Friday, 13 March 2015

Petrol is not expensive, get used to it (or why petrol prices do not gyrate with the price of Brent Crude)

The price of petrol is one topic guaranteed to get many people hot under the collar.  “why is petrol so expensive?” and more particularly, “why don’t oil companies pass on the benefit when global oil prices go down?" are two of the most frequently seen questions on the web.  The suppliers themselves frequently state that petrol prices are influenced by a lot of factors, but decline to go further because such information is very sensitive commercially, and publishing data may even get companies into trouble with competition authorities. 

On the other hand industry bodies could provide some insight without jeopardising individual producer’s confidentiality - and this may be out there, but I could not find it today.  I am also sure that the press has carried models in the past but I could not find them either just now, so lets have a go at building one. Any suggestions for refinements would be appreciated.

Lets start with a pump price of 107pence per litre of unleaded (Daily Mail, Friday 13th March, 2015).  Diesel and high octane are more expensive but the differentials are not based on crude price, so I have ignored them)

Tax (VAT at 20% and fuel duty) account for 76 pence (again according to the Daily Mail), leaving 31p (28%) for everything else.

Crude Oil, at $60 per barrel, assuming today’s exchange rate of $1.4 = £1, is approximately 25p per litre (ignoring temperature and pressure adjustments, but this is good enough for our purposes).  The recent strengthening of Sterling v the USD makes the raw material relatively cheaper.  At $1.3=£1, the cost is 28p.

We are left with 6p for everything else; refining, distribution, marketing, selling, admin, R&D, and of course profit.

Manufacture (refining) – I can find US refining costs for 2006-8 at around 4-8p/litre (30-60cents per gallon).  The actual price varies considerably with the  size and age of the refinery, the kind of crude used and the mix of products (usually varied to maximise the return to the refinery).  However lets use these figures and assume that efficiency increases in the last 6-8 years offset the impact of cost inflation.

This gives us plus 2p to minus 4p for everything else. I have to assume this includes all additives in the fuel.

We know petrol stations keep around 1-1.5p per litre for their own costs and profit on a good day and this is unrelated to oil price as that is “netted back” to the supplier.  So depending on distribution, marketing costs the margin available to the oil company is between 1p and a significant loss. Not sure how this would be calculated but Shell’s 2014 SEC filing shows Selling, Distribution, Administration and R&D as around 4% of Downstream turnover.  Half of this of course relates to upstream, so for the sake of argument say 2% relates to Downstream (that part of the business which makes and sells fuels), which would be 2p at today’s prices, suggesting that Shell, assuming it is one of the more efficient producers, is just about breaking even on UK pump sales.
Smaller distributors will have lower overhead than the likes of Shell, BP or Exxon; no R&D and probably fewer admin costs (no investor relations, qualms about ethical compliance, no R&D etc..), and they can supply products to the supermarkets more cheaply (fewer additives, so not necessarily as good to your engine).  The Supermarkets of course have negligible forecourt costs and are known to cross-subsides from their groceries.

Finally, gasoline is actually traded on spot and forward markets in Europe, so it is possible independents to scoop up cargoes at sharp prices and sell them on quickly to make a buck if prices are “maintained” at a high level.  And while the volumes are probably not high enough to have a significant impact on retail prices generally especially as securing supply is critical to manufacturers and major retailers so they are likely to be buying far ahead, this will affect public expectations when they see independents or supermarkets selling at lower prices than the major just down the road.

No wonder many oil companies have been exiting retail markets over the last 10-20 years, and closing refineries across Europe as well (building fewer, bigger, newer ones reduces unit costs).  What is all the more amazing is that they are still out there selling petrol at all.  This is of course a political issue as their reputation and brand depend on public perception and would soon disappear if they stopped selling fuel in the key home markets.  They also want to keep in with governments so that they can continue to operate in the upstream (exploration and production) where most of their profits come from. 

With economics like this is it surprising that pump prices do not reflect the gyrations of Brent Crude? Better analysis than mine will undoubtedly come up with more reliable figures but the popular press should really stop trying it on with overhyped headlines and under-researched articles.  Instead they could try to educate the public (as with so many political issues).  But that is probably too much to ask (not a comment on the Daily Mail by the way, I just happened to search and find their article today).

1.  Daily Mail Friday March 13th.  “Petrol Prices Back on the Up”

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