Fuel Prices – We can’t do anything?

Wednesday 9th November 2011 - Posted in Business
By Steve Irwin, Trading Manager, Portland FPP

I live, breathe and love (in an all too geeky way) all things related to the price of fuel.

I have listened and scowled at politicians who offer at best a misguided and at worst a misleading view of why fuel prices are high and what can and can’t be done to rein in the rising cost of fuel. I have seen protests come and go, noble in their intentions but again misguided in their direction.

Consequently when I came across the thread on the Yorkshire Mafia LinkedIn site entitled ‘Fuel Prices – Should We be Doing Anything?’ I wanted to offer what none of the protest groups or politicians seemed to have: information about the fuel industry and how fuel is priced.

I am only talking about the price of fuel and do not want to be diverted with the environmental argument about why we need to reduce our fuel usage. Whilst being a valid point to argue, that is for the experts in the environmental sector to discuss. I appreciate that it is a long blog post so I have put headers in the various sections so you can skip it if it is not of interest but I will begin by explaining a little about how the price of fuel breaks down.

What are the Components of the Fuel Price?
The fuel price (excluding VAT) has three main elements to it

i) The Wholesale Price
ii) Duty
iii) The Supplier Premium.

The wholesale price is the price fuel is traded at on international oil markets. It changes on a minute by minute basis and is subject to supply and demand factors.
Duty is set by the government and is taken at the point of importing or refining the fuel. It changes once or twice a year according to the requirements of the treasury, the chancellor and the government, changes in duty rates are often notified in advance. The current formula for calculating fuel duty by the treasury is current duty level i.e. 57.95 pence per litre (ppl) multiplied by RPI (inflation) plus 1ppl, which makes the next duty rise 3.02 ppl to be applied in January 2012.
Supplier premium is the cut for the company supplying you your fuel and includes all the costs associated with that supply such as transport of the fuel, overheads and profit.

Why are fuel Prices Higher now than in 2008 when Oil was $30 per Barrel More?
This is down to 2 of the 3 pricing elements, the wholesale price and duty. Firstly the wholesale price, diesel and petrol are traded internationally in US Dollars per Tonne. The wholesale price of diesel for example in July 2008 reached $1,250 per tonne. The exchange rate plays a big factor in how this figures translates to pence per litre and in 2008 the exchange rate of the UK £ against the US $ was around $2 dollars to £1

Therefore $1,250 per tonne = £625 per tonne, which for diesel equates to 52.83ppl.

If in July 2012 the exchange rate is $1.50 per £ then:
If diesel is $1,250 = £833.33 per tonne which equates to 70.44ppl.

An increase of 17.61ppl when all that has changed is the exchange rate!

Then there is duty, in July 2008 duty was 50.35ppl, with the increase planned for January that will be 60.97ppl, an increase of 10.62ppl. VAT has gone up for end consumers (who cannot claim the VAT back) from 17.5% in July 2008 to 20% now, meaning that in total the price of diesel at the pumps (except for the supplier premium) could go from 121.24ppl in July 2008 to 157.69ppl without a change in the wholesale price in dollars, all because of exchange rate, duty and VAT, an increase of 36.45ppl.

A current calculation of price with diesel trading around $1,000 per tonne and the exchange rate currently around 1.6000 makes diesel 52.83ppl (coincidentally the same as in July 2008 even though diesel is $250 per tonne cheaper), plus duty at 57.95ppl, plus VAT makes 132.94ppl an increase from 2008 of 11.70ppl all of which is going to the government as either duty or VAT increases.

Should we protest filling stations or ‘Are Fuel Retailers Ripping Us Off?’
This section is dealing with the supplier premium at filling stations. On my way home last night I stopped to fill up my car, it cost 139.99ppl, but how is this broken down? Well straight off the top is VAT currently 20% which is 28ppl, so that leaves us 111.99ppl. Duty is currently 57.95ppl which leaves 54.04ppl. The wholesale cost of diesel averaged 53.77ppl last week but the lowest price was on Friday at 53.38ppl so assuming this retailer bought on the cheapest day of the week, that leaves (54.04 – 53.38) 0.66ppl for the retailer. But then the retailer has to pay the transport costs of getting the fuel to the filling station and the profit margin of the supplier who brought the fuel and pay for the overheads of the site etc etc. Clearly this ‘rip off merchant’ was not going to make his millions selling diesel to me at this price. The fact that these margins are ridiculously low (loss making) are borne by the fact that in 1990 there were around 20,000 filling stations in the UK, now that figure is nearer 9,000, they wouldn’t be closing so fast if they were making good profits. Incidentally I paid for this transaction with my credit card which usually incurs a 2% charge to the retailer (2.80ppl) so it is quite likely that the credit card company made more profit from this transaction than the retailer!

Should we protest ‘Big Oil’?
What effect would a protest such as ‘On a given day everyone in the country refuses to buy from BP or Shell etc’ have on big oil companies? I’ll take this one stage further and say what if everyone in the UK decided to stop buying fuel completely. Fuel is a global commodity and according to BP’s Statistical Review of World Energy 2011, UK oil consumption accounted for 1.8% of global consumption. If this volume was taken out of the global demand for oil, prices would drop slightly, but it would hardly bring about the kind of drop in prices that is badly sought after by protest groups. In fact the UK uses about the same amount of oil as Libya produces and most of the Libyan capacity is not producing at the moment, so even if the UK stopped buying fuel entirely it would only redress the supply / demand balance back before the uprising. Protesting one company in the UK will not affect the global oil price at all as that company can simply sell the fuel elsewhere as the next paragraph explains.

Are Speculators driving up the price of oil?
Firstly a little information about trading oil, which is the wholesale element of the overall price of fuel. Oil is traded in barrels (in multiples of 1,000 barrels), refined products such as diesel, gasoil and kerosene are traded in tonnes (in multiples of either 100 or 1,000 tonnes depending on the particular grade of fuel) and all are priced in US dollars. The main trading hubs for these products are New York, London and Singapore. The CFTC is responsible for regulating the trading of oil (and other products) in the US and publishes figures for the amount of trading that goes on there, the ICE exchange publishes similar figures for oil trading in the UK. The figures show that the American market is much bigger than the UK market and trades roughly 2.5 times more oil. It also shows that there is approximately 25% more speculation in the US compared to the UK. This means that in terms of actual numbers of speculators the US market has (2.5 + 25%) 3.13 speculators for every 1 speculator in the UK. All this being said the price of US crude, is currently trading around $18 per barrel less than the UK barrel, whereas historically they would normally be about the same. If speculators really were responsible for raising prices then the US Crude should be trading at a higher price than the UK Crude. There are reasons for the difference but they are rooted in the real world, not the electronic world of the speculator. A certain amount of speculation is necessary for a market to operate as there are not enough participants trading regularly enough otherwise, but the dreaded speculator is an easy scapegoat to point the finger at, as they are generally faceless and unknown. No, speculators are not responsible for driving up the price of oil.

While on this subject I will mention another type of trader caller the ‘Arbitrageur’. This trader exploits price differences in the markets. For example if diesel in the US were cheaper than the UK the arbitrageur would buy diesel in the US market raising the US price and sell it in the UK market, lowering the UK price thus restoring a balance in prices globally. Such difference may only exist for short periods of time before the arbitrageur steps in to restore the balance. These traders ensure that prices in one region never vary too much from anywhere else and perform a balancing function to prices overall. It is because of this that the price of fuel in the UK is linked to the price of fuel everywhere else in the world and we cannot just reduce the wholesale price of fuel in the UK alone.

What about OPEC – Should we have an international body to counter OPECs influence?
We already have one. The International Energy Agency (IEA) consists of of 28 member countries (all of whom are members of the OECD) who make up the main fuel buying countries in the world of which the UK is included. Notable exceptions in the member list include more recent additions to the list of big oil consuming nations such as China and India. The IEA was set up in response to the 1970’s oil crisis and one of the main reasons for its inception was to counter the perceived growing influence of OPEC in global oil supplies. It works to reduce volatility and ensure that oil prices are fair for consuming nations. One way it has done this is through the introduction of compulsory stock holding. Each member must hold 60 days worth of its annual fuel consumption for times of crisis. When supply is constrained these stocks can then be released to relieve the pressure on prices. They released 60 million barrels of oil in May this year to counter the supply lost by the Libyan uprising. The last time before that was in 2005 when stocks were released following the devastation caused by Hurricane Katrina in the US Gulf Coast.

Can the government tax the profits of big oil companies?
The government can introduce legislation to tax the profits of big oil companies more heavily, but would they really want to? The revenue raised from such a tax could be in the billions of £ but how could you really take this from oil companies without them considering operating in a country with a more friendly tax environment? The last thing you want, is to lose these companies and the jobs they provide. One option is to impose a one off windfall tax, which sounds like a good idea, but a one hit wonder is not going solve the issue. It might at the very best delay the next rise in duty a few months but again could encourage these big employers to look at where they are best located. There may be a balancing act to be struck with higher taxes but it would discourage new companies from setting up here (not that I think there is a flood of new companies about to spring up anytime soon) and I would not want to be the politician that forced the oil companies to move abroad.

Can the government tax the extraction of oil from the North Sea?
Similar issues exist around deterring companies from operating in the UK as above but the government has tried this approach with the ‘Fair Fuel Stabiliser’ which enabled the chancellor to reduce fuel duty by 1ppl in March this year (what do you mean your wallet didn’t feel any fuller?). The windfall tax was predicted to raise £2Bn for the treasury. The effect of this one (small) drop in duty has hardly been noticed by motorists because of rises in the wholesale price of fuel which reached its peak in April this year. More and more taxation of extraction in the North Sea, which is already becoming an expensive place to extract oil, will encourage companies to pack up and look for oil in cheaper locations, not something the communities that rely on North Sea oil jobs want. We couldn’t even nationalise the North Sea fields for our own use, then set a national oil price as we don’t produce enough oil from them to meet the UK’s oil consumption requirements.

Government Duty – Can we reduce duty?
Yes absolutely we can, one man (the Chancellor) can make the decision to reduce duty and it can be implemented today and show its effect at the pumps next week. But do we want to and has duty gone up excessively recently? If we start with 2006 (because duty had remained at 47.10ppl since 2003) and apply the annual average RPI measure of inflation to the duty rate what would duty be now? Duty has not gone up as fast as inflation, using the RPI measure of inflation since 2006 at least. But the chancellor also receives additional income through the increase VAT take whenever duty is increased, this amounts to an extra 2.17ppl being taken compared with 2006 which when added to current duty is 60.12ppl, which is still lower than if duty had increased by RPI alone.

The other argument that the government will put forward regarding reducing duty is the need to reduce the deficit and how it cannot afford to reduce tax revenue. There is a case that the higher duty goes, the more unaffordable driving becomes and thus the less people will drive which actually reduces the net revenue taken in duty. MP Robert Halfon argues in his e-petition (to the government regarding fuel prices) that we are at the point of diminishing returns for the government and reducing duty will actually increase the tax generated from fuel by increasing the amount people will drive.

Reducing VAT is another option but this would not help the beleaguered bus and coach sector or the haulage industry, which have to buy fuel to keep their business running. Businesses generally can claim back the VAT they spend on fuel although reducing VAT would help the individual motorist.

Use Less Fuel
Without a doubt the easiest way to reduce your fuel spend is to reduce the amount of fuel you use. Whether this is by using public transport, buying a more economical car, moving closer to work or whatever option suits you best. This choice is only available to those who do not use a car / bus/ truck as part of their job of course. Also there is only so far you can take ‘being green’ to affect an economic benefit. Bio-fuels are more expensive than fossil fuels and carry the same duty rates. Electric cars are more expensive than petrol / diesel engine vehicles and have range limitations. You can check your tyres are inflated correctly (although I have never noticed a benefit to fuel economy after I have checked my tyres) and you can drive less aggressively. We all know these things so I will not say any more on the matter, but wait for the boffins to make our engines far more efficient.

What solutions are there?
One idea is trying to get businesses in the UK to spend money in the UK with UK companies and thus retaining the wealth rather than seeing it go abroad. This is an extension of the Yorkshire Mafia ethos of keeping business done in Yorkshire with businesses based in Yorkshire. This would help the recovery and then reduce the need for such a burdensome level of duty. Private and Government procurement should look at total net benefit to the UK PLC when assessing the merits of any large tender involving foreign companies. This relies on there being comparable service, quality and price available from a UK bidder of course, comparable being the operative word, not necessarily the absolute cheapest.

One such example was the recent tender to build new train carriages which was awarded by the Government to German company Siemens when a British company, Bombardier, was also bidding. The FT reported the contract was worth over £3Bn and while I am not privy to the details of each tender, I would ask, was due consideration given to the net economic benefit of retaining the jobs and contracts in the UK economy rather than just looking at the cost of the project to the DfT? I hope so is all I can comment on this, but I digress. Getting back to fuel, a company can protect itself from rising costs by fixing its fuel prices for up to the next twelve months with Portland (and other companies too – shameless plug) and this is one way to protect yourself against rising prices, however this does not guarantee a saving. If you fix and the price of fuel subsequently falls (if only) then you would have been better off doing nothing.

This is a method of taking a variable, unknown cost and making it into a fixed cost to allow for better budgeting and this then protects a the profit margin from erosion as the price of fuel rises. This does not take into account duty or VAT rises, and this service is not available for individual motorists.

Perhaps smarter procurement of fuel can save you a few pence per litre on what you are currently paying and this too is an area we specialise in for businesses and can offer expert advice.

Ultimately the gloomy truth is that you might be able to delay a rise in fuel price for a few months or perhaps even a year but the fact is that oil is a dwindling resource that becomes more in demand with each passing year and whenever that happens the price will only ever go in one direction – and it isn’t the direction we all want.

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