So I was reading this article by Ajay Shah about administered pricing for petroleum. He does an excellent (though it gets a bit technical in terms of statistics) analysis about what could go wrong if the government were to free pricing of petroleum products. He mostly argues in favour of deregulation, and that is a view that I completely endorse.
One of the big fears about deregulation that he mentions is the fear that volatility in retail prices of petroleum products might increase, and he argues that this is a good thing and is much better than the government artificially hiding the prices and subjecting the junata to major price shocks once in a while. While I agree with him on this, I don’t think prices will change frequently in the first place.
While I was reading this article, I started thinking about the neighbourhood Sri Ganesh Fruit Juice (yeah there are a dozen of those in every neighbourhood in Bangalore) center. About how the guy keeps the price of orange juice constant throughout the year, despite the price and availability of oranges themselves fluctuating wildly across seasons. Yeah he might do minor adjustments such as changing the proportion of water but he can’t do too much of it since he needs to maintain quality.
The basic funda here is that customers want certainty. Every time they go to the shop for their fix of orange juice, they want certainty in the prices. Even if you are on an average cheaper, you will lose customers if your price is more volatile than your competitor’s. Of course there are occasions when you can’t help it and are forced to change your price – and on these occasions your competitors are also likely to do the same. But as far as possible, you try your best to decouple the price of orange juice from the price of orange which is pretty volatile.
Now I don’t know if the volatility in crude oil prices is more than the volatility in orange prices (it’s likely to be) but considering that oil companies are supposed to be more sophisticated than your neighbourhood juice shop guy, I would expect similar behaviour from them – of keeping retail prices of petroleum products as stable as they can. Of course they are likely to follow long-term trends but they are surely not going to pass on the short-time noise in prices to the customers.
So this fear of increase in volatility of retail prices is unfounded, assuming of course that the oil marketing companies are good businesspeople!