Crude tacticsPetrol-powered motorists around the world enjoyed cheaper fuel prices in late 2015 and most of 2016 because the Organisation of Petroleum Exporting Countries (OPEC) kept exceeding their production targets, primarily in a bid to cripple the booming US shale oil industry.
Combined with a resurgence in Iranian and Iraqi production plus an economic slowdown in China, the global market was soon in a state of oversupply – and as the first rule of economics states: when supply moves one way, demand (and price) moves the other way.
This placed increasing pressure on OPEC members as their profits and financial reserves shrank while the shale oil producers merely moderated their operations in response, so in November last year the organization committed to reducing production in the first half of 2017 (non-OPEC oil producers followed suit almost immediately).
Oil, like any other commodity, is traded by middlemen who move it from the producer to the refiner – and it is the decisions of traders that push the price up or down.
If a trader sees an oversupplied market where demand is more likely to fall than rise, then they will carry out transactions that anticipate this drop.
If they see a situation where supply has shrunk and will shrink more, they will do the opposite.
The market responds to oil becoming more desirable and so the price rises on the basis of promised supply cuts rather than actual ones.
An explanation of the futures market, where these transactions take place, and how it actually works is a whole other article … but let’s just say traders with enough money to buy commercial-sized oil contracts rarely lose out whether they ‘go long’ (bet on a rise) or ‘go short’ (bet on a fall) and neither the producers nor the refiners are surprised by the results.
Ship to shore
Once oil is pumped and sold, it makes its way through the refining process where it is turned into petrol – and also engine oil, machine lubricant, diesel, kerosene and asphalt as well as key components of plastics and pharmaceuticals – and then distributed around the world.
Three-quarters of the petrol consumed in Australia originates as Tapis oil and most of this is pumped from the South China Sea by Malaysian oil companies then refined in Singapore, with some fuel also sourced from Korea and India.
Even though our market consumes little petrol drawn from OPEC sources, the global oil industry is deeply intertwined and movements in one market affect others – especially when OPEC is responsible for 42 per cent of total global production.
The price at which the refined Singaporean product is sold is known as Mogas, and this in turn is a key component of the Australian wholesale cost, referred to locally as the Terminal Gate Price (TGP).
The NRMA has already comprehensively analysed the price process from this point onwards: the historic and contemporary factors that influence prices, the 10 things that set today's retail price, the mechanics of a typical price spike and what NRMA is doing to make things fairer.
All that remains is to explain why prices moved so differently in metropolitan markets compared to rural and regional areas.
City v country
Example: The price of petrol rose by the usual amount of just over 20 cents per litre (CPL) at the start of December 2016 but then fell at less than half its usual rate over the rest of the month – see the brown line in the graph below:
The cost of regular unleaded (ULP) was only 8 CPL lower than the December 5 peak price (129.2 CPL) by January 3, when prices bottomed out at 121.2 CPL.
The average ULP price then shot up by nearly 20 CPL and as of January 9, Sydney motorists were paying around 140 CPL for the first time since September 2015.
This occurred because the retailers correctly anticipated the rise in the wholesale price (blue line in graph above) over this period, as they had seen what was happening on the oil futures market.
The proof of this is that their gross profit margin trend (the broken red line in the graph) was similar to what occurred in the previous cycle and the overall average profit of around 10 CPL is also on-trend.
Meanwhile, rural and regional motorists remained largely undisturbed by fuel price changes but then watched as the average ULP cost rose by nearly 7 CPL between January 9 and 16 – a huge increase by country standards.
The reason for this disparity – time and distance – is simpler than the explanation given for the city situation.
This refers to the fact that most rural and regional retailers take much longer to run down their reserves than city servos due to lower patronage despite having similar-sized storage tanks, along with the delay in the higher-priced wholesale fuel reaching them as a result by the distance over which it must be transported.
Also, country retailers are less likely to have high levels of local competition and will instead set their prices on the basis of wholesale expenditure, plus the usual considerations of cost and profit.
Where to from here?
The world is a volatile place and unpredictable events like terrorist attacks, trade wars or disruptions to financial markets can flow quickly through to oil prices.
In the face of all this, the best you can do is keep informed – and that’s exactly why we’ve written this article.