&P Licensing Policy”, P-87.

6.3.9(b). Analysis of Foreign Investments in Exploration Rounds

Before entering into a contract, an exploration and production (E&P) company
has to balance the risk and reward of the venture and compare it with other
ventures around the world that are competing for scarce resources. Companies
will only bid on attractive acreage. The fiscal terms are generally of secondary
importance. Attractive acreage has to be made available and be seen to be
attractive. Success needs to be demonstrated.

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Despite favourable terms and conditions given to major countries world-wide the
9 bidding rounds conducted thus far have met with poor response. The reasons
for such a performance have been discussed in the following paragraphs.

The stipulation that the prospective investors should participate in biddings

seems to have put off many.

There was a perception that the blocks with high prospects were reserved for the
NOC‟s and only high risk areas were offered to private investors. The NOC‟s
continued to hold on to the blocks they were awarded on a nomination basis.
They also played a decisive role in the delineation of the blocks. Though it was
recommended that, where feasible, an exploration block should include a
producing field or an area with oil / gas finds, there were instances where this
was not done and the producing areas were deliberately left out of the blocks.
There were also instances of a block being advertised and later withdrawn at the
instance of a NOC. These factors reduced the commercial attractiveness of the
blocks offered. If an acreage had been extensively explored (e.g. by the NOC‟s)
without success it would not be considered attractive. Much of the acreage
offered in rounds seemed to be on offer because it had already been
unsuccessfully explored.

The incentive structure was designed after a study of practices followed by other
countries such as China and Indonesia. The bidders, however, felt better
incentives were necessary in India to make up for the higher perceived risks.
Many improvements have indeed been made in the NELP.

A very important factor was the delay in making and implementing the
exploration policies. The award of production sharing certificates (PSC‟s)
required clearances from several ministries, leading to inordinate delays.
Though there was an empowered committee of secretaries, it had limited
success in cutting through bureaucratic red tape. While it should normally take a

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few months to award these contracts after the receipt of bids, in practice it took 2-
3 years. Further, the awards were followed by lengthy negotiations prior to
signing of the contract. In all the procedural delays disappointed even the most
determined bidders. Even after the contract was signed, many approvals,
including the all-important exploration licence, were required. These also took
years to be realized.

A disturbing point that has been made is that the agencies that were not
associated with the negotiation of the PSC‟s but had to be approached
subsequently for various approvals were not prepared to treat the PSC‟s as
binding and sought to reopen matter that were negotiated and settled. Some
state governments have been of the view that they have the right to select the
awardees as the exploration licence has to be issued by them. These issues
have not yet been fully resolved which could cause problems in awarding blocks
in the future. The blocks already offered would not be affected by this problem.

The current PSC‟s allow ONGC to obtain up to 40 per cent equity risk free in a
successful discovery. The remaining 60 per cent of the production is split
between the government and the contractor, with the government receiving
between 20-50 per cent. On the remaining portion, up to 48 per cent income tax
is paid. The overall revenue received by the contractor is less than 18 per cent,
over a period of 25 years.

Acreage is assessed by inspecting data. All data has to be freely available and
of good quality. A reasonable time has to be allowed for the assessment of the
data. Industry has to know what acreage is available. There was no
comprehensive map showing all open acreages, or areas for which the NOC‟S
have already put in an application to explore. The data dockets for the various
blocks offered during the bidding rounds had insufficient data and were
overpriced.

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The effective date was the date of signing the PSC. There are penalties if work
does not commence within a specified time limit from this effective date.
However, there was no corresponding penalty on the government if it did not
provide approvals in time.

Exploration blocks were not of the size expected by international operators (the
threshold size for exploration and developments considered to be of the order of
100-300 million barrels and 20-50 million barrels respectively).

The bidding process was handled by a group called the Exploration Contract
Monitoring Group (EXCOM) which formed a part of ONGC. The bidders
perceived this to be against their interest.

6.3.9(c). Speculative Survey Rounds

In 1993, GoI offered blocks for geophysical and other surveys to upgrade the
information on hydrocarbon potential of India‟s unexplored sedimentary basins.
After completion of the work, GoI was to offer these blocks in the subsequent
rounds of exploration. Until 1996, GoI announced three such rounds with the last
round called the Joint Venture Speculative Survey Round (JVSSR), 1995, with a
provision of risk participation by DGH of up to 50 per cent.

The companies could enter into a speculative survey contract by signing profit
sharing contract with GoI through their nominee, DGH. The contract could be for
any type of geophysical survey and companies were free to bid for any number
of blocks, on their won or by forming a consortium. The participation in these
rounds, however, was very low because of high perceived risk and the long-time
taken to settle negotiations.

The terms and conditions of JVSSR were as follows;

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Provision for cost sharing by Gol / DGH up to 50 per cent. Data acquisition,
processing and interpretation work to start within six months of obtaining the
petroleum exploration licence. The work should be completed within 24 months
from the date of signing the contract. The total period for sale of data is up to
seven years from the announcement of subsequent exploration round in case the
block is not awarded.

The acquired speculative survey data can be sold to any interested hydrocarbon
exploration company in India. The original data acquired, as well as all the
processed, re-processed and interpreted date is to be given free to the
government. The price of data packages and any subsequent change have to be
agreed upon by the government.

Companies have to indicate the minimum work programme and the expenditure
that would be incurred to complete it. Further, the company has to indicate profit-
sharing with the government, which has to be based on a sliding scale, after cost
recovery.

In the case of taxes and duties, the Income Tax Act, 1961 is to apply.
Companies are entitled to customs duty exemption on goods imported for us in
petroleum operations under the contract.
Foreign companies are fee to remit amounts out of India, which are due to the
company under the contract.

6.3.9(d). Analysis of foreign Investments in Speculative Survey Rounds

The first two speculative survey rounds failed to generate any response from
companies and as a result GoI decided to go for a joint venture round in 1995. A
contract was signed in 1997 when DGH formed a joint venture with Western
Atlas, USA, to undertake 2D seismic survey in the deep-water areas of Bay of
Bengal. This was the first joint venture to be formed under the joint venture
round for speculative surveys announced in October, 1995 Western Atlas

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acquired more than 10,900 standard line km of data in the eastern offshore
region.

6.3.9.(e). Development Rounds

GoI offered the development of small and medium sized oilfield (having proven
reserves and discovered by ONGC or OIL) to the private sector in August, 1992.
This was done because of limited finances available with GoI its resultant
predilection to develop and produce in medium and bigger fields with better oil
recovery prospects.

Two JV rounds for the development of already-discovered fields were announced

by GoI. Since fields were already discovered by the BOC‟s, the risk element as
opposed to the exploration bid rounds was minimal and hence the response was
much better than the exploration rounds.

These development rounds evoked much enthusiasm, especially for the medium
sized fields. A total of 117 bids were received response to GoI‟s First Round of
Development of medium and small sized oil and gas fields.

Companies or consortiums could participate in the development of medium and

small sized fields offered under the various rounds. The terms and conditions of
the last round are stated below:

The joint venture to be formed for development of a medium sized field could be
an incorporated venture with equity participation of up to 51 per cent and the
interest of ONGC or OIL being 40 per cent ONGC or OIL had no participating or
carried interest in the case of small sized fields.

On signing of a PSC between the company or joint venture and the government
the sharing of profit had to be indicated in the offer based on a sliding scale tied
to post-tax rates of return or multiplies of investment recovered. Further the

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percentage of annual production of crude oil and gas expected to be allocated for
cost recovery purposes was to be indicted.

As against the First Round of Development where the private players had to
supply natural gas to GoI, the Second round allowed private players to market
their natural gas. However, the domestic market was accorded the first priority to
market the natural gas produced from any field. Arrangements for marketing the
gas produced were negotiable between GoI and the company. The pricing
formula for gas was based on internationally accepted principles.

A signature and production bonus was to be paid. Royalty, cess and other
applicable levies were also to be paid. Companies were subject to a corporate
income tax rate of 50 per cent of the taxable income. Ring fencing was allowed
for development costs. No private company in a consortium that was awarded a
field for additional development could unilaterally withdraw from the consortium.
Further, government approval was required for the induction of any new player.
Companies were required to adhere to the original schedule and the government
had the right to revoke the contract if companies did not follow the schedule.

6.3.9.(f). Analysis of Foreign Investments in Development Rounds

The offer of small sized and medium sized fields in India by the GoI received
overwhelming response from the companies as can be seen from the number of
bids submitted against the blocks on offer.

However, the operators of the medium sized fields which were awarded the fields
for development in 1994-95 faced certain roadblocks. The PSC‟s provided that
crude oil/gas sales agreements would be drawn up within 90 days. Adhoc
arrangements were made to buy oil / gas from these fields as they came into
production. The adhoc prices delayed the cost recovery by the operators and
resulted in a lot of frustration amongst them. The teams engaged for negotiating

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the crude sales agreements were different from the teams negotiating the PSC‟s
which created problems for the operators.

Table-6.3.9(f)
Year Round Medium sized field Small Sized fields Bids No. of
offered offered Received fields for
Offshore Onshore Offshore Onshore which
contracts
awarded
or
signed
Aug One 6 6 10 21 117 18
1992
Oct Two 2 6 4 29 54 12
1993
Source: PetroFed, Paper on “Review of E&P Licensing Policy”, P-92.

In spite of all the above sustained efforts aimed at increasing the indigenous
production of oil and gas through the efforts of the private sector, and PSUs, it
was felt that much more needed to be done. It was emphasized that despite
these good efforts, they were not leading to a substantial increase in the
domestic production of crude oil and natural gas. Moreover, constraints were
also faced in the sense that companies were not ready to engage enough risk
capital investments in the exploration. As a result, over two third of the Indian
sedimentary basins remained unexplored or poorly explored. Out of the
estimated total prognosticated hydrocarbons reserves of 29 billion tonnes, only
less than one fourth had been established. The efforts of the NOC‟s also needed
to be complemented and there was also a need to provide a level playing field as
well as competition to the NOC‟s by giving similar fiscal and contract terms as
applicable to private players.

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6.4. New Exploration Licensing Policy:-

Given the historically prevalent situation till about 1990‟s, the GOI reviewed the
policy of inviting investment in exploration of oil and gas including the fiscal and
contract terms. Given the concerns and clear objectives in mind, the GOI in
February 1997 formulated “the New Exploration Licensing Policy” (henceforth
referred to as NELP). The Union Cabinet announced NELP in the 1997-1998
Budget. But that was merely the first step; the follow-through has been
extremely inexpedient. The course has had its ups and downs. NELP has not
come through smoothly. In fact the dithering of the Union Government has
proven to be quite expensive two successive governments took ages almost two
fiscal years to finalize the tax incentives promised to prospective investors
Meanwhile fate frowned. Crude prices tumbled to almost half.

NELP hug fire due to the lack of inter-Ministerial consensus on action

necessary to operationalize the policy. These included the pros and cons of the
new petroleum tax code the compilation of attractive fiscal incentives for
investors. For instance, North Block shot down the Petroleum Ministry‟s proposal
to exempt E&P companies from the minimum alternate tax (MAT). This was one
of the six recommendations in the new petroleum tax code. The Revenue
Department consented to accord „infrastructure statuses to petroleum companies
and all tariff concessions that go with it, but not exemption from MAT. The
Department also turned down the suggestion that multinationals be allowed to
pay the same rate of corporate tax as NOC‟s, when developing new exploration
blocks. NOC‟s paid 35 per cent tax and transnational‟s, roughly 10 per cent
more.

There were ambiguities in the clauses pertaining to taxation in the model

production –sharing contract drawn up for NELP. Also, a clause, which offset a
loss in one exploration block with profits from another, needed to be amended
before the policy was notified, as it could lead to a substantial revenue loss for

117
the government. Then, the Ministry of Law raised objection to the bid evaluation
criteria and the bidding format.

Numerous such snags delayed the NELP notification. The delay sent out signals
that the government was not serious about opening up the hydrocarbons sector
to private participation. It seemed to be doing very little to make NELP a
success. Attracting foreign investment in the high-risk capital-intensive business
of oil and gas exploration is difficult at the best of times but all the more so when
oil companies were reeling under the impact of slackening global demand and
the consequent fall in prices. With oil companies all over the world mostly
reporting poor second or third quarter results in 1998, wide-ranging cost cuts
were certain to offset pressure on margins. Hence many of them would take a
second look at their exploration priorities and slash budgets for high risk new
ventures. As it is the probability of striking hydrocarbons in a low potential
country like India was seen to be extremely low.

The way the exploration business was conducting, indicated that there was a
little interest in addressing the basic concerns of potential investors. First, it did
little to remove misgivings that only unattractive acreage was being offered to
them even under the new policy. The Government did not provide potential
investors easy access to geological data of the blocks that it had, thereby
denying them the opportunity of studying the blocks before bidding. Also the
Government was oblivious to the frustrating delays experienced by investors in
starting work on the exploration blocks already awarded. Further, a Government
decision on the price of the crude oil or gas discovered and produced was
interminably delayed.

The Oil fields Regulation and Development Act, 1948, was also
awaiting amendment. The Royalty Amendment Bill to this Act would usher in a
new and more rational royalty regime for new exploration blocks under NELP.
Since the Bill could not be adopted in Parliament, an Ordinance was passed.
This enabled the Government to fix different cost and risk factors attached. The
new royalty rates for on land areas are 12.5 per cent for oil and 10 per cent for

118
gas. Offshore the rate is 10 per cent for oil and gas except for deep-water
discoveries (beyond 400 m bathymetry), which are at 5 per cent for the first
seven years of production. The Lok Sabha finally passed the Oilfield Regulations
Bill in December, 1998.

So, after the various enthusiastic go-aheads and the almost immediate
half commands, NELP finally took shape at the beginning of 1999. New year,
new hopes. But some critics felt that the response to the maiden international
bidding proposed under NELP would be lukewarm, as there were mostly
cosmetic changes in 44 of the blocks on offer.

This was countered by pointing out that a substantial difference

between these and the earlier blocks was that they were financially much more
attractive than earlier fiscal packages. The NELP, however, does not change the
perceived geological prospects of discovering hydrocarbons in the oil blocks until
and unless data packages for the offered blocks are substantially upgraded
through fresh exploration efforts by NOC‟s.

The main Features of NELP are:

1. Fiscal stability provision in the contract.

2. Finalizations of contract on the basis of Model Production sharing
Contract (MPSC).
3. Petroleum tax guide to facilitate investors.
4. Possibility of seismic option in the first phase of the exploration
period.
5. NOC‟s to compete for acreages.
6. No payment of signature, discovery or production bonus.
7. No customs duty on imports required for petroleum operations.
8. No minimum expenditure commitment during the exploration
period.
9. No mandatory state participation carried interest by NOC‟S.

119
 10. Freedom to sell crude oil and natural gas in domestic market at
market related prices.
11. Biddable cost recovery limit up to 100 per cent.
12. Sharing of profit petroleum based on pre-tax investment multiple
achieved and is biddable.
13. No cess on crude oil production.
14. Royalty payment for crude oil and natural gas on ad-valorem basis.

Table 6.4.(a) Royalty Payment on ad-valorem basis under

NELP

Onland Blocks Offshore Deep Water #

Crude Oil 12.5 Per Cent 10 Per cent 5 Per cent *

Natural Gas 10 Per cent 1 Per cent 5 Per cent *

*For first years of commercial production
# Beyond 400m bathymetry

15. Option to amortize exploration and drilling expenditures over a

period of 10 years from first commercial production.
16. Contribution to site restoration fund fully deductible in same year for
income tax.
17. Liberal depreciation provisions making companies eligible for
further tax adjustments.
18. 7 years tax holiday from the commencement of production.
19. Conciliation and Arbitration Act, 1996, which is based on
UNCITRAL model, shall be applicable.

Under NELP companies are required to bid for:

a) Work programme commitment

120
 b) Profit petroleum share expected by the contractor at various
level of pre-tax multiple of investments.
c) Percentage of annual production sought to be allocated towards
cost recovery.

An objective Bid Evaluation Criteria (BEC) is in place wherein the following main
parameters will be considered while evaluating the bids.

1. Technical capability of the bidding company consortium.

2. Operatorship experience
3. Financial capability of the bidding company consortium.
4. Work Programme.
5. Profit sharing offered by the bidder / along with proposed cast
recovery limit.

DGH provides the companies with seismic data on the Indian sedimentary
basins. Companies are free to purchase and inspect this data. Successful
Winning bidders enter into a Production Sharing Contract, based on the MPSC.

The major differences between earlier rounds of bidding for exploration blocks
and NELP are:-

Table 6.4.(b)

Terms Earlier Rounds NELP

Companies exempt from
payment royalty. No
Royalty / Cess. Cess.
ONGC/OIL to bear these Companies to bear
on private companies
behalf, as per fiscal
package approved by
government

121
 0 percent 40 percent at
their option except for the
Participating interest by Joint Venture Exploration No participation by
NOC‟S Programme (JVEP), NOC‟s as government
where they had to take nominees.
25 per cent 40 per cent
interest from the
beginning.
NOC‟s had 30 per cent
carried interest
Carried interest of NOC‟s exercisable on No carried interest by
commercial discovery, NOC‟s
except in JVEP where
they have working
interest from the start.
NOC‟s carried the burden NOC‟s get international
on behalf of private price on their production
Level playing field for companies and for their of oil and gas and
NOC‟s own operations they did exemption from payment
not get the same terms of customs duty and
available to private cess.
investors.

NOC‟s to compete for NOC‟s got acreage on NOC‟s to compete for

acreage preferential basis. acreage
Only half royalty for
Incentive for exploration No special incentive deep-water to be paid in
the initial seven years

NELP terms beneficial to NOC‟s

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 1. NOC‟s are exempted form payment of cess (a concession of
almost US $3.0/bbl.).
2. The maximum royalty rate is 12.5 per cent of international price
as against 20 per cent of the administered price in non NELP
areas.
3. Incentive for deep water exploration with only half of the royalty
payable in the initial seven years from commencement of
commercial production
4. Exemption from customs duty
5. NOC‟s to get international prices on their production of oil and
gas
6. Seven-year tax holiday from the date of commencement of
commercial production.
7. Liberal depreciation provisions will make companies eligible for
further tax adjustments
8. Contribution made to the Site Restoration Fund Scheme is
deductible in the year of Contribution and not in the year of Site
Restoration as per earlier provision of the income Tax Act.

NELP terms beneficial to private investors-other than all the above benefits that
are applicable to private investors as well, the following benefits also apply.

(a) Carried interest of NOC‟s at 30 per cent has been abolished.

(b) Companies are free to have 100 percent participating interest as
earlier up to 40 per cent participating interest was to be held by
NOC‟s this will also provide operational flexibility to the
companies in selecting partners of their choice.
(c) A level playing field as no blocks is reserved for NOC‟s.

Progress under NELP

According to a DGH press release the progress of NELP in terms of exploratory

wells drilled and discoveries made can be summed up as follows:

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 i. From the year 2000 onwards, so far 71 wells have been drilled
under NELP PSC‟s. Out of these 37 wells have been successful
in terms of striking hydrocarbons. Thus the success ratio of
exploratory wells drilled under NELP is 50 per cent which is very
encouraging.
ii. As many as 23 discoveries have been notified by companies like
Cairn Energy, Niko Resources, Gujarat State Petroleum
Corporation and Reliance Industries. Out of these discoveries,
two discoveries by Niko in the block CB – ONN – 2002/2 have
already been brought to production. One discovery, namely
Dhirubhai – 2, by Reliance has been declared commercial.
iii. Development plans for two deep-water discoveries of Reliance
Dhirubhai – I & Dhirubhai -3 have been approved and
materialized.

6.5. NELP Bidding Rounds

6.5.1. NELP-I:- The first round of New Exploration Licensing Policy (NELP) was
announced on January, 8, 1999 by Gol. A total of 48 blocks were put on offer for
exploration of oil and natural gas. Of these, 12 blocks were deep water (beyond
400 m isobaths), 26 shallow offshore and 10 were onland blocks. The bid
closing date was August, 18, 1999. The companies could bid for one or more
blocks, singly or in association with other companies and the successful
company / consortium was free to form an unincorporated or incorporated
venture.

For the first time in India, blocks categorized under the nomenclature of Deep
water blocks were put on offer under NELP I under the pre-NELP rounds there
were only two categories of blocks, either on land or offshore. Companies were
provided with only the Basin Information Docket for the deep water blocks as
there was no separate Data Package available for each block. However, seismic
and gravity-magnetic data was made available for each of the blocks along with
Satellite Gravity Data.
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By the bid closing date of August, 18th1999, GoI received 45 bid for the 27 blocks
on offer. Ten foreign, 6 Indian private companies and 5 public sector enterprises
submitted their bids. The PSC‟s were signed for 24 exploration blocks
comprising 7 deep water, 16 shallow offshore and 1 on land.

A total of 16 discoveries have been made in two KG deep water blocks and one
shallow offshore block in Mahanadi- NEC. These discoveries include the world
class gas discovery made by the RIL-Niko Resources consortium in 2002 in the
Krishna Godavari (KG) basin deep water block KG-DWN-98/3. The other two
discoveries include the gas discovery made by Scottish company Cairn Energy in
2001 in the deep water block KG – DWN 98/2 and gas discovery by RIL in block
NEC-OSN-97/2 in the Mahanadi NEC shallow offshore area.

6.5.1.1. Analysis of foreign investment under NELP-I

The foreign companies which bid under NELP I, either on their own or in
consortium with an Indian Company, include Enron Corporation-USA,
PETRONAS Carigali-Malaysia, OAO Gazprom – Russia, Energy Equity India
petroleum Pty Ltd.-Australia, Cairn Energy-Australia, Niko Resources Ltd.,-
Canada, Geopetrol International Inc,-Panama, Mosbacher India LLC-USA,
Grynberg Petroleum Co (RSM Production Corporation, USA) and south Asia Oil
& Gas Plc-Australia.

Out of the 10 foreign companies who submitted their bids under NELP I only 5
were successful in bagging a block. These foreign companies were Cairn
Energy (1 block), Niko Resources (12 blocks in consortium with RIL). OAO
Gazpron (1 block) and 1 block by Mosbacher India Ltd, and Energy Equity India
Pvt. Ltd.

6.5.2. NELP II (2000)

GoI invited bids under NELP II on December 15th, 2000 for 25 blocks for
exploration of oil and natural gas. Of these, 8 blocks were deep water, 8 shallow
offshore and 9 were onland blocks. For the first time blocks in the west coast

125
were put on offer as at that time more than 50 per cent of the countries crude
production came from ONGC‟s Mumbai High fields on the west coast. The
bidders were given time duration of three and a half month to submit their bids
and file their documents by March 31st, 2001.

After the NELP I round, comments were invited from 43 E&P companies and
organizations on the MPSC and based on the comments received GoI approved
some changes to the MPSC issued under NELP I. Also, to increase
transparency in the bidding process and to make it more investor friendly the
weightage of the broad parameters for bid evaluation were made public for the
first time.

The PSC‟s for the 23 blocks were signed on July 17, 2001, three and half months
from the closure of bids on March 31, 2001 as against just about seven and half
months in the first round of NELP. The total investment committed in these 23
blocks was US$290 million (Rs. 1,300 crore) in phase –I and US$ 788 million( Rs
3700 Crore) in all three phases.

A total of 3 discoveries have been made in two blocks viz. CB-ONN-2000/1 &
CB-ONN-2000/2 located in Cambay basin which were offered under NELP II
GSPCL discovered oil in the CB-ONN-2000/1 block in August 2004. Niko
Resources struck natural gas in the CB-ONN-2000/2 block in 2002.
Subsequently significant quantities of Shallow gas (NSA field) have been
discovered in the block.

6.5.2.1. Analysis of foreign Investment in NELP II

To woo private investors, both foreign and domestic, GoI appointed IHS Energy
Group of USA as the marketing consultant for NELP II and road shows were held
at Delhi, London, Houston, Singapore and Tokyo. Among the major oil firms that
participated in these road shows included shell, British Petroleum, British Gas
Premier Oil, Cairn Energy, Exxon Mobil, Marathon, Philips, Chevron. Texaco and
Pertamina of Indonesia.

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The foreign companies who submitted their bid under NELP II round were Niko
Resources, Canada, Cairn Energy, UK, Petrom, Romania, Heramec, UK, Hardy
Exploration & Production India, UK, Joshi Technologies USA, Petrobas, Brazil,
ExxoMobil, USA, Premier Oil Pan Canadian, Total Fina Elf France and BHP
petroleum Australia.

6.5.3. NELP III (2002)

NELP III was announced on March 27th, 2002 and bids were invited by the GoI
for 27 blocks for exploration of oil and natural gas. Of this 9 blocks were deep
water, 7 shallow offshore and 11 were on land blocks. The bid closing date was
August 28, 2002.

As in the previous rounds, the GoI undertook a comprehensive promotional

exercise to promote the blocks though five road-shows at New Delhi, Singapore,
London, Houston and Calgary and through an exclusive NELP III Indigo Pool
website.

A total 45 bids were received for the 23 blocks on offer under the NELP III by the
bid closing date. Out of the 27 blocks on offer, PSCs were signed for 8 on land
blocks, 6 shallow water offshore blocks and 9 deep water blocks. No bids were
received for 3 on land blocks and 1 shallow-water offshore block.

A further analysis of the NELP III response reveals that 18 blocks attracted
multiple bids, whereas 5 blocks attracted single bids. Thus about 78 per cent of
the blocks on offer attracted multiple bids under NELP III as compared to around
50 per cent blocks attracting multiple bids under NELP – I and NELP – II.

6.5.3.1. Analysis of foreign Investment in NELP III

The year 2002 was a mixed bag for the foreign E&P investors. On one hand
efforts were being made by the GoI to attract foreign investments such as
deregulation of the petroleum sector w.e.f. April, 1 st 2002, and reduction in the
income tax rate applicable to foreign companies from 48 per cent to 40 per cent
while on the other hand apprehensions were being expressed by the investor

127
community regarding the Indo-Pakistan border tension and travel advisories
issued by certain countries.

By the time NELP III was announced in March 2002 hydrocarbon discoveries had
been made under the first two rounds of NELP which included discoveries by
Cairn Energy in block KG-DWN-98/2(NELP I) and Niko in block CB-ONN-2000/2
(NELP II). The Government, on the strength of these discoveries, was confident
that the perception long held by the foreign E&P companies regarding the low to
moderate hydrocarbon prospectivity of India, would change and that such
discoveries would instill confidence among the foreign investors while investing in
India.

However, the NELP III round received lackluster response from the foreign E&P
companies. A total of 11 companies submitted their bids out of which 7 were
domestic oil companies and 4 were foreign companies which included Cairn
Energy, UK. Premier Oil, UK. Hardy Exploration and production, UK. and Geo
Global Resources, Canada. Amongst the foreign companies Premier Oil and
Geo Global Resources had bid for the first time under NELP.

Scottish explorer Cairn Energy and Premier Oil of UK had bid for one and three
blocks respectively but drew a blank. However, Hardy Oil of UK in consortium
with RIL was successful in bagging seven of the nine prime deep water blocks on
offer, Geo Global Resources in consortium with Gujarat State Petroleum
Corporation (GSPC) and Jubilant Enpro, was successful in bagging the KG-
OSN-2001/3 in which a huge gas discovery of 20 tcf has been reported in June
2005 by GSPC.

6.5.4. NELP IV (2003)

Fourth round of NELP was announced by GoI on May 8 th, 2003, under which it
invited bids for 24 blocks for exploration of oil and natural gas. Of these, 12
blocks were deep water, 1 shallow offshore and 11 were onland blocks. The bid
closing date was September 30th, 2003.

128
As many as 48 companies reviewed the data packages for the 24 blocks on
offer. A total of 19 companies submitted their bids. Out of these 12 were
domestic (six Public Sector and six Indian private companies), and seven were
foreign. Nine companies were first time bidders under NELP PSC‟s were signed
for 20 exploration blocks comprising 10 deep water and 10 on land blocks. The
two blocks in Manipur and Palar Offshore basin did not receive any response.

Some of the changes made by NELP IV include:

(a) Provision of fast-track arbitration.

(b) Higher weightage for technical and financial capability for deep
water blocks.
(c) Surcharge on income tax for foreign companies abolished.
(d) Bank guarantee to be returned after minimum work programme
completion.

6.5.4.1. Analysis of foreign investments in NELP IV

NELP IV was expected to generate a large participation from the foreign

companies, especially in the aftermath of world class gas discovery reported by
the RIL-Niko consortium in the KG-DWN-98/3 block in October 2002 in the KG
basin. Although international oil majors like Total, ExxonMobil and Shell showed
interest, especially in the deep water blocks, but decided not to participate in the
NELP IV bidding process.

The seven foreign companies who participated in NELP IV round were Enpro
Finance, Niko Resources, Canada, Canoro Resources, Canada, Cairn Energy,
UK,; Geoglobal Resources, Zarubezneftgaz, Russia,; BG, UK; and Hardy
Exploration & Production, UK.; Out of the above 7 foreign companies
Zarubezneftgaz, BG and Canoro Resources had participated for the first time
under NELP.

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6.5.5. NELP V (2005)

NELP V was launched on January 4th 2005 offering 20 blocks six deep water
blocks, two shallow water blocks and 12 on land blocks. The launch was earlier
scheduled for May 25th but was postponed due to the political uncertainty in the
wake of the general elections. For the first time Maharashtra was included for
exploration under NELP – V. The bid closing date was May 31st, 2005.

A total of 69 bids for 20 blocks (18 bids for six deep-water blocks, seven bids for
two shallow water blocks and 44 bids for 12 onland blocks) were received. On
July, 25th, 2005 the Cabinet Committee on Economic Affairs (CCEA) approved
the award of 18 blocks under NELP V.

Some of the new features introduced under NELP V are:

1. All Geo-Scientific data was made available online through the

internet to enable companies to view data at their own convenience
and location. Work stations were provided at Data Centers at
London, Houston, Calgary and Dubai to facilitate companies to
review and analyze data and to provide on the spot clarifications.
2. Details of all operational blocks from earlier rounds such as work
programme, fiscal terms, etc., were made available at Data Centers
to enable companies to assess existing work programme as well as
other bidding parameters while formulating their own bids and also
help them in forming strategic alliances.
3. In order to provide marketing stability to the companies. The
Government decided to exercise its option to take its profit share of
natural gas in cash or in kind for a block of 5 years instead of such
option being made every year as in the previous rounds.
4. In order to encourage small and medium sized investors,
companies having a net worth of US$ 500 Million or more were not
required to give a bank guarantee towards MWP commitment in

130
 respect of onland and shallow water blocks. This threshold value in
the previous round was US$ 1,000 Million.
5. In order to provide transparency to the bidding process, weightage
for all bid evaluation criteria including weightage for sub-criteria
were made public under NELP V for the first time.

6.5.5.1. Analysis of foreign investments in NELP V

A total of 26 foreign companies and 21 Indian companies (eight Public Sector

Undertaking and 13 Private Sector Undertakings) submitted their bids.

Out of the 26 foreign companies 17 companies submitted their bids for the first
time. These companies are British Petroleum (UK), Petrobras (Brazil), ENI SPA
(Italy), Hunt Oil (UK), Beach Petroleum (US), KUFPEC (Kuwait), Norwest Energy
(US), Suntera Resources Limited (Russia), Zakros Holdings Ltd. (Cyprus),
Foresight (UK), Providence Resources (UK), Birkbeck Investment Limited
(Mauritius), Exspan Exploration and Production International (Indonesia), Istech
Resources Asia (Indonesia), Jubilant Energy India (V) Ltd., (Cyprus), and
Welwyn Resources Limited (Cananda).

Energy majors like shell (US),Total (France), BHP Billion (Australia), Statoil
(Norway) , showed interest after initially purchasing the data packages for
various blocks but stayed away from submitting bids at the last moment.

The handsome response generated by NELP V as compared to the previous

NELP rounds can be attributed to the professional and extensive promotional
exercise undertaken by the Government in promoting NELP V acreages and also
the huge gas and oil discoveries made by Reliance Industries Ltd., Niko
Resources consortium and Cairn Energy.

6.5.6. NELP VI

A total fifty five block (55) were offered during NELP VI round for exploration of
oil and natural gas in 16 prospective sedimentary basins consists of 25 onland, 6
shallow water and 24 Deep water blocks. 165 bids from 68 E&P companies (36

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foreign and 32 Indian) had participated in the bidding process as consortium /
individually. The PSC‟s were signed for 52exploration blocks comprising 21 deep
water, 6 shallow water and 25 onland. The exploration activities are going on in
52 awarded blocks.

6.5.7. NELP-VII

A total of fifty seven blocks (57) were offered during the NELP VII round for
exploration of oil and natural gas in 18 prospective sedimentary basins consists
of 29 Onland, 9 shallow water and 19 deep water blocks. On 22 December 2008
Contracts were signed for 41 blocks out of which 11 blocks in deep water, 7
blocks in shallow water and 23 onland blocks.

6.5.8. NELP VIII

Under the eighth round of New Exploration Licensing Policy (NELP-VIII),

Government has offered 31 production sharing contracts on 30 June 2010. There
are 8 deep water blocks, 11 shallow water blocks and 12 onland blocks which
are in state of Assam(2), Gujrat(8), Madhya Pradesh(1) and Manipur(1).

6.5.9. NELP IX

A total of 33 exploration blocks were offered during bidding process. State owned
Oil and Natural Gas Corporation Ltd(ONGC) bagged 10 of the 33 oil and gas
exploration blocks. Oil India Ltd(OIL) bid for as many 29 blocks and managed to
get 10. Reliance Industries bid for two deep sea blocks in Andaman Basin in the
Bay of Bengal and four onshore blocks in Rajasthan and Gujrat.

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6.6. Downstream sector (Refineries in India):

To meet the growing demand of petroleum products, the refining capacity in the
country has gradually increased over the years by setting up of new refineries in
the country as well as by expanding the refining capacity of the existing
refineries. As of June, 2011 there are a total of 21 refineries in the country
comprising 17 (seventeen) in the Public Sector, 3 (three) in the Private Sector
and 1 (one) as a joint venture of BPCL & Oman Oil Company. The country is not
only self-sufficient in refining capacity for its domestic consumption but also
exports petroleum products substantially. The total refining capacity in the
country as on 1.6.2011 stands at 193.386 MMTPA. The company-wise location
and capacity of the refineries as on 1.6.2011 is given in Table 6.6:

Table 6.6. Refineries in India.

Name of Location of Capacity,MMTP

S.no Company Refinery A

Indian Oil
Corporation Guwahati,
1. 1.00
Limited (IOCL) Assam

Indian Oil

2. Corporation Barauni, Bihar 6.00

Limited (IOCL)

Indian Oil Koyali,

3. Corporation Vadodara, 13.70
Limited (IOCL) Gujarat

Indian Oil
Corporation Haldia, West
4. 7.50
Limited (IOCL) Bengal

133
 Indian Oil
Mathura,
5. Corporation 8.00
Uttar Pradesh
Limited (IOCL)

Indian Oil

6. Corporation Digboi, Assam 0.65

Limited (IOCL)

Indian Oil
Corporation Panipat,
7. 15.00
Limited (IOCL) Haryana

Indian Oil
Corporation Bongaigaon,
8. 2.35
Limited (IOCL) Assam

Hindustan
Petroleum Mumbai,
9. Corporation 6.50
Maharashtra
Limited (HPCL)

Hindustan
Petroleum
Corporation Visakhapatnam,
10. Limited 8.30
Andhra Pradesh
(HPCL)HPCL,
Visakh

Bharat
Petroleum Mumbai,
11. Corporation 12.00
Maharashtra
Limited (BPCL)

12. Bharat Kochi, Kerala 9.50

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 Petroleum
Corporation
Limited (BPCL)

Chennai
Petroleum Manali, Tamil
13. Corporation 10.50
Nadu
Limited

Chennai
Petroleum Nagapattnam,
14. Corporation 1.00
Tamil Nadu
Limited (CPCL)

Numaligarh
Refinery Numaligarh,
15. 3.00
Ltd.(NRL) Assam,

Mangalore
Refinery & Mangalore,
16. Petrochemicals 11.82
Karnataka
Ltd. (MRPL)

Tatipaka
Refinery Tatipaka,
17. 0.066
(ONGC) Andhra Pradesh

Bharat
Petroleum
Corporation Bina, Madhya
18. 6.00
Limited & Oman Pradesh
Oil Company,
joint venture,

135
 Bina

Reliance
Industries Ltd. Jamnagar,
19. (RIL); Private 33.00
Gujarat
Sector

Reliance
Petroleum Jamnagar,
20. Limited (SEZ); 27.00
Gujarat
Private Sector

Essar Oil
Limited (EOL); Jamnagar,
21. 10.50
Private Sector Gujarat

TOTAL 193.386

Source: Indian Petroleum and Natural Gas Statistics, 2010-11, Govt. of India
Ministry of Petroleum and Natural Gas, Economic Division, New Delhi.

6.7. Policy Framework

The objective of the GOI, for the refining sector was clear; move towards
increased self-sufficiency and an uninterrupted supply of the country‟s basic
requirements of petroleum products particularly petrol, kerosene, and diesel.
This thinking is reflected across most of the Five Year Plans. Interestingly, this
was also one of the main objectives when the multinational giants in the country
built the first three refineries, in early 1950‟s. Until the early 1950‟s, India was
almost entirely dependent upon imports for requirements of all kinds of petroleum
products. The only source of domestic production was a small refinery
established by the Assam Oil Company, a subsidiary of the larger Burmah Oil
Company, at Digboi in the north-east of Assam. By 1951, the Indian requirement

136
of petroleum products was about 4 million tonnes per year, and increasing at the
rate of some 10 per cent a year (Khera, 1979).

Post-Independence, the first major development took place in the early 1950s
with the establishment of three privately owned refineries by international oil
companies, under the terms of formal agreements made with the GOI. All these
were coastal refineries, two of them at Bombay (now Mumbai) owned by Burmah
Shell and Esso respectively, and the third owned by Caltex in Vishakhapatnam
(Henderson, 1975). The combined capacity of the three refineries was just less
than 4 million tonnes of crude a year, just sufficient to supply the existing
demand, but without the provision for an expanding market (Khera, 1979).
These were important developments as far as the setting up of refineries was
concerned. In the 1948 Industrial Policy Resolution, the GOI placed future
development of the Oil industry, along with six other basic and strategic
industries, under the ownership of the GOI.

It was not until mid-fifties that the idea of public ownership of refineries was
translated into action (Dasgupta, 1971). The GOI then in 1959 set up an agency
the Indian Oil Company, to undertake the distribution and marketing of oil
products. The company had the responsibility of handling the distribution of the
output of two PSU‟s refineries, which were under construction and later of the
third refinery projected in Gujarat (GOI, 1961). Two more refineries, both in PSU,
were constructed at Guwahati in Assam and Barauni in Bihar, to refine crude
supplies from the eastern fields, and another refinery constructed at Koyali in
Gujarat. It is important to point out that even at this early stage of the
development of the Indian refining industry, questions were raised on the public
ownership of refineries.

The expansion in the refining capacity was necessitated, given the growth in the
demand for petroleum products. The period from mid-1950‟s to till about late
1970‟s was the period of rapid phase in demand for petroleum products, given
that the country was seeing growth industrialization and demand for

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transportation. The consumption of petroleum products, which was 5.2 million
tonnes in 1956, registered a more than fourfold increase by 1973 when it touched
23.7 million tonnes. After a brief respite, due to price increase, when the demand
remained static at around 23 million tonnes, the growth in consumption has been
quite perceptible being 25.4 million tonnes in 1976-77, 27 million tonnes in 1977-
78, 28 million tonnes in 1978-79 and 29.65 million tonnes in 1979-80. Such was
the growth in demand for petroleum products that even with the additions of
refining capacity we were expected to face shortage, leading to import of crude
oil, and so also petroleum products. For instance, the Sixth Plan warned that
even after completion of various schemes in refining sector, the availability of
petroleum products will increase to only about 41 million tonnes against a
demand of 49 million tonnes. Thus, it would be necessary to install additional
refining capacity to the extent of 9 million tonnes by 1985-86 to keep the need for
import of products at a manageable level (GOI, 1980).

Apart from the ever increasing problem of meeting the demand for petroleum
products through the addition to the refining capacity, during the decade of
1960‟s and 1970‟s there were also problems in the optimum utilization of the
existing Indian refineries. For instance (Hederson, 1975) rate of utilization was
higher in the public and joint sectors than in private sector, which was mainly due
to the disagreements between the GOI and the private companies, relating to
both the amount of capacity which the companies were properly authorized to
create and to sources, prices, and amounts of crude oil to be processed. By
1976, however, negotiations between the GOI and the foreign oil companies had
resulted in mutually satisfactory agreements whereby the GOI took over the
refineries and their running and paid mutually acceptable compensation to the
companies (Khera, 1979).

During the 1950‟s and 1960‟s, the problem of product imbalance dominated the
discussions of the oil sector in India. The refineries in India produced a surplus
of light distillates, which accompanied an acute shortage of middle distillates,
kerosene and diesel. The problem was that it gave rise to the hard task of

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finding markets for surplus products in a competitive world, while continuing to
import, in exchange for foreign exchange, the deficit products (Dasgupta, 1971).
Given the characteristics of Indian refineries, on one hand, lack of adequate
secondary processing facilities and, on other hand, high demand for middle
distillates, the tendency sometimes had been to think of other products as
potentially surplus. Thus, conscious attempts were made during the 1960‟s to
develop indigenous fertilizer and petrochemical plants based on naphtha as a
feedstock, because surplus of light distillates was otherwise anticipated
(Henderson, 1975). Analysts have time and again called for a design of
refineries which more closely matched the pattern of product demand. The point
was to develop secondary processing facilities of the Indian refineries.

6.7.1. Product Imbalance

One of the major distinguishing characteristic of Indian refining sector has been
the proportionally high share of the middle distillates over the years. For
instance, Henderson (1975) pointed out that during the decade from 1951 to
1961 the share of middle distillates gradually rose well to over 50 per cent, and
that of other products also raised, both at the expense of the share of light
distillates. Even, if we analysis the product wise consumption of petroleum
products of PSU‟s, we see that at the end of 2001 to 2010, the consumption of
light distillates is 20.4% , middle distillate 47.4% and heavy ends 11.0%
respectively.

Compared to other countries, the share of middle distillates is unusually high

even before and after deregulated era. This reflected the continuous usage of
kerosene for domestic purposes, as well as the growth of consumption of diesel.
Analysts have critiqued this particular development in the Indian fuels market
over the years. Bhatia (1985) has pointed out that mainly on account of
differential in excise duties there were significant differences in the market prices
of petrol and diesel, which has provided the incentives for consumers to shift
away from petrol using vehicles to diesel using vehicles, thereby exacerbating

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the growth in diesel consumption and hence pressure on the Indian refining
industry to meet the demand for this fuel. Dasgupta (1968) pointed out that the
discount rate imposed by the GOI in late 1950‟s and 1960‟s based on the pricing
Committees‟ had aggravated the problem of product imbalances, by making the
production of petrol more attractive than that of middle distillates from the point of
view of the refineries.

Clearly, a conscious policy decision had created an unusual situation in the

Indian fuels market. Interestingly enough, this anomaly still persists in the fuels
market. That is, the historical practice still continues. A look at the consumption
pattern highlights this fact due to differential taxation structure for both fuels. GOI
too was equally conscious about the skewed pattern of demand for petroleum
products. For instance, the Seventh Plan pointed out that such skewed growth is
not compatible with refining capabilities. While with a hydrocracker, it may be
possible to obtain from suitable imported crude over 60 per cent as middle
distillates, the maximum yield from Fluid Catalytic Cracking (henceforth referred
to as FCC) secondary processing facility which is presently installed in most of
our refineries was about 52 per cent (GOI, 1985).

During the late 1980‟s and early 1990‟s major increases in the demand of middle
distillates were foreseen and technology options were accordingly selected. It
was realized that the hydrocracking option offered a technically more acceptable
solution to maximize the production of middle distillates of very high quality and
to offer the flexibility of upgrading existing refinery streams to the desired product
quality by blending. Use of this process technology also made possible the
processing of relatively low API and high sulphur crude as well. Accordingly,
during this period a number of project arose where in hydrocracking was the
primary secondary processing facility in grass-root units and a number of existing
refineries. Hydrocracking units were installed in parallel or upstream of FCC
units with the objective of improving product slate and providing additional
operating flexibility (Singh & Babbar, 2005).

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6.7.2. The Regulated Era

Oil industry in India was operating as a free market till the mid-1970‟s and many
of the multinational oil companies like Shell, Caltex and Esso had a significant
presence in the market. Nationalization of the industry during mid1970‟s resulted
in the private players being bought out by the GOI. Such was the phase of
nationalization that from 3 per cent in 1962, the share of PSU refineries
increased to about 93 per cent in 1976. This was in sharp contrast to the
situation prevailing till about 1960 when foreign oil companies had the monopoly
of refining and marketing of petroleum products in India. All the time units
comprising oil industry were expected to be very soon under the GOI ownership
during those times. Since then the state owned PSU‟s played a dominant role in
this sector (Sudararajan, 2000).

The move towards nationalization also coincided with the implementation of

recommendations of the Oil Prices Committee 1976. The concept of
administered price mechanism (henceforth referred to as APM) in the oil industry
was introduced by GOI (1976). A system of retention prices for each product and
for each refinery was introduced with effect from 16 th December, 1977. GOI
(1976) suggested various norms and averages for industry performance. To
adjust any variations from norms and averages, GOI (1976) suggested various
pool accounts. Given the emergence of so many pool accounts; a need was felt
for some organization to administer the pool accounts, among other things.

Thus, in the mid 1970‟s based on GOI recommendations, GOI(1976) set up a

Committee named as Oil Coordination Committee (hence referred to as OCC) to
provide technical and operational support to the MoPNG in making policy
decisions and their implementation . In a sense the OCC acted as a regulator.
MoPNG regulated the import of crude oil and refined petroleum products through
the Empowered Standing Committee (ESC) set up by the Cabinet. Each
refinery‟s crude Oil production and allocation were, to the extent feasible,

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controlled in line with the demand in its supply envelope movement of petroleum
products to various demand centers was governed by the industry supply plan.
This plan was formalized through the Industry Coordination Meeting and the
Supply Plan Meeting, which were held on a monthly basis, which endeavoured to
ensure availability of products to all the oil companies from various sources. Also
it had to be ensured that there should not be any unwanted movement of goods.
This was taken care by the hospitality arrangement among different oil
companies. The amount charged for use of the owner company‟s facilities by
other companies was regulated by the GOI and was based on the “costs plus a
reasonable return on investment” principle (GOI, 1996).

The enforcement of distribution discipline and equalization of prices at the

refinery gate were achieved though the various oil pool accounts by the OCC.
The OCC administered the oil pool accounts under the APM and controlled the
inflows and outflows to the pool account. Development of retail marketing
network was decided by the GOI through annual marketing plans. Selection of
dealers/distributors was accomplished with the help of a Committee appointed by
the GOI, the oil selection boards. The enrolment of LPG customers, ceilings on
distributors refill sales, kerosene quotas and commissions for dealers /
distributors were also controlled by the GOI.

The pool accounts were maintained to provide uniform and stable prices within
the country. They were supposed to be self-balancing. The inflow to the pool
account was from the collection of surcharges on sale of petroleum products
while the outflow was for meeting the variation in the elements of standards cost.
The difference between the inflows and outflows represented the surplus/deficit
position of the pool accounts. Though the number of pool accounts was more
than 50, there were few key accounts for the major inflows and outflow. The
OCC did play a significant role in almost all the policy decision-making processes
in the downstream sector of the Indian oil industry. In the heydays of control in
the oil industry, the OCC played a significant role. It acted in many ways as a
downstream corporate planning – cum – supply – planning department.

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Thus from mid-1970‟s to about early 1990‟s the Indian Oil Industry evolved in a
controlled environment, largely determined by GOI, 1976 and obviously by the
then ruling GOI policies. The functioning of the Oil Industry was totally regulated,
as was succinctly shown in the above analysis. The first wave of reforms in the
sector started under the overall economic reform process that was initiated
across the Indian economy from early 1990‟s.

6.7.3. Changing face of the industry: the reform process

After attaining political independence, our planners preferred to adopt the

socialistic pattern of the society to attain economic self-reliance. The Second
Five Year Plan stated the adoption of socialistic pattern of society as the national
objective, as well as the need for planned and rapid development requires that all
industries of basic and strategic importance, or in the nature of public utility
services, should be in public sector. Other industries, which are essential and
require investment on a scale, which only the state in the present circumstances,
could provide, have also to be in the public sector. The state had, therefore, to
assume direct responsibility for the future development of industries over a wide
area. However, this perception started changing when after four decades of
socialism. It was realized that PSU‟s seemed to perform well only when
protected through GOI created monopolies, entry reservations, high tariffs,
quotas etc. (GOI, 2002).

The major deviation from the then followed policy of socialism started in 1991
when the GOI started deregulating the areas of its operation and subsequently
the disinvestment in PSU was announced. The Industrial policy of the 1991
started the process of de-licensing. The Industrial Policy Statement of July, 24th
1991 stated that the GOI would disinvest part of its holdings in selected PSU‟s
but did not place any cap on the extent of disinvestment. Nor did it restrict
disinvestment in favour of any particular class of investors. It was acknowledged
that deregulation and dismantling of the bureaucratic controls along with the
liberalization of trade, technology and capital inflows were some of the far –

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reaching changes initiated by the GOI under the structural reforms introduced
from July 1991. The focus thus shifted to ensuring fair business practices,
safeguarding consumer interest, and minimizing adverse effects of
industrializations on the environment. No wonder in accordance with these
overall objectives of the GOI, the Oil Industry also needed to be deregulated.
Deregulation not only encourages domestic enterprises but it is also considered
as an essential ingredient for improving the climate for foreign investment (GOI,
1995).

Beginning with the early 1990‟s a number of policy initiatives were taken by the
GOI. For instance, in 1992, lubricating oil were first to be decontrolled when the
import of base oil for blending of lubricants was allowed. International majors like
Shell, Mobil Exxon and Caltex took advantage of this and started marketing their
lubricants in the county. Again in February, 1993, the private sector was allowed
to import LPG and kerosene under their own arrangements and sell it at market
related prices. No controls on distribution or pricing were exercised. In addition
to the products covered under the parallel marketing scheme, imports were
allowed for products like the ATF, furnace Oil (henceforth referred to as FO),
Benzene, Toluene, and Bitumen against “Special Import Licenses”
(Sundararajan, 2000). The situation during this early phase of reform was very
critical as far as the oil industry was concerned. On one hand, the share of oil
and gas in commercial energy consumption was increasing, and on the other
hand, domestic resources to meet this shift in consumption were dwindling .

During the last two decades leading to the early 1990s, the value of net imports
of crude oil and petroleum products was consistently increasing, in the later part
of the Seventh Plan; the import bill on petroleum products was substantial. This
was largely on account of stagnation in domestic crude oil production levels
(GOI, 1992). No wonder one of the thrust areas of the Eighth Plan was to restrict
oil imports to reasonable levels. The Eighth Plan clearly spelled out the concerns
when it pointed out that the import bill of petroleum products continues to be
substantial and in fact has increased in later part of the Seventh Plan, as the

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level of demand satisfaction from indigenously available crude oil has declined
from 70 per cent in 1985-86 to 56 per cent in 1990-91. This was on account of
the stagnation in domestic crude oil production levels. It was envisaged that any
further increase in dependence on oil imports, due to an increase in demand, is
likely to pass severe pressure on foreign exchange reserves and in view of the
uncertainty of world oil prices, make the economy more vulnerable. It would,
therefore, be necessary to examine the oil intensity and dependence on
petroleum products in each sector of the economy and to find ways to contain,
and where possible to compress, the demand for the oil products.

The Report of the Group on “Hydrocarbon Perspective 2010: Meeting the

Challenges” (GOI, 1995) laid the stone for the deregulation of the Indian
Hydrocarbon sector. GOI (1995) was expected to carry out an in-depth analysis
and make suitable recommendations, which would be inputs for consideration by
a Strategic Restructuring Group also called the „R‟ Group (GOI, 1996). GOI
(1995) among many recommendations recommended that it was necessary to
abolish the APM and introduce market determined pricing mechanism where in
the prices of crude oil and petroleum products will be determined by market
forces.

GOI (1996) observed that oil industry also need to be liberalized with easier entry
for a range of actors that could contribute to its development in keeping with the
national objectives. This will include the private sector in India as well as
international companies that could do business in this country‟s hydrocarbon
sector. One of the most important perspectives of GOI (1996) was the emphasis
on the need to introduce competition, domestic and international, in the
hydrocarbon sector, upstream, mid-stream and downstream. Competitive
markets and consequential market determined prices would help to mobilize
massive resources for investment required and also deploy them effectively.

APM had worked satisfactorily until recently and helped the PSU oil companies
to grow under a protective environment. However, APM had become a serious

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handicap in securing oil supplies for future. In order to achieve the primary
objective of securing oil supplies to meet the future growing demand, it would be
absolutely necessary to move towards a market-driven price mechanism and to
free the petroleum sector from APM. GOI (1996 recommended the gradual
phasing out of APM and introduction of a free marketing mechanism. In 1996,
the GOI also appointed an Expert Technical Group (henceforth referred to as
ETG) to examine the impact on various sector at different levels of duty structure
in the face of dismantling of APM. The ETG dealt with phased movement to
market determined pricing mechanism and rationalization of custom tariffs, and
exercise duty rates in respect of dismantling of APM along with its impact on
various other sectors.

The recommendations of GOI (1996) and the ETG paved the way for a phased
dismantling of the APM structure. On 1st April 2002, the Administered Pricing
Mechanism (APM) for petroleum products was abolished as a part of the
continuing reform of petroleum sector towards a sector based on market
mechanism. In theory, India‟s public downstream oil companies would now be
free to set retail prices of all petroleum products based on an international parity
pricing formula under the supervision of a petroleum sector regulator. The
Government would abstain from influencing petroleum product pricing. Until then,
prices were controlled (or administered) for two transport fuels, petrol and high
speed diesel, two cooking fuels, kerosene and LPG. Therefore, with the
beginning of the new F.Y on 1st April 2002, the APM and with it oil pool account
was abolished.

The subsidies for the two cooking fuels are considered an important social
instrument to help poorer households shift from biomass to modern fuel (The
World Energy Outlook 2006 includes a discussion on health hazards of and pre-
mature deaths resulting from cooking with biomass). Following the abolishment
of the APM, the Government would thus provide subsidies for kerosene and LPG
ex-ante in its annual budget. Subsidies would not exceed 15% of the LPG and
33% of kerosene import parity price respectively. Within 3 to maximum 5 years

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all budget subsidies on LPG and kerosene would be abolished and market prices
would be in place for all petroleum product in India. Petrol, diesel , LPG and
kerosene account for 60 % of India‟s total petroleum product consumption. Diesel
is India‟s single most important fuel as most of its vehicles, commercial and
private, have diesel engine. Over 75% of India‟s crude requirement is imported.

The practice of retail price setting was different from the theory right from the
beginning of the post-APM period .The so-called Public downstream “Oil
Marketing Companies” (OMC) implemented regular retail price adjustment for
petrol and diesel during first two financial years following the abolishment of
APM. Despite these regular price increase the OMC incurred minor shortfalls for
the sale of petroleum and diesel. However, these shortfalls were mitigated
through the refining margins which now benefited from the import-parity pricing
formula.

As of 1 April 2004 the intervals between price revisions grew larger and the
OMCs started to incur substantial under recoveries for these two products in line
with the drastic increase in international crude prices. This was the case despite
a new semi-monthly automatic price adjustment formula put in place by
Government on 1 August 2004, The formula gave the public the impression that
prices were indeed set by the market while in reality OMCs were still required to
seek approval from MoPNG for each price adjustment.

According to this formula the OMCs could increase prices on the basis of a
rolling average CIF price of the last three months with a +/- 10% band. However
when international prices continued to climb the formula was quietly abandoned
as more often than not the OMCs were requested by the GOI to keep prices
constant for social (and political) reasons. This resulted in mounting losses on
account of sales of petrol and diesel to OMCs, the similar case for cooking fuels,
thus OMCs suffer most. Therefore, GOI realized that the financial burden
imposed on the OMCs was getting critical and was potentially undermining their
long term financial health. Since the most obvious action, a sufficient increase in

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retail prices, was not considered politically feasible, the GOI came up with an
innovative solution, let the upstream oil companies ONGC, OIL and Downstream
natural gas company GAIL share the burden of under recovery. GOI also started
issue government bonds to OMCs covering also one third expected under
recoveries. Finally, “Rangarajan Committee” was formed under the
Chairmanship of Dr. C. Rangarajan and the committee presented report in
February 2006.

6.7.4. Rangarajan Committee Report.

The recommendations of the committee were based on the following principles:

a) taxation should be rationalized to improved efficiency, b) petroleum product
price should be aligned to the international prices, c)subsidy should be targeted
to help BPL(Below Poverty Line) families and it should be transparently
accounted for in the union budget, d)custom duties should be rationalized to
ensure that domestic refineries are not at a disadvantage, e)excise duties should
be rationalized to shield consumers from price volatility. The specific
recommendations of the committee were as follows:

1. The price of motor spirit and diesel to refineries should be weighted

average of import parity and export parity prices in the ration 80:20. This
was based on the data that about 20% of refinery products are exported.
2. The customs duty on motor spirit and diesel should be reduced to 7.5 %,
thereby reducing the protection to refineries.
3. The government should allow OMCs to fix retail prices of motor spirit and
diesel, subject, if necessary to ceilings. This would encourage competition.
4. The principle of freight equalization should be discontinued. The
government may consider some other manner of mitigating the impact of
this measure on remote areas.
5. The ad valorem levies should be replaced with specific levies at the rate of
Rs 5.00 per litre and Rs 14.75 per litre of motor spirit.
6. Subsidized Kerosene should be available only to BPL families.

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 7. The price of domestic LPG should be raised by Rs 75 per cylinder(14.5
kg) and thereafter the price should be adjusted gradually to eliminate
subsidy altogether.
8. The subsidy sharing by upstream companies(ONGC, GAIL and OIL)
should be discontinued and instead the OIDB cess collected from them
should be increased to Rs 4800 per tonne ( from the present Rs 1800 per
tonne)
9. The share of the subsidy to be borne by the government should be met
through budget provision.
The thrust of the recommendations is clearly to bring in a regime where the
prices of the petroleum products are benchmarked to international prices, the
taxes are rationalized to remove distortions, the industry is encouraged to
become more efficient, the responds to changes in the international prices of the
products, the subsidies are capped and targeted properly and the burden of the
subsidy is recognized today rather than being transferred to the future. The
recommendations could not be accepted by the government for variety of
reasons.

Nevertheless, even the Rangarajan Committee did not suggest a complete and
clean break from the past to cast taxes purely on value added basis, and
subsidies as direct subsidies, which alone would have removed the core
distortions on account of adulteration , diversion, distortionary effect on value
chain , competition and exports.

6.7.5. Chaturvedi Committee Report.

The Prime Minister constituted in 2008, the High Powered Committee on

Financial Position of Oil Companies under Chairmanship of Mr. B.K.Chaturvedi
to assess the implication of the severe negative impact of the petroleum products
pricing policies of the government on the financial position of the oil marketing
companies between 2004 -05 to 2008 and recommend measure to deal with the
situation.

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Acknowledging the need to take steps urgently to improve the cash flow situation
of OMCs so that they are in a position to undertake the investments required to
sustain long term growth and maintained efficiency of operations and product
quality, the Committee recommended the following measures:

I. The refinery gate price should be the FOB export prices ( to be revised
every month on the basis of average prices for the month).
II. The distribution and marketing expenses and the applicable Union taxes
and duties should be added to the prices charged by the refineries to
arrive at the retail selling prices.
III. The refineries should be allowed to recover specific state taxes such as
entry tax, octroi and CST from the OMCs in turn should be permitted to
recover the same from the consumer of that state.
IV. The import duty on motor spirit and diesel should be eliminated (as in
case of kerosene, LPG and crude). The excise duties on these products
should be simultaneously reduced and by March 2009, the domestic
prices should reflect the prevailing international prices.
V. Industrial consumers of diesel should be charged the full price of diesel
with immediate effect.
VI. The subsidy on diesel to Railways and State Road Transport Corporations
also be rapidly done away with.
VII. A gradual monthly increase in price of motor spirit and diesel for retail
consumers should be effected with immediate effect, till the market prices
are reached. The proposed increase in price of MS should be Rs 2 per
litre and the increase in price of diesel should be Rs 0.75 per litre.
VIII. SKO should be made available at concessional rate only to BPL families
in long run. This subsidy should be delivered through smart cards or cash
transfer and through supply of kerosene at below fair market prices.
IX. The subsidy of domestic LPG should also be available only to BPL
families in long run. This subsidy too (as the case of kerosene) should be
delivered through smart cards or cash transfer and not through supply at
below fair market prices.
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X. Special Oil Tax should be levied on domestic producers of crude Oil (on
pre NELP leases). The tax will kick in if crude prices exceed $75 per
barrel, at the rate of 100% for ONGC and OIL and 40% for private
producers. The tax is seen as temporary measure till the product prices
adjust fully to international prices.

It is quite evident that the Chaturvedi Committee too has in effect

recommended that the process of arriving at the domestic prices of petroleum
products should at the earliest possible start reflecting the prevailing
International prices. This would ensure that the domestic industry becomes
efficient and cost competitive and the economy responds to changes in the
prices of the products. The state should take care of the burden of high prices
on BPL families through disbursement of subsidies directly to eligible families
and not through distortionary controls on pricing of products.

The Chaturvedi Committee still operated under the framework of pricing on

parity which is essentially a regulation of the sector. The point though is that
true exit from any administration of prices and market determination would
mean allowing the companies to freely price their products.

******

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 Chapter- 7
Crude Oil Price and Commodity Market
This Crude oil pricing mechanism is like the commodity type pricing mechanism.
The oil market developed commodity pricing mechanism in the mid 1980‟s,
replacing the system of official selling oil prices determined by OPEC. The
commodity pricing mechanism in the oil sector has evolved technically from the
spot trading to the future market and financial derivatives, which are typically
found in all commodity market.
Oil is the most important energy source, accounting for more than a third of the
world primary energy mix. It is expected to continue to hold the largest share in
the coming decades, although the share will decline marginally. In volume terms,
oil production / consumption fell after the second oil crisis in 1979 and bottomed
in 1983. Since then, however, the volume has been continuously increasing,
despite variations in the price.

Crude oil is a global commodity. It has been traded internationally soon after the
modern oil industry started in Pennsylvania, US, in the 1860‟s. oil trading has
come a long way from the stable, controlled system of the Major‟s, which ended
in the late 1960‟s through OPEC‟s quota system in the 1970‟s and the first half of
the 1980‟s to the market mechanism since the mid – 1980‟s. Crude trading
represents the key link between the two poles of the industry: upstream
(Exploration and Production) and downstream (refining and marketing), and
crude prices give signals to both upstream and downstream operations.

The size, scope and complexity of global crude trade are unique among physical
commodities. As of 2011, more than 86 million barrels of oil are produced and
consumed every day. Beyond the scale oil has played a significant role in world
history in the 20th century. The strategic importance of oil and the crucial role it
plays in the economy make oil a commodity like no other.

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The global crude oil market has been in a constant process of transformation.
The impact of burning fossil fuels (including Oil) on the environment became a
serious issue in the late 1980‟s. The rise in terrorism and political uncertainties in
the Middle East have revived supply security concerns. Higher oil prices are
encouraging the development of non-fossil fuels, such as nuclear, fuel cells and
biofuels. These and other factors will affect future prices and pricing
mechanisms.

7.1. Crude Oil and Petroleum Products

There are over 161 crude grades around the world. However, crude oil itself has
almost no direct end use (one exception is direct burning of light, sweet
Southeast Asian Crude at Power Plants in Japan and China). Crude oil needs to
be refined into petroleum products (gasoline / Petrol, heating oil and other) to be
consumed. It is the total value of the products processed from crude (called
gross product worth or GPW that determines the crude value. (This does not
mean that product prices set crude prices). The two are interactive. From the
refiner‟s view point, GPW defines the upper limit of crude price. Each stream of
crude has its own property and each generates different combinations of
products.

Crude oil that has a low sulphur content (less than 0.5%) is called „sweet‟ and
one with a high sulphur content (more than 1.5%) „Sour‟. To measure crude
gravity, the API (American Petroleum Institute) standard is often used. Heavy
crude is under API 22, while light crude is above API 33. Medium grades are in
between. Some crude streams contain metals. All of these factors affect crude
prices.

FOB (Free on Board) is a price for crude or products at the loading port, while
CIF (Cost, Insurance and Freight) is one at the destination. Buyers have to pay
the additional costs of transport when buying crude or products at a FOB price,
which CIF prices include costs of transportation. Furthermore, the timing of the

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pricing is different. FOB prices are taken on the loading date and CIF prices on
the unloading date. Since tanker transportation normally takes between a few
days and a few weeks, the difference is often appreciable. It is more common for
crude to be traded at a FOB price and for products at a CIF price. This means
that crude buyers normally hire tankers to pick up crude at the terminal of oil
exporting countries and product sellers usually deliver products to buyers.

7.2. Benchmark Crude

In the late 1970‟s and 1980‟s, new benchmark crude grades emerged. A
benchmark crude grade serves as the reference for crude of similar qualities and
locations. Arabian Light, with its 5 MBD production volume, was the benchmark
crude under OPEC‟s official selling price system. However, in light of the
development of spot and futures markets, the role of Arabian Light was taken
over by West Texas Intermediate (WTI) and Brent.

North Sea Brent possesses all of the vital criteria for a bench marker: security of
supply, diversity of sellers and broad acceptance by refineries and consumers.
Although Brent was not the largest field in the North Sea and had faced
production problems in the past, its satellite fields provided enough production
volumes for market trading liquidity. An important factor is that production is
shared by several participants and is not concentrated in a single producer. This
was the main reason why Forties, whose production was dominated by BP, did
not become the North Sea benchmark, despite it being the first major North Sea
oil field to come on stream, and that its production was larger than that of Brent.

WTI was selected as the reference grade for crude oil futures contract at the New
York Mercantile Exchange (NYMEX) in 1983. Its landlocked delivery system and
the distance from international markets may not best suit the conditions for a
benchmark grade. Nor does it have a large physical production. Nonetheless,
trading at the NYMEX saw a huge success. With large trading volumes, WTI
gained worldwide recognition.

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While the financial market oriented WTI reacts immediately to market
perceptions, Brent‟s linkage to the physical markets provides a picture on the
international supply demand relationship. Benchmark grades are critical in
defining the prices of other related crude. They became the key price variables
in many pricing formulas. In addition, since the two benchmarks are the
reference for trade in the futures markets, they also became the basis for most
hedging and risk management operations and attracted more trading interests in
the markets.

As Saudi Arabia sold its oil only under long-term contracts, Dubai displaced
Arabian Light as the Middle East benchmark. Dubai became a benchmark
because there was the need for a Middle East reference and for a heavier, high
sulphur international benchmark. The Dubai trading now faces declining physical
production and liquidity problems. As a result, Oman plays an increasing role in
supporting Dubai. Dubai in combination with Oman is linked to other Middle East
Crude. The monthly average of Dubai / Oman is a basic ingredient in retroactive
pricing formula for the sales by large OPEC Middle East producers, such as
Saudi Arabia, Iran and Kuwait.

Crude from various fields in Russia and the former Soviet republics is mingled
when transported by Transneft‟s pipeline system and becomes the Urals grade.
Urals exports are currently around 6.4 MBD, the second largest physical trading
grade after Arabian Light. There was also another grade called Siberian Light,
which was transported by a separate line of Transneft to the Black sea port of
Taupse. Its export volumes were several hundred thousand barrels per day.
The problem Urals is facing is that its markets are limited. Urals is sold mainly to
Eastern Europe via the Druzhba pipeline; North West Europe by tanker from the
Baltic Sea ports and the Mediterranean by tanker from the Black Sea ports
through the Turkish Straits. It is currently sold at a larger discount to Brent than
the quality difference.

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Most market places for crude oil are linked to ports. However, markets can be
developed even in inland areas. Various market places for crude oil on the North
American Continent and the market for Russian Urals are good examples. There
has been heavy trading of Russian Urals along the Druzhba pipeline between
crude oil producers and buyers (mainly refineries in Germany, Poland, Hungary,
Slovakia and the Czech Republic). This has created a spot market and prices
are quoted by reporting agencies.

There are other regional benchmark grades, such as Tapis (Malaysia), Minas
(Indonesia) and Bonny Light (Nigeria). The Tapis field off Malaysia is operated
by Exxon, and Malaysia‟s state-owned PETRONAS is a regular seller of spot
Tapis. Most trading activity takes the form of swaps between regional producers
and refiners. Indonesian Minas is traded regularly in the spot market, although
not as much as Tapis. Minas is middle grade in its quality, and production
volumes are the largest in the region. Minas production is in the hands of Caltex
and Indonesian state owned Pertamina.

OPEC Basket price is a reference price – made up of 11 grades: Sharan Blend

(Algeria), Minas (Indonesia), Iran Heavy (Islamic Republic of Iran), Basra Light
(Iraq), Kuwait Export (Kuwait ), Es sider (Libya), Bonny Light (Nigeria), Qatar
Marine (Qatar), Arab Light (Saudi Arabia), Murban (UAE) and BCF 17
(Venezuela).

While the benchmarks play the key role in defining the absolute price levels,
most other crude are traded in the form of spread trading. The preference for
spread trading reflects a natural reaction to the volatility that is common in
international oil markets. The differences between prices tend to be less volatile
than absolute price tend to be less volatile than absolute price levels. Spread
trading reflects a need for markets to constantly adjust inter-market relationships
in price fluctuations.

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7.3. Crude Transactions
7.3. (a) Barter Deal

Barter deals remain important, and are said to account for around 10% of total
trading volumes. These transactions typically involve trading of crude oil or
petroleum products in exchange for goods, services or finances. Middle Eastern
countries use barter deals to acquire industrial facilities (e.g., desalination plants)
in exchange for oil. Other countries pay for petroleum products, e.g., with
cargoes of sugar or cashew nuts. Financing agreements can be part of these
deals. Typically under these agreements, hard currency loans are provided and
the principal and interest are paid by crude cargo deliveries. Countries which
have difficulties in accessing international financial markets can benefit from this
technique.

Closely related to barter deals are crude-for-product swaps and processing

arrangements. They are used by oil exporters to meet domestic needs for
refined products beyond their refining capacity. Under crude for product swaps,
a certain volume of crude is swapped for refined products. A processing deal
usually involves refining an amount of crude at a plant in a third country in return
for products at pre agreed product yields. Some products are taken back while
the rest is sold to the refiners or on the spot market. In some cases, these
arrangements look like netback sales.

7.4. Cargo Transaction

Spot and forward contracts are based on cargo by cargo transactions. Forward
transactions (i.e., sales at a fixed price for a fixed future delivery) cover purchase
and sale of cargoes with delivery scheduled typically for one to three months
ahead. Spot transactions mean those with schedules within 15 days to one
month (oil trading for delivery on the same day is rare). Volumes of oil traded on
a spot basis are thought to amount to about 30% of international oil trade.

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7.5. Long Term Contract
After the integrated system of the Majors, OPEC developed long-term contracts
in the early 1970‟s. Producing countries took control of the upstream sector and
as a result, the oil industry was transformed. Upstream concessions were
replaced by contractual relations and then expropriated. Contracts were typically
FOB priced since tanker transportation remained with international oil companies
(IOCs). New national oil companies were emerging. The Majors lost control of
oil prices, and oil prices were set at OPEC meetings as official selling prices.
This official selling price system lasted until the mid-1980. Against this
background long term contracts offered some degree of supply security.

Long term contracts are widely used in international crude trading today.
Although comprehensive data are scarce, it is thought that more than 50% of
internationally traded crude is under long term contracts. OPEC countries in the
Middle East sell their crude exclusively to refiners through long term contracts.
The situation is similar for Russian crude oil, which is transported to refineries by
crude oil export pipeline. The duration of the contracts is normally one year with
renewals, in terms of the trading volumes. For producing countries, long term
contracts guarantee market access for their crude refiners in the consuming
country can enjoy stable supply volumes and crude qualities provided by long
term contracts. On this basis, refiners can optimise their operation by buying
residual volumes through spot trading.

7.6. Price Formula

Prior to 1979-80, long-term contracts accounted for most international trade. In
the 1970‟s crude was sold at official selling prices, which were set according to
differentials to Arabian Light. The differentials were based on physical properties
of the grades and distances to the markets. However, the official price system,
which was the basis for most long-term contracts then, was no longer working in
the mid-1980‟s, under the decreasing call for OPEC oil due to increased non-
OPEC production and diminishing oil demand in the early 1980‟s. Saudi Arabia,

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which played the role of swing producer within the OPEC quota system,
established the netback pricing system in late 1985 to defend its market share,
and abandoned the official prices. The netback pricing system tied the value of
crude oil to the spot market prices of refined products.

The netback pricing system was followed by a brief, unsuccessful return to the
fixed official price system. In late 1987, however, geographically specified pricing
formulas were introduced. This system is still in place today. It has a direct
reference to the global crude markets. It also permits sellers to target specific
areas and customers by modifying formulas and other aspects of the contracts to
meet individual needs. These adjustments have resulted in highly individualised
contracts and price formulas. Although the use of tailor-made formula reduces
transparency of prices, pricing formula has proved to be an effective, durable and
flexible tool.

If a price formula is only linked to benchmark crude, the particular characteristic

and special market circumstances of the referred crude can have large effects.
To avoid this, the use of crude baskets involving more than one benchmark is
common. For instance, common formulas for crude sales of Arabian Light to the
Asia-Pacific market (eastbound sales) are linked to the Dubai and Oman grades.
Meanwhile, those for Europe and North America (westbound sales) refer to IPE
Brent futures price (IPE BWAVE). Normally the eastbound sales prices are
higher than the west bound sales prices (the difference is called the „Asian
Premium‟).

7.7. Netback Pricing

Although netback pricing was a brief episode in the history of crude oil pricing
mechanisms, the concept is often used in pricing other fuels than oil, e.g., natural
gas. The netback pricing in the oil sector was developed by Saudi Arabia in
1985. By 1984-85 the official selling price system, which was the basis for most
long term contracts, had broken down. Buyers were finding the strict conditions

159
and official prices unacceptable, in the face of a global supply glut. At the time,
Saudi Arabia was acting as swing producer with the OPEC quota system,
lowering its production volumes so that total OPEC production could be kept
within the volume to support the prices set by OPEC. However, under this policy,
the country‟s production had to be cut back from 10 MBD to 3.5 MBD coming to
the lower limit Saudi Arabia had to produce in view of associated gas needs. In
additions, Saudi Arabia‟s efforts were not necessarily shared by the other OPEC
countries. Finally, in 1985 King Fahd decided to increase production and recover
his country‟s market share. Netback pricing was introduced as the instrument to
implement this production increase. It proved to be a very effective tool for Saudi
Arabia to quickly regain market share.

The netback pricing formula was;

Crude oil price (FOB) = GPW in the spot market – fixed refining margin –
transportation costs (from the terminal in the oil-exporting country to the refinery
in the oil-importing country). This netback pricing system introduced the concept
of market prices for crude oil, although it was based on petroleum products.

Netback pricing was also attractive to the buyers (refiners), which otherwise were
suffering from unstable, low margins. However, the success of netback pricing
and the increase in Saudi Arabia‟s production led to a huge drop in oil prices in
1986, plunging below 10$/bbl. This is sometimes called „the counter oil crisis as
opposed to the two previous oil crises. Netback pricing was blamed for the price
crash. After a brief period of netback pricing dominance, the fixed official selling
prices returned briefly in late 1987, producing countries stopped posting the
prices in 1988.

7.8. Refining Margins

Refining margins represent monetary gains or losses associated with crude oil
processing operation. To make comparisons possible by crude grade, refinery
operation or region, calculations normally assume standardised refinery

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configurations. The margin calculation takes into account wages, construction
and other associated costs incurred in refinery operation, together with variable
costs including buying and processing crude oil. Although margin calculations
are more reflective of economics of processing a marginal barrel rather than
returns from base load operation, refining margins can suggest indications of
financial returns to a refinery.

Refining margin = GPW – Crude Costs – Transport Costs and Applicable

fees and Duties – Financial Costs – Variable Costs – Fixed Costs.

There are four main types of refining operation; hydro skimming catalytic,
cracking, hydrocracking and cocking. The hydro skimming refineries are the
basic, standard ones in which crude components are separated at atmospheric
pressure by heating, condensing and cooling. The hydro skimming refineries are
equipped with atmospheric distillation, naphtha reforming and
hydrodesulphurisation facilities. The catalytic cracking refineries have, in
addition to the above, vacuum distillation, catalytic cracking and alkylation
processes. The catalytic cracking process breaks down the larger, heavier and
more complex hydrocarbon molecules into simpler and lighter molecules by heat
and the presence of a catalyst, but without adding hydrogen. Hydrocracking is
similar to catalytic cracking, but with hydrogen and higher pressure. The
hydrocracking process can convert heavy oil (fuel oil components) to lighter and
more valuable products (notably naphtha and middle distillate components). A
cocking unit thermally de-composes residues under high temperature and
pressure, and produces lighter products (gasoline (petrol), naphtha, gas oil).

There are several refining centres in the world, including Northwest Europe,
Mediterranean, US, Gulf Coast, US West Coast and Singapore. To calculate
regional refining margins, it is common to reflect regional characteristics into the
background assumptions. Brent and Urals are normally assumed to be crude
inputs in Northwest Europe, and Urals and Es Sider from Libya in the

161
Mediterranean. Refineries in the US Gulf Coast are typically equipped with
cracking and cocking process facilities. Refineries in the US West Coast are
designed to process heavier crude. Singapore refining margin calculation is
often based on the Dubai Crude and hydro skimming and hydrocracking
refineries.

7.9. Spot and Futures Markets

The current spot transactions have their origin in the first and second oil crises.
The Organisation of Arab Petroleum-exporting Countries (OAPEC) oil embargo
of 1973 and the Iranian revolution of 1979, sparked fears of a shortage in crude
supply.

Crude buyers became nervous and wanted crude at any price. Spot prices rose
to higher levels than the official selling prices and supply volumes under long –
term contracts shifted to spot markets. At the same time, rising volumes of new
oil production from the non –OPEC area went into the spot markets. Cargoes
from the North Sea were sold in the 1980‟s exclusively on a spot basis. Until
1985, most oil-producing countries nevertheless continued to offer long term
fixed price contracts. These contracts increasingly countered resistant from the
buyers. Finally, in 1988 long term fixed price contracts ceased to exist after an
episode of netback pricing.

Although spot market took over the control of oil prices from OPEC, the task
remained in the late 1980‟s to organise spot markets, as there were as many
spot markets as crude streams. Gradually Brent and WTI emerged as the two
most influential benchmarks. Markets were re-organised in line with these crude
grades and the other grades are indexed to them.

At the same time futures markets were being formed in Western countries.
There was a desire on the part of oil companies to reduce risk in light of high
volatility after 1973. Developments in information technology, development in

162
financial theory and a political climate favouring markets over government
administrative guidance led to the creating of financial derivative markets,
Including futures and options.

Oil futures markets are not new. Price volatility in the early days of the US oil
industry resulted in the first oil futures contracts in Pennsylvania in 1860‟s, which
took the form of pipeline certificates. During the next 30 years, more than 10
exchanges in the US, Canada and Europe traded crude futures. However, when
Rockefeller established monopoly control and, later, when the Majors controlled
the market, prices became more stable, the need for market risk management
disappeared, and the early futures trading disappeared as well.

In 1979 heating oil became the first new futures contract at the NYMEX, and the
International Petroleum Exchange (in London followed in 1981. Gasoline (petrol)
futures trading started on the NYMEX in 1981. WTI trading started in 1983 on
the NYMEX and Brent in 1988 on the IPE. The NYMEX launched natural gas
futures in 1990 and the IPE in 1997. The NYMEX still has an open trading floor,
called outcry, but it began electronic trading after hours on NYMEX access in
1993. At IPE, the open outcry system was abolished in 2005, and now all
contracts of the IPE are traded electronically on screen only.

The NYMEX WTI future is the most actively traded commodity in the world some
230 MBD is currently traded, almost three times as much as the physical oil
production / consumption. The contract trades in units of 1000 barrels and is
listed for up to 72 months. The delivery point is Cushing, Oklahoma. Trading
volumes of IPE‟s Brent futures are around 100 MBD. Like WTI, Brent contracts
are 1000 barrels per unit and listed for up to 72 months. The IPE has a delivery
system called exchange of futures for physicals (EFP). Under this system Brent
contract holders can cancel out a future contract with a physical spot contract.
By doing so, the holders can have the same result as physical delivery of the
commodity.

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7.9.1. Spot Market
Spot transactions are mainly conducted by telephone or computer network
between two parties. It is an over the counter (OTC) market as opposed to an
exchange. Spot markets do not necessarily have trading floors. The term „spot
market‟ applies to all spot transactions concluded in an area where strong trading
activities take place. A key advantage of the OTC market is that the terms of a
contract do not have to have the specifications required by an exchange. A
disadvantage is that there is usually a lack of transparency in the market.
Counter party risk also exists in an OTC trade, which is otherwise taken by the
exchange.

The main spot markets for crude oil are Rotterdam for Europe and New York for
the US. These markets have their own benchmarks: Brent and WTI. In
particular, Brent was the centre of spot and forward trading in the 1980‟s. There
are other grades which have strong spot trading activities. They are: Ekofisk,
Forties, Oseberg from the North Sea; Russian Urals; Dubai (UAE); Oman; Minas
(Indonesia); Tapis (Malaysia); Alaska North slope (ANS) and West Texas Sour
(WTS) in the US; and Forcados and Bonny light from Nigeria. Although most
OPEC grades are contracted on a long – term basis, some OPEC countries are
known to use spot transactions to sell part of their production.

The main markets for petroleum products are located in Northwest Europe (ARA
– Amsterdam, Rotterdam, Antwerp), the Mediterranean (Genoa, Lavera), the
Gulf, Southeast Asia (Singapore), US Gulf of Mexico (including the Caribbean)
and US East Coast (New York).

Spot market participants are refiners and producers where crude oil is
concerned. For petroleum products, buyers are traders or large consumers, and
sellers are refiners. Traders play an essential middleman role. They buy
cargoes from sellers and re-sell them to end-users or other traders. Alongside
traders are trading divisions of oil companies. There are also intermediaries and

164
brokers, who help conclude transactions. Although they do not buy or sell
cargoes themselves, they earn a commission.

Formation of a spot market requires large trade volumes and various market
operators. The Rotterdam market, sometimes referred to as the ARA area
ideally matches these conditions. It has both the European consumption centres
and the North Sea production region nearby. The area itself is heavily
industrialised, with many refinery plants. There are also large storage capacities
available. The area is the largest port in Europe. It has access to the northern
European market by sea. Also barges go to Germany Switzerland and France
via the Rhine and other rivers and channels. Many financial institutions and oil
brokerage houses (Eurol, Frisol, Transol, Vanol and Vito) are based in the area.
Overall, the open Dutch and Belgian economies helped establish a large crude
and product market place.

Spot transactions take place in a similar manner from one market to another, a
buyer who seeks a cargo of crude available within one month contract different
producers and traders working in the area. Negotiations take place normally by
telephone. Telephone conversations are recorded in case of disputes. Payment
is made thirty days after loading of the ship for crude oil (payment deadlines are
normally shorter for petroleum products). Spread trading mechanism governs
most crude spot sales, in which negotiation does not centre on the price in
absolute terms but on the price differential between the crude traded and the
benchmark. Prices of North Sea Crude (e.g., Ekofisk or Forties), for instance,
are normally indexed to that of Brent.

In the OTC market, transaction prices are normally known only to the two
contracting parties. This can become a major obstacle to active and fluid spot
trading. Therefore, there are publications which list price records. They are
called reporting agencies. Platts Oilgram (McGraw Hill) and Petroleum Argus are
the two most famous. To track prices, Platts journalists contact sellers and

165
buyers in the market and interview them on transaction prices during the day.
Platts accordingly publishes the previous day‟s quotations. As this price
reporting is an estimate based on the survey, there is a risk of price manipulation.

7.9.2. Forward Market

Spot trading generated on additional risk of high price volatility. To hedge this
risk, forward and futures markets were established. In Europe, however, crude
futures exchange started trading only in 1988. Instead, forward markets were
developed around Brent crude in the 1980s. Therefore, Brent has three price
quotations. Spot markets handle cargoes within fifteen-day availability, called
„dated Brent‟ while forward markets were developed for more distant future
deliveries, named „fifteen – day Brent‟. Brent traded on the IPE futures markets
is called „IPE Brent‟.

The forward fifteen – day Brent market has more standardised operation than the
spot dated Brent market. The cargo size is fixed at 500,000 barrels ± 5%. The
delivery takes place at the Sulom Voe terminal in the North Sea. In the fifteen
day Brent trading, only the month of delivery can be designated (e.g., January,
delivery Brent, February delivery Brent, March delivery Brent, etc.). The buyer
specifies the month and the volume and the seller indicates the delivery date of
the cargo at least fifteen days prior. The name came from this practice. When a
fifteen – day Brent cargo is name and dated, it becomes a spot dated Brent
transaction. In addition to the Brent crude, there are forward markets of gasoline
(Petrol), Diesel, Kerosene, Naphtha and heavy Fuel Oil in Europe.

Forward contracts are in between spot and futures contracts (Table 7.9). In a
hedging operation, a position is taken in the forward market in an opposite
direction to a position in the physical market. However, speculation also takes
place in the forward market, when an operator takes a position in order to gain
profit from price fluctuation. A cargo of crude oil can be transferred from one
trader to another many times between loading and delivery. Series of

166
consequential transactions in the forward market are called „Daisy Chains. Most
transactions are cancelled out by reversed transactions.

Participant in the fifteen – day Brent market are normally limited to oil companies
and large traders, because of the high risk involved in trading. Forward contracts
are traded in OTC markets, which are not as well organised as the exchanges.
Many elements are in the hands of the two parties in the deal. There is less price
transparency in the forward market than in the futures market, despite the fact
that Platt‟s, Petroleum Argus and other news services survey and report daily
prices. Furthermore, unlike in the futures market, there is no clearing house
system. Therefore, there is the counter – party risk and all transaction records
have to be kept track of individually.

7.9.3. Futures Market and Option market

Futures and Option markets have grown considerably since the mid-1980s. Oil
companies and traders as well as financial institutions use the futures and option
markets for hedging against the risk of price fluctuations and risk management.

Table 7.9.3 Characteristics of Spot / Forward / Futures / Options Deals

Contract Spot Forward Futures Options

Trading OTC OTC Exchange OTC/Exchange

Derivatives No Yes Yes Yes

Delivery Yes Yes No No

7.9.4. Analysis of International Crude Oil Price.

Oil has become a global commodity and in this global market place, there have
been fundamental changes which will have a large impact on the future price of

167
oil. On the supply side, the main concern is the availability of crude oil at
affordable price. On demand side, global composition of demand is shifting
away from the advanced economies in Europe, Japan and North America
towards developing economies, especially those in Asia. This means the
impact in US in determining oil price is becoming less and less of a factor.

The critical role played by crude oil, events in the oil market has a major impact
on overall economy. Between 1945 to 1972 oil prices, as measured by West
Texas Intermediate (WTI), were essentially flat and ranged from $2 to $3 a
barrel. Then, the world economy faced two major oil shocks in 1973-74 and
1979-80, both of which were largely due to cutbacks/supply disruption in OPEC
production. In 1973-74, oil prices rose from $2-$3 a barrel to about $11-$12 a
barrel and then in 1979-1980 they spiked up again to about $39 a barrel. During
both oil shocks, the US and much of the global economy moved into recession
and unemployment rate rose sharply. Oil prices peaked in April‟1980 at $39.50 a
barrel and then steadily declined for almost 20 years, until they bottomed out in
December 1998 at $11.28 a barrel. This 20-year period of fall in prices set the
stage for the price surge over the past decade. Investments in the oil industry
became unprofitable and there was no longer much of an incentive for
consumers to conserve energy. As a result, oil companies cut back on their
capital budgets and oil rig counts and drilling activity fell sharply. The relatively
low price of oil at the pump encouraged consumers to buy less fuel-efficient
vehicles and bigger homes. Crude prices starting edging up again at the end of
1990‟s, but the upward price spike did not become noticeably pronounced until
late 2003, with oil prices rising sharply between 2003 and 2008 and reaching a
peak of over $148 a barrel in July 2008.

Prices for WTI fell from over $148 a barrel in 2008 to a low of $31 in December
2008. Despite sluggish recovery in advanced countries and record levels of
inventories, oil prices trended upwards since the recession ended in 2009 and
touched over $100 a barrel by June of 2012. Oil prices are now at levels that are
well above those experienced prior to the global recession. Oil prices (WTI)

168
averaged around $56 a barrel in 2005 and $66 a barrel in 2006 at a time when
the global economy was expanding at a rapid rate.

Figure: 7.9.4

Plot of International Crude Oil Prices

120.00

100.00

80.00 Dubai,$/bbl *

Brent, $/bbl †
60.00

Nigerian Forcados, $/bbl

40.00
West Texas Intermdiate,
$/bbl ‡

20.00

0.00
1986
1980
1982
1984

1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

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 Chapter-8
Data Analysis, Interpretations and Model Estimations
The study reports data analysis elaborately and step by step with statistical
methods followed by interpretations and estimation of econometrics models.
8.1. KARL PEARSON'S CORRELATION COEFFICIENT (r):---

The Karl Pearson correlation coefficient (r) is used to measure the correlation
between variables X (Crude oil price) and Y (Wholesale price index or WPI). The
Karl Pearson coefficient is designated by the letter "r" and is sometimes called
"Pearson's r." Pearson's correlation reflects the degree of linear relationship
between two variables. It ranges from +1 to -1. A correlation of +1 means that
there is a perfect positive linear relationship between variables. A correlation of
-1 means that there is a perfect negative linear relationship between variables. A
correlation of 0 means there is no linear relationship between the two variables.

Mathematical Formula:--

The quantity r, called the linear correlation coefficient, measures the strength and
the direction of a linear relationship between two variables. The linear correlation
coefficient is sometimes referred to as the Pearson product moment correlation
coefficient in honor of its developer Karl Pearson.

The mathematical formula for computing r is:

Where, N = numbers of the observations

∑XY = Sum of the products of paired variables.

∑X = Sum of X variables

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 ∑Y = Sum of Y variables

∑X² = Sum of squared X variables.

∑Y² = Sum of squared Y variables.

Table- 8.1

WPI Crude
monthly Price $,
² ²
(Y) (X) (XY) (X ) (Y )
April,2000-
01 151.7 22.51 3414.77 506.70 23012.89
May 151.8 26.60 4037.88 707.56 23043.24
June 152.7 28.49 4350.42 811.68 23317.29
July 153.1 27.26 4173.51 743.11 23439.61
August 153.4 28.46 4365.76 809.97 23531.56
September 154.7 31.34 4848.30 982.20 23932.09
October 157.9 30.50 4815.95 930.25 24932.41
November 158.2 30.92 4891.54 956.05 25027.24
December 158.5 23.25 3685.13 540.56 25122.25
January 158.6 24.02 3809.57 576.96 25153.96
February 158.6 25.92 4110.91 671.85 25153.96
March 159.1 23.82 3789.76 567.39 25312.81
April,2001-
02 159.9 24.82 3968.72 616.03 25568.01
May 160.3 26.95 4320.09 726.30 25696.09
June 160.8 26.63 4282.10 709.16 25856.64
July 161.1 23.99 3864.79 575.52 25953.21
August 161.7 25.01 4044.12 625.50 26146.89
September 161.7 24.79 4008.54 614.54 26146.89
October 162.5 20.05 3258.13 402.00 26406.25
November 162.3 18.24 2960.35 332.70 26341.29
December 161.8 18.24 2951.23 332.70 26179.24
January 161 18.92 3046.12 357.97 25921.00
February 160.8 19.55 3143.64 382.20 25856.64
March 161.9 23.31 3773.89 543.36 26211.61
April,2002-
03 162.3 25.03 4062.37 626.50 26341.29
May 162.8 25.00 4070.00 625.00 26503.84
June 164.7 24.05 3961.04 578.40 27126.09

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July 165.6 25.18 4169.81 634.03 27423.36
August 167.1 25.86 4321.21 668.74 27922.41
September 167.4 27.49 4601.83 755.70 28022.76
October 167.5 26.90 4505.75 723.61 28056.25
November 167.8 23.68 3973.50 560.74 28156.84
December 167.2 27.11 4532.79 734.95 27955.84
January 167.8 29.59 4965.20 875.57 28156.84
February 169.4 31.26 5295.44 977.19 28696.36
March 171.6 28.83 4947.23 831.17 29446.56
April,2003-
04 173.1 24.21 4190.75 586.12 29963.61
May 173.4 25.00 4335.00 625.00 30067.56
June 173.5 26.42 4583.87 698.02 30102.25
July 173.4 27.46 4761.56 754.05 30067.56
August 173.7 28.66 4978.24 821.40 30171.69
September 175.6 26.27 4613.01 690.11 30835.36
October 176.1 28.45 5010.05 809.40 31011.21
November 176.9 28.20 4988.58 795.24 31293.61
December 176.8 28.97 5121.90 839.26 31258.24
January 178.7 30.01 5362.79 900.60 31933.69
February 179.8 29.61 5323.88 876.75 32328.04
March 179.8 32.21 5791.36 1037.48 32328.04
April,2004-
05 180.9 32.36 5853.92 1047.17 32724.81
May 182.1 36.09 6571.99 1302.49 33160.41
June 185.2 34.22 6337.54 1171.01 34299.04
July 186.6 36.35 6782.91 1321.32 34819.56
August 188.4 40.53 7635.85 1642.68 35494.56
September 189.4 39.15 7415.01 1532.72 35872.36
October 188.9 43.37 8192.59 1880.96 35683.21
November 190.2 38.82 7383.56 1506.99 36176.04
December 188.8 36.85 6957.28 1357.92 35645.44
January 188.6 41.00 7732.60 1681.00 35569.96
February 188.8 42.58 8039.10 1813.06 35645.44
March 189.4 49.27 9331.74 2427.53 35872.36
April,2005-
06 191.6 49.43 9470.79 2443.32 36710.56
May 192.1 47.02 9032.54 2210.88 36902.41
June 193.2 52.72 10185.50 2779.40 37326.24
July 194.6 55.01 10704.95 3026.10 37869.16
August 195.3 60.03 11723.86 3603.60 38142.09
September 197.2 59.74 11780.73 3568.87 38887.84
October 197.8 56.28 11132.18 3167.44 39124.84

172
November 198.2 53.31 10566.04 2841.96 39283.24
December 197.2 55.05 10855.86 3030.50 38887.84
January 196.3 60.61 11897.74 3673.57 38533.69
February 196.4 58.95 11577.78 3475.10 38572.96
March 196.8 60.01 11809.97 3601.20 38730.24
April,2006-
07 199 67.06 13344.94 4497.04 39601.00
May 201.3 67.33 13553.53 4533.33 40521.69
June 203.1 66.90 13587.39 4475.61 41249.61
July 204 71.29 14543.16 5082.26 41616.00
August 205.3 70.87 14549.61 5022.56 42148.09
September 207.8 60.94 12663.33 3713.68 43180.84
October 208.7 57.26 11950.16 3278.71 43555.69
November 209.1 57.80 12085.98 3340.84 43722.81
December 208.4 60.34 12574.86 3640.92 43430.56
January 208.8 52.62 10987.06 2768.86 43597.44
February 208.9 56.49 11800.76 3191.12 43639.21
March 209.8 60.26 12642.55 3631.27 44016.04
April,2007-
08 211.5 65.48 13849.02 4287.63 44732.25
May 212.3 65.76 13960.85 4324.38 45071.29
June 212.3 68.10 14457.63 4637.61 45071.29
July 213.6 72.58 15503.09 5267.86 45624.96
August 213.8 68.97 14745.79 4756.86 45710.44
September 215.1 74.78 16085.18 5592.05 46268.01
October 215.2 79.33 17071.82 6293.25 46311.04
November 215.9 89.15 19247.49 7947.72 46612.81
December 216.4 87.92 19025.89 7729.93 46828.96
January 218.1 89.52 19524.31 8013.83 47567.61
February 219.9 92.16 20265.98 8493.47 48356.01
March 225.5 99.76 22495.88 9952.06 50850.25
April,2007-
08 228.5 105.77 24168.45 11187.29 52212.25
May 231.1 120.91 27942.30 14619.23 53407.21
June 237.8 129.72 30847.42 16827.28 56548.84
July 240 132.47 31792.80 17548.30 57600.00
August 241.2 113.05 27267.66 12780.30 58177.44
September 241.5 96.81 23379.62 9372.18 58322.25
October 239 69.12 16519.68 4777.57 57121.00
November 234.2 50.91 11923.12 2591.83 54849.64
December 229.7 40.61 9328.12 1649.17 52762.09
January 228.9 43.99 10069.31 1935.12 52395.21
February 227.6 43.22 9836.87 1867.97 51801.76

173
March 228.2 46.02 10501.76 2117.84 52075.24
April,2008-
09 231.5 50.14 11606.39 2513.58 53592.25
May 234.3 58.00 13590.19 3364.39 54896.49
June 235 69.12 16242.09 4776.92 55225.00
July 238.7 64.82 15473.63 4202.23 56977.69
August 240.8 71.98 17332.59 5181.00 57984.64
September 242.6 67.70 16424.42 4583.51 58854.76
October 242.5 73.06 17718.09 5338.39 58806.25
November 247.2 77.39 19131.02 5989.35 61107.84
December 248.3 75.02 18626.53 5627.43 61652.89
January 250.5 76.61 19190.51 5868.91 62750.25
February 250.5 73.69 18460.42 5430.85 62750.25
March 253.4 78.02 19769.84 6086.86 64211.56
April,2009-
10 257.5 84.08 21651.05 7069.74 66306.25
May 260.4 76.16 19832.44 5800.56 67808.16
June 259.8 74.33 19311.22 5525.11 67496.04
July 262.5 73.54 19305.05 5408.58 68906.25
∑ 24337.1 6,226.73 1303113.23 393668.43 4894250.07
N = 124

Therefore, Karl Pearson‟s correlation coefficient „ r „ = 0.829812

8.2. Model-1 :- To determine the influence of crude oil price on inflation of the
Indian economy. The following time series regression equation was fitted.
Yt= a + bX + et ---------- (1)
Where
Yt denotes the WPI ( base year 1993- 94 )
„a‟ denotes constant quantity, i.e. the intercept of the line on Y- axis.
„b‟ denotes the co-efficient of X.
„X‟ denotes the crude oil price.( monthly Indian basket price).
„et‟ is residual term of the model.

174
 Graph- 8.2
300

250

200
WPI monthly

150

100 WPI monthly

50

0
0.00 20.00 40.00 60.00 80.00 100.00 120.00 140.00
Crude oil prices

Scatter Plot of X and Y

We shall now briefly discuss the mechanics of the Model - 1, two variable linear
regression, the equation of the model is Y= a + bx + e t , the scatter plot of X=
crude oil price and Y= WPI monthly is shown in the graph 8.2.

The observed data are used to estimate the two parameters, „a‟ and „b‟ of the
model and „et‟ is the stochastic term or noise. The actual numerical estimates of
the intercept and the slope are written as „a^‟ and „b^‟ , where the “hats” indicate
that the quantity is an estimate of a model parameter – an estimate that is
computed from the observed data.

The above equation can be written as Y=a+bX, in absence of error term, i.e. et=0.
In the equation, the parameter „a‟ is the intercept, it gives the quantity of
wholesale price index (WPI) without the influence of crude price, i.e. when X=0,
and Constant „b‟ is the co-efficient of Y in relation to X or the slope.

The slope, a summary of the relationship between X and Y, answers the

equation, when X changes by one unit, by how many units does Y change? The
answer is that Y changes by „b‟ units. In the research of the impact of crude oil
prices (Indian basket) on WPI (wholesale price index), the fitted line with the
observed data is shown in the graph.

175
 Graph-8.2.1.

300
y = 1.00027x + 146.0375
R² = 0.6886
250

200
WPI monthly

150
WPI monthly
100 Linear (WPI monthly)

50

0
0.00 20.00 40.00 60.00 80.00 100.00 120.00 140.00
Crude oil prices
Fitting a Regression line

The equation, WPI = 146.0375 + 1.00027*Crude oil price, fits the relationship
between the incremental increase in WPI on the incremental increase of crude oil
price. The estimated slope, „b^‟, is 1.00027; that is,

Changes in Y Change in percent of WPI

„b^‟ = ---------------------- = -------------------------------------------------- = 1.00027
Changes in X Change in percent of crude oil price

This means that a 1% change in crude oil price was typically accompanied by a
change of 1.00027% of WPI. Thus an increase of only 1% in crude oil price
would increase substantially in WPI. Of course, it works in other way, too; a drop
of 1% of crude oil price is associated with decrease of 1.00027% of WPI. The
estimate of slope measures what is call “swing ratio” – the swing or change in
WPI for a given change in crude oil prices.

176
It can be seen from graph above that total change in Y is not explained by a
change in X. The regression line can explain the total change in Y in response to
change in X only if the entire crude oil price & WPI points fall on the regression
line. But, as is evident from the graph, all crude oil price & WPI combination
points do not fall on the regression line. Some points are placed above and some
points are placed below the regression line. This means that b, i.e. the slope of
the regression line, does not explain the total change in Y in response to a
change in X. The unexplained part of Y is called the error term, the residual or
the disturbance. The purpose of regression technique is to find the average
values of „a‟ and „b‟ which make the values of observed pairs of X and Y,
i.e.(X1,Y1), (X2,Y2), etc., as close to the regression line as possible. The line so
fitted is called the best fit regression line. This objective is achieved by
minimizing the error terms, i.e., the deviation of observed value of Yt (tth value, t=
1, 2, 3, … n) from its estimated value Yt^ can then be defined as error term,
therefore, error term is, et = Yt – Yt^.

Regression technique minimizes the error term with a view to find the best fits the
observed data. So the problem is how to minimize the error term. It can be seen
from the graph of the fitting line that the error terms in some months are positive
as the points are above the line and in some months they are negative. So, one
way to minimize the error could be to find the sum of the error terms. In this
method positive and negative errors would tend to cancel out. It would mean
error does not exist or there are no deviations from the estimated line whereas, it
can be seen in graph, the positive and negative error term may not cancel out.
Therefore, the sum of the error terms cannot be used as a measure of deviation
of the observed data from the estimated one. This problem is avoided by using
the square of the error term. The technique that regression analysis uses to
minimize the error term is called Ordinary Least Square (OLS) method. It is the
sum square of the error terms that regression techniques seek to minimize and
find the values of „a‟ and „b‟ that produce best fit line.

177
 Table :- 8.2. Two variable regression

Yt Xt Xt Yt Xt²
WPI
monthly Crude Price $
April,2000-01 151.7 22.51 3414.77 506.70
May 151.8 26.6 4037.88 707.56
June 152.7 28.49 4350.42 811.68
July 153.1 27.26 4173.51 743.11
August 153.4 28.46 4365.76 809.97
September 154.7 31.34 4848.3 982.20
October 157.9 30.5 4815.95 930.25
November 158.2 30.92 4891.54 956.05
December 158.5 23.25 3685.13 540.56
January 158.6 24.02 3809.57 576.96
February 158.6 25.92 4110.91 671.85
March 159.1 23.82 3789.76 567.39
April,2001-02 159.9 24.82 3968.72 616.03
May 160.3 26.95 4320.09 726.30
June 160.8 26.63 4282.1 709.16
July 161.1 23.99 3864.79 575.52
August 161.7 25.01 4044.12 625.50
September 161.7 24.79 4008.54 614.54
October 162.5 20.05 3258.13 402.00
November 162.3 18.24 2960.35 332.70
December 161.8 18.24 2951.23 332.70
January 161 18.92 3046.12 357.97
February 160.8 19.55 3143.64 382.20
March 161.9 23.31 3773.89 543.36
April,2002-03 162.3 25.03 4062.37 626.50
May 162.8 25 4070 625.00
June 164.7 24.05 3961.04 578.40
July 165.6 25.18 4169.81 634.03
August 167.1 25.86 4321.21 668.74
September 167.4 27.49 4601.83 755.70
October 167.5 26.9 4505.75 723.61
November 167.8 23.68 3973.5 560.74
December 167.2 27.11 4532.79 734.95
January 167.8 29.59 4965.2 875.57
February 169.4 31.26 5295.44 977.19
March 171.6 28.83 4947.23 831.17

178
April,2003-04 173.1 24.21 4190.75 586.12
May 173.4 25 4335 625.00
June 173.5 26.42 4583.87 698.02
July 173.4 27.46 4761.56 754.05
August 173.7 28.66 4978.24 821.40
September 175.6 26.27 4613.01 690.11
October 176.1 28.45 5010.05 809.40
November 176.9 28.2 4988.58 795.24
December 176.8 28.97 5121.9 839.26
January 178.7 30.01 5362.79 900.60
February 179.8 29.61 5323.88 876.75
March 179.8 32.21 5791.36 1037.48
April,2004-05 180.9 32.36 5853.92 1047.17
May 182.1 36.09 6571.99 1302.49
June 185.2 34.22 6337.54 1171.01
July 186.6 36.35 6782.91 1321.32
August 188.4 40.53 7635.85 1642.68
September 189.4 39.15 7415.01 1532.72
October 188.9 43.37 8192.59 1880.96
November 190.2 38.82 7383.56 1506.99
December 188.8 36.85 6957.28 1357.92
January 188.6 41 7732.6 1681.00
February 188.8 42.58 8039.1 1813.06
March 189.4 49.27 9331.74 2427.53
April,2005-06 191.6 49.43 9470.79 2443.32
May 192.1 47.02 9032.54 2210.88
June 193.2 52.72 10185.5 2779.40
July 194.6 55.01 10704.9 3026.10
August 195.3 60.03 11723.9 3603.60
September 197.2 59.74 11780.7 3568.87
October 197.8 56.28 11132.2 3167.44
November 198.2 53.31 10566 2841.96
December 197.2 55.05 10855.9 3030.50
January 196.3 60.61 11897.7 3673.57
February 196.4 58.95 11577.8 3475.10
March 196.8 60.01 11810 3601.20
April,2006-07 199 67.06 13344.9 4497.04
May 201.3 67.33 13553.5 4533.33
June 203.1 66.9 13587.4 4475.61
July 204 71.29 14543.2 5082.26
August 205.3 70.87 14549.6 5022.56

179
 September 207.8 60.94 12663.3 3713.68
October 208.7 57.26 11950.2 3278.71
November 209.1 57.8 12086 3340.84
December 208.4 60.34 12574.9 3640.92
January 208.8 52.62 10987.1 2768.86
February 208.9 56.49 11800.8 3191.12
March 209.8 60.26 12642.5 3631.27
April,2007-08 211.5 65.48 13849 4287.63
May 212.3 65.76 13960.8 4324.38
June 212.3 68.1 14457.6 4637.61
July 213.6 72.58 15503.1 5267.86
August 213.8 68.97 14745.8 4756.86
September 215.1 74.78 16085.2 5592.05
October 215.2 79.33 17071.8 6293.25
November 215.9 89.15 19247.5 7947.72
December 216.4 87.92 19025.9 7729.93
January 218.1 89.52 19524.3 8013.83
February 219.9 92.16 20266 8493.47
March 225.5 99.76 22495.9 9952.06
April,2007-08 228.5 105.77 24168.4 11187.29
May 231.1 120.91 27942.3 14619.23
June 237.8 129.72 30847.4 16827.28
July 240 132.47 31792.8 17548.30
August 241.2 113.05 27267.7 12780.30
September 241.5 96.81 23379.6 9372.18
October 239 69.12 16519.7 4777.57
November 234.2 50.91 11923.1 2591.83
December 229.7 40.61 9328.12 1649.17
January 228.9 43.99 10069.3 1935.12
February 227.6 43.22 9836.87 1867.97
March 228.2 46.02 10501.8 2117.84
April,2008-09 231.5 50.14 11606.4 2513.58
May 234.3 58.00 13590.2 3364.39
June 235 69.12 16242.1 4776.92
July 238.7 64.82 15473.6 4202.23
August 240.8 71.98 17332.6 5181.00
September 242.6 67.70 16424.4 4583.51
October 242.5 73.06 17718.1 5338.39
November 247.2 77.39 19131 5989.35
December 248.3 75.02 18626.5 5627.43
January 250.5 76.61 19190.5 5868.91

180
 February 250.5 73.69 18460.4 5430.85
March 253.4 78.02 19769.8 6086.86
April,2009-10 257.5 84.08 21651 7069.74
May 260.4 76.16 19832.4 5800.56
June 259.8 74.33 19311.2 5525.11
July 262.5 73.54 19305.1 5408.58
∑ 24337.1 6226.73 1303113 393668.43
N=124
Mean 196.27 50.22

2 2 2
a ={(∑Xt ) (∑Yt) - (∑Xt)(∑XtYt)} †{ N(∑Xt - (∑Xt) }

a=146.0376

2 2
b={N(∑XtYt) - (∑Xt)(∑Yt)} ÷ {N(∑Xt ) - (∑Xt) }

b=1.00027

8.2.1. The Test of Significance of Estimate Parameters

We have estimated the parameters „a’ and „b’ in regression equation of two
variable regression equation and have also discussed the use of the estimated
regression to estimate the value of Y (WPI) for a given amount of crude oil price
(X). The question that now arises is how reliable is the estimated value of
coefficient b or how well does the estimated regression line fit to the observed
data? For example, since b = 1.00027, an increase of $1 in crude oil price will
cause an increase in WPI of approximately 1.00027. How far is this conclusion
reliable? The technique that is used to answer this question is called test of
statistical significance.

The process of a testing of statistical significance begins with making a

hypothesis that estimate b = 0. This is called „Null hypotheses. It means
assuming that there is no relationship between Y and X. The task is now to
accept or reject the hypothesis. If null hypothesis is accepted, it means that

181
there is no relationship between Y and X or, in other words, the variation in Y
(WPI) is not explained by the variation in X. On the contrary, if the null
hypothesis is rejected, it means that estimated b ≠ 0 and that b > 0 significantly.
The task now is, therefore, to test the null hypothesis. In fact, the task is to find
the probability of rejecting the null hypothesis. The probability of rejecting a
hypothesis is known as finding the level of significance. The rule in this regard is
that if the level of significance is 5 per cent or less, then the hypothesis is
rejected. It means that if the level of significance is 5 per cent or less, then the
estimated coefficient b is statistically significant. That is, if estimated coefficient b
is statistically significant at 5 per cent level of significance, then it is concluded
that X ( Crude oil price) is a significant determinant of Y (WPI).

How is the level of significance determined? The level of significance is

determined on the basis of the standard error and t-ratio to t statistic. We will first
describe the precise method of calculating the standard error and the t-ratio.

The „standard error‟ is the standard deviation of the estimated value from the
sample values. This is the principle of least squares, which says

Minimize Σet2 , -that is, minimize Σ(Yt – Yt^)2 ,

Therefore, to test the hypothesis that there is a statistically significant relationship

between Y (WPI) and X (Crude oil price); we need to calculate standard error of
coefficient b, denoted as Sb. The estimates of error (and other Statistical tests)
are provided by computer programs of software. However, it is useful to know
how Sb is estimated and used in the test of statistical significance. The formula
for estimating Sb is given below.

Sb= ∑( Yt – Yt^ )2/ (N-k)∑(Xt – ̅ )2} = ∑et2/ (N-k)∑(Xt – ̅ )2}

Where Xt and Yt are the observed values for month t, Yt^ is the
estimated value of Y in month t, ̅ is the mean value of X, N is the number of
observations and et= ( Yt – Yt^) is the error term, and k is the number of estimated

182
coefficients ( 2 in the case of a two variable regression equation, „a‟ and „b‟). In
fact, (N-k) is the degree of freedom, i.e. 124-2 =122.

Table:8.2.1. Calculation of Standard Error of Coefficient

Xt
-
Yt (WPI (Crude Xt = (Xt – X
2
monthly) Price $) Yt^ et =Yt – Yt^ (Yt – Yt^)² )
April,2000-01 151.7 22.51 168.56 -16.86 284.13 767.60
May 151.8 26.60 172.65 -20.85 434.60 557.69
June 152.7 28.49 174.54 -21.84 476.88 472.00
July 153.1 27.26 173.31 -20.21 408.34 526.96
August 153.4 28.46 174.51 -21.11 445.53 473.30
September 154.7 31.34 177.39 -22.69 514.77 356.29
October 157.9 30.50 176.55 -18.65 347.76 388.70
November 158.2 30.92 176.97 -18.77 352.25 372.32
December 158.5 23.25 169.30 -10.80 116.56 727.14
January 158.6 24.02 170.07 -11.47 131.48 686.21
February 158.6 25.92 171.97 -13.37 178.68 590.27
March 159.1 23.82 169.87 -10.77 115.92 696.73
April,2001-02 159.9 24.82 170.87 -10.97 120.27 644.93
May 160.3 26.95 173.00 -12.70 161.22 541.29
June 160.8 26.63 172.68 -11.88 141.07 556.28
July 161.1 23.99 170.04 -8.94 79.86 687.78
August 161.7 25.01 171.06 -9.36 87.55 635.32
September 161.7 24.79 170.84 -9.14 83.48 646.46
October 162.5 20.05 166.10 -3.60 12.93 909.96
November 162.3 18.24 164.28 -1.98 3.94 1022.44
December 161.8 18.24 164.28 -2.48 6.17 1022.44
January 161 18.92 164.97 -3.97 15.72 979.41
February 160.8 19.55 165.60 -4.80 22.99 940.38
March 161.9 23.31 169.36 -7.46 55.60 723.91
April,2002-03 162.3 25.03 171.08 -8.78 77.03 634.31
May 162.8 25.00 171.05 -8.25 68.01 635.82
June 164.7 24.05 170.10 -5.40 29.12 684.64
July 165.6 25.18 171.23 -5.63 31.66 626.78
August 167.1 25.86 171.91 -4.81 23.11 593.19
September 167.4 27.49 173.54 -6.14 37.67 516.45
October 167.5 26.90 172.95 -5.45 29.67 543.62
November 167.8 23.68 169.73 -1.93 3.71 704.14

183
December 167.2 27.11 173.16 -5.96 35.49 533.87
January 167.8 29.59 175.64 -7.84 61.43 425.41
February 169.4 31.26 177.31 -7.91 62.54 359.31
March 171.6 28.83 174.88 -3.28 10.74 457.34
April,2003-04 173.1 24.21 170.26 2.84 8.09 676.29
May 173.4 25.00 171.05 2.35 5.54 635.82
June 173.5 26.42 172.47 1.03 1.07 566.23
July 173.4 27.46 173.51 -0.11 0.01 517.82
August 173.7 28.66 174.71 -1.01 1.02 464.64
September 175.6 26.27 172.32 3.28 10.78 573.39
October 176.1 28.45 174.50 1.60 2.57 473.74
November 176.9 28.20 174.25 2.65 7.04 484.68
December 176.8 28.97 175.02 1.78 3.18 451.37
January 178.7 30.01 176.06 2.64 6.98 408.26
February 179.8 29.61 175.66 4.14 17.16 424.59
March 179.8 32.21 178.26 1.54 2.38 324.20
April,2004-05 180.9 32.36 178.41 2.49 6.21 318.82
May 182.1 36.09 182.14 -0.04 0.00 199.53
June 185.2 34.22 180.27 4.93 24.31 255.86
July 186.6 36.35 182.40 4.20 17.64 192.25
August 188.4 40.53 186.58 1.82 3.31 93.81
September 189.4 39.15 185.20 4.20 17.64 122.45
October 188.9 43.37 189.42 -0.52 0.27 46.86
November 190.2 38.82 184.87 5.33 28.40 129.86
December 188.8 36.85 182.90 5.90 34.81 178.64
January 188.6 41.00 187.05 1.55 2.40 84.93
February 188.8 42.58 188.63 0.17 0.03 58.30
March 189.4 49.27 195.32 -5.92 35.09 0.89
April,2005-06 191.6 49.43 195.48 -3.88 15.08 0.62
May 192.1 47.02 193.07 -0.97 0.95 10.21
June 193.2 52.72 198.77 -5.57 31.07 6.27
July 194.6 55.01 201.06 -6.46 41.79 22.99
August 195.3 60.03 206.09 -10.79 116.34 96.32
September 197.2 59.74 205.80 -8.60 73.89 90.71
October 197.8 56.28 202.34 -4.54 20.57 36.78
November 198.2 53.31 199.36 -1.16 1.36 9.58
December 197.2 55.05 201.10 -3.90 15.25 23.37
January 196.3 60.61 206.67 -10.37 107.46 108.04
February 196.4 58.95 205.01 -8.61 74.06 76.29
March 196.8 60.01 206.07 -9.27 85.86 95.93

184
April,2006-07 199 67.06 213.12 -14.12 199.32 283.74
May 201.3 67.33 213.39 -12.09 146.12 292.90
June 203.1 66.90 212.96 -9.86 97.18 278.37
July 204 71.29 217.35 -13.35 178.20 444.13
August 205.3 70.87 216.93 -11.63 135.24 426.61
September 207.8 60.94 207.00 0.80 0.65 115.01
October 208.7 57.26 203.32 5.38 28.99 49.62
November 209.1 57.80 203.86 5.24 27.50 57.52
December 208.4 60.34 206.40 2.00 4.01 102.50
January 208.8 52.62 198.67 10.13 102.53 5.78
February 208.9 56.49 202.55 6.35 40.38 39.37
March 209.8 60.26 206.32 3.48 12.14 100.89
April,2007-08 211.5 65.48 211.54 -0.04 0.00 233.00
May 212.3 65.76 211.82 0.48 0.23 241.63
June 212.3 68.10 214.16 -1.86 3.45 319.85
July 213.6 72.58 218.64 -5.04 25.40 500.17
August 213.8 68.97 215.03 -1.23 1.51 351.73
September 215.1 74.78 220.84 -5.74 32.95 603.41
October 215.2 79.33 225.39 -10.19 103.87 847.65
November 215.9 89.15 235.21 -19.31 373.03 1515.89
December 216.4 87.92 233.98 -17.58 309.19 1421.62
January 218.1 89.52 235.58 -17.48 305.70 1544.84
February 219.9 92.16 238.22 -18.32 335.80 1759.34
March 225.5 99.76 245.83 -20.33 413.18 2454.65
April,2007-08 228.5 105.77 251.84 -23.34 544.69 3086.30
May 231.1 120.91 266.98 -35.88 1287.56 4997.70
June 237.8 129.72 275.80 -38.00 1443.62 6320.96
July 240 132.47 278.55 -38.55 1485.78 6765.79
August 241.2 113.05 259.12 -17.92 321.15 3948.17
September 241.5 96.81 242.88 -1.38 1.89 2171.04
October 239 69.12 215.18 23.82 567.46 357.38
November 234.2 50.91 196.96 37.24 1386.54 0.48
December 229.7 40.61 186.66 43.04 1852.36 92.27
January 228.9 43.99 190.04 38.86 1509.95 38.76
February 227.6 43.22 189.27 38.33 1469.06 48.94
March 228.2 46.02 192.07 36.13 1305.20 17.60
April,2008-09 231.5 50.14 196.19 35.31 1246.86 0.01
May 234.3 58.00 204.06 30.24 914.52 60.65
June 235 69.12 215.17 19.83 393.07 357.20
July 238.7 64.82 210.88 27.82 773.83 213.42

185
August 240.8 71.98 218.04 22.76 518.08 473.66
September 242.6 67.70 213.76 28.84 831.75 305.76
October 242.5 73.06 219.12 23.38 546.44 522.06
November 247.2 77.39 223.45 23.75 563.98 738.50
December 248.3 75.02 221.08 27.22 741.12 615.07
January 250.5 76.61 222.67 27.83 774.54 696.60
February 250.5 73.69 219.75 30.75 945.31 551.25
March 253.4 78.02 224.08 29.32 859.70 772.99
April,2009-10 257.5 84.08 230.14 27.36 748.33 1146.92
May 260.4 76.16 222.22 38.18 1457.56 673.19
June 259.8 74.33 220.39 39.41 1553.06 581.56
July 262.5 73.54 219.60 42.90 1840.16 544.17
∑ 24337.1 6226.73 -0.27 36647.60 80989.69
N=124
Mean 196.26694 50.21556

Sb = 0.060902

t=b/Sb 16.42426

Now that we have obtained the values of two test-standard error and t-ratio-we
use them finally to test the null hypothesis, that is there is no relationship
between Y (WPI) and X (Crude oil price). To test the hypothesis we need to
perform statistical t test, i.e., to compare the computed t – ratio (16.42) with the
critical t value with different degrees of freedom.

The degrees of freedom is equals n – k = 124 – 2 = 122. The critical t values for
different degrees of freedom are given in the t – table. The t test is usually
performed at 5 per cent level number 122 under the degrees of freedom. When
we link 122 with 5 per cent level of confidence, under the column 0.05, we get
critical t value as 1.96 for the so called „two – tailed test‟. The value of t that we
have calculated in our regression analysis is 16.42. This value of t (i.e., 16.42)
far exceeds the critical t value (i.e.. 1.96) at the 5 per cent level of significance.
Therefore, the null hypothesis that „there is no relationship between Y (WPI) and
X (Crude oil price)‟ is rejected. The rejection of null hypothesis at 5 per cent level

186
of significance means that there is a statistically significant relationship between
Y (WPI) and X (Crude oil price). More precisely, we arrive at the conclusion that
we are 95 per cent confident that there is a statistically significant relationship
between Y (WPI) and X (Crude oil price).

8.2.2. The Test of Goodness of Fit: The Coefficient of Determination

Apart from testing for the statistical significance of the relationship between X
(Crude oil price) and Y (WPI) another test is performed to test the overall
explanatory power of the estimated regression equation. This test is performed
by calculating the coefficient of determination. The coefficient of determination,
denoted usually by the symbol R2, gives the measure of the overall strength of
the association between the dependent (Y) and the independent (X) variables.
The coefficient of determination (R2) is defined as the proportion of the total
variation in the dependent variable Y (about its mean), explained by the
variations in the independent variable or what is also called the explanatory
variable, X. Given the definition, the coefficient of determination (R 2) is
measured as follows:

Explained Variation in Y
2
R = ----------------------------
Total variation in Y

The explained variation is the sum of the squares of the deviation of measured
value of Y in each year from the mean of Y. That is,

Explained variation in Y =∑ )²

The total variation in Y equals the sum of the squares of the deviation of each
observed value of Y from the mean of observed Y. That is,

Total variation in Y =∑ )²

Thus, the coefficient of determination (R2) can be redefined in terms of the ratio
of explained variation in Y and total variation in Y as
187
 ∑ )²
R2 = -------------------------
∑ )²

From an explanation point of view, total variation in Y is constituted of two parts

(i) explained variation, and (ii) unexplained variation. Explained variation has
already been defined above. The unexplained variation in Y equals the sum of
squares of the difference between the observed value of Y in each month and
the estimated value of Y for each month. That is,

Unexplained variation = ∑ )²

Thus, the total variation in Y can be redefined in terms of explained and

unexplained variation in y as,

Total variation = Explained Variation + unexplained variation

=∑ )² + ∑ )²

Although computer programs provide R2, we will illustrate here the process of its
calculation. The process of calculation of the coefficient of determination (R 2 as
defined above) is given below,

Table :- 8.2.2. Calculation of Coefficient of Determination

Yt(WPI yt = Yt - Yt^ - et =Yt – (Yt –

- -
monthly) Y¯ (yt - Y¯)2 Yt^ Y (Yt^ - Y )² Yt^ Yt^)²
April,2000-
01 151.7 -44.57 1986.21 168.56 -27.71 767.89 -16.86 284.13
May 151.8 -44.47 1977.31 172.65 -23.62 557.89 -20.85 434.60
June 152.7 -43.57 1898.08 174.54 -21.73 472.16 -21.84 476.88
July 153.1 -43.17 1863.38 173.31 -22.96 527.14 -20.21 408.34
August 153.4 -42.87 1837.57 174.51 -21.76 473.47 -21.11 445.53
September 154.7 -41.57 1727.81 177.39 -18.88 356.40 -22.69 514.77
October 157.9 -38.37 1472.02 176.55 -19.72 388.83 -18.65 347.76
November 158.2 -38.07 1449.09 176.97 -19.30 372.44 -18.77 352.25
December 158.5 -37.77 1426.34 169.30 -26.97 727.42 -10.80 116.56
January 158.6 -37.67 1418.80 170.07 -26.20 686.46 -11.47 131.48
February 158.6 -37.67 1418.80 171.97 -24.30 590.49 -13.37 178.68

188
March 159.1 -37.17 1381.38 169.87 -26.40 696.99 -10.77 115.92
April,2001-
02 159.9 -36.37 1322.55 170.87 -25.40 645.17 -10.97 120.27
May 160.3 -35.97 1293.62 173.00 -23.27 541.48 -12.70 161.22
June 160.8 -35.47 1257.90 172.68 -23.59 556.48 -11.88 141.07
July 161.1 -35.17 1236.71 170.04 -26.23 688.04 -8.94 79.86
August 161.7 -34.57 1194.87 171.06 -25.21 635.55 -9.36 87.55
September 161.7 -34.57 1194.87 170.84 -25.43 646.70 -9.14 83.48
October 162.5 -33.77 1140.21 166.10 -30.17 910.32 -3.60 12.93
November 162.3 -33.97 1153.75 164.28 -31.98 1022.85 -1.98 3.94
December 161.8 -34.47 1187.97 164.28 -31.98 1022.85 -2.48 6.17
January 161 -35.27 1243.76 164.97 -31.30 979.80 -3.97 15.72
February 160.8 -35.47 1257.90 165.60 -30.67 940.75 -4.80 22.99
March 161.9 -34.37 1181.09 169.36 -26.91 724.18 -7.46 55.60
April,2002-
03 162.3 -33.97 1153.75 171.08 -25.19 634.55 -8.78 77.03
May 162.8 -33.47 1120.04 171.05 -25.22 636.06 -8.25 68.01
June 164.7 -31.57 996.47 170.10 -26.17 684.89 -5.40 29.12
July 165.6 -30.67 940.46 171.23 -25.04 627.01 -5.63 31.66
August 167.1 -29.17 850.71 171.91 -24.36 593.41 -4.81 23.11
September 167.4 -28.87 833.30 173.54 -22.73 516.63 -6.14 37.67
October 167.5 -28.77 827.54 172.95 -23.32 543.81 -5.45 29.67
November 167.8 -28.47 810.37 169.73 -26.54 704.40 -1.93 3.71
December 167.2 -29.07 844.89 173.16 -23.11 534.05 -5.96 35.49
January 167.8 -28.47 810.37 175.64 -20.63 425.55 -7.84 61.43
February 169.4 -26.87 721.83 177.31 -18.96 359.42 -7.91 62.54
March 171.6 -24.67 608.46 174.88 -21.39 457.50 -3.28 10.74
April,2003-
04 173.1 -23.17 536.71 170.26 -26.01 676.54 2.84 8.09
May 173.4 -22.87 522.90 171.05 -25.22 636.06 2.35 5.54
June 173.5 -22.77 518.33 172.47 -23.80 566.43 1.03 1.07
July 173.4 -22.87 522.90 173.51 -22.76 518.00 -0.11 0.01
August 173.7 -22.57 509.27 174.71 -21.56 464.80 -1.01 1.02
September 175.6 -20.67 427.12 172.32 -23.95 573.59 3.28 10.78
October 176.1 -20.17 406.71 174.50 -21.77 473.90 1.60 2.57
November 176.9 -19.37 375.08 174.25 -22.02 484.85 2.65 7.04
December 176.8 -19.47 378.96 175.02 -21.25 451.52 1.78 3.18
January 178.7 -17.57 308.60 176.06 -20.21 408.40 2.64 6.98
February 179.8 -16.47 271.16 175.66 -20.61 424.73 4.14 17.16
March 179.8 -16.47 271.16 178.26 -18.01 324.30 1.54 2.38
April,2004-
05 180.9 -15.37 236.14 178.41 -17.86 318.92 2.49 6.21
May 182.1 -14.17 200.70 182.14 -14.13 199.58 -0.04 0.00

189
June 185.2 -11.07 122.48 180.27 -16.00 255.93 4.93 24.31
July 186.6 -9.67 93.45 182.40 -13.87 192.30 4.20 17.64
August 188.4 -7.87 61.89 186.58 -9.69 93.82 1.82 3.31
September 189.4 -6.87 47.15 185.20 -11.07 122.46 4.20 17.64
October 188.9 -7.37 54.27 189.42 -6.85 46.86 -0.52 0.27
November 190.2 -6.07 36.81 184.87 -11.40 129.88 5.33 28.40
December 188.8 -7.47 55.76 182.90 -13.37 178.68 5.90 34.81
January 188.6 -7.67 58.78 187.05 -9.22 84.93 1.55 2.40
February 188.8 -7.47 55.76 188.63 -7.64 58.30 0.17 0.03
March 189.4 -6.87 47.15 195.32 -0.94 0.89 -5.92 35.09
April,2005-
06 191.6 -4.67 21.78 195.48 -0.78 0.61 -3.88 15.08
May 192.1 -4.17 17.36 193.07 -3.19 10.20 -0.97 0.95
June 193.2 -3.07 9.41 198.77 2.51 6.29 -5.57 31.07
July 194.6 -1.67 2.78 201.06 4.80 23.02 -6.46 41.79
August 195.3 -0.97 0.93 206.09 9.82 96.42 -10.79 116.34
September 197.2 0.93 0.87 205.80 9.53 90.81 -8.60 73.89
October 197.8 1.53 2.35 202.34 6.07 36.82 -4.54 20.57
November 198.2 1.93 3.74 199.36 3.10 9.59 -1.16 1.36
December 197.2 0.93 0.87 201.10 4.84 23.41 -3.90 15.25
January 196.3 0.03 0.00 206.67 10.40 108.15 -10.37 107.46
February 196.4 0.13 0.02 205.01 8.74 76.37 -8.61 74.06
March 196.8 0.53 0.28 206.07 9.80 96.03 -9.27 85.86
April,2006-
07 199 2.73 7.47 213.12 16.85 283.96 -14.12 199.32
May 201.3 5.03 25.33 213.39 17.12 293.14 -12.09 146.12
June 203.1 6.83 46.69 212.96 16.69 278.59 -9.86 97.18
July 204 7.73 59.80 217.35 21.08 444.46 -13.35 178.20
August 205.3 9.03 81.60 216.93 20.66 426.93 -11.63 135.24
September 207.8 11.53 133.01 207.00 10.73 115.12 0.80 0.65
October 208.7 12.43 154.58 203.32 7.05 49.68 5.38 28.99
November 209.1 12.83 164.69 203.86 7.59 57.59 5.24 27.50
December 208.4 12.13 147.21 206.40 10.13 102.60 2.00 4.01
January 208.8 12.53 157.08 198.67 2.41 5.79 10.13 102.53
February 208.9 12.63 159.59 202.55 6.28 39.42 6.35 40.38
March 209.8 13.53 183.14 206.32 10.05 100.99 3.48 12.14
April,2007-
08 211.5 15.23 232.05 211.54 15.27 233.20 -0.04 0.00
May 212.3 16.03 257.06 211.82 15.55 241.83 0.48 0.23
June 212.3 16.03 257.06 214.16 17.89 320.10 -1.86 3.45
July 213.6 17.33 300.44 218.64 22.37 500.54 -5.04 25.40
August 213.8 17.53 307.41 215.03 18.76 352.00 -1.23 1.51
September 215.1 18.83 354.68 220.84 24.57 603.84 -5.74 32.95

190
October 215.2 18.93 358.46 225.39 29.12 848.24 -10.19 103.87
November 215.9 19.63 385.46 235.21 38.95 1516.88 -19.31 373.03
December 216.4 20.13 405.34 233.98 37.72 1422.56 -17.58 309.19
January 218.1 21.83 476.68 235.58 39.32 1545.84 -17.48 305.70
February 219.9 23.63 558.52 238.22 41.96 1760.47 -18.32 335.80
March 225.5 29.23 854.57 245.83 49.56 2456.19 -20.33 413.18
April,2007-
08 228.5 32.23 1038.97 251.84 55.57 3088.21 -23.34 544.69
May 231.1 34.83 1213.34 266.98 70.72 5000.71 -35.88 1287.56
June 237.8 41.53 1725.00 275.80 79.53 6324.72 -38.00 1443.62
July 240 43.73 1912.58 278.55 82.28 6769.81 -38.55 1485.78
August 241.2 44.93 2018.98 259.12 62.85 3950.57 -17.92 321.15
September 241.5 45.23 2046.03 242.88 46.61 2172.42 -1.38 1.89
October 239 42.73 1826.11 215.18 18.91 357.65 23.82 567.46
November 234.2 37.93 1438.92 196.96 0.70 0.49 37.24 1386.54
December 229.7 33.43 1117.77 186.66 -9.61 92.27 43.04 1852.36
January 228.9 32.63 1064.92 190.04 -6.23 38.75 38.86 1509.95
February 227.6 31.33 981.76 189.27 -7.00 48.93 38.33 1469.06
March 228.2 31.93 1019.72 192.07 -4.19 17.59 36.13 1305.20
April,2008-
09 231.5 35.23 1241.37 196.19 -0.08 0.01 35.31 1246.86
May 234.3 38.03 1446.51 204.06 7.79 60.72 30.24 914.52
June 235 38.73 1500.25 215.17 18.91 357.47 19.83 393.07
July 238.7 42.43 1800.56 210.88 14.62 213.60 27.82 773.83
August 240.8 44.53 1983.19 218.04 21.77 474.01 22.76 518.08
September 242.6 46.33 2146.75 213.76 17.49 306.00 28.84 831.75
October 242.5 46.23 2137.50 219.12 22.86 522.45 23.38 546.44
November 247.2 50.93 2594.18 223.45 27.18 739.01 23.75 563.98
December 248.3 52.03 2707.44 221.08 24.81 615.51 27.22 741.12
January 250.5 54.23 2941.23 222.67 26.40 697.10 27.83 774.54
February 250.5 54.23 2941.23 219.75 23.49 551.65 30.75 945.31
March 253.4 57.13 3264.19 224.08 27.81 773.53 29.32 859.70
April,2009-
10 257.5 61.23 3749.49 230.14 33.88 1147.68 27.36 748.33
May 260.4 64.13 4113.05 222.22 25.96 673.66 38.18 1457.56
June 259.8 63.53 4036.45 220.39 24.12 581.98 39.41 1553.06
July 262.5 66.23 4386.82 219.60 23.34 544.57 42.90 1840.16
-
∑ 24337.1 0 117682.03 196.27 81033.43 36647.60

2
R= 0.6885794
r= 0.8298069

191
Since we have computed the elements of the coefficient of determination, we can
calculate R2. Column 4 of Table above shows the total variation and column 7
shows the explained variation. Given the values, we get,

∑ )² 81033.43
2
R = ------------------------- = ------------------ = 0.6885794
∑ )² 117682.03

From above calculation, R2 = 0.68. It means that 68 per cent of the total variation
in the dependent variable Y (WPI) is explained by the independent variable X i.e.,
the crude oil price. It means that the regression equation has a high explanatory
power and that the regression line is a „good fit‟

And important aspect of the coefficient of determination (R 2) is that its square

root gives the coefficient of correlation, denoted by r. That is, r=√ R² .The
coefficient of correlation measures the degree of association between the
dependent and the independent variables. It also important to note here that
while regression equation assumes that the variation in the dependent variable
(Y) is caused by the variation in the independent variable (X), the coefficient of
correlation gives the measure of only the degree of association or covariance
between the dependent and the independent variables. We may apply this
formula to find the correlation coefficient between WPI and Crude oil price.

r = SQRT (R2) = SQRT (0.6885794) = 0.8298

This means that there is a very strong association or correlation between WPI
and Crude oil price.

8.2.3. Analysis of Variance

The analysis of variance is a technique to test the overall explanatory power of

the regression equation. For this purpose, the analysis of variance uses the F-
statistics or F- ratio. The formula for computing the value of F – statistic is given
below.

192
 {(Explained variation) / (k – 1)}
F = ------------------------------------------------
{(Unexplained variation)/ (N - k)}

Where k= number of estimated parameters, N = number of observations.

The F – statistics can also be calculated by the following formula,

R²/ (k-1)
F = ------------------------------------------
(1 - R²)/ (N-k)

The F- statistics is used to test the hypothesis that the variations in the
independent variables (X) explain a significant proportion of variation in
dependent variable (Y). The F – statistic so calculated is checked in F-
distribution table with respect to degrees of freedom and critical values. The
computerized results also provide the analysis of variance.

(81033.43)/ (2-1)
F= --------------------------------------- = 269.76
(36647.60) / (124 – 2)

Similarly, the regression outputs of WPI on Crude oil price using excel software
package has three components:

 Regression statistics table or Model Summary

 ANOVA table
 Regression coefficients table.

193
Table:-8.2.4.INTERPRETATION OF REGRESSION MODEL SUMMARY
Model R R square Adjusted R Std. Error Number of
square of the observation
estimate
1 0.8298 0.68858 0.68603 17.3317 124

The Regression Statistics Table or model summary gives the overall goodness-
of-fit measures: R2 = 0.68. The Correlation between dependent variable Y and
independent variable X is r =√ (R²) =0.8298. The standard error here refers to
the estimated standard deviation of the error term et. It is sometimes called the
standard error of the regression. It equals SQRT (SSE/ (n-k)).
Table:-8.2.5 ANOVA
Model Sum of df Mean F
square square
1 Regression 81034.43 1 81034.43 269.79
Residual 36647.60 122 300.39
Total 117682.03 123

The ANOVA (analysis of variance) table splits the sum of squares into its
components.

Total sums of squares = Residual (or error) sum of squares + Regression (or
explained) sum of squares.

Thus Σ i (yi - ybar)2 = Σ i (yi - yhati)2 + Σ i (yhati - ybar)2 ; where yhati is the value of
yi predicted from the regression line and ybar is the sample mean of y.

Therefore,
R2 = 1 - Residual SS / Total SS (general formula for R2)
= 1 – 36647.60/117682.03 (from data in the ANOVA table)
= 0.68858798 (which equals R2 found in the regression Statistics table
above).

194
Table : 8.2.6. REGRESSION COEFFICIENTS TABLE

Coefficients Std. Error t-statistics p-value

Intercept or
(Constant) 146.0375 3.43148 42.558 4.75E-75

Crude_Price 1.000276 0.060901 16.424 1.07E-32

The population regression model is: y = a + bx + et ; where, the error et is

assumed to be distributed independently with mean 0 and constant variance.

we focus on inference on b, using the row that begins with crude price.
Similar interpretation is given for inference on „a‟, using the row that begins with
intercept. The column "Coefficient" gives the least squares estimates of “a” and
“b”.

The column "Standard error" gives the standard errors (i.e. the estimated
standard deviation) of the least squares estimate of “a” and “b” .

The second row of the column "t Stat" gives the computed t-statistic for H01: b = 0
against H11: b ≠ 0. This is the coefficient divided by the standard error: here
1.00027 / 0.060901 = 16.42449. It is compared to a T distribution with (n-k)
degrees of freedom where here n = 124 and k = 2.

The column "P-value" gives for crude prices are for H01: b = 0 against H11: b ≠ 0.
This equals the Pr{|T| > t-Stat}where T is a T-distributed random variable with n-k
degrees of freedom and t-Stat is the computed value of the t-statistic given is the
previous column. This P-value is for a 2-sided test. For a 1-sided test divide this
P-value by 2 (also checking the sign of the t-Stat).

195
A simple summary of the above output is that

 The fitted line is Y = 146.0375+1.00027*X

 The slope coefficient has estimated standard error of 0.060901
 The slope coefficient has t-statistic of 16.424.
 The slope coefficient has p-value of 1.07E-32.
 The standard error of the regression is 17.33

Correlation between WPI and Crude oil prices = 0.8298.
 R2 = 0.6885 ; Adjusted R2 = 0.6860
 The regression model is

Y = 146.0375 + 1.00027X

There is a strong positive correlation between WPI and Crude oil prices.

For deriving elasticity co-efficient of dependent variable, double log natural

regression model was used. One attractive feature of double natural log model is
that the slope coefficient „b‟ measure elasticity Y with respect to X, that is percent
change of Y for a given percent change in X.

Table 8.2.7. Log natural transformation data of WPI and Crude Price

WPI Ln( Crude

monthly Crude Price $ Ln(WPI) price)
April,2000-01 151.7 22.51 5.021905 3.11396
May 151.8 26.60 5.022564 3.280911
June 152.7 28.49 5.028475 3.349553
July 153.1 27.26 5.031091 3.30542
August 153.4 28.46 5.033049 3.3485
September 154.7 31.34 5.041488 3.444895
October 157.9 30.50 5.061962 3.417727
November 158.2 30.92 5.06386 3.431403
December 158.5 23.25 5.065755 3.146305
January 158.6 24.02 5.066385 3.178887
February 158.6 25.92 5.066385 3.255015
March 159.1 23.82 5.069533 3.170526
April,2001-02 159.9 24.82 5.074549 3.21165
May 160.3 26.95 5.077047 3.293983
June 160.8 26.63 5.080161 3.282038

196
July 161.1 23.99 5.082025 3.177637
August 161.7 25.01 5.085743 3.219276
September 161.7 24.79 5.085743 3.21044
October 162.5 20.05 5.090678 2.998229
November 162.3 18.24 5.089446 2.903617
December 161.8 18.24 5.086361 2.903617
January 161 18.92 5.081404 2.94022
February 160.8 19.55 5.080161 2.972975
March 161.9 23.31 5.086979 3.148882
April,2002-03 162.3 25.03 5.089446 3.220075
May 162.8 25.00 5.092522 3.218876
June 164.7 24.05 5.104126 3.180135
July 165.6 25.18 5.109575 3.22605
August 167.1 25.86 5.118592 3.252697
September 167.4 27.49 5.120386 3.313822
October 167.5 26.90 5.120983 3.292126
November 167.8 23.68 5.122773 3.164631
December 167.2 27.11 5.119191 3.299903
January 167.8 29.59 5.122773 3.387436
February 169.4 31.26 5.132263 3.442339
March 171.6 28.83 5.145166 3.361417
April,2003-04 173.1 24.21 5.153869 3.186766
May 173.4 25.00 5.155601 3.218876
June 173.5 26.42 5.156178 3.274121
July 173.4 27.46 5.155601 3.31273
August 173.7 28.66 5.15733 3.355502
September 175.6 26.27 5.168209 3.268428
October 176.1 28.45 5.171052 3.348148
November 176.9 28.20 5.175585 3.339322
December 176.8 28.97 5.175019 3.366261
January 178.7 30.01 5.185708 3.401531
February 179.8 29.61 5.191845 3.388112
March 179.8 32.21 5.191845 3.472277
April,2004-05 180.9 32.36 5.197944 3.476923
May 182.1 36.09 5.204556 3.586016
June 185.2 34.22 5.221436 3.53281
July 186.6 36.35 5.228967 3.593194
August 188.4 40.53 5.238567 3.702042
September 189.4 39.15 5.243861 3.6674
October 188.9 43.37 5.241218 3.769768
November 190.2 38.82 5.248076 3.658936

197
December 188.8 36.85 5.240688 3.606856
January 188.6 41.00 5.239628 3.713572
February 188.8 42.58 5.240688 3.751385
March 189.4 49.27 5.243861 3.897315
April,2005-06 191.6 49.43 5.25541 3.900558
May 192.1 47.02 5.258016 3.850573
June 193.2 52.72 5.263726 3.964995
July 194.6 55.01 5.270946 4.007515
August 195.3 60.03 5.274537 4.094844
September 197.2 59.74 5.284218 4.090002
October 197.8 56.28 5.287256 4.030339
November 198.2 53.31 5.289277 3.976124
December 197.2 55.05 5.284218 4.008242
January 196.3 60.61 5.279644 4.10446
February 196.4 58.95 5.280153 4.07669
March 196.8 60.01 5.282188 4.094511
April,2006-07 199 67.06 5.293305 4.205588
May 201.3 67.33 5.304796 4.209606
June 203.1 66.90 5.313698 4.203199
July 204 71.29 5.31812 4.266756
August 205.3 70.87 5.324472 4.260847
September 207.8 60.94 5.336576 4.10989
October 208.7 57.26 5.340898 4.047602
November 209.1 57.80 5.342813 4.056989
December 208.4 60.34 5.339459 4.099995
January 208.8 52.62 5.341377 3.963096
February 208.9 56.49 5.341856 4.034064
March 209.8 60.26 5.346155 4.098669
April,2007-08 211.5 65.48 5.354225 4.181745
May 212.3 65.76 5.358 4.186012
June 212.3 68.10 5.358 4.220977
July 213.6 72.58 5.364105 4.284689
August 213.8 68.97 5.365041 4.233672
September 215.1 74.78 5.371103 4.31455
October 215.2 79.33 5.371568 4.373616
November 215.9 89.15 5.374815 4.49032
December 216.4 87.92 5.377129 4.476427
January 218.1 89.52 5.384954 4.494462
February 219.9 92.16 5.393173 4.523526
March 225.5 99.76 5.41832 4.602767
April,2007-08 228.5 105.77 5.431536 4.661267

198
May 231.1 120.91 5.442851 4.795046
June 237.8 129.72 5.47143 4.865378
July 240 132.47 5.480639 4.886356
August 241.2 113.05 5.485626 4.72783
September 241.5 96.81 5.486869 4.57275
October 239 69.12 5.476464 4.235844
November 234.2 50.91 5.456175 3.930059
December 229.7 40.61 5.436774 3.704014
January 228.9 43.99 5.433285 3.783962
February 227.6 43.22 5.42759 3.766303
March 228.2 46.02 5.430222 3.829076
April,2008-09 231.5 50.14 5.44458 3.914731
May 234.3 58.00 5.456602 4.060501
June 235 69.12 5.459586 4.235776
July 238.7 64.82 5.475208 4.171685
August 240.8 71.98 5.483967 4.276377
September 242.6 67.70 5.491414 4.215111
October 242.5 73.06 5.491002 4.29134
November 247.2 77.39 5.510198 4.348869
December 248.3 75.02 5.514638 4.317704
January 250.5 76.61 5.523459 4.338712
February 250.5 73.69 5.523459 4.299925
March 253.4 78.02 5.534969 4.356943
April,2009-10 257.5 84.08 5.55102 4.431789
May 260.4 76.16 5.562219 4.332855
June 259.8 74.33 5.559912 4.308529
July 262.5 73.54 5.570251 4.297871

The regression is carried out using excel software package has three
components:

 Regression statistics table or Model Summary

 ANOVA table
 Regression coefficients table.

199
SUMMARY OF REGRESSION OUTPUT

Regression Statistics
Multiple R 0.886158
R Square 0.785276
Adjusted R
Square 0.783516
Standard Error 0.072439
Observations 124

ANOVA
Significance
df SS MS F F
Regression 1 2.34123705 2.341237 446.1723 1.42584E-42
Residual 122 0.64018069 0.005247
Total 123 2.98141774

Standard
Coefficients Error t Stat P-value
Intercept 4.230286 0.04952673 85.4142 1.1E-110
Ln( Crude price) 0.273585 0.0129521 21.12279 1.43E-42

Therefore, the double log regression model shows that the crude oil price
elasticity of WPI is 0.27 and it is positively correlated. Thus, our natural log –log
regression model is,

Ln(Y) = 4.230286 + 0.273585 Ln(X).

200
8.3. Model 2.
The Karl Pearson correlation coefficient (r) between the sets of variables Y (GDP
growth rate) and X(Inflation) is calculated. Pearson's correlation reflects and
measures the strength of linear association between two variables.

Table 8.3 Two variable data for correlation

Quarterly Quarterly
India GDP India
growth Inflation
² ²
(Y) rate (X) (XY) (X ) (Y )
2005-06 Q1 9.25 3.97 36.73 15.76 85.62
Q2 8.91 3.27 29.14 10.69 79.40
Q3 9.69 4.12 39.90 16.97 93.81
Q4 9.99 5 49.95 25.00 99.81
2006-07 Q1 9.81 5.57 54.66 31.02 96.29
Q2 10.13 6.92 70.09 47.89 102.59
Q3 9.38 7.06 66.22 49.84 87.96
Q4 9.59 7 67.12 49.00 91.93
2007-08 Q1 9.34 6.67 62.33 44.49 87.33
Q2 9.39 6.47 60.76 41.86 88.18
Q3 9.73 5.81 56.55 33.76 94.74
Q4 8.49 5.47 46.42 29.92 72.03
2008-09 Q1 8.04 7.81 62.79 61.00 64.65
Q2 7.81 8.52 66.54 72.59 61.00
Q3 5.59 10.22 57.16 104.45 31.28
Q4 5.76 9.93 57.23 98.60 33.21
2009-10 Q1 6.32 8.45 53.40 71.40 39.93
Q2 8.64 10.97 94.77 120.34 74.64
Q3 7.33 12.21 89.50 149.08 53.73
Q4 8.57 15.35 131.48 235.62 73.36
∑ 171.76 150.79 1252.74 1309.30 1511.48
N= 20

r = - 0.536
201
In order to measure the expected influence of inflation on GDP growth, the
econometric model, YGDP = a1 + b1 XInflation+ et, which is shown in scatter plot and
fitting regression line in the graph below.
Graph-8.3
12.00
y = -0.2452x + 10.437
Quarterly India GDP growth (Y)

10.00 R² = 0.2851

8.00

6.00

4.00

2.00

0.00
0 2 4 6 8 10 12 14 16 18
Quarterly India Inflation rate (X)

Scatter Plot of X and Y with Fitting of Regression line

The ordinary least square method is used to develop values of a1^ and b1^ the
estimates of model parameters a1 and b1 respectively. The resulted estimated
regression equation is Y^GDP = a1^ + b1^ Xinflation .

8.3.1.Two variable regression analysis

yt =
(YGDP Xinf xt = Xinf - YGDP -
2 2
(XInflation) growth) YGDP Xinf Xinf¯ YGDP¯ xt xtyt
2005-06,
Q1 3.97 9.25 36.73 15.76 -3.57 0.66 12.74 -2.37
Q2 3.27 8.91 29.14 10.69 -4.27 0.32 18.23 -1.38
Q3 4.12 9.69 39.90 16.97 -3.42 1.10 11.69 -3.75
Q4 5 9.99 49.95 25.00 -2.54 1.40 6.45 -3.56
2006-07,
Q1 5.57 9.81 54.66 31.02 -1.97 1.22 3.88 -2.41
Q2 6.92 10.13 70.09 47.89 -0.62 1.54 0.38 -0.95
Q3 7.06 9.38 66.22 49.84 -0.48 0.79 0.23 -0.38
Q4 7 9.59 67.12 49.00 -0.54 1.00 0.29 -0.54
2007-08,
Q1 6.67 9.34 62.33 44.49 -0.87 0.76 0.76 -0.66

202
 Q2 6.47 9.39 60.76 41.86 -1.07 0.80 1.14 -0.86
Q3 5.81 9.73 56.55 33.76 -1.73 1.15 2.99 -1.98
Q4 5.47 8.49 46.42 29.92 -2.07 -0.10 4.28 0.21
2008-09,
Q1 7.81 8.04 62.79 61.00 0.27 -0.55 0.07 -0.15
Q2 8.52 7.81 66.54 72.59 0.98 -0.78 0.96 -0.76
Q3 10.22 5.59 57.16 104.45 2.68 -3.00 7.19 -8.03
Q4 9.93 5.76 57.23 98.60 2.39 -2.83 5.71 -6.75
2009-10,
Q1 8.45 6.32 53.40 71.40 0.91 -2.27 0.83 -2.07
Q2 10.97 8.64 94.77 120.34 3.43 0.05 11.77 0.18
Q3 12.21 7.33 89.50 149.08 4.67 -1.26 21.81 -5.88
Q4 15.35 8.57 131.48 235.62 7.81 -0.02 61.00 -0.18
∑ 150.79 171.76 1252.74 1309.30 0.00 0 172.42 -42.28
N=20
Mean 7.54 8.59

Thus, from the above we can estimate a1 and b1.

^
b1 = (Σxtyt)/ Σx2 = -0.24522

- -
a1^ =Y -b X = 10.439

It can be seen from graph above that total change in Y is not explained by a
change in X. The regression line can explain the total change in Y in response to
change in X only if all the inflation – GDP growth points fall on the regression
line. But, as is evident from the graph, all inflation – GDP growth combination
points do not fall on the regression line. Some points are placed above and some
points are placed below the regression line. This means that estimated b1^, i.e.
the slope of the regression line, does not explain the total change in Y in
response to a change in X. The unexplained part of Y is called the error term, the
residual or the disturbance. The purpose of regression technique is to find the
average values of „a1^‟ and „b1^‟ which make the values of observed pairs of X
and Y, i.e.(X1,Y1), (X2,Y2), etc, as close to the regression line as possible. The
line so fitted is called the best fit regression line. This objective is achieved by
minimizing the error terms, i.e. et .

203
8.3.2. Calculation of Standard Error of Coefficient

(YGDP et = (YGDPt -
^ 2 2
(XInflation) growth) Y GDP Y^GDP) et xt = (Xt - X-)2
2005-06,
Q1 3.97 9.25 9.47 -0.88 0.77 12.74
Q2 3.27 8.91 9.64 -1.05 1.10 18.23
Q3 4.12 9.69 9.43 -0.82 0.67 11.69
Q4 5 9.99 9.21 -0.62 0.39 6.45
2006-07,
Q1 5.57 9.81 9.07 -0.46 0.21 3.88
Q2 6.92 10.13 8.74 -0.15 0.02 0.38
Q3 7.06 9.38 8.71 -0.12 0.01 0.23
Q4 7 9.59 8.72 -0.13 0.02 0.29
2007-08,
Q1 6.67 9.34 8.80 -0.22 0.05 0.76
Q2 6.47 9.39 8.85 -0.26 0.07 1.14
Q3 5.81 9.73 9.01 -0.43 0.18 2.99
Q4 5.47 8.49 9.10 -0.51 0.26 4.28
2008-09,
Q1 7.81 8.04 8.52 0.06 0.00 0.07
Q2 8.52 7.81 8.35 0.24 0.06 0.96
Q3 10.22 5.59 7.93 0.66 0.43 7.19
Q4 9.93 5.76 8.00 0.58 0.34 5.71
2009-10,
Q1 8.45 6.32 8.37 0.22 0.05 0.83
Q2 10.97 8.64 7.75 0.84 0.70 11.77
Q3 12.21 7.33 7.44 1.14 1.31 21.81
Q4 15.35 8.57 6.67 1.91 3.66 61.00
∑ 150.79 171.76 0.00 10.32 172.42
N=20
Mean 7.54 8.59

From the model and its assumption we can conclude that σ2 the variance of e,
also represents the variance of Y values about the regression line. The deviation
of the Y values about the estimated regression line is called residuals. Thus,
SSE, the sum square residuals is a measure of the variability of the actual
observations about the estimated regression line. The mean square error (MSE)
provides the estimate of σ2, it is SSE divided by its degrees of freedom. MSE

204
provides an unbiased estimator of σ2. Because the value of MSE provides an
estimate of σ2, the notation S2 is also used.

SSE 10.32
MSE (Estimate of σ2) = S2 = --------- = --------- = 0.5733
N-2 20-2

To estimate σ, we take the square root of S 2, the resulting value; S is referred to

as the standard error of estimate.
Therefore, S = = =0.7572.

8.3.3: t-Test.

The simple linear regression model is YGDP = a1 + b1 X inflation+ et. If x and y are
linearly related we must have b1 ≠ 0. The purpose of the t test is to see whether
we can conclude that b1 ≠ 0.
To test the parameter b1, following hypotheses are to be tested,
H0 : b1 = 0.
Ha : b1 ≠ 0
If H0 is rejected, we will conclude that b1 ≠ 0 and that a statistically significant
relationship exists between the two variables. However, if H 0 cannot be rejected
we will have insufficient evidence to conclude that a significant relationship
exists. The properties of the sampling distribution of b 1, the least square
estimator of b1, provides the basis for hypothesis test.

S 0.7572 0.7572
Sb1 = ----------------------------------- = ------------------- = ---------------- = 0.0576
SQRT {Σ(Xinfla – X-)2 } 13.1308

as the estimated standard deviation of b1.

The t test for a significant relationship is based on the fact that the test statistic
(b1^ - b1)/ Sb1 follows a t distribution with N-2 degrees of freedom. If the null
hypothesis is true, then b1 = 0 and t = b1^/ Sb1 = - 0.245 / 0.0576 = - 4.2534.

205
The t distribution table shows that with N-2 = 20-2 = 18 degree of freedom, t=
1.734 provides an area of 0.05 in the upper tail. Thus, the area in the upper tail of
t distribution corresponding to the test statistic t= 4.2534 must be less than 0.05.
because this test is a two tailed test, we double this value to conclude that p-
value associated with t=4.253 must be less than 2(0.05) = 0.1, excel show the p-
value =0.015, we reject the H0 and conclude that b1 is not equal to zero. This
evidence is sufficient to conclude that a significant relationship exists between
quarterly GDP growth YGDP(growth) and quarterly inflation Xinflation .

8.3.4: Confidence Interval for b1

The form of a confidence interval for b1 is as follows

b1± t α/2 Sb1
The point estimator is b1 and the margin of error is t α/2Sb1. The confidence
coefficient associated with the interval is 1-α, and t α/2 is the t value providing an
area of α/2 in the upper tail of a t distribution with N-2 degrees of freedom.
Suppose that we want to develop a 95% confidence interval estimate of b 1.
From t distribution table we find that the value of t corresponding to α=0.05 and
N-2 = 20-2=18 degrees of freedom is t0.05 = 1.734, thus 95% confidence interval
estimate of b1 is
b1± t α/2 Sb1 = -0.245 ± 1.734( 0.0576) = -0.245 ± 0.0998
or -0.3448 to -0.1452.
In using the t test for significance, the hypotheses tested were
H0 : b1 = 0.
Ha : b1 ≠ 0
At the α = 0.05 level of significance, we can use the 95% confidence interval as
an alternative for drawing the hypothesis testing. Because 0, the hypothesized
value of b1, is not included in the confidence interval (-0.3448 to -0.1452), we can
reject H0 and conclude that a significant statistical relationship exists between the
quarterly GDP growth and quarterly inflation.

206
8.3.5: F test
An F test, based on the F probability distribution, can also be used to test for
significance in regression. With only one independent variable, the F test will
provide the same conclusion as t test, i.e. if the t test indicates b 1 ≠ 0 and hence
a significant relationship, the F test will also indicate a significant relationship. But
with more than one independent variable, only the F test can be used to test for
an overall significant relationship.
The logic behind the use of F test for determining whether the regression
relationship is statistically significant is based on the development of two
independent estimates of σ2, if the null hypothesis, H0 : b1 = 0 is true, the sum of
squares due to regression, SSR, divided by its degrees of freedom provides
another independent estimate of σ2, this estimation is called the mean square
due to regression, or simply the mean square regression, and is denoted by
MSR. In general,
SSR
MSR = --------------------------------------------
Regression degrees of freedom
For the model we consider the regression degree of freedom is always equal to
the number of independent variables in the model.

SSR
MSR = --------------------------------------------
Number of independent variables
Because we consider only regression model with one independent variable we
have MSR = SSR/1 = SSR, hence MSR =SSR =10.365.
If the null hypothesis (H0: b1 = 0) is true, MSR and MSE are independent
estimates of σ2 and the distribution MSR/MSE follows an F distribution with
numerator degrees of freedom one and denominator degrees of freedom N-2.
Therefore when b1 = 0, the value of MSR/MSE =1. But if the null hypothesis is
fails, then b1≠ 0, MSR will over estimate σ2 and the value of MSR/MSE will be

207
inflated, thus large values of MSR/MSE lead to the rejection of H 0 and the
conclusion that the relationship between x and y is statistically significant.
10.365
F= ---------------------------- = 7.181
1.443
The f distribution table shows that at 1 degree of freedom in the numerator and
N-2=20-2=18 degrees of freedom in denominator, F= 4.41 provides an area of
0.05 in the upper tail. Thus, the area in the upper tail of F distribution
corresponding to test statistic F= 7.181 must be less than 0.05. Thus, we
conclude that the p-value must be less than0.05. Excel show the p-value= 0.015

8.3.6 Calculation of Coefficient of Determination

Yt = et =
(YGDP - (YGDP - Y^ - (YGDP (YGDP -
2
(XInflation) YGDP Y¯) Y¯) Y^ Y- (Y^ - Y-)² - Y^) Y^)²
2005-
06, Q1 3.97 9.25 0.66 0.4420 9.47 0.88 0.77 -0.21 0.045
Q2 3.27 8.91 0.32 0.1041 9.64 1.05 1.10 -0.72 0.518
Q3 4.12 9.69 1.10 1.2037 9.43 0.83 0.69 0.26 0.066
Q4 5 9.99 1.40 1.9664 9.21 0.62 0.39 0.78 0.605
2006-
07, Q1 5.57 9.81 1.22 1.4991 9.07 0.46 0.21 0.74 0.547
Q2 6.92 10.13 1.54 2.3726 8.74 0.15 0.02 1.39 1.922
Q3 7.06 9.38 0.79 0.6253 8.71 0.12 0.01 0.67 0.451
Q4 7 9.59 1.00 0.9999 8.72 0.13 0.02 0.87 0.749
2007-
08, Q1 6.67 9.34 0.76 0.5728 8.80 0.22 0.05 0.54 0.293
Q2 6.47 9.39 0.80 0.6435 8.85 0.26 0.07 0.54 0.289
Q3 5.81 9.73 1.15 1.3122 9.01 0.43 0.18 0.72 0.518
Q4 5.47 8.49 -0.10 0.0103 9.10 0.51 0.26 -0.61 0.373
2008-
09, Q1 7.81 8.04 -0.55 0.3002 8.52 -0.06 0.00 -0.45 0.203
Q2 8.52 7.81 -0.78 0.6050 8.35 -0.24 0.06 -0.54 0.291
Q3 10.22 5.59 -3.00 8.9727 7.93 -0.66 0.43 -2.34 5.476
Q4 9.93 5.76 -2.83 7.9822 8.00 -0.58 0.34 -2.24 5.022
2009-
10, Q1 8.45 6.32 -2.27 5.1476 8.37 -0.22 0.05 -2.05 4.192
Q2 10.97 8.64 0.05 0.0026 7.75 -0.84 0.70 0.89 0.793
Q3 12.21 7.33 -1.26 1.5835 7.44 -1.14 1.31 -0.11 0.013
Q4 15.35 8.57 -0.02 0.0005 6.67 -1.91 3.66 1.89 3.574

208
∑ 150.79 171.76 0.00 36.3459 0.00 10.33 0.00 25.940
N=20
Mean 7.54 8.5882

∑ )² 10.33
2
R = ------------------------- = ------------------ = 0.284
∑ )² 36.3459

Table :8.3.7 Model Summary

Std. Error of the Number of
Model R R Square Adjusted R Square
Estimate observations

d
i
m
e
n a
2 0.534 0.2851 0.2454 1.201 20
s
i
o
n
0

a. Predictors: (Constant), Inflation

b
Table : 8.3.8 ANOVA TABLE
Sum of
Model df Mean Square F Sig.
Squares

Regression 10.36556025 1 10.36556025 7.18158 0.01529173

Residual 25.98036549 18 1.443353638

Total 36.34592574 19

a. Predictors: (Constant), Inflation

b. Dependent Variable: GDP growth

209
 a
Table 8.3.9 Coefficients

Coefficients Std. Error t-statistics p-value

Intercept or 10.4368021 0.740285064 14.09836 3.62E-11

(Constant)

Inflation -0.245191 0.091494387 -2.67985 0.015292

Residuals or sum of error term in output regression is zero.

Therefore, The regression model is

YGDP growth = 10.436 – 0.245Xinflation

There is a strong negative correlation between GDP growth and Inflation.

For deriving elasticity co-efficient of dependent variable, double log natural

regression model was used. One attractive feature of double natural log model is
that the slope coefficient „b1‟ measure elasticity Y with respect to X, that is
percent change of Y for a given percent change in X.

Table : 8.3.10. Log natural transformation data (GDP growth & Inflation)

Quarterly
India Ln(Quarterly Ln(Quarterly
Quarterly India Inflation India GDP India Inflation
GDP growth rate growth) rate)
9.253026216 3.97 2.224951 1.378766
8.910811668 3.27 2.187265 1.18479
9.685300842 4.12 2.270609 1.415853
9.990474822 5 2.301632 1.609438
9.812564453 5.57 2.283664 1.717395
10.12849792 6.92 2.315353 1.934416
9.378929362 7.06 2.238466 1.954445
9.588109882 7 2.260524 1.94591
9.344993483 6.67 2.234841 1.89762
9.390370435 6.47 2.239685 1.867176
9.733684021 5.81 2.275592 1.759581

210
 8.486877024 5.47 2.138521 1.699279
8.040235203 7.81 2.084458 2.055405
7.810385895 8.52 2.055454 2.142416
5.592739847 10.22 1.721469 2.324347
5.762913079 9.93 1.751443 2.29556
6.319358159 8.45 1.843618 2.134166
8.639328802 10.97 2.156325 2.395164
7.329826066 12.21 1.991952 2.502255
8.565269211 15.35 2.147716 2.731115

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.538234
R Square 0.289695
Adjusted R
Square 0.250234
Standard
Error 0.15537
Observations 20

ANOVA
Significance
df SS MS F F
Regression 1 0.177217 0.177217 7.341241 0.014359732
Residual 18 0.434518 0.02414
Total 19 0.611735

Standard
Coefficients Error t Stat P-value
Intercept 2.614991 0.180101 14.51956 2.22E-11
Ln(Inflation) -0.24589 0.090753 -2.70947 0.01436

Therefore, the double log regression model shows that the inflation elasticity of
GDP growth is - 0.24 and it is negatively correlated. Thus, our natural log –log
regression model is,

Ln(Y) = 2.614 - 0.245 Ln(X).

211
8.4. Multivariable Regression Analysis:
Multivariable regression analysis is a statistical technique for estimating
relationship among variables. We will now extend the work to multivariable
regression analysis or what is also called multiple regressions. When a
dependent variable (Y) is a function of more than one independent or exploratory
variable, it is called multivariable regression. We have the variables (GDP
growth, inflation rate and Crude oil price change rate and let us mark these by1,
2, 3). The correlation coefficients are given below.
Correlation co-efficient
r12 -0.534
r13 0.454
r23 -0.207

In order to analyze and understand the impact of both crude oil price change rate
and inflation rate on GDP growth, we have to calculate the partial correlation
coefficients. As we have considered 1, 2, 3 are the three variables GDP growth,
inflation rate and Crude oil price change rate then we denote by r12,3 the
coefficient of partial correlation between GDP growth and inflation rate keeping
crude price change rate constant, then
r12 - r13. r23
r12,3 = ------------------------------------------------ = - 0.505
sqrt{1-(r13)2}. sqrt{1-(r23)2}

Similarly, the coefficient of partial correlation between GDP growth and crude oil
price change rate, keeping inflation rate constant. Which is denoted by r13,2.

r13 - r12. r23

r13,2 = ------------------------------------------------ = 0.415
sqrt{1-(r12)2}. sqrt{1-(r23)2}

212
and in the same way, the coefficient of partial correlation between Inflation rate
and crude oil price change rate, keeping GDP growth constant. This is denoted
by
r23,1.

r23 - r12. r13

r23,1 = ------------------------------------------------ = 0.0469
sqrt{1-(r12)2}. sqrt{1-(r13)2}

Again, we have a basic assumption is that the independent variables are not
interdependent. But there is often a chance that there exist interdependency
between the independent variables, most independent variables in a multiple
regression are correlated to some degree with one another, in multiple
regression analysis this correlation among the independent variables is called
multicollinearity. Statisticians have developed thumb rule, according to the rule
of thumb test, multicollinearity is a potential problem if the absolute value
of the sample correlation coefficient exceeds 0.7 for any two of the
independent variables. (Source: David R Anderson, Dennis Sweeney, Thomas
A. Williams, “Statistics for Business and Economics,” India Edition, 2008,
Chapter 15, pp-655 ). Thus in our multivariable analysis, to find multicollinearity
between the independent variables, we can treat inflation rate as dependent
variable and crude oil price change rate as independent variable to determine
correlation coefficient, rx1x2 = -0.207,

213
 Graph 8.4 (Plot of Inflation and crude oil price change rate)
20

Inflation rate in percent

15

10

5
y = -0.0153x + 7.851
0 R² = 0.0431
r= - 0.207
-100 -50 0 50 100
Crude oil price change rate in percent
…

Thus, we find the correlation coefficient is r = -0.207, which is less than 0.7;
therefore, the multicollinearity problem can be neglected for proceeding multiple
regression analysis.
8.4.1. Test of Multicollinearity: To test for multicollinearity, each
explanatory variable is regressed against other explanatory variable and the
auxiliary R2 is calculated. The variance inflation factor (VIF) is calculated for the
auxiliary R2 . The VIF is a method of detecting how severe the multicollinearity is,
it is calculated as;

VIF (βi) = 1/( 1- R2) and the general rule is that If VIF>5 indicate severe
multicollinearity.

Table 8.4.1: Test of Multicollinearity; auxiliary regression results

Variable Auxiliary R2 VIF

1. Qrty rate change 0.043 1.044
in Crude oil price
&Qrly. Inflation rate

214
Explanation and discussion: As VIF calculated value is less than 5, therefore,
there is no Multicollinearity between the explanatory variables.

In order to carry out the regression analysis among the variables, GDP growth as
dependent variable, crude oil price change rate and inflation rate as independent
variable. An analysis has been carried out on Multivariable linear regression
model, In the present case, GDP growth rate is the dependent variable, inflation
and rate of change of crude oil price are the independent variables and all are in
percent, the regression is carried out in excel package.

Table 8.4.2 Multivariable Regression Analysis

Quarterly India Quarterly India Crude oil price

GDP growth in Inflation rate in rate change in
percent percent percent
2005-06, Q1 9.253026 3.97 45.29515
Q2 8.910812 3.27 50.65943
Q3 9.685301 4.12 38.30645
Q4 9.990475 5 35.18519
2006-07,Q1 9.812564 5.57 34.93564
Q2 10.1285 6.92 16.20323
Q3 9.378929 7.06 6.523324
Q4 9.58811 7 -5.69663
2007-08,Q1 9.344993 6.67 -0.96885
Q2 9.39037 6.47 6.514032
Q3 9.733684 5.81 46.18543
Q4 8.486877 5.47 66.18246
2008-09,Q1 8.040235 7.81 78.80795
Q2 7.810386 8.52 58.24435
Q3 5.59274 10.22 -37.3508
Q4 5.762913 9.93 -52.6596
2009-10,Q1 6.319358 8.45 -50.2694
Q2 8.639329 10.97 -40.2594
Q3 7.329826 12.21 40.36235
Q4 8.565269 15.35 71.37131

215
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.638732
R Square 0.407979
Adjusted R Square 0.338329
Standard Error 1.12505
Observations 20

ANOVA
df SS MS F Significance F
Regression 2 14.82837 7.414185 5.857596 0.011610911
Residual 17 21.51756 1.265739
Total 19 36.34593

Standard
Coefficients Error t Stat P-value
Intercept 9.9326232 0.743423776 13.36065 1.91E-10
Quarterly India Inflation
rate -0.211065 0.087586424 -2.40979 0.027575
Change in crude oil price 0.012115 0.006451942 1.877726 0.077685

RESIDUAL OUTPUT

Observation Predicted Y Residuals Standard Residuals

1 9.643444952 -0.390418736 -0.366868969
2 9.856178536 -0.945366868 -0.888343043
3 9.527117291 0.158183551 0.148642037
4 9.303566033 0.686908789 0.645474963
5 9.180235753 0.6323287 0.594187105
6 8.668355263 1.46014266 1.372067944
7 8.521534352 0.857395011 0.805677583
8 8.386153839 1.201956043 1.12945495
9 8.513082205 0.831911278 0.78173101
10 8.64595013 0.744420305 0.699517427
11 9.265871069 0.467812952 0.439594823
12 9.579896815 -1.093019791 -1.027089653
13 9.238962221 -1.198727018 -1.126420699

216
 14 8.839978549 -1.029592654 -0.967488393
15 7.323034883 -1.730295037 -1.62592493
16 7.198777669 -1.435864589 -1.349254308
17 7.540111922 -1.220753763 -1.147118807
18 7.129498626 1.509830177 1.418758346
19 7.844508694 -0.514682627 -0.483637355
20 7.557437592 1.007831619 0.947039967

Graph- 8.4.2.1 Residual plot

Inflation rate Residual Plot

2

1
Residuals

0
0 5 10 15 20
-1

-2
X Variable inflation rate

Graph- 8.4.2.2 Inflation rate line fit plot

Inflation rate Line Fit Plot

12

10

6
Y

Y
4
Predicted Y
2

0
0 5 10 15 20
X Variable inflation rate

217
Graph- 8.4.2.3 Residual plot

Crude oil price change rate Residual

Plot
2

1
Residuals

0
-60 -40 -20 0 20 40 60 80 100
-1

-2
X Crude oil price change rate

Graph- 8.4.2.4, Crude oil price change rate Line Fit Plot

Crude oil price change rate Line Fit

Plot
12

10

6
Y

Y
4
Predicted Y
2

0
-100 -50 0 50 100
X Crude oil price change rate

218
Table 8.4.3 Probability output data

PROBABILITY
OUTPUT Normal Probability Plot
12
Percentile Y
2.5 5.59274 10
7.5 5.762913
12.5 6.319358 8
17.5 7.329826
22.5 7.810386 6

Y
27.5 8.040235
32.5 8.486877 4
37.5 8.565269
42.5 8.639329 2
47.5 8.910812
52.5 9.253026 0
0 20 40 60 80 100 120
57.5 9.344993
Sample Percentile
62.5 9.378929
67.5 9.39037
72.5 9.58811
77.5 9.685301
82.5 9.733684
87.5 9.812564
92.5 9.990475
97.5 10.1285

8.5 : Durbin Watson Statistics

The Durbin – Watson statistics provides the test of existence of autocorrelation.
A Durbin-Watson statistics around of 2 indicates the absence of autocorrelation.
If Durbin Watson statistics is significantly greater or less than the value of 2, it
shows the existence of autocorrelation. The formula for D-W statistics is

∑
D-W = ----------------------------
∑

219
Table 8.5.1 Residual data for D W statics calculation
2 2
Residuals Rt-1 (Rt- Rt-1 ) Rt Rt.Rt-1
-0.39042 0.152427
-0.94537 -0.39042 0.3079674 0.152427 0.369089
0.158184 -0.94537 1.2178235 0.893719 -0.14954
0.686909 0.158184 0.2795504 0.025022 0.108658
0.632329 0.686909 0.002979 0.471844 0.434352
1.460143 0.632329 0.685276 0.39984 0.92329
0.857395 1.460143 0.3633047 2.132017 1.251919
1.201956 0.857395 0.1187223 0.735126 1.030551
0.831911 1.201956 0.1369331 1.444698 0.999921
0.74442 0.831911 0.0076547 0.692076 0.619292
0.467813 0.74442 0.0765116 0.554162 0.348249
-1.09302 0.467813 2.4361989 0.218849 -0.51133
-1.19873 -1.09302 0.011174 1.194692 1.310232
-1.02959 -1.19873 0.0286064 1.436946 1.234201
-1.7303 -1.02959 0.4909838 1.060061 1.781499
-1.43586 -1.7303 0.0866893 2.993921 2.484469
-1.22075 -1.43586 0.0462727 2.061707 1.752837
1.50983 -1.22075 7.4560887 1.49024 -1.84313
-0.51468 1.50983 4.0986521 2.279587 -0.77708
1.007832 -0.51468 2.3180496 0.264898 -0.51871
sum 20.169438 20.65426 10.84876

DW=∑{(Rt- Rt-1 )2} / ∑(Rt2), ρ = ∑( Rt.Rt-1) / ∑( Rt2), which is known as the

coefficient of auto covariance also interpreted as the first order coefficient of
autocorrelation
DW = 20.16944/20.65426 = 0.976527 Rho(ρ) =0.525255

d = 2(1-10.848/20.65426) = 0.949489

H0 : ρ = 0 versus H1 : ρ > 0. Reject H0 at α level if d < dU. From

DW d statistic, at n=20, k‟=2,at 0.05 level of significance,
du=1.537, that means d<du.
That means, there is statistically significant positive auto
correlation .

Computation of ρ in excel is found as ρ = 0.517, and is a first order

autoregressive scheme and is denoted as AR(1).

220
8.6. Stationarity is time series data:- Loosely speaking, a time series is
stationary if its characteristics ( e.g , mean , variance, and covariance) are time
invariant; that is , they do not change over time. In the time series literature, weak
stationarity or covariance stationary means that mean and the variance of a
stochastic process do not depend on t (that is they are constant) and the auto-
covariance between Yt and Yt+τ only can depend on the lag τ (τ is an integer, the
quantities also need to be finite).
To explain weak stationarity, let Yt be a stochastic time series with this
properties;
Mean: E(Yt) = μ
Variance : var(Yt) = E(Yt – μ)² = σ²
Covariance γk = E{( Yt – μ)( Yt+k – μ)}
Where γk, the covariance ( or auto-covariance) at lag k, is the covariance
between the values of Yt and Yt+k that is between two Y values k periods apart. If
k=0, we obtain γ0, which is simply the variance of Y (=σ²); if k=1, γ1 is the
covariance between two adjacent values of Y.
One simple test of stationarity is based on so called auto correlation function
(ACF). The ACF at lag k, denoted by ρk is defined as
γk
ρk = -------
γ0

covariance
= ---------------------
Variance

Since variance and covariance measured in the same units of measurement, ρ k

is unit less or a pure number. It lies between -1 to +1 as any correlation
coefficient does. If we plot ρk against k, the graph we obtain is known as the
population correlogram.
Since in practice we only have a realization ( i.e. sample) of a stochastic process,
we can only compute sample autocorrelation function(SAFC) ρ^k .

221
To compute this, we must first compute the sample covariance at lag k, γ^k and
the sample variance γ^0, which is defined as

∑ {( Yt – ̅ )( Yt+k – ̅ )}
γ^k = --------------------------
n

∑( Yt – ̅ )
γ^0 = ---------------------------
n

where, n is the sample size and ̅ is the sample mean. Therefore, the sample
autocorrelation function at lag k is

γ^k
ρ^k = ----------------
γ^0

Which is simply the ratio of sample covariance( at lag k ) to sample variance. A

plot of ρ^k against k is known as sample correlogram.

8.6.1 Box- Jenkins strategy:

It is a common practice to suitably transform the original series, the logarithmic
transformation has been done in our time series data, i.e. GDP growth rate,
inflation rate and crude oil price change rate. This logarithmic transformation is
given by,

Yt = log10 yt,

Where yt are the time series data of the variables.

For which the logarithmic transformations are given in table 8.6.1 below.

222
Table 8.6.1. Logarithmic transformations of GDP growth

Yt=log10yt(GDP variance co variance

growth), at lag k=1 ;
i.e.γ1
GDP growth
2005-06, Q1 9.253026 0.966284 0.001486
Q2 8.910812 0.949917 0.000492 0.000855
Q3 9.685301 0.986113 0.003409 0.001295
Q4 9.990475 0.999586 0.005163 0.004195
2006-07, Q1 9.812564 0.991783 0.004103 0.004603
Q2 10.1285 1.005545 0.006055 0.004984
Q3 9.378929 0.972153 0.001973 0.003457
Q4 9.58811 0.981733 0.002916 0.002399
2007-08, Q1 9.344993 0.970579 0.001836 0.002314
Q2 9.39037 0.972683 0.002021 0.001926
Q3 9.733684 0.988277 0.003666 0.002722
Q4 8.486877 0.928748 1.04E-06 6.16E-05
2008-09, Q1 8.040235 0.905269 0.000504 -2.3E-05
Q2 7.810386 0.892672 0.001229 0.000787
Q3 5.59274 0.747625 0.032438 0.006314
Q4 5.762913 0.760642 0.027918 0.030093
2009-10, Q1 6.319358 0.800673 0.016143 0.02123
Q2 8.639329 0.93648 7.66E-05 -0.00111
Q3 7.329826 0.865094 0.003923 -0.00055
Q4 8.565269 0.932741 2.51E-05 -0.00031

Mean = 0.92773, To compute ACF, one third of the sample is considered as the
choice of lag length of the time series, since n=20, hence lags of 6 to 7 will do.

223
For this series the lag variance and covariance also lag autocorrelation and
partial auto correlations are given below in table.
Table 8.6.2.ACF and PACF
lag variance covariance ACF PACF
1 0.00577 0.00449 0.77747 0.77747
2 0.00577 0.00360 0.623917 0.04919208
3 0.00577 0.002186 0.378856 -0.7024688
4 0.00577 0.001189 0.206066 -0.2582486
5 0.00577 -0.00014 -0.024263 -0.497024
6 0.00577 -0.00086 -0.149047 -0.7095343
7 0.00577 -0.00119 -0.206239 -1.1297106
8 0.00577 -0.00198 -0.343154 -3.0287074

The above data of ACF and PACF are plotted is two different graphs against the
lag lengths.

Graph-8.6.2.1 ACF plot

ACF
1

0.8

0.6

0.4

0.2

0
1 2 3 4 5 6 7 8
-0.2

-0.4

From the above ACF plot, it is seen that ACF declines sharply in the bar graph.

224
The PACF plot indicates that PACF declines sharply after lag1 in the graph
below, therefore the series is AR(1).
Graph:8.6.2.2, PACF

PACF
1
0.5
0
1 2 3 4 5 6 7 8
-0.5
-1
PACF
-1.5
-2
-2.5
-3
-3.5

AR(1) SERIES.

Similarly, the inflation and crude oil price change rate data are taken and
logarithmic transformation done, and the mean, variance and covariance are
computed, then by computing auto correlation function (ACF) and partial auto
correlation function (PACF), the data are tabulated below

225
Table:- 8.6.3 , Variance, covariance table for inflation
Yt=log10yt(Inflation), variance covariance
at lag k=1 ;
i.e.γ1
Inflation
2005-06, Q1 3.97 0.59879 0.06096
Q2 3.27 0.51455 0.10965 0.08175
Q3 4.12 0.61490 0.05326 0.07642
Q4 5.00 0.69897 0.02152 0.03386
2006-07, Q1 5.57 0.74586 0.00997 0.01465
Q2 6.92 0.84011 0.00003 0.00056
Q3 7.06 0.84880 0.00001 -0.00002
Q4 7.00 0.84510 0.00000 0.00000
2007-08, Q1 6.67 0.82413 0.00046 0.00001
Q2 6.47 0.81090 0.00121 0.00075
Q3 5.81 0.76418 0.00664 0.00283
Q4 5.47 0.73799 0.01160 0.00878
2008-09, Q1 7.81 0.89265 0.00221 -0.00506
Q2 8.52 0.93044 0.00718 0.00398
Q3 10.22 1.00945 0.02682 0.01388
Q4 9.93 0.99695 0.02288 0.02477
2009-10, Q1 8.45 0.92686 0.00659 0.01228
Q2 10.97 1.04021 0.03784 0.01579
Q3 12.21 1.08672 0.05810 0.04689
Q4 15.35 1.18611 0.11589 0.08205

Mean = 0.84568
To compute ACF, one third of the sample is considered as the choice of lag
length of the time series, since n=20, hence by this rule lags of 6 to 7 will do.

For this series the lag variance and covariance also lag autocorrelation and
partial auto correlations are given below in table.

226
Table : 8.6.3.1 ACF , PACF for Inflation

lag variance covariance ACF PACF

1
0.02764 0.21798 7.886111 0.788611
2
0.02764 0.73005 26.41185 -3.8690346
3
0.02764 0.726 26.26533 1.2605498
4
0.02764 0.726 26.26533 1.39563292
5
0.02764 0.722 26.12062 1.92342389
6
0.02764 0.711 25.72266 -0.0731604

The above data of ACF and PACF are plotted is two different graphs against the
lag lengths.

Graph 8.6.3.2 ACF plot for Inflation

ACF PLOT
for
INFLATION
30
25
20
15
10
5
0
1 2 3 4 5 6

PACF plot for inflation against lag length is shown below,

227
Graph 8.6.3.4 PACF plot for Inflation

PACF plot for

Inflation
3
2
1
0
PACF

-1 1 2 3 4 5 6
-2
-3
-4
-5
lag

From the above two plots we found that ACF and PACF do not drop down fast
and remain fairly large. This suggests that the series is nonstationary. Therefore,
a first order differenced series is considered, delta Yt = Yt –Yt-1 is obtained and
for this differenced series again ACF and PACF are computed,

Table 8.6.4 ACF, PACF for first order difference inflation series

lag variance covariance ACF PACF

1 0.00433 -0.00004 -0.00878 -0.00088

2 0.00433 -0.00021 -0.04850 -0.04851

3 0.00433 -0.00089 -0.20554 -0.20839

4 0.00433 -0.00218 -0.50346 -0.57463

5 0.00433 -0.00064 -0.14781 -0.72472

6 0.00433 -0.00037 -0.08545 -0.94392

The above data of ACF and PACF are plotted is two different graphs against the
lag lengths.

228
Graph 8.6.4.1 ACF PLOT

ACF
0.00000
1 2 3 4 5 6
-0.10000

-0.20000

-0.30000 ACF

-0.40000

-0.50000

-0.60000

ACF plot indicates sharp decline after lag 2. The PACF plot indicates that PACF
declines sharply after lag2 in the graph below, therefore the inflation time series
is AR(2). The PACF plot is shown below
Graph-PACF plot

PACF
0.00000
-0.10000 1 2 3 4 5 6
-0.20000
-0.30000
-0.40000
-0.50000 PACF
-0.60000
-0.70000
-0.80000
-0.90000
-1.00000

AR(2) Series.

229
Table 8.6.5 , variance covariance for crude oil price change rate

Yt=log10yt(Crude oil price variance co variance

change rate), at lag k=1 ;
Crude oil i.e.γ1
price change
rate
2005-06,
Q1 45.29 1.656 0.9004
Q2 50.66 1.7047 0.9951 0.9466
Q3 38.31 1.5833 0.7677 0.8741
Q4 35.19 1.5464 0.7044 0.7354
2006-07,
Q1 34.94 1.5433 0.6993 0.7018
Q2 16.2 1.2095 0.2524 0.4201
Q3 6.52 0.8142 0.0115 0.0538
Q4 -5.69 -0.755 2.1381 -0.157
2007-08,
Q1 -0.96 0.0177 0.4752 1.008
Q2 6.51 0.8136 0.0113 -0.073
Q3 46.19 1.6645 0.9167 0.1019
Q4 66.44 1.8224 1.2439 1.0679
2008-09,
Q1 78.81 1.8966 1.4148 1.3266
Q2 58.24 1.7652 1.1196 1.2586
Q3 -37.35 -1.572 5.1957 -2.412
Q4 -52.65 -1.721 5.8976 5.5355
2009-10,
Q1 -50.26 -1.701 5.8001 5.8486
Q2 -40.26 -1.605 5.3453 5.568
Q3 40.36 1.606 0.8079 -2.078
Q4 71.37 1.8535 1.3143 1.0304

Mean = 0.707107

For this series the lag variance and covariance also lag autocorrelation and
partial auto correlations are given below in table.

230
Table 8.6.5.1, ACF and PACF

lag variance covariance ACF PACF

1 1.80056 1.14513 0.63599 0.77747

2 1.80056 0.26300 0.14607 -0.68915
3 1.80056 -0.47500 -0.26381 -1.08480
4 1.80056 -1.10200 -0.61203 -4.03720
5 1.80056 -0.84800 -0.47096 1.68389
6 1.80056 -0.22990 -0.12768 1.83051
7 1.80056 0.41000 0.22771 1.68704
8 1.80056 0.44400 0.24659 1.49953

The above data of ACF and PACF are plotted is two different graphs against the
lag lengths.
Graph:- 8.6.5.2, ACF plot

ACF
0.80000

0.60000

0.40000

0.20000

0.00000 ACF
1 2 3 4 5 6 7 8
-0.20000

-0.40000

-0.60000

-0.80000

From the above ACF plot, it is seen that ACF declines sharply after lag1 and the
ACF plot follows the sine curve fashion, the PACF plot indicates that PACF
declines sharply after lag1 in the graph below, therefore the series is AR(1).

231
Graph:- 8.6.5.2, PACF plot

PACF
3.00000

2.00000

1.00000

0.00000
1 2 3 4 5 6 7 8
-1.00000 PACF

-2.00000

-3.00000

-4.00000

-5.00000

The Series is stationary and Autoregressive at lag1, i.e. AR(1).

Further, the stationarity of the above time series data is tested by unit root test,
and in case unit root test fails then augmented Dickey – Fuller (ADF) test is
done.
We start with Yt = ρYt-1 + ut , -1≤ρ≤+1, where ut is a white noise error term.
We know that if ρ = 1, that is in case of unit root, becomes a random walk model
without drift, which we know is a nonstationary stochastic process. Therefore if
we regress Yt on its lagged value Yt-1 and find out the estimated ρ is statistically
equal to 1.then we say Yt is nonstationary. That is the general idea behind the
unit root test of stationarity.

For theoretical reasons, we will subtract Yt-1 from the both side of the above
equation to obtain:
Yt –Yt-1 = ρYt-1 - Yt-1 + ut
= ( ρ – 1) Yt-1 + ut
Which can be alternatively written as

232
Δ Yt = δYt-1 + ut ;
Where δ = ( ρ – 1) and Δ, as usual, is the first difference operator, therefore, we
will estimate and test the null hypothesis that δ = 0, if δ = 0, then ρ = 1, that is we
have a unit root, meaning the time series under consideration is nonstationary.
If δ = 0, then the equation become
Δ Yt = (Yt –Yt-1) = ut,
Since ut is a white noise error term, it is stationary, which means that the first
differences of a random walk time series are stationary.

On estimation δ, the first difference GDP growth rate is regressed with the
lagged values of growth rate, we found that

ANOVA table 8.6.6.

df SS MS F
Regression 1 2.118027 2.118027 2.232459
Residual 16 15.17987 0.948742
Total 17 17.29789

Standard
Coefficients Error t Stat P-value
Intercept 2.057256 1.408729 1.460363 0.163548
Yt-1 -0.24295 0.162603 -1.49414 0.154598

Thus we have δ=ρ-1, now δ is estimated slope coefficient in this regression, if δ

is zero, we conclude that Yt is nonstationary, But if it negative we conclude that
Yt is stationary.

As δ = -0.24295,
ρ = 1+δ =1- 0.24295 = 0.75705. i.e. ρ<1, the series is stationary

Again, in case of testing of unit root test for inflation rate stationary series,
the estimation δ, the first difference inflation rate is regressed with the lagged
values of inflation rate, we have found the ANOVA table 8.6.7

233
 Table:- 8.6.7 ANOVA TABLE
ANOVA
df SS MS F
Regression 1 0.592 0.592 0.3857
Residual 16 24.56 1.535
Total 17 25.152

Coefficients Standard Error t Stat P-value

Intercept 0.1025 0.9611 0.1066 0.9164
Yt-1 0.0778 0.1254 0.621 0.5433

Thus we have δ=ρ-1, now δ is estimated slope coefficient in this regression, if δ

is zero, we conclude that Yt is nonstationary, But if it negative we conclude that
Yt is stationary.
As δ = 0.0778, therefore the series is nonstationary,
Further, ρ = 1+δ =1+ 0.0778 = 1.0778, Since, ρ>1, the series is nonstationary
the unit root test failed. Therefore we will proceed for augmented Dickey –
Fuller (ADF) test.
We have estimated the slope coefficients for the inflation series using one lagged
difference of inflation, the results are as follows
ANOVA Table:8.6.8
df SS MS F
Regression 4 25.067344 6.266835938 3.819E+32
Residual 11 1.805E-31 1.64098E-32
Total 15 25.067344

Standard
Coefficients Error t Stat P-value
Intercept 1.75E-16 1.395E-16 1.254999329 0.23548694
Yt-1 -1.03E-16 3.598E-17 -2.876551535 0.01506393
(Yt-1 - Yt-2) -1.37E-16 3.682E-17 -3.729114119 0.00332859
(Yt-2 - Yt-3) -1 5.016E-17 -1.9937E+16 6.349E-175
t 4.82E-17 1.55E-17 3.107927116 0.00996224

234
The t (= τ ) value of the inflation(Yt-1) coefficient(=δ ) is -2.8765, but this value in
absolute terms is much higher than critical value of t- statistics at df=11 at 5% to
10% is 1.796, suggesting the series is stationary. Therefore, ADF test holds true,
the inflation series is stationary.

Again in case of testing the stationarity of crude oil price change rate, we
have carried out the unit root test. On estimation of δ, the first difference crude oil
price change rate is regressed with the lagged values of crude oil price change
rate and we have found that
Table 8.6.9
ANOVA
df SS MS F
Regression 1 2864.454761 2864.5 2.7891
Residual 17 17459.30372 1027
Total 18 20323.75848

Coefficients Standard Error t Stat P-value

Intercept 6.9300379 8.070177182 0.8587 0.4024
Yt-1 -0.3140823 0.188066506 -1.67 0.1132

Thus we have δ=ρ-1, now δ is estimated slope coefficient in this regression, if δ

is zero, we conclude that Yt is nonstationary, But if it negative we conclude that
Yt is stationary.

As δ = - 0.3140,
ρ = 1+δ =1- 0.3140 = 0.6860. i.e. ρ<1, the series is stationary

Stationarity of the three time series ( GDP growth rate, inflation rate and crude oil
price change rate) are tested and found stationary. For the number of lagged
terms to be introduced in the causality tests , Akaike or Schwarz information
criterion is used, AIC and SIC values are -0.06787 and 0.280635 at lag length 3
for inflation and 3 for crude oil price change rate respectively, similarly, AIC and

235
SIC values are 0.736304 and 1.184383 at lag length 4 for inflation and 4 for
crude oil price change rate.

8.7. Ganger causality test:- Model 3

To proceed with Ganger causality test, we have the null hypothesis that crude oil
price rate change does not granger cause inflation. Time series inflation is
regressed with lagged inflation without including any lagged terms of crude oil
price change rate and this is the restricted regression, and the restricted residual
sum square is obtained (RSSR = 19.56, at lag length 3 of inflation). Now, Inflation
is regressed with 3 lagged inflation and with 3 lagged crude oil price changed
rate , and this is the unrestricted regression, and the unrestricted residual sum
square is obtained (RSSUR = 9.28).

The F-statistics is defined as

{( RSSR - RSSUR )/m}

F=
{RSSUR/T-k}

Where, m = number of lagged crude oil rate change terms; n = number of lagged
inflation; T = number of observations = 20

k = is the numbers of parameters estimated in unrestricted regression.( m+n+ 1)

( 19.56 – 9.28) / 3
F = ----------------------------- = 4.79,
( 9.28/ 13)
the estimated F value 4.79 is significant than the critical F value at 5% level
3.41, ( for 3 and 13df ) and therefore null hypothesis is rejected, the alternative
hypothesis crude oil price change rate granger causes inflation.

Similarly,

236
we have the null hypothesis inflation does not granger cause crude oil price rate
change. Time series crude oil price change rate is regressed with lagged crude
oil price changed rate without including any lagged terms of inflation and this is
the restricted regression, and the restricted residual sum square is obtained
(RSSR = 6059.78, at lag length 3 of crude oil price change rate). Now, crude oil
price change rate is regressed with 3 lagged of crude oil price change rate and
with 3 lagged inflation , and this is the unrestricted regression, and the
unrestricted residual sum square is obtained (RSSUR = 3265.73). and the F-
value is

(6059.78 – 3265.73) / 3
F = ---------------------------------------- = 3.71,
(3265.73/ 13)

the estimated F value 3.71 is significant than the critical F value at 5% level
3.41, ( for 3 and 13df ) and therefore null hypothesis is rejected, the alternative
hypothesis inflation granger causes crude oil price change rate.

8.8. Model :4

Now we can proceed Ganger causality test with another null hypothesis that the
inflation does not granger cause GDP growth rate. Time series GDP growth is
regressed with lagged GDP growth rate without including any lagged terms of
inflation and this is the restricted regression, and the restricted residual sum
square is obtained (RSSR = 10.92, at lag length 3 of GDP growth rate). Now,
GDP growth rate is regressed with 3 lagged GDP growth rate and with 3 lagged
inflation , and this is the unrestricted regression, and the unrestricted residual
sum square is obtained (RSSUR = 9.716 ).

(10.92 – 9.716) / 3
F = ---------------------------------------- = 0.54,
(9.716 / 13)

Similarly , four lagged terms

237
 (10.34 – 7.17) / 4
F = ---------------------------------------- = 1.21,
(7.17 / 11)

the estimated F values 0.54 and 1.21 are insignificant than the critical F value at
5% level 3.41, ( for 3 and 13df ) and 3.36 (for 4 and 11df) and therefore null
hypothesis is accepted.

Similarly,

Ganger causality test is carried out with another null hypothesis that the GDP
growth does not granger cause inflation. Time series inflation is regressed with
lagged inflation without including any lagged terms of GDP growth and this is the
restricted regression, and the restricted residual sum square is obtained (RSSR =
23.22, at lag length 3 of inflation). Now, inflation is regressed with 3 lagged
inflation and with 3 lagged GDP growth, and this is the unrestricted regression,
and the unrestricted residual sum square is obtained (RSSUR = 10.25 ).

(23.22 – 10.25) / 3
F = ---------------------------------------- = 5.48
(10.25 /13)

Similarly, four lagged terms

(20.66 – 5.5) / 4
F = ---------------------------------------- = 7.58
(5.5 / 11)

the estimated F values 5.48 and 7.58 are significant than the critical F values at
5% level 3.41, (for 3 and 13df ) and 3.36 (for 4 and 11df) and therefore null
hypothesis is rejected. Therefore the alternative hypothesis holds true, thus GDP
growth granger causes inflation.

238
8.9. Model 5.

The “Cobb-Douglas” production function is applied for estimating the output of

Indian industries. The real output of industries depend upon the capital and labor
as well as energy resources. The “Cobb-Douglas” production function may be
written as

y= A ert ha kb Ec ------------ equation (1)

Where y = is output,

h = labor measured in man-days

k = capital input,

E = flow of energy.

A = a scaling factor; t = year;

r = is the trend rate of growth of output due to technological change;

a,b,c = are the output elasticities of respective inputs.

The estimated production function was restricted by requiring that the sum of
exponents a,b,c equal to unity. The basic implications of such a “Cobb-Douglas”
production function are constant return to scale and partial elasticities of
substitution of unity.

Now if enterprise maximize economic profits, they employ energy at a rate where
the value of additional product obtained from employing more energy equals its
price. The demand for energy from equation above can be written as

E = c.y.( pe / pd )-1 ----------equation (2)

Where, pe is the price of energy and pd is the price of output of the business
enterprise. The (pe / pd) is the relative price of energy, the relative price of energy
measured by the ratio of whole sale price index of fuel, related products, power,

239
light and lubricants to the wholesale price index and expressed in percent with
respect to base year.

On simplification of the equations (1) and (2) with energy demand, the model
reduced to ln(y/k) = α + β ln(h/k) + γ ln(pe/pd) +δ.t -------- equation(3)
Where, α = (1/1-c)lnA*, A*=A.(c)c ; β = a/(1-c) ; γ = (-c/1-c); δ = (r/1-c)
Table:- 8.9. Data of Indian Industries

WPI of
Capital
Fuel,
Output in input in power, whole sale
Crores at crores at light and price index
constant constant Labour in lubricants( , AC, (base
price (y) price (k) („000man- base year year 1993-
Year days) 1993-94) 94)
1992-93 371250 284966 4755575 86.55 99.29 1

1993-94 425744 320855 4772361 100.0 100.0 2

1994-95 460024 347065 5017841 108.9 112.6 3

1995-96 551410 417345 5590226 114.5 121.6 4

1996-97 583182 437826 5341039 126.4 127.2 5

1997-98 629771 480496 5102960 143.8 132.8 6

1998-99 557051 433578 4505809 148.5 140.7 7

1999-00 617989 488207 4386738 162.0 145.3 8

2000-01 595313 480766 4270813 208.1 155.7 9

2001-02 596688 483092 4133469 226.7 161.3 10

2002-03 677794 549272 4267805 239.2 166.8 11

2003-04 731894 591031 4209588 254.5 175.9 12

2004-05 892985 727678 4539818 280.2 187.3 13

240
2005-06 976141 789595 4893916 306.7 195.5 14

2006-07 1168631 945351 5418029 323.9 206.1 15

2007-08 1285646 1029622 5622386 327.2 215.9 16

2008-09 1399230 1137873 6047169 351.3 233.9 17

Table 8.9., Ln converted data

y/k h/k (pe/pd) ln(y/k) ln(h/k) ln(pe/pd) t

1992-93 1.3028 16.688 0.8717 0.2645 2.8147 -0.137 1

1993-94 1.3269 14.874 1 0.2828 2.6996 0 2

1994-95 1.3255 14.458 0.9671 0.2818 2.6712 -0.033 3

1995-96 1.3212 13.395 0.9416 0.2786 2.5949 -0.06 4

1996-97 1.332 12.199 0.9937 0.2867 2.5014 -0.006 5

1997-98 1.3107 10.62 1.0828 0.2705 2.3628 0.0796 6

1998-99 1.2848 10.392 1.0554 0.2506 2.3411 0.054 7

1999-00 1.2658 8.9854 1.1149 0.2357 2.1956 0.1088 8

2000-01 1.2383 8.8834 1.3365 0.2137 2.1842 0.2901 9

2001-02 1.2351 8.5563 1.4055 0.2112 2.1467 0.3404 10

2002-03 1.234 7.7699 1.4341 0.2103 2.0503 0.3605 11

2003-04 1.2383 7.1225 1.4468 0.2138 1.9633 0.3694 12

2004-05 1.2272 6.2388 1.496 0.2047 1.8308 0.4028 13

2005-06 1.2363 6.198 1.5688 0.2121 1.8242 0.4503 14

2006-07 1.2362 5.7312 1.5716 0.212 1.7459 0.4521 15

241
2007-08 1.2487 5.4606 1.5155 0.2221 1.6976 0.4158 16

2008-09 1.2297 5.3144 1.5019 0.2068 1.6704 0.4067 17

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.92485
R Square 0.85535
Adjusted R Square 0.82197
Standard Error 0.01343
Observations 17

ANOVA
df SS MS F
Regression 3 0.01389 0.00462 25.62
Residual 13 0.00234 0.00018
Total 16 0.01633

Coefficients Standard Error t Stat P-value

Intercept 0.207 0.2675 0.7736 0.459
ln(h/k) 0.020 0.0943 0.2191 0.829
ln(pe/pd) -0.148 0.0536 -2.7602 0.010
t 0.002 0.0067 0.2762 0.780

The regression coefficient of log natural energy relative is negative, indicates that
a rise in price of energy relative to output leads to decline in productivity of capital
and labor. Thus, the regression equation is

ln(y/k) = 0.207 + 0.02ln(h/k) – 0.148ln (pe/pd) + 0.002 t

(0.2675) (0.0943) (0.0536) (0.0067),
( )in the parenthesis is s.e.
Therefore, output elasticities of the inputs are, a=0.017; b= 0.855; c = 0.128;
r=0.0017 and A=1.6, and thus Cobb Douglas (C-D) production function for Indian
industries for the period; 1992-2009: is Y = 1.6 e0.0017t h0.017 k0.855 (E)0.128.
********

242
 Chapter-9

Results and Discussion

Based on the data and methodology discussed, we have applied statistical tool of
Correlation and the regression models to test hypotheses and to obtain the
results of the models.

9.1. Hypothesis: 1
H01 : Crude oil price plays an insignificant role in rising WPI of
Indian economy.
H11 : Crude oil price plays a significant role in rising WPI of
Indian economy.
In the analysis of data for testing hypothesis 1, We have first calculated Karl
Pearson‟s correlation co-efficient between crude oil price and WPI. It is found
that there is a positive correlation exist between crude oil price and WPI and
value of r =0.829. Then, we have run first model by considering entire data sets
considering 124 observations comprising of WPI and crude oil price. Table- 9.1
presents the regression results.

Table-9.1. Results of regression analysis:-

Regression Statistics
Multiple R 0.886158237

R Square 0.785276421

Adjusted R Square 0.783516392

Standard Error 0.07243882

Observations 124

N=124, Inflation (wpi) elasticity w.r.t crude oil price =0.27.

243
Explanation:-Based on the Karl Pearson‟s correlation co-efficient and the
regression analysis it is evident that there is significant positive correlation
between crude oil price and inflation (WPI) (r = 0.829, R = 0.886, R2 = 0.7852, F
=446.17, P = 1.42584E-42), 88% of variance on WPI is explained by crude oil
price.

Discussion & comment:- F-Table value (95% confidence)at (dfn1 = 1, and dfn2
=122) i.e F0.95(1,122)= 3.89
i.e. tabled F value 5% significance level

Calculated F value= 446.17

FCALCULATED > F0.95(1,122),

Hence, H01 is rejected.

H11 is accepted.

Thus, The Hypothesis H11, “Crude oil price plays a significant role in rising
WPI of Indian economy” is accepted.

244
9.2. Hypothesis: 2

H02 : The role of Inflation is insignificant for declining GDP growth of Indian
economy.
H12 : The role of Inflation is significant for declining GDP growth of Indian
economy.

In testing the hypothesis 2, we have first calculated Karl Pearson‟s correlation co-
efficient between quarterly data GDP growth and Inflation. It is found that there is
a negative correlation exist between GDP growth and Inflation and value of
Pearson‟s co-efficient, r = - 0.536. Then, we have run second model by quarterly
data sets of 20 observations comprising of GDP growth rate and Inflation. Table
9.2 presents the regression results.

Table-9.2. Results of regression analysis:-

Regression Statistics
Multiple R 0.538233596

R Square 0.289695404

Adjusted R Square 0.250234037

Standard Error 0.155370176

Observations 20

N= 20, GDP growth elasticity w.r.t Inflation = - 0.245;

Explanation:-Based on the Karl Pearson‟s correlation co-efficient and the
regression analysis it is evident that there is significant negative relationship
between GDP growth and inflation rate( r = -0.536, R = 0.538 , R2 = 0.2896 , F =
7.341 , P = 0.01 ), 53.8 % of variance on GDP growth retardation is explained
by inflation, with sign negative of the coefficient of regressor.

245
Discussion & Comment: Table value of F (95% confidence)at (df n1 = 1, and
dfn2 =18) i.e F0.95(1,18) = 4.41
i.e. tabled F value 5% significance level
Calculated F value= 7.341

FCALCULATED > F0.95(1,18),

Hence, H02 is rejected.

H12 is accepted.

Thus, The Hypothesis H12, “The role of inflation is significant in declining

GDP growth of Indian economy” is accepted.

246
9.2.1. Multivariable Linear Regression Model

An analysis has been carried out on Multivariable linear regression model, which
is with three variables, one dependent and two independent variables. In the
present case, GDP growth rate is the dependent variable, inflation and rate of
change of crude oil price are the independent variables and all are in percent.

Table-9.2.1.Results of Multivariable (three variable ) linear regression

analysis:-
t- R2 Durbin- Rho (ρ) d
Variable Coefficient
statistic Watson
Intercept 9.9326 13.3606
Quarterly
inflation -0.211 -2.4097
rate
Quarterly 0.407 0.976 0.525 0.949
rate of
change in 0.012 1.8777
crude oil
price
Residuals: AR(1),ρ=0.517,

H0 : ρ = 0 versus H1 : ρ > 0. Reject H0 at α level, if d <dU. From Durbin –

Watson d statistic, at n = 20, k’ = 2 , where n= no of observations, k‟= number
of explanatory variables excluding constant term, at 0.05 level of significance,
the dU = 1.537 , that means d <dU. Therefore, there is statistically significant
positive auto correlation.

247
9.2.2. Runs test: ( - - ) ( + + + + + + + + + ) ( - - - - - - ) ( + ) ( - ) ( + ).

N= 20.

N1=11 ( + Runs)

N2= 9 (- Runs)

R = 6 (Runs)

Mean = (2N1N2/N) + 1

Variance =σ2 =2N1N2 (2N1N2-N)/ (N)2 (N-1)

Mean = 10.9

Variance = σ2 = 4.637

Therefore, σ = 2.153369

The 95% confidence interval for R in our test is thus ((10.9 - 1.96*2.153369);
(10.9+1.96*2.153369))

= ( 6.674 ; 15.1206 )

Obviously this interval does not include 6. Hence, we can reject the hypothesis
that the residuals in our GDP growth, inflation & crude price change regression
are random with 95% confidence. In other words, the residuals exhibit
autocorrelation. Swed and Eisenhart have developed special tables that give
critical values of the runs expected in a random sequence of N observations if N1
or N2 is smaller than 20. Using these tables , in the present case 20
observations, we have N1=11 and N2 = 9, the critical values of runs at the 0.05
level of significance are 6 and 16 as shown by tables of critical values of runs in
the run test, as in our application , we have found that the numbers of the runs 6
which is equal to the tabled value 6, we can reject( at the 0.05 level of
significance ) the hypothesis that the observed sequence is random. Therefore,

248
we find that the residuals in our regression are indeed nonrandom, actually they
are positively correlated.

9.2.3. Test of Multicollinearity: To test for multicollinearity, each

explanatory variable is regressed against other explanatory variable and the
auxiliary R2 is calculated. The variance inflation factor (VIF) is calculated for the
auxiliary R2 . The VIF is a method of detecting how severe the multicollinearity is,
it is calculated as;

VIF(βi) = 1/( 1- R2) and the general rule is that If VIF>5 indicate severe
multicollinearity.

Test of Multicollinearity; auxiliary regression results

Table 9.2.3
Variable Auxiliary R2 VIF
Qrty rate change in 0.043 1.044
Crude oil price &Qrly.
Inflation rate

Explanation and discussion: As VIF calculated value is less than 5, therefore,

there is no Multicollinearity between the explanatory variables.

249
9.3. Hypothesis: 3

H03 : Crude oil price rate change does not Granger cause inflation.
H13 : Crude oil price rate change Granger causes inflation.

The totality of the data that we are going to analyze is quarterly frequency of rate
of change of crude oil price and inflation respectively. The two series obtained in
values are the rate of change of crude price of India basket and the inflation rates
have been used.

The first step in this analysis concerns the stationarity of the series of rate of
inflation and the rate of change of crude oil price. Granger causality requires that
the series have to be covariance stationary, so as Unit root test or Augmented
Dickey- Fuller test can be done and has been calculated. For all the series the
null hypothesis H0 of non-stationary can be rejected at 5% confidence level.

Then, since the Granger causality test is very sensitive to the number of lags
included in the regression, both Akaike Information Criteria(AIC) and Schwarz
Information Criteria(SIC) have been used in order to find an appropriate number
of lags.

After these requirements have been satisfied, Granger – causality tests are
computed. Taking Granger equation (i), the two steps procedure in testing
whether crude price change causes inflation is as follows

1. Inflation is regressed on the lagged inflation excluding lagged crude price

rate change in the regressors. This is called the restricted regression, from
which we obtained the restricted sum squared residuals.
2. Thus a second regression is computed including the lagged crude oil price
rate change, this is called the unrestricted regression from which the
unrestricted sum of squared residuals is obtained.

250
 3. The statistics is defined as
{( RSSR - RSSUR )/m}
F=
{RSSUR/T-k}

Where, m = number of lagged crude oil rate change terms; n = number of lagged
inflation; T = number of observations.

k = is the numbers of parameters estimated in unrestricted regression.( m+n+ 1)

Results

The series are found covariance stationary, also the slope co-efficient of first
difference operator , δ is found not equal to 0,Hence, the hypothesis that δ=0,
i.e. non-stationary is rejected, the time series are stationary.

251
Results of stationarity test:
Table 9.3.0.
Series Covariance Unit root test, ADF test
stationary (δ) value
Rate of stationary AR(1) -0.320 -
change of
crude oil price
Inflation rate stationary AR(2) 0.0778 Critical value
of t- statistics
at df= 16-5=11
at 5% to 10%
is 1.796, which
is less than
the calculated
value of t-
statistics(-
2.876) in
absolute term.
Hence by ADF
test the series
is stationary.
GDP growth stationary AR(1) -0.2429 -
rate

AIC = -0.06787, lag length 3 for inflation and 3 for crude oil price rate change.

SIC = 0.280635, lag length 3 for inflation and 3 for change in crude oil price

AIC = 0.736304 , lag length 4 for inflation and 4 for crude oil price rate change.

SIC = 1.184383, lag length 4 for inflation and 4 for change in crude oil price

252
Results of Granger-Causality tests

Table 9.3.1
Direction of causality F value Decision
Change in rate of 4.79, m=3,n=3,df=13 Reject the null
CoPInflation hypothesis and accept
the alternative
hypothesis.
Inflation Change in 3.71,m=3,n=3,df=13 Reject the null
rate of CoP hypothesis and accept
the alternative
hypothesis

This is the bidirectional causality.

CoP = Crude Oil Price.

Explanation :-These results suggest that the direction of causality is

bidirectional, since the estimated F values are significant at 5% level, the critical
F value at 5% level is 3.41, ( for 3 and 13df ) .

Discussion: The F-critical value is less than the F calculated vales, therefore
reject the null hypothesis and accept the alternative hypothesis. Hence, Crude
oil price rate change Granger causes inflation and vice versa.

9.4. Hypothesis: 4

H04 : Inflation does not (Granger) cause GDP Growth.

H14 : Inflation (Granger) causes GDP Growth.

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Results of Granger Causality test
Table 9.4.0
Direction of causality F value
Inflation  GDP growth 0.53, m=3,n=3,df=13
1.21, m=4,n=4,df=11
GDP growth Inflation 5.48,m=3,n=3,df=13
7.58,m=4,n=4,df=11
Decision
Don‟t reject (i.e. accept)
the null hypothesis and
Reject the alternative
hypothesis.
Reject the null
hypothesis and accept
the alternative
hypothesis

Explanation: - The estimated F values are insignificant at 5% level for which the
critical F values are 3.41 (for 3 and13 df) and 3.36 (for 4 and 11 df). Hence, the
null hypothesis “Inflation does not Granger cause GDP growth” is accepted.
Again, the estimated value of F for reverse hypothesis is significant at 5% level
than the critical F value are 3.41,( for 3 and 13df ) and 3.36 (for 4 and
11df).Hence, the null hypothesis is rejected and the alternative hypothesis “GDP
growth ganger causes inflation” is accepted.

Discussion and Comment: Comparing the F-critical value with F- calculated, it

can be seen that, the direction of causalities are unidirectional, therefore accept
null hypothesis and reject the alternative hypothesis. Therefore “Inflation does
not ( Granger) cause GDP Growth” is accepted. Similarly, reversing the
hypothesis and on testing causality with F values, it is found that the
alternative hypothesis holds true for reverse hypothesis, hence “GDP
growth (Granger) causes Inflation.

254
9.5. Hypothesis: 5
H05 : A rise in the price of energy relative to output does not lead to decline in
productivity of existing capital and labor.

H15 : A rise in the price of energy relative to output leads to decline in

productivity of existing capital and labor.

Regression Equation: ln(y/k) = 0.207 + 0.02ln (h/k) – 0.148ln (pe/pd) + 0.002 t

(0.2675) (0.0943) (0.0536) (0.0067),
( )in the parenthesis is s.e.

Results of regression :

Table 9.5.0
Number of Intercept Co- R2 t Stat F
observation efficient value
values

Intercept 17 0.207 0.85535 25.62

0.7736
ln(h/k) 0.02
0.2191
ln (pe/pd) -0.148
-2.7602
t 0.002
0.2762

Explanation: Based on the regression analysis it is evident that there is

significant negative relationship between the energy price relative to output
productivity of capital and labor, ( R = 0.92485 , R2 = 0.85535 , F =25.62 , P =
0.010 ), 92.48% of variance on productivity decline is explained by energy price
relative.

255
Comment: Table value of F (95% confidence)at (df n1 = 3, and dfn2 =13) i.e
F0.95(3,13) = 3.41
i.e. tabled F value 5% significance level

Calculated F value= 25.62

FCALCULATED > F0.95(3,13),

Hence, H05 is rejected .

H55 is accepted .

Therefore, the alternative hypothesis “A rise in the price of energy relative

to output leads to decline in productivity of existing capital and labor” is
accepted.

*****

256
 Chapter-10
Summary of the Hypotheses, Econometrics and
Statistical Tools Used with Results

Table 10.0.
Sr. Hypothesis Statistical / Results Comments
No Econometric
tools
1 Null Hypothesis Correlation ( r = 0.829, R = Therefore
H01: Crude oil price and 0.886 , R2 = “Crude oil
plays an insignificant Regression 0.7852 , F price plays a
role in rising WPI of Model-1 =446.17 , P = significant
Indian economy. 1.42584E-42 ), role in rising
Alternative Hypothesis 88% of WPI of Indian
H11: Crude oil price plays variance on WPI economy” is
a significant role in rising is explained by accepted
WPI of Indian economy. crude oil price .
2 Null Hypothesis Correlation r = -0.536, R = Therefore
H02: The role of inflation and 0.538, R2 = “The role of
is insignificant in Regression 0.2896 , F = inflation is
declining GDP growth Model-2 7.341 , P = 0.01 significant in
of Indian economy. ), 53.8 % of declining
Alternative Hypothesis variance on GDP growth
H12: The role of inflation GDP growth of Indian
is significant in retardation is economy” is
declining GDP growth explained by accepted.
of Indian economy inflation
regressor.

257
Sr. Hypothesis Statistical / Results Comments
No Econometric
tools
3 Null Hypothesis Test of Test of Accept the
H03:Crude oil price rate covariance stationarity, Alternative
change does not stationary, URT, ADF Hypothesis
Granger cause Unit root test, AIC, SIC, “Crude oil
inflation. ADF test, Causality test price rate
AIC, SIC and valid change
Alternative Hypothesis Granger‟s Granger
H13: Crude oil price rate Causality causes
change Granger test. inflation.”
causes inflation. Bidirection
al causality
holds true.
4 Null Hypothesis Test of co - Test of Accept the
H04: Inflation does not variance stationary, URT, Null
Granger cause GDP stationary, ADF Hypothesis
growth. Unit root test, AIC, SIC, “Inflation
ADF test, Causality test does not
Alternative Hypothesis AIC,SIC, valid Granger
H14: Inflation Granger Granger‟s Cause GDP
causes GDP Growth. Causality test growth”.

258
Sr. Hypothesis Statistical / Results Comments
No Econometric
tools
5 Null Hypothesis (H05): A Regression ( R = 0.92485 , Therefore, “A
rise in the price of energy analysis R2 = 0.85535 , rise in the
relative to output does (natural Log F = 25.62 , P = price of
not lead to decline in linear form) 0.01 ), 92.48% energy
productivity of existing of variance on relative to
capital and labor. productivity output leads
decline is to decline in
Alternative Hypothesis explained by productivity
(H15): A rise in the price of energy price of existing
energy relative to output relative. capital and
leads to decline in labor” is
productivity of existing accepted.
capital and labor.

*******

259
 Chapter-11
Conclusion

There always remains uncertainty for the availability of crude oil at stable prices.
Crude oil is the most important ingredient which controls the prices of other fuels
in the energy mix. Crude oil prices remain an important economic variable
inflicting inflation and cause substantial damage to GDP growth of the economy
of oil importing country like India.

This study adds to the existing literature by bringing an awareness of the

importance of the impact of crude oil prices on Indian economy. The objectives
and the hypotheses of the study have brought about certain conclusions with
respect to the study. The study confirms that crude oil prices have inflationary
effect, which plays a significant role in rising whole sale price index of Indian
economy. Crude oil prices have positive impact on Whole sale price index (WPI),
Karl Pearson Correlation coefficient between crude oil price and inflation (WPI) is
positively correlated and is equal to 0.829. Our double log regression model
shows that the crude oil price elasticity of inflation 0.27. The analysis of variance
indicates that F- statistic is 446.17 and p-value is 1.42584E-42 is highly
significant against the critical value of F- distribution 3.89 for 5% level of
significance. Therefore, the null hypothesis is rejected and the alternative
hypothesis “The crude oil price plays a significant role in rising the inflation (WPI)
of Indian economy” is accepted.

It is observed statistically that the role of inflation is significant in declining GDP

growth of Indian economy. The study of Karl Pearson Correlation coefficient
between inflation and GDP growth is -0.536, indicates that there is a negative
linkage between inflation and GDP growth. The log-log model shows that the
inflation elasticity of GDP growth is -0.24. The analysis of variance indicates that
F- statistic is 7.34 and p-value is 0.01 is significant against the critical F-value of
4.41 for 5% level of significance. Based on statistical results null hypothesis is

260
rejected and the alternative hypothesis is accepted. Therefore, it is inferred that
the role of inflation is significant in declining GDP growth of Indian economy.

It is also revealed during multivariable regression analysis of GDP growth, crude

oil price change rate and inflation rate, the coefficient of explanatory variables
crude oil price change rate and inflation rate are 0.012 and -0.21 respectively; the
DW statistic of the residual data is 0.9765, ρ=0.5252, d=0.9494, and by Run test
of residuals, it is found that there is statistically significant positive auto
correlation exist and it is first order autoregressive scheme and is denoted by
AR(1). Further, it is statistically observed by partial correlation that the impact of
inflation on GDP growth keeping the crude oil price change rate constant is
(r12,3)= -0.505, Similarly, the impact of crude oil price change rate on GDP growth
keeping inflation rate constant is (r13,2)= 0.451 and the impact of crude oil price
change rate on inflation rate keeping GDP growth constant is (r23,1) = 0.0469.
The absolute value of correlation coefficient of the independent variables is 0.207
which is less than 0.7, therefore there is no multicolinearity between explanatory
variables, which is further validated by variance inflation factor (VIF) which is
found 1.044 and is less than 5 confirms the nonexistence of multicolinearity.

The study has a magnificent revelation that the time series data of the variables
(GDP growth, inflation rate and the crude oil price change rate) are stationary
with respect to unit root test for both GDP growth and Crude oil price change rate
respectively, also with respect to augmented Dickey-Fuller (ADF) test for inflation
rate. It is also observed econometrically and by ACF, PACF that the times series
data of the variables are autoregressive, i.e. AR (1) for GDP growth; AR (2) for
inflation rate and AR (1) for crude oil price change rate. These meet the
fundamental requirements for the study of the Granger‟s causality test for
hypotheses 3 and 4.

It is observed in testing Granger‟s causality test for hypothesis 3 that the

alternative hypothesis “Crude oil price change rate causes inflation and vice

261
versa” are accepted at lag length 3, by rejecting null hypotheses with F statistics
4.79 and 3.70 respectively at 5% level of significance. Similarly, for hypothesis 4,
it is observed that the null hypothesis “Inflation does not granger cause GDP
growth of Indian economy” is valid and accepted at leg length 3 and 4 by
rejecting the alternative hypothesis with F statistics 0.54 and 1.21 respectively at
5% level of significance, but for the Granger‟s causality test for reverse
hypothesis 4, it is observed that the alternative hypothesis “GDP growth ganger
causes inflation in Indian economy “ is accepted at lag length 3 and 4 by rejecting
the null hypothesis with F statistics 5.48 and 7.58 respectively at 5% level of
significance.

The econometric fitting of “Cobb-Douglas” production function to the data for the
period 1992-2009 for Indian industries, yielded the following results:
ln(y/k) = 0.207 + 0.02ln (h/k) – 0.148ln (pe/pd) + 0.002 t
(0.2675) (0.0943) (0.0536) (0.0067),
( )in the parenthesis is s.e.
R2=0.8553.
The Goodness of Fit is 0.8553, which indicates the model is fit and acceptable.
The regression coefficient of log natural energy relative is negative, indicates that
a rise in price of energy relative to output diminish the capital and labor
productivity. Further, the F statistic is 25.62 which is highly significant than the
critical F value 3.2 (at dfn1=3 and dfn2= 13 at 5% level of significance). Therefore,
the null hypothesis is rejected and the alternative hypothesis “A rise in the price
of energy relative to output leads to decline in the productivity of existing capital
and labor” is accepted. Thus it is inferred that with the increase of energy or fuel
price relative the derived output leads to diminish the productivity of existing
capital and labour.” The output elasticities of the inputs are, a=0.017; b= 0.855;
c = 0.128; r=0.0017 and A=1.6, and thus Cobb Douglas (C-D) production
function for Indian industries for the period; 1992-2009:
Y = 1.6 e0.0017t h0.017 k0.855 (E)0.128.
******

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 Chapter-12

Managerial Implications
There is always an uncertainty in sourcing crude oil at optimum price for
importing country like India. To meet the requirement of crude various strategies
are need to be adopted by both Explorers and Refiners. The key strategic points
are
(a) Enhancing availability of resources for sustainable development.
(b) Ensuring accessibility of resources for growth.
(c) Reforms in petroleum sectors for both upstream and downstream
companies also making India as export hub for petroleum products to earn
foreign exchange.
(d) Initiatives for Diversification Strategy for nonconventional and green
energy etc.
(e) Initiative for Strategic Reserves.
Therefore, there is a need of multilateral strategy for the oil companies to source
the raw material through long term contracts and at the same time to sourcing
the crude oil through acquisition of oil block in foreign countries, public as well as
private investment is required to be intensified for the exploration block of the
country through NELP (New Exploration license Policy) bid , increasing the oil pie
in the primary energy of the country by exploration and production through PSC
(Production Sharing Contract), expansion of refining capacities and creation of
refining hub in India in the Asia Pacific Region is most important area of
management for exporting petroleum products and earning foreign exchange to
protect the foreign reserves also to offset high crude oil prices.

Diversification Strategy:- The need of the hour is to take the opportunity by oil
companies through conglomeration in the area of Nuclear energy , Renewable
energy like solar energy, wind energy, biomass energy, tidal energy through
collaboration or alliance with domain expert for Green energy and Green
positioning of the companies both explorers and refiners.

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Strategic Crude Oil Reserves:- This stockpile would take care of oil security
concerns of the country and could be released to meet contingencies arising out
of supply disruptions and cushion abnormal increase in prices.

India has begun the development of a strategic crude oil reserve sized at 37.4
million barrel i.e. 5.33 million tonnes enough for two weeks of consumption.

The construction of the proposed strategic storage facilities is being managed by

Indian Strategic Petroleum Reserves Limited (ISPRL), a Special Purpose
Vehicle, owned by Oil Industry Development Board (OIDB).

The construction strategic facilities expected to be completed by 2013 and further

studies have been initiated to construct space to store additional 12.5 million
tonnes of strategic reserves by 2017.

Petroleum Product Pricing:- Petroleum pricing is fundamental for the operation of

efficient energy markets. Petroleum product prices perform the important role of
balancing consumer energy demand with producer supply. The fundamentals of
energy pricing are economic efficiency, social equity and financial viability.
Efficiency principle seeks to ensure the regulation of prices in such a manner that
the allocation of the society‟s resources to the energy sector fully reflects their
values in alternative uses. Equity principle relates to welfare and income
distribution considerations. This may result in differential pricing schemes on
grounds of basic and essential needs or the establishment of uniform prices to
specific user groups regardless of different costs of supply, justified on the basis
of regional equity or similar concerns. Financial principle suggests that energy
supply systems should be able to raise sufficient revenues to remain financially
viable, so that continuity and quality of service is ensured and common people
and community benefits from the energy supply system for sustainable growth
and development.

Petroleum product pricing in India is frequently seen as a black hole of subsidies.

Economists and oil companies complain about the impacts those subsidies have

264
on public finances, financial performance of oil companies and demand-side
management. The petroleum product pricing in India is more complex than the
one-way flow of subsidies. It distorts product prices and encourages unhealthy
substitution of subsidized products for other products which are more efficient. It
dampens price signals and discourages energy conservation. It creates vast
distortions and makes good governance almost impossible. It also threatens
India‟s international competitiveness in long run. With the abolition of APM, the
current market economy has tried to address the above short comings in product
pricing and to deliver efficient pricing. Therefore, the product price should be free
and fair enough for oil refining and marketing companies so that investments in
refining and distribution are not distorted and efficiencies are rewarded at the
same time some variant must be kept in pricing for the end consumer for the
beneficiary of social sector particularly economically poor people of India.

Green House Gases (GHG):- Combustion of hydrocarbon based fuels in

industrial activity generates by-product materials, many of which are considered
to be air pollutants. The emissions are the greenhouse gases (GHG) and
particulate matter which could cause impact on environment quality, global
warming and climate change are to be reduced with regulations and control.
India is faced with the challenge of sustaining its rapid economic growth while
dealing with the global threat of climate change. This threat comes from
accumulated man made greenhouse gas emission in the atmosphere generated
through long term, intensive industrial growth and high consumption life style.
India is very vulnerable to climate: floods, droughts, vector borne disease,
cyclones, ocean storm surges etc.

National Action Plan on Climate Change (NAPCC) document released in 2008

and it identified measures to advance India‟s development without affecting
climate change related adaptation and mitigation.

1. Protecting the poor and vulnerable section of the society through

sustainable development strategy sensitive to climate change.

265
 2. Achieving national growth objectives, while enhancing ecological
sustainability leading to mitigation of greenhouse gas emissions.
3. Devising efficient and cost-effective strategies for Demand Side
Management.
4. Deploying appropriate technologies for both adaption and mitigation of
greenhouse gases emissions extensively as well as rapidly.
5. Engineering new and innovative forms of market, regulatory and voluntary
mechanisms to promote sustainable development.
6. Effecting implementation of programs and projects through local
government institutions and public private partnership.

Energy conservation is another area to be strengthened; energy conservation

refers to efforts made to reduce energy consumption. Energy conservation can
be achieved through increased efficient energy use in conjunction with
decreased energy consumption and/or reduced consumption from conventional
energy sources. Energy Conservation and Energy Efficiency are separate, but
related concepts. Energy conservation is achieved when growth of energy
consumption is reduced in physical terms. Energy Conservation, therefore, is the
result of several processes or developments, such as productivity increase or
technological progress. On the other hand Energy efficiency is achieved when
energy intensity in a specific product, process or area of production or
consumption is reduced without affecting output, consumption or comfort levels.
Promotion of energy efficiency will contribute to energy conservation and is
therefore an integral part of energy conservation promotional policies.

The Government of India has enacted the Energy Conservation Act in 2001 to
provide legal framework and institutional arrangements for enhancing energy
efficiency. This act led to the creation of Bureau of Energy Efficiency (BEE) as
the nodal agency at the center and State designated Agencies (SDA‟s) at the
State level to implement the provisions of the Act. Under the Act, Central
Government, State Government and Bureau of Energy Efficiency have major
roles to play in implementation of the Act. The Mission of BEE is to develop

266
policy and strategies based on self-regulation and market principles with the goal
of reducing, energy intensity of the Indian economy. This will be achieved with
active participation of all stakeholders, resulting in rapid and sustained adoption
of energy efficiency in all sectors.

Energy conservation can result in increased financial capital, environmental

quality, national security, personal security, and human comfort. Individuals and
organizations that are direct consumers of energy choose to conserve energy to
reduce energy costs and promote economic security. Industrial and commercial
users can increase energy use efficiency to maximize profit.

*****

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 Chapter-13
Acquisition Dynamics and Vertical Integration
With the Corporate restructuring followed with deregulation and opening up of
petroleum sector by the Govt. of India after economic liberalization; the
acquisition has become essential for shaping the complexity of energy business
and for the energy security of the country.

Growth of a business can be organic or inorganic. In an organic growth

environment there is an incremental growth of a Company‟s people, customers,
infrastructure resources whereby it positively impacts the revenue and profits of
the company. Inorganic growth on the other hand involves leapfrogging several
stages in growth process. Acquisition form part of inorganic growth of any
Company.

13.1. Framework for an acquisition

Competitive forces resulting from globalization and deregulation in many

industries have forced many corporate to consolidate. To embark on an
acquisition strategy there is a need to put in place a framework of considerations
which inter alia includes the following.

1. Synergies through consolidation:

Synergies can be realized through cheaper production bases or cost
savings and pooling of resources in R&D, marketing and distribution.
Research has also proved that the return on capital goes up when
concentration index rises.

2. Vertical Integration
To sustain growth a Company could merge to achieve increased market
share, gaining access to additional customers and better access to
distribution and marketing. This can be either backward-integration with
suppliers and lateral or horizontal-integration with customers or forward /
upward integration for product market.
268
 3. Technology
Acquisitions / mergers take place to keep pace with technology and to
graduate to a higher level of technology.

4. Tax Consolidations
Reduction in sales tax in case of vertical mergers and taxation benefits in
case of reverse mergers are instances. Legal provision are spelt under
Sections 35A, 35AB, 35ABB, 35D, 47 and 72A of the Income tax Act,
1961 and the legislations in India on indirect taxation.

13.2. Policy Environment of India

The policy environment of India governing Mergers and Acquisitions is complex

and straddles several areas of law and accounting which include:

1. The laws relating to acquisition of share of listed/quoted companies are

governed by SEBI (Substantial Acquisition of Share and Take over)
Regulations.

2. Under Indian Companies Act 1956,

i. Section 293 – If the acquisition value exceeds 60% of Indian

company‟s net worth or 100% of its free reserves, then the Indian
company is required to take prior approval from its shareholders for
making investment in the target company.
ii. For merger the detailed procedure prescribed under Section 391-
394 are to be followed.
iii. Section 372A providing ceiling on investment has a decisive
impact.

269
 3. Clauses 40A and 40B of the listing agreement govern the takeover of a
listed company.

4. Provisions of Competition Act 2002 regulating mergers and acquisitions

based on monetary limits with respect to assets and turnover.

5. The tax benefits under Income Tax Act, 1961, supra, are one of the prime
motivators in Merger deals.

6. The accounting aspects are governed by Accounting Standard-14 issued

by Institute of Chartered Accountant of India.

13.3. Target Evaluation

The steps undertaken to evaluate a target for acquisition would include the
following steps:

1. Check whether the acquisition fits into the vision and strategy of all
stakeholders.

2. Institute a reasonable thorough search for the right candidate(s) where in

aim is to achieve optimal results.

3. Evaluate the candidates on the basis of some key criterion like

contribution towards profitability, market share, image, core competency
etc.

4. Settle down on right price.

5. The value to the acquirer and acquiree will also influence the eventual
price. Capitalization, assets in the balance sheet of the acquiree Company

270
 etc. Afterwards, the right price shall be negotiated and the exchange is
harmonized.

13.4. Target Valuation:

Perfect valuation of a target company is a challenge. There are various

valuation methods /models are used for valuation purpose.

1. Equity Valuation Model

2. Dividend Discount Model
3. Constant Growth Model
4. Price- Earnings Ratio
5. Discounted Cash Flow Technique.
6. Economic Profit Model
7. Operational Value.
In general checks are made whether the cash flow is sustainable in future;
whether assets are legally held in the name of the company; whether feedstock
supply is guaranteed for long run; are there any major liabilities that could wipe
out future profitability and are there any contingent liabilities that do not appear in
the accounts.

The methodologies adopted to value a company also suffer from various

limitations. So the challenge includes selecting the appropriate techniques for
valuation. Valuation is a scientific exercise which requires competence and
experience of analyst conducting it. Two important elements in selecting a
valuation professional are experienced and demonstrated ability in the industry in
which the firm to be valued completes and considering certifications like ABV
(Accreditation in Business Valuation).

“The value of the deal is not that important, vis-à-vis the success or failure of
acquisition. What justifies the value is how well one integrates the entity with the
existing business”.

271
13.5. Due Diligence

Due Diligence is the process of examining all aspects of a Company including

manufacturing, financial, legal, tax, IT system, labor issues, checking for
regulatory issues, as well as understanding issues related to IPR, the
environment and other factors. It is done to investigate and evaluate a potential
Company for acquisition purposes.

13.5.1. Conducting due diligence

The parties are to any transaction always should conduct their own due diligence
to obtain the most accurate assessment of risks and rewards. Though some
degree of protection is achieved through a well-written contract; legal
agreements should never be viewed as a substitute for conducting formal due
diligence. Various aspects include:

13.5.2. Buyer due diligence

It is the process of validating assumptions underlying valuation. Primary

objectives are to identify and confirm sources of value and to mitigate real or
potential liability by looking for fatal flaws that reduce value. Due diligence
involves three primary reviews;

1. Strategic / Operational / Marketing review conducted by senior operations

and marketing management.
2. Financial review directed by financial and accounting personnel.
3. Legal review by legal counsel.
Selecting due diligence team

Teams should include those with expertise in financial, environment, legal and
technology issues.

13.5.3. Limiting Due Diligence process

Due Diligence is an expensive and exhausting process. The buyer will want as
much time necessary while seller will try to limit the length and scope. It is highly

272
intrusive and places demand on managers‟ time and attention. It rarely works to
seller‟s advantage as long as detailed due diligence is likely to uncover items that
buyer will use an excuse to lower price. Consequently, sellers may seek to
terminate it before buyer feels is appropriate. Thus, it is in the interests of buyer
to conduct a thorough due diligence in shortest possible time so as not to
alienate the seller and disrupt business.

Sometimes buyer and seller may agree to abbreviate due diligence period. The
theory is buyer can be protected in a well-written agreement of purchase and
sale in agreement; seller is required to make certain representations and warrant
that they are true. Such “representations and warranties” could include seller‟s
acknowledgement that they own all assets listed in agreement free of any liens or
attachments. If representation is breached the agreement will include a
mechanism for compensating buyer for any material loss. What constitutes
material loss is defined in contract, relying on “representations and warranties‟ is
rarely a good idea. A data room is another method used by sellers to limit the
due diligence. This amounts to the seller sequestering the acquirer‟s team in a
room to complete due diligence.

13.5.4. Seller’s Due Diligence;

Though bulk of due diligence is done by buyer, seller should also perform it on
buyer and themselves. By doing so, seller can determine if buyer has financial
wherewithal to finance purchase price. In addition, seller as part of its own due
diligence will require its managers to frequently sign documents stating that to
the “best of their knowledge” what is being represented in the contract that
pertains to their area of responsibility is true. By doing so, seller hopes to mitigate
liability stemming from inaccuracies in seller‟s representations and warranties
made agreement of purchase and sale.

13.5.5. Importance of Due Diligence (DD) Report

1. It factors all critical issues which impact the decision on valuation of the
target.

273
 2. It becomes the basis for negotiating the valuation price.
3. It provides in the transaction documentation comprehensive
representations and warranties.
4. Where issues that cannot be immediately resolved before closing the deal,
they are put under what is called as „Conditional Subsequent‟ (CS).
Normally, Industries and Corporate bodies are hiring the financial services from
Merchant / Investment Bankers for providing services in relation to merger and
acquisition. Merchant / Investment Bank will check all the documents of target
company; prepare all reports like Financial Statement Analysis, Due diligence,
SWOT Analysis, Cash Flow statement, Valuation etc. of target company and
finally the feasibility report for merger/acquisition will place before the
Corporation/ public sector enterprise (PSE). The corporate planning/ Investment
wing of PSE goes for debate and deliberation in line of strategic planning of GoI,
that is as per India‟s developmental five year plans and finally tabled the
feasibility report in board meeting before the Board of Directors, on assent and
duly signed by Board, the feasibility report sends to its administrative ministry.

The administrative ministry carries out a preliminary scrutiny of feasibility report

and sends copies of the same to the various appraising agencies, namely, the
planning commission, the department of Economic Affairs and the Plan Finance
Division of the Finance Ministry and the Bureau of Public Enterprises (BPE) for
their comments.

The Project Appraisal Department (PAD) of the Planning Commission carries out
a detailed appraisal.

The Investment Planning Committee of Planning Commission discusses the

appraisal note of the PAD and recommends to the PIB the view of the Planning
Commission on whether the project should be accepted, rejected, deferred or
redesigned.

The Public Investment Board (PIB) considers the:

a) Appraisal note of the PAD along with the view of the Planning Commission

274
 b) The comments of BPE.
c) The comments of Plan Finance Division of the Ministry of Finance, and
d) The note of Administrative Ministry.
If the PIB clears the project, it sends to the Cabinet for its approval. The Cabinet
generally accepts the recommendations of PIB and approves the
Implementation.

13.6. Vertical Integration: - (Inbound Acquisition by ONGC)

In a significant development in 2002, ONGC was granted rights for marketing

transportation fuels on the condition of assured sourcing of products. Indian oil
officials and Industry experts felt that ONGC‟s new strategy was essential. They
felt that there was a pricing cycle for crude, gas, refinery margin, marketing
margin, petrochemical margin and that international prices operated on different
cycles in each case. This meant that confining to one sector, where upstream or
downstream or petrochemicals would make any organization vulnerable to the
ups and downs of a particular cycle. The integration of these activities would
ensure profitable operation across a number of cycles and financial stability.

To fulfill this, ONGC acquired 297 mn shares (i.e. 37.39 per cent equity stake) of
MRPL from A V Birla (AVB) group, a leading business conglomerate in India, for
Rs 2 per share in March 2003. It thus diversified into the downstream (refining
and retailing) business. The Company pumped in Rs 6 bn by issuing fresh equity
of MRPL, increasing its equity stake to 51 percent. Later on, ONGC purchased
356 mn shares from institutional investors and increased its stake in MRPL, to
71.5 percent. This deal was worth about Rs 3.9 bn. The total amount invested by
ONGC in MRPL was about Rs 10.494 bn. In addition to equity, ONGC lent Rs 24
bn to MRPL at a rate of 6%, saving MRPL an estimated interest cost of Rs 820
mn per annum.

MRPL had a refining capacity of 9.69 mn metric tonnes per year. This company
had been established when the APM was in practice in Indian Oil Industry. GoI‟s
regulatory framework provided assured returns. However, after the refining

275
sector was deregulated in 1998, MRPL lost the regulatory protection and became
vulnerable to price fluctuations in the international market. This affect the
company‟s operating profitability significantly and it posted continuous losses for
four year in a row, and became sick eventually.

Despite this poor financial performance, ONGC acquired MRPL, for venturing
into the retail business because it possessed advanced technology, including the
capability to meet Euro II norms for transportation of fuel quality. The acquisition
was considered good for ONGC in the long term, as setting up a similar state-of-
the-art nine million tonnes refinery would cost four times the acquisition amount.
Moreover, by taking over a loss- making company, ONGC was entitled to huge
tax concessions.

The retail business also promised growing demand for petroleum products and
consequent stability to ONGC‟s financial position, even if its core business was in
trouble. Because of MRPL, ONGC could divert oil from Mumbai High to the
refinery for captive consumption. The GoI permitted ONGC to set up 600 retail
outlets for marketing products from MRPL refinery. MRPL was also a partner in
the Mangalore- Hassan- Bangalore product pipeline, which helped mobilize
products into remote areas.

Due to the injection of funds and operational and managerial support of ONGC,
the operational performance and credit profile of MRPL, improved considerably.
During 2002-03, it registered an operating profit of Rs 3.48 bn, in spite of net loss
of Rs 4.12 bn. Due to the access to Mumbai High Crude, for the year 2002-03,
MRPL processed 7.25 mn tonnes of crude against 5.5 mn tonnes in 2001-02.
Grant of marketing rights and acquisition of MRPL were the major steps in
transforming ONGC into an integrated oil and gas corporate.

********

276
 Chapter-14
Limitation of the Study and Future Scope of Research
The limitations of the study are as follows –
(i) The data for the study of the impact of crude oil prices was confined to
average Indian Basket Prices of crude oil on Indian economy. Data from
International Crude oil prices for different types and API grades of crude
would have enabled a comparative analysis.
(ii) The study was confined to the economic impact of Indian Basket Prices
(Crude), and it has not covered the areas of taxation, duties, Government
revenues derived from crude oil and petroleum products.
(iii) There are ample scope of future research in the field of Petroleum
products distribution and marketing, infrastructure investment and oil field
development, petroleum products transportation through pipelines both
national and transnational, taxation of volatile oil prices with policy
recommendation for ensuring minimum level of consumption and
conservation.

********

277
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 Appendix-I (Plots and Diagrams)

Bar diagram A.I. – 1.0

140

2000-01
120
2001-02
100 2002-03
2003-04
80
2004-05
60 2005-06
2006-07
40
2007-08
20 2008-09

0 2009-10
2010-11

Crude Oil Price in $ (Indian Basket)

284
 50

0
100
150
200
250
300
April,2000-01
October
April,2001-02
October
April,2002-03
October
April,2003-04
October
April,2004-05
October
April,2005-06
October
April,2006-07
October

285
April,2007-08
October
April,2007-08
October
Line diagram, A.I. - 2.0

April,2008-09
October
April,2009-10
Plot of Indian Crude Basket Price (Average) in $ and WPI
WPI monthly
Crude Price $
 Line diagram, A.I. - 3.0

300

250

200
gdp growth
150
wpi

100 crude price

50

0
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Plot of GDP growth, WPI and Crude Price

286
 Line diagram A.I. - 4.0

120.00

100.00

80.00 Dubai,$/bbl *

Brent, $/bbl †
60.00

Nigerian Forcados, $/bbl

40.00
West Texas Intermdiate,
$/bbl ‡

20.00

0.00
1986
1980
1982
1984

1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

Plot of Prices of different grades, API crudes

287
 Line diagram, A.I. – 5.0

180.0

160.0

140.0

120.0

100.0
Consumption
80.0
Production

60.0

40.0

20.0

0.0
1989
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987

1991
1993
1995
1997
1999
2001
2003
2005
2007
2009

A plot of Crude oil Consumption and Production of India.

288
 Line diagram, A.I. - 6.0

140

120

100

80 gdp growth
inflation
60
crude oil price
40

20

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

A Plot of GDP growth, Inflation, Crude oil price

289
 Scatter plot diagram, A.I. - 7.0.

300

250

200

150
gdp growth
100 wpi
crude oil price change
50

0
0 5 10 15 20 25
-50

-100

Scatter plot of GDP Growth, WPI and Crude Oil Price Change.

290
 Line diagram A.I. - 8.0

300

250

200

150
gdp growth
100 wpi
crude oil price change
50

0
Q2

Q3
2005-06,Q1
Q2
Q3
Q4

Q3
Q4

Q2

Q4

Q2
Q3
Q4

Q2
Q3
Q4
2006-07,Q1

2007-08,Q1

2008-09,Q1

2009-10,Q1
-50

-100

Line diagram of GDP Growth, WPI and Crude Oil Price Change

291
 Line diagram A.I. - 9.0

18

16

14

12

10 Quarterly India GDP growth

8
Quarterly India Inflation
6 rate

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

A Plot of Quarterly GDP growth and Inflation rate

292
 Line diagram A.I. - 10.0.

100

80

60

40 Quarterly India Inflation

rate
20
Change in crude oil price
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
-20

-40

-60

A Plot of Quarterly Inflation rate and crude oil price rate change

293
 Line diagram, A.I. - 11.0

100

80

60

40
gdp growth
20 inflation
Crude oil price change rate
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
-20

-40

-60

Plot of GDP growth, Inflation and Crude oil price change rate .

294
 Pie diagram, A.I. - 12.0.

Oil Production by Region at the end of 2011

(Mtoe)

399.4, 10%
648.2, 17%
North America
478.2, 12% S & C America
350.0, 9% Europe & Eurasia
Middle East
Africa
1184.6, 30% 853.3, 22%
Asia Pacific

295
 Pie diagram A.I. - 13.0

Oil Production Outlook 2030 by Region

(Mtoe)

311.3,
7%
788.3, 17%
497.6, 11% North America
S & C America

477.7, 11% Europe & Eurasia

Middle East

1646.4, 36% Africa

790.5, 18%
Asia Pacific

296
 Bar diagram A.I. – 14.0

2000.0

1800.0

1600.0

1400.0

1200.0

1000.0 2010
800.0 2030

600.0

400.0

200.0

0.0
North S&C Europe & Middle East Africa Asia Pacific
America America Eurasia

Future Crude oil consumption in Million tonnes by Region

297