Consumers in Malaysia and around the world have not only watched the price of fuel rise and fall, but experienced it themselves as well. This situation makes consumers wonder why the price fluctuates so often. What are the factors that affect the price of a good or service or in this case, the price of fuel? What are the implications? The vital factor that leads to the fluctuation of fuel price is inevitably the strength of demand and supply. In general, if there is an over-supply of a product or good in a particular market or if the demand falls, an impact on the price of that product can be seen.
Before proceeding to further analyse this principle, demand in economic terms is described as the desire and degree of willingness of a consumer to pay for a good. Demand can be illustrated by constructing a demand curve and understood through the aids of a demand schedule. As stated in the law of demand, when the amount of a particular good demanded falls, the price rises (Sloman, Wride and Garratt, 2012). Based on this statement, it can be concluded that there exists an inverse relationship between the price and quantity of the desired product. Supply on the other hand is how much producers can provide and how willing they are to sell their goods at a specific price, given that other factors are held constant (Sloman, Wride and Garratt, 2012). Likewise, supply can be illustrated by constructing a supply curve and understood through supply schedule. The price of a good or service is relative to the supply. The higher the price, the higher the supply as it is now more profitable to the sellers.
Petronas, is an established oil company founded in 1974 and owned by the Malaysian government. Petronas is granted with all the oil and gas resources in the country. They are also given responsibility to develop and add value to these resources (Petronas, no date). Owning such feat directly allows them to monopolise the fuel industry and the corporation is able to prevent new firms from entering the market (barrier of entry). In fact in 2012, Petronas is renowned as one of the 500 biggest corporations in the world by Fortune (Fortune Global, 2012). This statistic shows how powerful they are and where they stand, not only in the Malaysian market but globally as well. However, monopoly and barriers of entry will be discussed further later on.
In December of 2009, Petronas’ profit fell by 50% (Anonymous, 2009). What are the factors that led to this huge profit loss? Profit loss co-relates to the fall in demand. When there is a fall in demand, over-supply occurs and the price of petrol drops. The economic slowdown that occurred in 2009, could be one of the factors that affected the demand of petrol. Before the economic downturn, Petronas was producing 1.73 million barrels worth of oil a day. However, due to the decline in economy, the domestic output dropped to 1.08 million barrels worth of oil a day. Producers had no choice but to lower the prices of their goods due to the economic slowdown. This is so because consumers could no longer afford to pay for the previously priced good which caused the demand for petrol to decrease simultaneously. In order to ensure that consumers do not choose the substitute, the price is reduced. Despite the reduction Petronas is still able to make revenues. Apart from that, with the price reduced, consumers will not substitute driving their own cars with other means of transportation such as taking buses or trains as well.
However, when the economy reverts back to its’ normal state, consumers’ income and demand would as well. As their income increases, producers will then be able to supply more according to the demand. When the supply for petrol increases, the price and the equilibrium price will decrease as well. In this case, both producers and consumers will benefit as producers are able to sell more at a lower price and likewise for consumers as they are able to buy more at a lower price.
The rightward shift of curves shows the increase in both demand and supply.
In the late 1980’s Petronas faced a battle against oil depletion. Considering that oil is required for the production of petrol, diesel and such to run vehicles, an increase in the price of fuel could be seen. This is mainly caused by scarcity of the production of oil. Scarcity in economic terms simply means the insufficiency of supply to meet the demand. Regardless of the fact that the production of oil is decreasing, the consumer’s demand for it stays the same and constant throughout. Thus the price for petrol increases. This paragraph can be explained through the aid of the diagram below.
To recover and postpone depletion, the corporation not only expanded their business internationally in the 1990’s but also developed substitutes to petrol (Gangopadhyay, 2013). The substitute being developed at that time was, natural gas. With the existence of natural gas as a substitute, the depletion of oil could be postponed and the demand for oil would decrease.
As previously mentioned, Monopoly in fuel can also be seen in Petronas through the power the government has over the corporation. In relation to this statement, Petronas allocates a large amount of their profits to the Malaysian government through annual dividend marked at nearly $10 billion (Gangopadhyay A., 2013). When there is only one firm in the industry that provides such good or service, it is referred to as monopoly. However, to be classified as a monopoly is unclear as it is dependent on the scale of the industry. For example, there may be other competitors to Petronas but since Petronas is the only corporation in the fuel industry to be owned completely by the government and given the entire oil and gas resources, they monopolize the fuel market in Malaysia. In fact, Petronas has ownership over the field of oil and gas in Iraq, Australia and approximately 20 other countries.
Even with the existence of competitors such as Shell, being the only corporation to own such feat, the government is able to raise and set the price for fuel and consumers will have no other firms to fall back to. Just recently, Petronas raised the price of crude oil in Tapis, Singapore to its’ highest as profits raked in from producing diesel (The Star, 2013). According to The Star, the price is now set to US$6.10 per barrel from $5.70 per barrel back in January. Last year, the price of crude oil per barrel was averaged at $6.65. Therefore, consumers have no choice but to pay a higher price or risk going without the demanded good.
Apart from that, they are also able to prevent new corporations from entering the market (barriers to entry). For Petronas to remain its monopoly, barriers to entry of new corporations, firms or company has to exist. There are existing barriers in Oligopoly as well but in monopoly, the firm’s power and barrier has to be high enough to prevent the entry of new firms. There are many forms of `barrier` and one of the many existing form is the ownership. As mentioned before, since Petronas governs the supply of fuel through the power the government granted them, they can deny all entries from potential competitors. Other than that, an established company like Petronas can also use aggressive tactics to stake their claim. Being an established company that they are, the corporation could not only handle, but also sustain losses better than a newly established firm. Moreover, Petronas is able to start a price war, introduce new firms to go against the new entrants and advertise on a much larger scale.
However, if the monopolist is obtaining extraordinary amount of supernormal profit and holding too much power over the oil industry, in the long run there will exist a threat of new firms entering the market. Demand for oil is generally price inelastic be it in the short or long run (Andrade, Chakravorty and Daubanes, 2013). Dealing with such high demand, Petronas is able to increase profits by charging higher prices provided that the prices will not alarm the profitability of its’ substitutes (Sloman, Wride and Garratt, 2012). In order to prevent such occurrence, monopolist should practise `limit pricing`. Such practise can be done by keeping the prices of their goods or in this case, the price of oil down to ensure that new firms does not enter the industry for the attractive profit they are able to make.
To conclude the findings, as consumers we are bound to deal with the constant fluctuations of fuel price. The increase in fuel price does not necessarily mean that the corporation or firm is seeking for merely profit. There are external factors that affect the fuel price and these factors has to be taken into consideration. We as consumers also affect the price of a good or a particular service. The factors may vary from economic downturn to scarcity and monopoly.
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