The market for crude oil is usually a volatile one. Indeed, in the last few months, the market has seen prices rise and fall due to various supply and demand influences. Crude oil is coined the ‘King of Commodities’ due to the impact it has on consumers, producers and both the micro and macro economy. The price of crude oil affects everything from the cost of producing plastics, transportation, and food at the supermarket.
This makes the market for crude oil an economic powerhouse which is closely watched by businesses, traders, and governments. To gain a full understanding of the movements in this market, it is important to identify how demand and supply affect the price of crude oil.
What influences the demand and supply of crude oil?
The law of demand and supply states that if demand increases, prices will rise, and if supply increases, prices will fall. This is exactly what happens in the market for crude oil. The consumer side of the market consists of various companies and hundreds of millions of people. The producer side of the market is made up of oil-producing countries. Collectively, both consumers and producers influence the market price.
However, the demand and supply of crude oil, and therefore the price, is also affected by global economic conditions and geopolitical tensions. What happens in the world impacts the price of oil, especially since a large proportion of the world’s biggest oil producers are in politically unstable areas.
Over the past five years, global events have had a major impact on the price of oil. The economic conditions created by the impact of the COVID pandemic saw prices plummet from around $55 per barrel just before the pandemic in February 2020 to around $15 per barrel in April 2020. By mid-2021 they had recovered to around $75 per barrel. Then, in the aftermath of Russia’s invasion of Ukraine in February 2022, the price surged to reach $133 in June 2022. More recently, geopolitical tensions in the Middle East and concerns about China’s economic outlook have intensified concerns about the future direction of the market. (Click here for a PowerPoint of the chart.)
Geopolitical tensions
In the first week of October 2024, the price of crude oil rose by almost 10% to around $78 per barrel as the conflict in the Middle East intensified. It unfortunately comes at a time when many countries are starting to recover from the rise in oil prices caused by the pandemic and the war in Ukraine. Any increase in prices will affect the price that consumers pay to fill up their vehicles with fuel, just when prices of diesel and petrol had reached their lowest level for three years.
The Governor of the Bank of England, Andrew Bailey, has said that the Bank is monitoring developments in the Middle East ‘extremely closely’, as the conflict has the potential to have serious impacts in the UK. The Bank of England will therefore be watching for any movement in oil prices that could fuel inflation.
The main concerns stem from further escalation in the conflict between Israel and the Iran-backed armed group, Hezbollah, in Lebanon. If Israel decides to attack Iran’s oil sector, this is likely to cause a sharp rise in the price of oil. Iran is the world’s seventh largest oil exporter and exports over half of its production to China. If the oilfields of a medium-sized supplier, like Iran, were attacked, this could threaten general inflation in the UK, which could in turn influence any decision by the Bank of England to lower interest rates next month.
Supply deficits
This week (2nd week of October 2024) saw the price of crude oil surge above $81 per barrel to hit its highest level since August. This rise means that prices increased by 12% in a week. However, this surge in price also means that prices rose by almost 21% between the start September and the start of October alone. Yet it was only in early September when crude oil hit a year-to-date low, highlighting the volatility in the market.
As the Middle-East war enters a new and more energy-related phase, the loss of Iranian oil would leave the market in a supply deficit. The law of supply implies that such a deficit would lead to an increase in prices. This also comes at a time when the US Strategic Petroleum Reserve has also been depleted, causing further concerns about global oil supply.
However, the biggest and most significant impact would be a disruption to flows through the Strait of Hormuz. This is a relatively narrow channel at the east end of the Persian Gulf through which a huge amount of oil tanker traffic passes – about a third of total seaborne-traded oil. It is therefore known as the world’s most important oil transit chokepoint. The risk that escalation could block the Strait of Hormuz could technically see a halt in about a fifth of the world’s oil supply. This would include exports from big Gulf producers, including Saudi Arabia, UAE, Kuwait and Iraq. In a worst-case scenario of a full closure of the Strait, a barrel of oil could very quickly rise to well above $100.
Disruption to shipments would also lead to higher gas prices and therefore lead to a rise in household gas and electricity bills. As with oil, gas prices filter down supply chains, affecting the cost of virtually all goods, resulting in a further rise in the cost of living. With energy bills in the UK having already risen by 10% for this winter, an escalation to the conflict could see prices rise further still.
China’s economic outlook
Despite the concern for the future supply of oil, there is also a need to consider how the demand for oil could impact price changes in the market. The price of oil declined on 14 October 2024 in light of concerns over China’s struggling economy. As China is the world’s largest importer of crude oil, there are emerging fears about the potential limits on fuel demand. This fall in price reversed increases made the previous week as investors become concerned about worsening deflationary pressures in China.
Any reduced demand from China could indicate an oversupply of crude oil and therefore potential price declines. Official data from China reveal a sharp year-on-year drop in the producer price index of 2.8% – the fastest decline in six months. These disappointing results have stirred uncertainty about the Chinese government’s economic stimulus plans. Prices could fall further if there are continuing doubts about the government’s ability to implement effective fiscal measures to promote consumer spending and, in turn, economic growth.
As a result of the 2% price fall in oil prices on 14 October, OPEC (the Organization of the Petroleum Exporting Countries) has lowered its 2024 and 2025 global oil demand growth. This negative news outweighed market concerns over the possibility that an Israeli response to Iran’s missile attack could disrupt oil production.
What is the future for oil prices?
It is expected that the market for oil will remain a volatile one. Indeed, the current uncertainties around the globe only highlight this. It is never a simple task to predict what will happen in a market that is influenced by so many global factors, and the current global landscape only adds to the complexity.
There’s a wide spectrum of predictions about what could come next in the market for crude oil. Given the changes in the first two weeks of October alone, supply and demand factors from separate parts of the globe have made the future of oil prices particularly uncertain. Callum Macpherson, head of commodities at Investec, stated in early October that ‘there is really no way of telling where we will be this time next week’ (see the first BBC News article linked below).
Despite the predominately negative outlook, this is all based on potential scenarios. Caroline Bain, chief commodities economist at Capital Economics suggests that if the ‘worst-case scenario’ of further escalation in the Middle East conflict does not materialise, oil prices are likely to ‘ease back quite quickly’. Even if Iran’s supplies were disrupted, China could turn to Russia for its oil. Bain says that there is ‘more than enough capacity’ globally to cover the gap if Iranian production is lost. However, this does then raise the question of where the loyalty of Saudi Arabia, the world’s second largest oil producer, lies and whether it will increase or restrict further production.
What is certain is that the market for crude oil will continue to be a market that is closely observed. It doesn’t take much change in global activity for prices to move. Therefore, in the current political and macroeconomic environment, the coming weeks and months will be critical in determining oil prices and, in turn, their economic effects.
Articles
- How worried should I be about rising oil prices?
BBC News, Michael Race (4/10/24)
- Interest rates could fall more quickly, hints Bank
BBC News, Dearbail Jordan (3/10/24)
- Oil Prices Eye $100 A Barrel As War Risk Premium Returns
FX Empire, Phil Carr (8/10/24)
- Crude oil futures reverse previous gains following disappointing economic data from China
London Loves Business, Hamza Zraimek (14/10/24)
- Oil falls 2% as OPEC cuts oil demand growth view, China concerns
Reuters, Arathy Somasekhar (14/10/24)
- Could war in the Gulf push oil to $100 a barrel?
The Economist (7/10/24)
- The Commodities Feed: Oil remains volatile
ING Think, Ewa Manthey and Warren Patterson (8/10/24)
- Who and what is driving oil price volatility
FT Alphaville, George Steer (9/10/24)
- Brent crude surges above $80 as conflict and storm spark supply fears
Financial Times, Rafe Uddin and Jamie Smyth (7/10/24)
Questions
- Use a demand and supply diagram to illustrate what has happened to oil prices in the main two scenarios:
(a) Conflict in the Middle East;
(b) Concerns about China’s economic performance.
- How are the price elasticities of demand and supply relevant to the size of any oil price change?
- What policy options do the governments have to deal with the potential of increasing energy prices?
- What are oil futures? What determines oil future prices?
- How does speculation affect oil prices?
On Saturday 31 August, tickets for the much-heralded Oasis reunion tour went on sale through the official retailer, Ticketmaster. When the company sells tickets, the acts or their promoters can choose whether to use a static pricing system, where each type of ticket is sold at a set price until they have all been sold. Or they can use a dynamic pricing system (‘in-demand’ or ‘platinum’ tickets, as Ticketmaster calls them), where there is a starting price quoted, but where prices then rise according to demand. The higher the demand, the more the price is driven up. Acts or their promoters have the option of choosing an upper limit to the price.
Dynamic pricing
The Oasis tickets were sold under the dynamic pricing system, a system previously used for Harry Styles, Bruce Springsteen, Coldplay and Blackpink concerts, but one rejected by Taylor Swift for her recent Eras tour. Standing tickets for the Oasis concert with a face value of around £135 were quickly being sold for over £350. There were long online queues, with the prices rising as people slowly moved up the queue. When they reached the front, they had to decide quickly whether to pay the much higher price. Some people later suffered from buyer’s remorse, when they realised that in the pressure of the moment, they had paid more than they could afford.
Dynamic pricing is when prices change with market conditions: rising at times when demand exceeds supply and falling when supply exceeds demand. It is sometimes referred to as ‘surge pricing’ to reflect situations when price surges in times of excess demand.
Dynamic pricing is a form of price discrimination. It is an imperfect form of first-degree price discrimination, which is defined as people being charged the maximum price they are willing to pay for a product. Pricing in an eBay auction comes close to first-degree price discrimination. With dynamic pricing in the ticket market, some people may indeed pay the maximum, but others earlier in the queue will be lucky and pay less than their maximum.
Ticketmaster justifies the system of dynamic pricing, saying that it gives ‘fans fair and safe access to the tickets, while enabling artists and other people involved in staging live events to price tickets closer to their true market value’. The company argues that if the price is below the market value, a secondary market will then drive ticket prices up. Ticket touts will purchase large amounts of tickets, often using bots to access the official site and then resell them at highly inflated prices on sites such as Viagogo and Stubhub, where ticket prices for popular acts can sell for well over £1000. The day after Oasis tickets went on sale, Viagogo had seats priced at up to £26 000 each!
Oasis and Ticketmaster have tried to stamp out the unofficial secondary market by stating that only tickets bought through the official retailers (Ticketmaster, Gigsandtours and SeeTickets) will be valid. If fans want to resell a ticket – perhaps because they find they can no longer go – they can resell them on the official secondary market though Ticketmaster’s Fan-to-Fan site or Twickets. These official secondary sites allow holders of unwanted tickets to sell them for anything up to the original face value, but no more. Buyers pay a 12% handling fee. It remains to be seen whether this can be enforced with genuine tickets resold on the secondary market.
Examples of dynamic pricing
Dynamic pricing is not a new pricing strategy. It has been used for many years in the transport, e-commerce and hospitality sectors. Airlines, for example, have a pricing model whereby as a flight fills up, so the prices of the seats rise. If you book a seat on a budget airline a long time in advance, you may be able to get it at a very low price. If, on the other hand, you want a seat at the last minute, you may well have to pay a very high price. The price reflects the strength of demand and its price elasticity. The business traveller who needs to travel the next day for a meeting will have a very low price sensitivity and may well be prepared to pay a very high price indeed. Airlines also learn from past behaviour and so some popular routes will start at a higher price. A similar system of dynamic pricing is used with advance train tickets, with the price rising as trains get booked up.
The dynamic pricing system used by airlines and train companies is similar, but not identical, to first-degree price discrimination. The figure below illustrates first-degree price discrimination by showing a company setting the price for a particular product.
Assume initially that it sets a single profit-maximising price. This would be a price of P1, at an output of Q1, where marginal revenue (MR) equals marginal cost (MC). (We assume for simplicity that average and marginal costs are constant.) Total profit will be area 1: i.e. the blue area ((P1 – AC) × Q1). Area 2 represents consumer surplus, with all those consumers who would have been prepared to pay a price above P1, only having to pay P1.
Now assume that the firm uses first-degree price discrimination, selling each unit of the product at the maximum price each consumer is willing to pay. Starting with the consumer only willing to pay a price of P2, the price will go on rising up along the demand with each additional consumer being charged a higher price up to the price where the demand curve meets the vertical axis. In such a case, the firm’s profit would be not just the blue area, but also the green areas 2 and 3. Note that there is no consumer surplus as area 2 is now part of the additional profit to the firm.
Although dynamic pricing by airlines is similar to this model of first-degree price discrimination, in practice some people will be paying less than they would be willing to pay and the price goes up in stages, not continuously with each new sale of a ticket. Thus, compared with a fixed price per seat, the additional profit will be less than areas 2 + 3, but total profit will still be considerably greater than area 1 alone. Note also that there is a maximum quantity of seats (Qmax), represented by a full flight. The airline would hope that demand and its pricing model are such that Qmax is less than Q2.
Dynamic pricing also applies in the hospitality sector, as hotels raise the prices for rooms according to demand, with prices at peak times often being considerably higher than off-season prices. Rather then pre-setting prices for particular seasons, dates or weekends/weekdays, many hotels, especially chains and booking agents, adjust prices dynamically as demand changes. Airbnb offers property owners what it calls ‘Smart Pricing’, where nightly prices change automatically with demand.
Another example is Uber, which uses dynamic pricing to balance demand and supply location by location. In times of peak demand on any route, the company’s algorithm will raise the price. This will encourage people to delay travelling if they can or use alternative means of transport. It will also encourage more Uber drivers to come to that area. In times of low demand, the price will fall. This will encourage more people to use the service (rather than regular taxis or buses) and discourage drivers from working in that area.
Where dynamic pricing varies with the time or date when the purchase is made, it is sometimes referred to as inter-temporal pricing. It is a form of second-degree price discrimination, which is where a firm offers consumers a range of different pricing options for the same or similar products.
Another example of dynamic pricing, which is closer to first-degree price discrimination is the use of sophisticated algorithms and AI by Amazon, allowing it to update the prices of millions of products many times a day according to market conditions. Another is eBay auctions, where the price rises as the end date is reached, according to the willingness to pay of the bidders.
Attitudes to dynamic pricing
Consumers have grown accustomed to dynamic pricing in many industries. People generally accept the pricing model of budget airlines, for example. What makes it acceptable is that most people feel that they can take advantage of early low-priced seats and can compare the current prices on different flights and airlines when making their travel plans. Pricing is transparent. With the Oasis concert, however, there wasn’t the same degree of price transparency. Many people were surprised and dismayed to find that when they got to the front of the online queue, the price had risen dramatically.
People are familiar of dynamic pricing in the context of price cuts to shift unsold stock. Supermarkets putting stickers on products saying ‘reduced for quick sale’ is an example. Another is seasonal sales. What is less acceptable to many consumers is firms putting up prices when demand is high. They see it a profiteering. Many supermarkets are introducing electronic shelf labels (ESLs), where prices can be changed remotely as demand changes. Consumers may react badly to this if they see the prices going up. The supermarket, however, may find it a very convenient way of reducing prices to shift stock – something consumers are hardly likely to complain about.
Returning to the Oasis tour, the UK government responded to the outrage of fans as ticket prices soared. Culture Secretary, Lisa Nandy, announced that the government will investigate how surge pricing for concert tickets is used by official retailers, such as Ticketmaster. This will be part of a planned review of ticket sales that seeks to establish a fairer and more transparent system of pricing.
The problem is that, with some fans being prepared to pay very high prices indeed to see particular acts and with demand considerably exceeding supply at prices that fans would consider reasonable, some way needs to be found of rationing demand. If it is not price, then it will inevitably involve some form of queuing or rationing system, with the danger that this encourages touts and vastly inflated prices on the secondary market.
Perhaps a lesson can be drawn from the Glastonbury Festival, where prices are fixed, people queue online and where security systems are in place to prevent secondary sales by ticket touts. The 2024 price was set at £355 + a £5 booking fee and purchasers were required to register with personal details and a photo, which was checked on admission.
Update
On 5 September, the CMA announced that it was launching an investigation into Ticketmaster over the Oasis concert sales. Its concerns centred on ‘whether buyers were given clear and timely information, and whether consumer protection law was breached’. This followed complaints by fans that (i) they were not given clear and timely information beforehand that the tickets involved dynamic pricing and warned about the possible prices they might have to pay and (ii) on reaching the front of the queue they were put under pressure to buy tickets within a short period of time.
Meanwhile, band member stated that they were unaware that dynamic pricing would be used and that the decision to use the system was made by their management.
Videos
Articles
- Oasis ticket sales – everything you need to know about reunion
BBC News (27/8/24)
- Ticketmaster demand-based pricing system criticised
BBC News, Annabel Rackham (10/10/22)
- I loved Oasis – until I saw Ticketmaster’s dynamic pricing
Metro, Issy Packer (2/9/24)
- A supersonic swindle: my £1,423 Oasis Ticketmaster hell
The Guardian, Josh Halliday (1/9/24)
- Bands urged to oppose dynamic pricing of concert tickets after Oasis ‘fiasco’
The Guardian, Josh Halliday and Rob Davies (1/9/24)
- Oasis tickets: what is dynamic pricing and why is it used for live music?
The Guardian, Rob Davies (1/9/24)
- Viagogo defends reselling Oasis tickets for thousands of pounds as ‘legal’
City A.M. (31/8/24)
- Oasis fans face ‘eye-watering’ resale ticket prices
i News, Adam Sherwin (30/8/240
- Would you really pay €500 for an Oasis ticket?
RTE Brainstorm, Emma Howard (3/9/24)
- When ‘dynamic pricing’ works – and when it doesn’t
Investors’ Chronicle, Hermione Taylor (11/12/23)
- The pros, cons and misconceptions of dynamic pricing for retailers
Computer Weekly, Glynn Davis (20/6/24)
- Dynamic Pricing (Taylor’s Version)
Linkedin, Economic Insight (10/7/23)
- Dynamic pricing: successful companies that use this pricing strategy
PriceTweakers, Simon Gomez (25/5/24)
- Five lessons for businesses investigating dynamic pricing
FT Strategies
- Inflated Oasis ticket prices ‘depressing’ – government promises review of dynamic pricing
Sky News (2/9/24)
- Lisa Nandy hits out at ‘incredibly depressing’ Oasis ticket sale and orders probe into surge pricing
Independent, Archie Mitchell (2/9/24)
- Oasis ticket row: How Ticketmaster’s owner has grip on UK live music scene
BBC News, Chi Chi Izundu and James Stewart (4/9/24)
- CMA launches investigation into Ticketmaster over Oasis concert sales
CMA Press Release (5/9/24)
- Revealed: the touts offering Oasis tickets for thousands on resale sites
The Guardian, Rob Davies, Hannah Al-Othman and Tiago Rogero (7/9/24)
Questions
- What is the difference between dynamic pricing and surge pricing?
- What is buyer’s remorse? How could dynamic pricing be used while minimising the likelihood of buyer’s remorse?
- Distinguish between first-degree, second-degree and third-degree price discrimination. Do the various forms of dynamic pricing correspond to one or more of these three types?
- Distinguish between consumer and producer surplus. How may dynamic pricing lead to a reduction in consumer surplus and an increase in producer surplus?
- Should Ticketmaster sell tickets on the same basis as tickets for the Glastonbury Festival?
- Is Oasis a monopoly? What are the ticket pricing implications?
- Are there any industries where firms would not benefit from dynamic pricing? Explain.
- What are the arguments for and against allowing tickets to be sold on the secondary market for whatever price they will fetch?
- How powerful is Ticketmaster in the primary and secondary ticket markets?
Coffee prices have been soaring in recent months. This applies to the prices of both coffee beans on international markets, coffee in supermarkets and coffee in coffee shops. In this blog we examine the causes and what is likely to happen over the coming months.
As we shall see, demand and supply analysis provides a powerful explanation of what has been happening in the various sectors of the industry and the likely future path of prices.
The coffee industry
The cultivating, processing and retailing of coffee is big business. It is the second most widely traded commodity after oil and around 2.5 billion cups are consumed worldwide on a daily basis. In the UK nearly 100 million cups of coffee a day are drunk, with coffee consumers spending around £4 billion per year on sit-down and takeaway coffees and on coffee bought in supermarkets and other shops for making at home. The average takeaway coffee costs around £3.40 per cup with speciality coffees costing more.
Global production in the coffee year 2023/24 was 178 million 60 kg bags (10.7 million tonnes) and the annual income of the whole sector exceeds $200 billion. Around 25 million farmers spread across 50 countries harvest coffee. The majority of these farms are small and family run. Some 100 million families worldwide depend on coffee for their living.
Brazil is by far the biggest producer and accounts for nearly 40% of the market. A good or poor harvest in Brazil can have a significant impact on prices. Vietnam and Columbia are the second and third biggest producers respectively and, with Brazil, account for over 60% of global production.
Coffee prices are extremely volatile – more so than production, which does, nevertheless, fluctuate with the harvest. Figure 1 shows global coffee production and prices since 1996. The price is the International Coffee Organization’s composite indicator price (I-CIP) in US cents per pound (lb). It is a weighted average of four prices: Colombian milds (Arabica), Other milds (Arabica), Brazilian naturals (mainly Arabica) and Robusta. Production is measured in 60 kilo bags.
Case Study 2.3 on the student website for Economics 11th edition, looks at the various events that caused the fluctuations in prices and supply illustrated in Figure 1 (click here for a PowerPoint). In this blog we focus on recent events.
Why are coffee prices rising?
In early October 2023, the ICO composite indicator price (I-CIP), was $1.46 per lb. By 28 August, it had reached $2.54 – a rise of 74%. Colombian milds (high-quality Arabica) had risen from $1.79 per lb to $2.78 – a rise of 55%. Robusta coffee is normally cheaper than Arabica. It is mainly used in instant coffee and for espressos. As the price of Arabica rose, so there was some substitution, with Robusta coffees being added to blends. But as this process took place, so the gap between the Arabica and Robusta prices narrowed. Robusta prices rose from $1.14 in early October 2023 to £2.36 in late August – a rise of 107%. These prices are illustrated in Figure 2 (click here for a PowerPoint).
This dramatic rise in prices is the result of a number of factors.
Supply-side factors. The first is poor harvests, which will affect future supply. Frosts in Brazil have affected Arabica production. Also, droughts – partly the result of climate change – have affected harvests in major Robusta-producing countries, such as Vietnam and Indonesia. With the extra demand from the substitution for Arabica, this has pushed up Robusta prices as shown in Figure 2. Another supply-side issue concerns the increasingly vulnerability of coffee crops to diseases, such as coffee rust, and pests. Both reduce yields and quality.
As prices have risen, so this has led to speculative buying of coffee futures by hedge funds and coffee companies. This has driven up futures prices, which will then have a knock-on effect on spot (current) prices as roasters attempt to build coffee stocks to beat the higher prices.
There have also been supply-chain problems. Attacks on shipping by Houthi rebels in the Red Sea have forced ships to take the longer route around the Cape of Good Hope. Again, this has particularly affected the supply of Robusta, largely grown in Asia and East Africa.
New EU regulation banning the import of coffee grown in areas of cleared rainforest will further reduce supply when it comes into force in 2025, or at least divert it away from the EU – a major coffee-consuming region.
Demand-side factors. On the demand side, the rise of the coffee culture and a switch in demand from tea to coffee has led to a steady growth in demand. Growth in the coffee culture has been particularly high in Asian markets as rapid urbanistion, a growing middle class and changing lifestyles drive greater coffee consumption and greater use of coffee shops. This has more than offset a slight decline in coffee shop sales in the USA. In the UK, the number of coffee shops has risen steadily. In 2023, there were 3000 cafés, coffee chains and other venues serving coffee, of which 9885 were branded coffee shop outlets, such as Costa, Caffè Nero and Starbucks. Sales in such coffee chains rose by 11.9% in 2023. Similar patterns can be observed in other countries, all helping to drive a rise in demand.
But although demand for coffee in coffee shops is growing, the rise in the price of coffee beans should have only a modest effect on the price of a cup of coffee. The cost of coffee beans purchased by a coffee shop accounts for only around 10% of the price of a cup. To take account of the costs to the supplier (roasting, distribution costs, overheads, etc), this price paid by the coffee shop/chain is some 5 times the cost of unroasted coffee beans on international markets. In other words, the international price of coffee beans accounts for only around 2% of the cost of a cup of coffee in a coffee shop.
Higher coffee-shop prices are thus mainly the result of other factors. These include roasting and other supplier costs, rising wages, rents, business rates, other ingredients such as milk and sugar, coffee machines, takeaway cups, heating, lighting, repairs and maintenance and profit. The high inflation over the past two years, with several of these costs being particularly affected, has been the major driver of price increases in coffee shops.
The future
The rise in demand and prices over the years has led to an increase in supply as more coffee bushes are planted. As Figure 1 shows, world supply increased from 87 million in 1995/6 to 178 million 60 kilo bags in 2023/4 – a rise of 105%. The current high prices may stimulate farmers to plant more. But as it can take four years for coffee plants to reach maturity, it may take time for supply to respond. Later on, a glut might even develop! This would be a case of the famous cobweb model (see Case Study 3.13 on the Essentials of Economics 9th edition student website).
Nevertheless, climate change is making coffee production more vulnerable and demand is likely to continue to outstrip supply. Much of the land currently used to produce Arabica will no longer be suitable in a couple of decades. New strains of bean may be developed that are more hardy, such as variants of the more robust Robusta beans. Whether this will allow supply to keep up with demand remains to be seen.
Articles
- Even more expensive coffee prices are brewing, but there are some good reasons why
The Conversation, Jonathan Morris (31/7/24)
- Coffee is becoming a luxury, and there’s no escaping it
AccuWeather, Erika Tulfo (1/8/24)
- Coffee prices will rise even higher, says Giuseppe Lavazza
The Guardian, Jonathan Yeboah (9/7/24)
- Coffee prices set to rise even higher, warns Italian roaster Lavazza
Financial Times, Susannah Savage (9/7/24)
- Soaring coffee prices force roasters to add lower-cost beans to blends
Financial Times, Susannah Savage (24/8/24)
- Soaring coffee prices foretell a financial grind
Reuters, Robert Cyran (31/8/24)
- Projected Coffee Price Increase Due to Supply Shortages and Rising Demand
ISN Magazine: International Supermarket News (14/8/24)
- Coffee Market Report
International Coffee Organization (July 2024)
- Strengthening global robusta production: an update
World Coffee Research: News (4/12/23)
- Houthi rebels and the EU make your coffee more expensive
Politico, Carlo Martuscelli (13/8/24)
Data
Questions
- Use a demand and supply diagram to compare the coffee market in August 2024 with that in October 2023.
- How is the price elasticity of demand relevant to determining the size of price fluctuations in response to fluctuations in the supply of coffee? Demonstrate this with a supply and demand diagram.
- How has speculation affected coffee prices?
- What are ‘coffee futures’? How do futures prices relate to spot prices?
- What is likely to happen to coffee prices in the coming months? Explain.
- Why have Robusta prices risen by a larger percentage than Arabica prices? Is this trend likely to continue?
- Look at the price of Colombian Arabica coffee in your local supermarket. Work out what the price would be per lb and convert it to US dollars. How does this retail price compare with the current international price for Colombian milds and what accounts for the difference? (For current information on Colombian milds, see the third data link above.)
- Distinguish between the fixed and variable costs of an independent coffee shop. How should the coffee shop set its prices in relation to these costs and to demand?
The UK Competition and Markets Authority (CMA) has been investigating road fuel pricing in the UK. In July 2022, it launched a study into the development of the road-fuel market over recent years. The final report of this study was published in July 2023 and covered the refining, wholesale and retail elements of the market.
In the retail part of the market, the CMA noted some potential causes for concern: retailer fuel margins had increased; there were geographical variations in pricing; filling stations with fewer competitors tended to charge higher prices; retail prices tended to rise rapidly when oil prices increased but fell slowly when oil prices fell (known as ‘rocket and feather’ pricing patterns); motorway service stations charged considerably higher prices than supermarkets or other filling stations.
In response to these findings, the CMA has been publishing an interim report every four months. These reports give average pump prices and margins. They also give relative average pump prices between different types of retailer, and between each of the supermarkets.
The latest interim report was published on 26 July 2024. It reiterated the finding of the 2023 report that the fuel market has become less competitive since 2019. What is more, it continues to be so. In particular, the range of retail prices and the level of retail margins remain high compared to historic levels. The interim report estimates that ‘the increase in retailers’ fuel margins compared to 2019 resulted in increased fuel costs for drivers in 2023 of over £1.6bn’.
Price leadership
Road fuel retailing is an oligopoly, with the major companies being the big supermarkets, the retail arms of oil companies (such as Shell, BP, Esso and Texaco, operating their own filling stations) and a few large specialist companies, such as the Motor Fuel Group (MFG), the EG Group and Rontec, whose filling stations sell one or other of the main brands. But although it is an oligopoly producing a homogeneous product, it is not a cartel (unlike OPEC). Nevertheless, there has been a high degree of tacit collusion in the market with price competition limited to certain rules of behaviour in particular locations. A familiar one is setting prices ending in .9 of a penny (e.g. 142.9p), with the acceptance by competitors that Applegreen will set it ending at .8 of a penny and Asda at .7 of a penny.
One of the main forms of tacit collusion in areas where there are several filling stations is that of price leadership. Asda, and in some areas Morrisons, have been price leaders, setting the lowest price for that area, with other filling stations setting the price at or slightly above that level (e.g. 0.2p, 1.2p or 2.2p higher). Indeed, other major retailers, such as Tesco, Sainsbury’s, Esso and Shell took a relatively passive approach to pricing, unwilling to undercut Asda and accept lower profit margins.
Things changed after 2019. Asda chose to increase its profit margins. In 2022 it did this by reducing prices more slowly than would previously have been the case as wholesale prices fell. In other words, it used price feathering. Other big retailers might have been expected to use the opportunity to undercut Asda. Instead, they decided to increase their own margins by following a similar pricing path. The result was a 6 pence per litre increase in the average supermarket fuel margin from 2019 to 2022.
More recently, Asda has increased its margins more than other major retailers, making it no longer the price leader. The effect has been to put less pressure on other retailers to trim their now higher profit margins.
Remedies
The 2023 CMA report made two specific recommendations to deal with this rise in profit margins.
The first was that the CMA should be given a statutory monitoring function over the fuel market to ‘hold the industry to account’. In May this year, legislation was passed to this effect. This requires the CMA to monitor the industry and report anti-competitive practice to the government.
The second was to introduce a new statutory ‘open data real-time fuel finder scheme’. This would give motorists access to live, station-by-station fuel prices.
Several major retailers already contribute to a voluntary price data sharing scheme. However, this covers only around 40% of UK forecourts. According to the CMA, it ‘falls well short of the comprehensive, real-time, station-by station data needed to empower motorists and drive competition’. The CMA has thus called on the new Labour government to introduce legislation to make its recommended system compulsory. This, it is hoped, would make the retail fuel market much more competitive by improving consumer information about prices at alternative filling stations in their area.
Articles
CMA reports
Questions
- What forms can tacit collusion take?
- Why are fuel prices at motorway service stations so much higher than in towns? What is the relevance of the price elasticity of demand to the answer?
- What are the main findings of the CMA’s July 2024 Interim Report
- What is meant by rocket and feather pricing?
- What recommendations does the CMA make for increasing competition in the retail road fuel market?
- Find out how competitive retail fuel pricing is in two other developed countries. Why are they more or less competitive than the UK?
Prices of used fully electric cars (EVs) are falling in the UK, even though prices of used internal combustion engine (ICE) cars are rising. According to Auto Trader (see the first two articles below), in February 2023 the average price of used petrol cars rose by 3.3% compared with January and the price of used diesel cars rose by 1.4%. But the price of used EVs fell by 9.1%. This follows a fall of 2.1% in January.
But why are used EV prices falling? After all, the last few years has seen a drive to replace ICEs with EVs and hybrids, with many consumers preferring electric cars to petrol and diesel ones. What is more, vehicle excise duty is currently zero for EVs (and will be until 2025) and the sale of new ICEs will be banned from the end of the decade. The answer lies in demand and supply.
On the demand side, many existing and potential EV owners worry about the charging infrastructure. The number of EVs has grown more rapidly than the number of charging points. In 2020 there was one charging point per 16 cars; by 2022 this had worsened to one per 30 cars. Also the distribution of charging points is patchy and there is a lack of rapid and ultra-rapid chargers. Increasingly, people have to queue for access to a charger and this can substantially delay a journey and could mean missed appointments. There were many pictures in the media around Christmas of long queues for chargers at service stations and supermarkets. Poor charging infrastructure can be more of a problem for second-hand EVs, which tend to have a smaller range.
Also on the demand side is the price of fuel. After the Russian invasion of Ukraine and the rise in oil prices, the price of petrol and diesel soared. This increased the cost of running ICE vehicles and boosted the demand for EVs. But the war also drove up the price of natural gas and this price largely determines the wholesale price of electricity. With government subsidies for electricity, this constrained the rise in electricity prices. This made running an EV for a time comparatively cheaper. 
More recently, the price of oil has fallen and with it the price of petrol and diesel. But electricity prices are set to rise in April as government subsidies cease. The cost advantage of running an electric car is likely to disappear, or at least substantially decline.
Another substitute for second-hand EVs is new EVs. As the range of new EVs increases, then anyone thinking about buying an EV may be more tempted to buy a new one rather than a used one. Such demand has also been driven by Tesla’s decision to cut the UK prices of many of it models by between 10% and 13%.
The fall in demand for used EVs is compounded, at least in the short term, by speculation. People thinking of trading in their ICE or hybrid car for a fully electric one are likely to wait if they see prices falling. Why buy now if, by waiting, you could get the same model cheaper?
On the supply side, EV owners, faced with the infrastructure problems outlined above, are likely to sell their EV and buy an ICE or hybrid one instead. This increases the supply of used EVs. This is again compounded by speculation as people thinking of selling their EV do so as quickly as possible before price falls further.
In many other countries, there is much more rapid investment in charging infrastructure and/or subsidies for purchasing not only new but used EVs. This has prevented or limited the fall in price of used EVs.
Articles
- Auto Trader diagnoses used car sector’s ‘robust health’ after February value rise
AM-online, Tom Sharpe (20/2/23)
- Auto Trader: Used car prices UP AGAIN in February but EV prices continue to tumble
Car Dealer, James Baggott (20/2/23)
- Used electric car prices caught in vicious downward cycle as experts warn of trouble ahead
Car Dealer, James Baggott (13/2/23)
- Used EV market needs more support in Spring Budget, says Vehicle Remarketing Association
Car Dealer, Jack Williams (15/2/23)
- Middle classes cannot afford electric cars, warns Vauxhall owner
The Telegraph, Howard Mustoe (23/2/23)
- British drivers are hurtling towards the electric car cliff edge
The Telegraph on msn, Ben Marlow (23/2/23)
- Cars Drivers should be ‘cautious’ when buying a used EV before 2030 car ban – ‘still an issue!’
Express, Felix Reeves (12/2/23)
- Motorpoint revenues accelerate but dealership group issues profit warning as used electric car prices crash
This is Money, Camilla Canocchi (27/1/23)
- Tesla cuts prices by up to a fifth to boost demand
BBC News, Lucy Hooker (13/1/23)
Questions
- Draw a supply and demand diagram to illustrate what has been happening in the market for used EVs.
- How has the price elasticity of (a) demand and (b) supply affected the amount by which used EV prices have fallen?
- Identify substitutes and complements for used electric vehicles. How relevant is the cross-price elasticity of demand for these complements and substitutes in determining price changes of used EVs?
- Draw a diagram to illustrate the effect of speculation on used EV prices.
- What is likely to happen to used EV prices in the months ahead? Explain.
- How are externalities in car usage relevant to government action to influence the market for EVs? What should determine the size of this intervention?
- Devise a short survey for people thinking of buying an EV to determine the factors that are likely to affect their decision to buy one and, if so, whether to buy a new or used one.
