Impact of oil in daily life is quite evident. Oil is considered as a strategic energy for economic time line. The price of oil has an effect on cost of production in diversified ways such as with the increase in oil prices, there is an increase in the costs of transportation of export, import and goods for local expenditure.
Apart from this there is also an upward slope in rates of air, road, rail and sea transportation with the rise in the price petroleum.
Oil endows with 97% of the transportation fuels that facilitates in running the trucks cars and other automobiles in the country’s highway. Thus, when the price of the oil increases, it evidently alarms the automobile industry because the auto-companies are in competition with one another to fulfill the new demands for more fuel proficient consumer mindful at condensed price. There are no reservations that profit margin of the companies are affected by this. Furthermore, rise in oil price also affects the kind of means of transportation demanded by the buyer and the way those vehicle motors are designed.
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The escalation in the petroleum prices plays a major part in the automotive industry. “The world consumes over 82 million barrels of oil per day (BPD), with the united states taking roughly 20 million BPD” (McFarlane).
Petroleum is one of the most essential contributions in a nation’s economy and its price has extensive economic and social impacts. Various researches illustrate that the price of petroleum in Pakistan is considerably high either with or without involving to per capita income and it needs to be leveled downwards in order to guarantee competitiveness of Pakistan’s exports and lessen the burden on the buying competence of the nation. Nevertheless, this cannot be a simple task as Pakistan heavily depends upon imported oil in order to fulfill its petroleum necessity and the development surcharges and the import revenues compose a major sector of the Government income. However, a feasible and reasonable solution to trim down oil price is needed keeping in sight the revenue making facet and the prevailing global prices of crude oil.
The major reason of escalated oil prices is linked with the demand of oil and the complication in oil refineries. Petroleum is used usually for two reasons: Firstly, in the gasoline production and secondly in the production of tires. In the US, during the last few years the prices of gasoline have risen up considerably reaching on an average over $ 3.00/gallon (EIA-Energy Information Administration).Oil is considered as the main element in the tires production. With the increase in the oil prices, the cost and expenditure in making the tires escalates, the cost to heat up or cool the manufacturing plant where tires are produced increases, and eventually escalates the expenditure of shipping the tires to further destinations. Because of the rise in the price of petroleum, the tire makers are also increasing the price of tires. The automobile sector is affected by both, tire production and gasoline prices as the profit margins are affected by the increase in gasoline prices and tire production prices.
The automobile industry catastrophe, currently worldwide phenomena, started during 2008-H2. The automotive sector is going through a crisis condition in US and Canada because of the Automobile products Trade Agreement. Nevertheless, all auto makers worldwide, especially in Japan and Europe are also facing the same crisis. The first fragile connection in the auto sector was the record high petroleum prices during 2008 which caused global oil crisis and made fuel costs and expenditures unreasonable, causing buyers to opt for smaller cars rather than larger SUVs (sports utility vehicles) and the pick up trucks.
The global oil crisis has affected Pakistan economy severely. Automobile sector has been greatly impacted by the oil price shocks. There had been consistency in the Gross Profit Margin of Pakistan’s Automobile industry. It raised from FY01 (6.83) to FY03 (13.73).Then had a downward slope for two consecutive years to 12.17 (FY05), then remained stable for two more consecutive years (FY05 – FY07).Since FY07 there has been a constant downward slope, reaching 6.14 (FY09).the diminishing Profit margin was because of the ever escalated cost of goods sold. The risen up cost is primarily due to the global oil price shocks and the high depreciation value of Rupee. The escalated costs were also linked to the high inflation rate during FY09.
Escalated oil prices have been accountable for periods of extreme inflation, recessions, and lower productivity and reduced economic growth. For the Automobile manufacturers the fuel price debate is nothing new. Due to predefined end of petroleum resources, the automakers have come up with various strategies to avert any sudden need for action. However till now, no one has clearly defined the oil supply definitive end.
Kiseol Lee and Shawn Ni analyzed the effects of oil price shocks on demand and supply in automobile industry depicting the effect of oil price shocks mainly reducing demand. They suggested that oil price shocks influence economic activities.
The first OPEC oil embargo in early 1970s has led to the start of debate over the oil shocks and its Macroeconomic effects. The most comprehensively surveyed theories on the direct consequence of oil price shocks incorporates that” an input-cost effect, that higher energy cost lowers usage of oil which in turn lowers productivity of capital and labor; and an income effect, that higher cost of imported oil reduces disposable income of U.S. households”. (K.Lee, 2002)
According to an editorial in 1973-1974 oil crisis :” Automobile sales, especially for standard and medium-sized cars, began diminishing almost with the first realization that the energy crisis is reality. The trade-in value of big gas-guzzlers toppled unmercifully and some dealers were threatening not to take them in trade at all. Gasoline mileage, not size and comfort suddenly became the paramount concern for the consumer.” (Ward’s Auto World)
K.Lee contrasted to the situation in the petroleum refinery and industrial chemical industries which were bothered by the escalated cost of fuel, research in trade papers proposed considerable indications that the automotive industry distraught by the two fuel price shocks mainly due to the demand for larger vehicles stabbed.The effects of oil price hikes for nearly all other industries are less severe and intricate. The writings in trade journals of rubber, metals and other machinery industries often cited that the major factor of soggy economical activity is the dejected and depressed automotive market, however the highlighted that various sectors of these industries have also gained benefit from augmented economic activity in energy exploration and protection.(K Lee ,2002)
The steel sector was adversely affected by the hunch in automotive sales. According to the Ward’s Auto World, Chemical week and Industry Week magazines, the oil prices crunches lowered the demand for the metals by their effect on automobiles, housing and consumer durables. Globally, the auto mobile assemblers are facing financial crisis at their worst which is eventually leading to recession.In the same way , as Pakistan ‘s Auto Market is an export driven industry which attracts both foreign and locals investments,therefore is facing decreasing sales and production level and depicting a depressing future. Because of the present critical situation prevailing in the automobile sector, many companies are on the threshold of economic failure and bankruptcy.
K Lee discussed that after an oil price shock, demand for vehicles is destabilized in view of the fact that a prospective new car holder may go for other ways of transportation to save the operating expenditure of vehicles, or delay buying a new car because ambiguity about future energy prices makes it difficult to come to a decision which type of automobile to purchase. Increase in Oil price also alters the composition of the automobile demand. As compared to the small-size cars, the demand for full-size cars is much more destabilized. The U.S. auto makers suffered more ruthlessly from rising and falling oil price because they manufacture inconsistently more full-size cars than their overseas competitors.
Hamilton in 1988 mentioned in his writings that the oil crisis stimulate recessions primarily because a sharp increase in oil price escalates ambiguity and elevates operating costs and expenditures of several durable goods, which diminishes demand for durables, venture and investments. (Hamilton 1988, 1999).
Brad M. Barber, Reid W. Click, Masako N. Darrough analyzed and empirically estimated the degree to which exchange rate and oil price alterations have contributed to this market swing. Increase in oil prices diminishes the amount of vehicles sold by the US auto makers, but conversely to the common idea, had minor effect on the Japanese auto mobile makers .That oil price effect reported 6.5 percent of the variance of alteration in monthly sales volume for US automobile manufacturers. They also discussed that productions costs are affected by oil prices hikes. For their research they used VAR to highlight the environmental issues that influence the cost of manufacturing and demand in the automobile industry.
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They clearly account for the effect of oil prices and exchange rates on manufacturing costs and the impact of oil prices and income on the demand for vehicles. Their outcomes suggested that the all the considered macroeconomic variables affected sales volumes as forecasted by the model they used. With reference to oil prices, escalated oil prices have certainly led to turn down in sales by the U.S automobile manufactures.
Hamilton proposed that financial slumps tend to emerge after oil price trends. In particular, the worldwide inflationary strains of 2008 became rigorous with the spikes up in fuel prices shocks in the global financial system including Pakistan. Fuel prices with respect to domestic currency emphasized the fact that the delivering channels of global shocks via exchange rates variations put down major effects on the domestic inflation with in the economy.
According to Hamilton, the variations in oil prices in local currency are inflated and unpredictable in contrast to the variations in prices of oil in dollar terms particularly in 1999 and onwards. This underlines the details that the impacts of external oil price shocks have considerable effect upon local inflation via exchange rate variations in the economy (Hamilton, 2005).
Bresnahan and Ramey discussed that the OPEC oil price shock in US during 1973 had major impact on the U.S auto mobile industry. It amplified the demand for smaller, fuel efficient cars and at the same time condensed the demand for larger cars. As the funds, financial stock and labor force were basically bound for the manufacturing and production of larger cars, therefore the U.S automotive companies were inadequate to respond to this oil price shock. As a result, capacity consumption, utilization and the output cut down during the period of Oil price shock. Only few plants were equipped to produce the small cars, manufacturing and operating at their peak capacity. (Bresnahan and Ramey ,1993).
Steven J. Davis, John Haltiwanger studied the impact of oil price shocks on the creation and devastation of American automobile manufacturing employment from 1972 to 1988. The oil price shock unfavorably had an effect on the proximity between the preferred and actual characteristics of factor contributed in the automobile industry along different dimensions. Firstly, a large amount of the physical resources in the auto industry was devoted to the manufacture of larger cars instead of the smaller ones. Secondly, the American automobile labor had built up proficiency that was skilled and specialized in the manufacture and production of particular car models, and these were likely to be larger vehicle models.
In Pakistan also the increase in oil prices had impact on many enterprises. Many different small to medium Automobile companies in the manufacturing sector are facing a severe threat of downsizing, closures, layoffs and limited production cuts due to an abrupt rise in their cost and expenditures of doing manufacturing and a significant reduction in their car sales. According to the owners of different small automakers, the sales of different auto parts have plunged downwards to 30%-in proportion to the reduction in the car sales. The overall margins have also dropped down.
With reference to the statistics of Pakistan Automotive Manufactures Association, car sales during the period of 2008-09 positioned at 82,844 units, which were declined by 48% from 164,650 units in the 2007-08.
According to Birol and Keppler (2007) the association between mobility, calculated as time spent in movement, and economic output is more stable than the relationship between output and fuel use, partly due to increased possibilities of substitution between the latter. This observation bears an important policy lesson: relative price changes to decrease energy consumption per unit of output are most effective where possibilities for substitution are highest. (Birol, Keppler, 2007)
Storchmann (2005) employed a pooled model to calculate approximate average fuel utilization using various explanatory variables such as, population, private income, urbanization rates, density, oil prices and automobile expenditures. The sales of automobile sector is affected by all these variables.
Thomas Klier and Joshua Linn estimated the impact of the price of gasoline on the demand for fuel efficient vehicles. They institute the idea that gasoline prices considerably influence the new auto market and the price escalations explained almost half of the down turn in market share of U.S auto firms. The outcomes suggested that consumer demand reacts when the price of gasoline increases or rise up during 1970’s and near the beginning of 1980’s. During stable prices in the middle period, the sales had a negligible effect by the prices of gasoline; their results were steady with casual observation of the new auto market.
Hamilton (1988) used a model called sectoral shifts that elucidated how an oil price slog might lower real GDP. The primary propagation method in this model is that an oil price escalation will lower consumer buying power of energy-using commodities such as automobiles.
Goldberg (1998) determined the rebound effect by means of the Consumer Expenditure Survey for the years between 1984-1990, as an ingredient of a bigger equation system that also forecast the effect of oil on automobile sales and prices.
Lutz Kilian in 2007 used Regression analysis to discuss that Automobile purchases were by far the most responsive expenditure item when the oil prices fluctuates. Purchase of other durables goods for instance appliances or furniture; by contrast, are far less responsive to energy price swings. Spending on public transportation and on food at home are few of the expenditure items that privileged from unexpected elevated energy prices.
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.