Petrol price rip off

Ever wondered why petrol is so expensive and fluctuates in price so often? We examine the real reasons behind pump prices.

The average price of unleaded petrol rose 0.1 of a cent to $151.7 last week, a three and a half year high, according to data from the Australian Institute of Petroleum.

Have you ever wondered why the price of petrol rises and falls and have you ever had a sense of unease about how it all works? The following was written earlier in the year but it is still as valid in April as it was in March.

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Recently, unleaded petrol in my local service station was $1.42 per litre. I began to wonder what makes up this price. Why does it vary and how is it connected to the wider world? And just why is it that the price of petrol shoots up just before long weekends and holidays?

I am not sure about your household but while our Holden Astra is pretty frugal we are still hyper aware of the price of petrol. But being honest about it, when I pay the cashier it’s not like I’ve really known what I am buying at a gut level. A kilo of potatoes yes, I generally know its journey, just like bread, bananas or the paper I read. But with the price of petrol being a bit of a mystery I thought I do a little bit of research..

But when I started researching this article I could not put it down. At 4 this morning, the laptop battery almost flat I finished the last sentence and crawled off to bed, more informed but more uneasy in a way that I had not expected.

I had soon discovered that to understand how we get a local pump price, we have to start looking further North, to Singapore, Malaysia and beyond.

Oil is a bulk commodity that is fundamentally difficult to extract, transport and process. Which is why the price of oil, quoted on the evening news, is generally, a reference to one of the major regional benchmarks such as Brent Crude, West Texas Intermediate or to a lesser extent the OPEC Reference Basket.

While price changes in each of these benchmarks are connected, they are more often than not individually subject to fluctuations of a regional nature, such as hurricane activity in the Gulf of Mexico, political instability in the Middle East and so on. Price changes also reflect the prevalent regional demand for energy.

Our regional fuel prices are based on a number of high quality, light sweet crude oils such as Tapis Blend 44, which is mined in Malaysia.

In practice, crude from a large number of oil fields is purchased by refiners based on benchmark or marker prices such as the Dated Brent or the Platts Tapis price quote, which is generated, based on the average prices of cargos loading 15 to 45 days in the future. Actual prices for these cargos are based on the varying crude oils physical characteristics and an added premium or discount designed to reflect market volatility, global events etc.

Tapis crude oil is currently priced around $0.73 per litre*. (See the Editors Note below for a brief overview on crude oil production costs).

How the price of crude is generated is important to know, as it is the base from which all else is priced, however the most connected to Australian pump prices is the regional spot price of the refined oil.

The refineries in Singapore, which are some of the world’s largest, add a margin generally between 2-4 cents per litre. In industry jargon, this is called the “gross Singapore petrol refiner margin”.

The Singapore benchmark, for commercially traded Australian-grade unleaded petrol is called Mogas 95 Unleaded or MOPS95 Petrol. 

MOPS95 Petrol is currently priced around $0.76.

As Australia imports most of its transport fuels, the local Australian market price is dependent upon, the regional pricing structure which is based on MOPS95 Petrol, plus transport, insurance and profits. The wholesale component of this adds roughly $0.09 per litre and the retail generally around $0.06.

With these costs combined, a litre of petrol, landed in Australia and now sitting in a petrol stations tank, is now costed at approximately AU$0.91.

Now add the AU$0.38 Fuel Excise tax and you are now looking a price of AU$1.29. With 10% GST added the final price comes to AU$1.42.

So my $1.42 per litre can be broken up into:

Tax $0.51
The retailers $0.06
The wholesalers $0.09
The refiners $0.03
The drillers $0.73

And when a company like Shell is drilling, refining and wholesaling oil based products it is quite conceivable that over half, $0.76, of my $1.42 goes either directly to or through the books of one oil company.

Naturally there are lot of costs and taxes paid along the way but it is interesting to ponder what percentage ends up in the profit column of the large oil companies. The tax bit seems fairly inevitable but it is not the biggest slice of the cake that I was expecting when I started this article.

But the other big question is about volatility. Basically why does the day to day price of petrol vary so much?

Broadly our prices at the pump are tied to the movement of the Singapore market price for MOPS95 Petrol and by extension the basic cost of Tapis crude. 

According to industry sources I spoke to, Singapore pricing is factored to the wholesale price within 24 hours. However and somewhat confusingly the Australian Institute of Petroleum (AIP) website still states that there is a 1 to 2 week lag between price changes in Singapore and Australian wholesale prices. This seems to be a factual anomaly that needs to be straightened out. 

The AIP maintains that “retail prices in metropolitan areas also tend to follow a discounting cycle which historically has ranged up to 12 cents from peak to heavily discounted trough”. Day to day fluctuations are also attributed, by the AIP, to local competition.

Although, in my mind, that has never adequately explained why petrol soars just before a long weekend.

The Terminal Gate Price (TGP) is a term describing the full cost of petrol, including tax, charged by wholesalers, but minus retail expenses. This price is publicly available and is the price independent retailers are required to pay when their petrol is picked up by tanker at the local terminal.

It is interesting to note that when I drafted this article the Sydney TGP price had increased from $1.357 on the Monday to $1.37 on Friday, indicating that the majority of the week’s day to day movements was not driven by retailers but by the wholesale price. Matching the TGP against the Tapis crude and the MOPS95 Petrol over the last few months shows a correlation but not an exact one.

Interestingly supermarket discount fuel dockets may also have increased upward price volatility.

Due to the introduction of fuel dockets there may now be less pressure to discount prices, as the increasingly fewer independent retailers have little incentive and less capacity to challenge the supermarket aligned brands and their favourable wholesale pricing and support.

By extension it is also likely that the supermarket branded chains would seek to recover the costs of discounting by extending the time that prices swing upwards and by increasing grocery prices.
 
There is also generally less competition in the market, as there has been a nationwide exodus of independent retailers. As an example, over the last few years in Victoria some 100 independent retail sites have exited the market and it is telling that there is no longer an independent petrol importer into the state.

A recent, rather detailed research paper, "Modelling the Price of Unleaded Petrol in Australia's Capital Cities"** has recently concluded that, in aggregate, Australian petrol prices follow the "rockets-and-feathers hypothesis". In other words prices shoot up like rockets but float down like feathers, i.e. overall asymmetric price responses, that justify not only further research but greater monitoring and regulation of pricing.

So that is petrol in a nutshell. Although I suspect I am not the only one who has noticed that petrol prices generally climb as you drive into the Eastern or Northern suburbs of Sydney. A point that it's really all about charging what the market will bear.

But I am sure I am not alone in feeling that somehow the price of petrol should not be this high, or so slow in responding to falls in the underlying costs of raw materials. But it sure seems to go up pretty quickly, very strange indeed. 

Editors Note: Crude oil production costs

I have seen estimates that production costs for a barrel of oil can be as little as US$2 in Saudi Arabia. While other cheaper sources such as Venezuela or Azerbaijan are around the US$5 to US$7 mark. On top of this is US$5 to US$7 in capital costs per barrel. For the more expensive fields, like the deep water wells in the Gulf of Mexico, the average combined production and capital costs vary from around US$12 to $US25 per barrel.

If the current price of oil is US$107.71  (Dated Brent Spot Price - 28/09/2001)  back of the envelope calculations, for crude produced in the Gulf of Mexico, seems to suggest that they are making a Gross figure of just shy of US$82 a barrel. So with US taxes and royalties around 40% the after tax profit is just shy of $US50 a barrel.

I’d note that many jurisdictions charge up to 90% taxes and royalties and as most large oil companies refine more oil than they produce, they also have to buy crude oil on the open market. However based on the rough calculation above they clearly can make considerable money off the oil they do produce.


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*All prices quoted in this article are in Australian dollars and prices were accurate as of the week commencing 19/09/2011.
** Australasian Accounting Business and Finance Journal, Volume 4, Issue 2, Article 3, by Abbas Valadkhani, University of Wollongong.

The views in this article are those of the author and are not necessarily those of Telstra BigPond.