From early January to late February 2013, the average pump price of petrol in the UK rose by over 6p per litre – a rise of 4.7% in just seven weeks. There have also been substantial rises in the price of diesel.
The higher prices reflect a rise in the dollar wholesale price of oil and a depreciation in the pound. From 2 January to 21 February the pound fell from $1.63 to $1.53 – a depreciation of 6.1% (see). Crude oil prices (in dollars) rose by just under 7% over this period. With oil imports priced in dollars, a weaker pound pushes up the price of oil in the UK. The price has then been pushed up even higher by speculation, fuelled by the belief that prices have further to rise.
The higher price of road fuel, plus the general squeeze on living standards from the recession, with prices rising faster than wages, has caused a reduction in the consumption of road fuel. Petrol sales have fallen to their lowest level for 23 years. Sales in January 2013 were 99m litres down on the previous month’s sales of 1564m litres (a fall of 6.3%).
Not surprisingly motorists’ groups have called for a reduction in fuel taxes to ease the burden on motorists. They also argue that this will help to drive recovery in the economy by leaving people with more money in their pockets.
Equally not surprisingly, those concerned about the environment have welcomed the reduction in traffic, as have some motorists who like the quieter roads, allowing journey times to be cut, with resulting reductions in fuel consumption per mile.
The following videos and articles discuss the causes of the most recent fuel price rises and also examine the responsiveness of demand to these higher prices and to the reductions in real incomes.
Webcasts
Rising petrol prices are ‘forcing drivers off the road’ BBC News, Richard Westcott (22/2/13)
Fuel prices ‘forcing drivers off road’ – AA BBC News (22/2/13)
Fuel Prices Head For Highest Level Ever Sky News (22/2/13)
Commodities Next Week: Fuel Prices Hit Fresh 2013 Highs CNBC (22/2/13)
Ministers to blame for high fuel prices, says competition watchdog The Telegraph, Peter Dominiczak (30/1/13)
Articles
Petrol price surge adds 6.24p to a litre in a month The Guardian (22/2/13)
Petrol prices set for record highs as speculators and weak pound drive up pump costs again This is Money (22/2/13)
How are motorists saving fuel? NNC Magazine, Tom Geoghegan (9/3/11)
AA Report
Fuel Price Report (February 2013)
Data
Weekly road fuel prices Department of Energy and Climate Change
Energy consumption in the UK Department of Energy and Climate Change
Oil and oil products: section 3, Energy Trends Department of Energy and Climate Change
Europe Brent Spot Price FOB (Dollars per Barrel) US Energy Information Administration
Crude Oil (petroleum), Price index Monthly Price – Index Number Index Mundi
Questions
- Is it possible to calculate the price elasticity of demand for petrol from the data given? Try making the calculation.
- How important is the ceteris paribus (other things being equal) assumption when calculating the price elasticity of demand for petrol?
- Why is the long-run price elasticity of demand for road fuel likely to different from the short-run price elasticity?
- If wholesale oil prices go up by x%, will prices at the pumps go up by approximately x% or by more or less then x%? Similarly, if the pound depreciates by y% would you expect prices at the pumps go up by approximately y% or by more or less then y%? Explain.
- How has speculation affected fuel prices? Is this effect likely to persist? Explain.
- Under what circumstances would a reduction in road fuel taxes help to drive the recovery? Are such circumstances likely?
- Which groups in society suffer most from higher fuel prices? Is this reflected in their price elasticity of demand and if so why?
- Is a rise in fuel prices above inflation likely to increase or decrease inequality in living standards? Explain.
- Should externalities from fuel consumption and production be taken into account when setting the duty on petrol and diesel and, if so, what would be the implication for prices?
Oil prices have been falling in recent months. By early June they had reached a 17-month low. The benchmark US crude price (the West Texas Intermediate price) fell to $83.2 at the beginning of the month, and Brent Crude (the North Sea reference price for refining into petrol) fell to $97.7 (see chart). (For a PowerPoint of the chart below, click here.)
At the same time various commodity prices have also been falling. The IMF all commodities price index has fallen by 7.2% over the past 12 months and by 6.2% in May alone. Some commodities have fallen much faster. In the 12 months to May 2012, natural gas fell by 44%, wheat by 25%, lamb by 37%, Arabica coffee by 36%, coconut oil by 45%, cotton by 47%, iron ore by 23% and tin by 29%.
Although part of the reason for the fall in the price of some commodities is increased supply, the main reason is weak world demand. And with continuing problems in the eurozone and a slowdown in China and the USA, commodity price weakness is likely to continue.
So is this good news? To the extent that commodity prices feed through into consumer prices and impact on the rate of inflation, then this is good news. As inflation falls, so central banks will be encouraged to make further cuts in interest rates (in the cases where they are not already at a minimum). For example, the Reserve Bank of Australia cut its cash rate last week from 3.75% to 3.5%. This follows on from a cut from 4.25% on 1 May. In cases where there is no further scope for interest rate cuts (e.g. the US Federal Reserve Bank, whose interest rate is between 0% and 0.25%), then the fall in inflation may encourage a further round of quantitative easing.
But falling commodity prices are also a reflection of bad news, namely the low economic growth of the world economy and fears of turmoil from a possible Greek exit from the euro.
Update
A day after this was written (9/6/12), a deal was agreed between eurozone ministers to provide support of up to €100 billion for Spanish banks. This helped to reduce pessimism about the world economy, at least temporarily. Stock markets rose and so too did oil prices, by around 1%. But if pessimism increases again, then the fall is likely to resume.
Articles
Oil prices hit a 17-month low on China slowdown fears BBC News (8/6/12)
Oil gives up gains without signs of Fed move BloombergBusinessweek, Sandy Shore (7/6/12)
Oil Heads for Longest Run of Weekly Losses in More Than 13 Years BloombergBusinessweek, (8/6/12)
Gold plunges as Bernanke gives no hint of stimulus Live5News(7/6/12)
Oil Price Tumbles Below $83 on Weak Economy Money News(8/6/12)
World food price index expected to fall for May Reuters(6/6/12)
Oil price losing streak continues Guardian, Julia Kollewe (8/6/12)
Data
Spot fuel prices US Energy Information Administration
Commodity Prices Index Mundi
Crude Oil Price Index Index Mundi
Questions
- Why have crude oil prices fallen to their lowest level for 17 months?
- How can the concepts of income elasticity of demand, price elasticity of supply and price elasticity of demand help to explain the magnitude of the fall in crude oil prices?
- Would a fall in inflation linked to a fall in commodity prices be a fall in cost-push or demand-pull inflation? Explain.
- What are the macroeconomic implications of the fall in crude oil prices?
- What factors are likely to have significant impact on crude oil prices in the coming months
- Why is it difficult to predict crude oil prices over the coming months?
Fuel prices at German petrol stations fluctuate wildly – by up to €0.14 per day. They are also often changed several times per day. In morning rush hours, when demand is less elastic, prices may shoot up, only to drop again once people are at work.
But is this a sign of healthy competition? Critics claim the opposite: that it’s a sign of the oligopoly power of the oil companies. More than two-thirds of Germany’s petrol stations are franchises of five big oil companies: BP/Aral, Esso, Jet, Shell and Total. These five companies directly control the prices at the pumps. According to the Der Spiegel article below, oil companies:
have sophisticated computer systems that allow them to precisely control, right down to the minute, when they increase their prices nationwide, and by how many cents. The prices are not set by the individual franchise holders. Instead, they are centrally controlled – for example, in the town of Bochum, at the headquarters of Aral, a BP subsidiary that is the market leader in Germany.
The price manager merely presses a button and price signs immediately change at all 2,391 Aral service stations in Germany. All filling stations are electronically linked with Bochum via a dedicated network called Rosi. After each price increase, they watch closely to see how the competition reacts and whether they follow suit.
… If the competitor’s prices are significantly cheaper, the Aral franchise holder can, with the help of Rosi, apply for permission to reduce the prices again.
Not only do the oil companies control the prices at the pumps, but they observe closely, via their franchise holders, the actions of their rivals, and then respond in ways which critics claim is collusive rather than competitive. The problem has become worse with the introduction of incentives to the franchise owners of additional commission if they exceed the price of their competitors within the local area. This has the effect of ratcheting prices up.
The sophisticated pricing strategies, with prices adjusted frequently according to price elasticity of demand, are making it very hard for independent operators to compete.
In response, the German Cartel Office has launched an investigation into the oil companies and in particular into the issues of collusion and frequent price changes and how these impact on independent operators.
German anti-trust authority probes alleged fuel cartel Deutsche Welle (4/4/12)
German antitrust watchdog to probe oil majors-paper Reuters, Ludwig Burger (3/4/12)
Oil giants probed over claims they rigged petrol prices in Germany The Telegraph, Nathalie Thomas (4/4/12)
BP, Exxon, Esso, Jet, Shell and Total in Germany Price Fix Probe International Business Times (9/4/12)
German cartel office probes petrol company pricing MarketWatch (4/4/12)
Kartellverfahren gegen fünf Mineralölkonzerne (in German) Frankfurter Allgemeine Zeitung, Helmut Bünder and Manfred Schäfers (4/4/12)
Crazy gas prices driving German consumers mad msnbc, Andy Eckardt (3/4/12)
Big Oil’s Strategy for Jacking Up Gas Prices Der Spiegel, Alexander Jung and Alexander Neubacher (5/4/12)
Questions
- What the features of the German road fuel oligopoly?
- Why does the price elasticity of demand for petrol and diesel vary with the time of day? Is it likely to vary from one week to another and, if so, why?
- In what ways have the actions of the big five oil companies been against the interests of the independent petrol station operators?
- Consider the alternatives open to the German Federal Cartel Office for making the market more competitive.
- Would it be a good idea for the big five German companies to be forced to adopt the Western Australian system of price changes?
Whilst perhaps not an essential in the sense of needing it to live, petrol is about as close as you can get to a ‘non-essential necessity’ these days. Most families have a car (many have more than one) and despite the hikes in petrol prices we’ve seen across the UK, demand for petrol has remained high: it is a prime example of a good with a highly inelastic demand.
Over the past few years many families have chosen to forego their holidays abroad and instead have taken to summer vacations across the UK in a bid to save money. However, with the summer season approaching and families beginning to think about where to go or plan their trips, one thing that should be considered is the cost of travel. Petrol prices across Europe have risen faster than those in the UK over the past year and this may pose a significant cost and possibly deterrent to European travel. As Sarah Munro of the Post Office said:
‘The high fuel price increases in Europe mean that UK holidaymakers should plan their routes carefully in advance to cut costs’.
Petrol prices were found to be the lowest in Luxembourg at 128p per litre and the highest in Norway at 182p – a definite deterrent to filling up your tank in Scandinavia. Despite motorists’ constant exclamations of the price of petrol in the UK, of the 14 countries surveyed the UK came in as the 4th cheapest at 136p. It also had the smallest increase since 2010 of 14p, compared to the average of the countries surveyed of 27.8p.
Although the higher fuel prices have been fuelled (no pun intended) by rising wholesale oil prices, when crude prices started to fall, petrol prices didn’t decline to match. This has sparked an inquiry into petrol prices, with demands for more transparency into the price setting behaviour of firms. The British Petrol Retailers’ Association is planning on referring its concerns to the Office of Fair Trading. So the moral of the story: petrol prices are high in the UK, but if you’re going on holiday this summer, you’ll probably find that many other countries across Europe have even higher prices, so planning is essential.
Holiday hike: European petrol prices soar by up to 35 per cent Daily Mail Online, Sarah Gordon (10/6/11)
UK holidaymakers ‘face high petrol prices’ BBC News (10/6/11)
Petrol prices are 35% higher in Europe than last summer Mirror, Ruki Sayid (10/6/11)
Motoring coalition calls on EU to investigate soaring price of petrol Telegraph, Rowena Mason (10/6/11)
Motoring groups demand petrol price investigation BBC News (30/5/11)
Questions
- How are European petrol prices set?
- Why does the exchange rate against the dollar have a big impact on oil prices?
- Why have petrol prices in the UK not increased by as much as other European countries over the past year?
- Why is there likely to be an investigation into how prices are set? Which factors do you think will be considered?
- The Telegraph article talks about the sport market. What is this and how does it affect how petrol prices are set?
- Why does petrol have such inelastic demand?
- If a higher tax is imposed on petrol, why is it that much of the cost will be passed on to consumers in the form of a higher price? Illustrate this on a diagram.
The snow the UK has seen over the past two winters created massive disruption, but that is only one reason for hoping for a milder winter to come. With the cold weather, the UK economy faced threats of gas shortages, as households turned on their heating. However, despite the freezing temperatures, many households were forced to turn off their heating regularly, due to the excessive bills they would face. This trend is expected to be even more prevalent if the 2011/12 winter is as cold, as fuel tariffs are predicted to rise. The Bank of England has said that gas and electricity prices could rise this year by 15% and 10% respectively. British Gas’s Parent company, Centrica said:
“In the UK the forward wholesale prices of gas and power for delivery in winter 2011/12 are currently around 25% higher than prices last winter, with end-user prices yet to reflect this higher wholesale market price environment.”
These predictions might see the average UK household paying an extra £148 over the next year. Although these are only estimates, we are still very likely to see many households being forced to turn off their heating. One thing which therefore is certain: a warmer winter would be much appreciated!
Articles
Switch energy tariff to help beat bill rises Guardian, Miles Brignall (14/5/11)
Quarter of households predicted to turn off heating BBC News, Brian Milligan (14/5/11)
Power bills set to soar by 50% in four years Scotsman (14/5/11)
Domestic fuel bills poised to rise by up to £200 Financial Times, Elaine Moore (13/5/11)
Data
Energy price statistics Department of Energy & Climate Change
Energy statistics publications Department of Energy & Climate Change
Questions
- Which factors have contributed to rising energy prices? Illustrate these changes on a demand and supply diagram.
- To what extent do these higher prices contribute to rising inflation?
- What impact might these price rises have on (a) poverty and (b) real income distribution in the UK?
- Why are energy prices currently being investigated by Ofgem? What powers does the regulator have and what actions could be taken?
