Monday, June 09, 2008

What price petrol?

Tim Shallcross

Last weekend the AAA made headlines in some of the American press. AAA is the Automobile Association of America - much the same as the AA in Great Britain. The story was that they have seen a major increase in the number of American motorists running out of gas (which is American for petrol). The reason? With soaring prices US drivers are only half filling their tanks or trying to make the gas last until the next payday, and failing.

The unprecedented price that’s causing all this American heartache is $4 a gallon or in our currency, about 44 pence a litre. While it’s easy for us to chuckle or groan ironically and think, as we fill up with the same stuff at three times the price, that they don’t know how easy they’ve got it, all these things are relative. However, this did set me thinking about the difference in price. If fuel for transport is so vital for the world economy, wouldn’t it make sense to have some sort of global standard price that we all recognise as fair and sustainable? Then we would all have the same incentives to use it efficiently and wisely.

A quick survey of garage forecourts around the world is quite revealing. Throughout most of western Europe petrol and diesel prices are roughly the same as here, but in eastern Europe they are significantly lower, prompting cries of “unfair” from the UK haulage industry. In Russia a litre of the precious spirit will set you back about 45p – roughly the same as in the US, whilst in Venezuela, they buy their “gasoline” for just 19 cents a gallon, or just a little over 2p per litre. With such enormous variation you have to wonder, what exactly is the “real price” of petrol or diesel?

If we take petrol, (and use all prices converted to UK pence per litre (ppl) for simplicity, along with a bit of rounding to avoid unnecessary precision and endless decimal places), the UK current average pump price is around 116ppl. 17p of that is VAT and just over 50p is duty, leaving a price before tax of about 50p per litre. Other western European countries are roughly the same, although the UK refining and distribution industry is very efficient and our pre-tax price is actually a few pence lower than most other European countries. (You don’t hear this industrial success for Britain promoted much in public by the government; instead they gleefully reap the benefit of it by charging us a higher rate of tax than almost any other country, so we still pay more at the pump than everyone else. This doesn’t sit too well with the constant government claims that it’s not their fault, it’s all global oil prices, OPEC won’t play the game and the rest of their excuses)

So how does our tax compare to others? Well, the US imposes a federal tax on its citizens at the rate of about 2ppl but then our government would argue that tax revenues have to be raised and other countries must raise them in a different way. Certainly anyone who has suffered the shock of seeing a US restaurant bill for the first time, with all the federal, state and local taxes on top of what started as a cheap meal, might think that paying the extra fuel duty is worth the certainty of knowing all the prices upfront. And of course, for US drivers those state and local taxes take a little cut out of the gasoline gallon as well.

Even so, that leaves Americans (and Russians) paying about 40p for their gasoline before tax against our 50p. So how do they manage that? Well, being a major oil producer certainly helps, and if the size of your internal market is measured in hundreds of millions rather than tens, you get appreciable economies of scale. Even so, that Venezuelan price of 2ppl can only be sustained by hefty subsidies from their oil rich government.

Subsiding fuel instead of taxing it may be an interesting concept to us, but it’s surprisingly common – Nigeria, Iran, Iraq, Libya, Egypt and Malaysia are just a few examples, but more importantly for world consumption, the treasuries of China and India also chip in towards the cost of a tankful for their citizens. With such huge markets offering their citizens an incentive to use fuel unwisely, there are comments from pundits in the west that these governments should act more responsibly, especially in view of global warming, peak oil and the other catastrophes awaiting us just over what would be the horizon if it wasn’t hidden by the smog.

Although this is understandable, it does smack of a fair amount of selfishness on our part – having spent a century using all the cheaply available oil inefficiently we now have all the sanctimony of a reformed smoker. We’ve finally realised that our habit can’t be sustained without serious consequences, so we now feel entitled to insist that everyone else should share in our self righteous zeal.

So, there’s a big divide between the countries that tax petrol and those that subsidise it – a gap that prices a litre of petrol at somewhere between 2p and 120p. I’m not an expert on commodity prices but I doubt there’s another product that’s identical in all markets, but varies in price by 6,000 per cent. With such a huge variation it doesn’t look as if we’re all going to be paying a standard price worldwide anytime soon.

The “right price” seems to be whatever our respective governments decide we can bear to pay without voting them out of office. So what are the prospects for UK fuel prices? Some experts talk about an oil price “bubble” that will soon burst, just as the technology industry and property bubbles have. Others say oil is different because there’s a sustained and growing demand alongside finite and diminishing supply. Whoever is right, it seems reasonable to assume that once all the dust settles, we’ll have entered a new phase where petrol and diesel prices are a significant step up from what they have been for the past decade.

Should we worry about this? In the longer term, no. For a start, since the 1970s we have had at least three periods of volatile fuel prices, separated by longish periods of relative price stability. Our economy has coped, and even flourished. There is no reason to believe that this “crisis” won’t settle down in just the same way.

Then there is the positive side to higher fuel prices. Previous price hikes have given us some great advances. Many of today’s motorists will remember the first big oil crisis in the 1970’s, when petrol (and it was just petrol for cars back then) more than doubled over a few years, eventually stabilising at around 75 pence a gallon, or some 16 pence per litre.

All of us felt the pain, but it was that crisis that made North Sea oil economically recoverable – before the 1970s, a barrel of oil fresh from the desert was so cheap that even the most ardent patriots didn’t think it worth trying to balance a drill half a mile long from a platform bobbing up and down on a cold sea, just so that we could have our own “British” oil. Once the price rocketed, some amazingly difficult tasks were suddenly worth doing, and the same applies today – this week, oil companies are saying that the higher crude prices mean that substantial new North Sea reserves are now worth extracting – possibly as much as all the oil pumped out so far is still sitting there waiting for us, if the price is right.

The higher petrol prices also created a market for more fuel efficient cars – and markets are what manufacturers respond to. You can legislate and regulate for more efficient cars all you want, but unless manufacturers know customers are waiting to buy them, they won’t make them. Suddenly, miles per gallon became an important feature and manufacturers rushed out “economy” versions of their products, which were generally awful. Then they got on with the job of designing them from the start to make better use of the fuel and we saw some major advances in technology. A couple more oil crises saw fuel prices swing upwards to new levels in the 1980s and 1990s and each time the market demanded more economy, so manufacturers responded. Take the Fiesta. Launched in 1976, it returned a very respectable 35 or so miles per gallon. Today’s diesel Fiestas are heavier and much better equipped, but return almost double the mpg of the originals.

So, it looks as if higher fuel prices are here to stay once again – even if they come down a little from today’s level they will stabilise a significant step above where they were a year or two ago. And while we’ll all feel a bit of pain to start with, if the new price levels give us a greater thirst for less thirsty cars, manufacturers will compete with one another to give us what we demand. I can see no reason why the combination of customer demand and manufacturer ingenuity won’t deliver even more economical cars to keep us independently mobile in the future. If, on the other hand, we are still wedded to our people carriers, performance figures and the need for more than two wheels to be connected to the engine, that’s what they will supply.

Of course, I said that in the longer term we needn’t worry, but that’s no comfort to the family today trying to work out what to cut out so they can still afford to get to work. Well, we all have a variety of choices we can make if we want to bear less pain from the fuel bills. Some of people can choose to buy a smaller car. But then if they can afford a new car, they’re probably not the ones feeling the problem the hardest. (That point seemed to be lost on Alistair Darling when he said in a radio interview that less well off families can simply buy a newer, more fuel efficient car to pay less of his new road tax. The last time anyone so out of touch with real family finances offered advice to the public, it was “Let them eat cake”.)

Talking of the Chancellor, he could choose to add up the extra revenue he receives every day in VAT when fuel goes up by 1p per litre. If he excludes lorries, buses and company cars, who all reclaim the VAT, that still leaves him with about £720 million more than he expected in the treasury coffers since last October. Will he use that to reduce the fuel duty to compensate us all? No, I don’t expect that to happen either.

So, we need to find a simple way to reduce the impact of higher prices – and there are loads. Unfortunately, they’re dull, they’re not new and they’re about as exciting as school shoes, but they do work and we all know what they are – check the tyre pressures, clear the junk out, and the rest. If you want just one thing to do, it depends on your age group. If you are under 25 and keen to save fuel (a rare combination, but there must be some), just pulling away without leaving rubber tracks smouldering on the road will achieve significant savings – in tyres as well as fuel. For the rest of us, the single most effective way of cutting our fuel bill is to stick to the speed limit. It’s our choice. Few on the M4 yesterday were heeding it – maybe we’ll get round to it before we all run out of gas.