The 2015 Christmas/New Year Break has seen a repeat of the annual community debate about petrol prices. The most notable aspect of this current debate has been the open public questioning of whether fuel businesses (wholesale and retail businesses) should actually be allowed to make a profit. The simple answer to that question is “Of course they should – they are businesses”.

The summer holiday media has again been dominated by stories about petrol prices with many questioning why retail fuel prices in Australia have not fallen as much as the highly publicised falls in global oil prices.

The debate has seen fuel refining companies characterised as “gougers”, service station owners branded as “bandits”, the ACCC called a “toothless tiger” and the current federal government accused of having a conflict of interest in securing higher taxes from persistently high fuel prices.

In Melbourne, some social media participants went so far as to label the State’s motoring club – the RACV – as an ‘apologist’ for the service station industry because they had the audacity to speak about the retarding effect of currency movements and ACAPMA’s CEO was branded as the “Christmas Grinch” on the front page of a Melbourne daily because he was saw no problem in fuel businesses actually realising improved profits.

There is so much wrong with the current debate that it is simply not possible to address all of the confusion in a single article – much of which appears to have been incited by some federal politicians understandably seeking political gain at the start of an election year.

So, let’s just look at the key question being posed.

Why haven’t petrol prices fallen by the same rate as crude oil?

Many participants in the current debate have been openly questioning why retail fuel prices are not at near record lows given that world oil prices are.

“Despite the best efforts of our industry in recent years, most people still fail to appreciate that there are three key influences on the retail price of fuels in Australia – and that the crude oil price is merely one element of one of these three key influences”, said ACAPMA CEO Mark McKenzie.

1. Crude oil is just one of a number of costs incurred in getting fuel to the petrol bowser.

Put simply, no one puts crude oil in their fuel tank. Consequently, the cost of crude oil is just one of a number of costs involved in producing and delivering transport fuels to Australian motorists.

Apart from crude oil, the costs incurred in producing and getting a transport fuel to a motorist’s fuel tank include (a) refining costs – an increasing proportion of which is incurred by international refineries as opposed to being produced locally, (b) government taxes which include fuel excise and GST, transport costs, wholesale costs and retail costs.

Unlike the crude oil component, which varies with global oil price movements, these other costs are largely fixed – with the exception of profit margins which are independently determined by each of the businesses that comprise the fuel supply chain (more on that later).

This difference in cost behaviour (i.e. variable versus fixed) means that, as crude oil prices fall, the significance of oil price on the final retail price actually diminishes over time – and the other costs become more significant to the final retail price.

Consider federal fuel excise, for example, which is fixed at 39.3 cents per unit of fuel sold. At $1.05 cents per litre for unleaded fuel, federal fuel excise accounts for 38% of the price paid at the pump and is currently more significant to this price than the 28% contributed by the purchase of crude oil (at $US30 bbl).

“All things remaining unchanged, high school mathematics tells you that a further 50% reduction in global crude prices will only deliver a 14% (i.e. half of 28%) reduction in the finished price of fuel”, said Mark.

“Yet you can bet that, even if we only get another 10% reduction in the global price of oil in coming weeks and months, there will be many questioning why the retail fuel price has not similarly gone down by 10%” said Mark.

2. The price of finished fuel is affected by movements in currency exchange rates.

On a positive note, the fuel industry appears to have been successful in making most commentators aware that changes in the value of the Australian dollar – relative to the US Dollar – will have a bearing on the relationship between crude oil and the retail prices paid at the fuel pump in Australia.

Unfortunately, however, it is the currency relationship with the finished price of fuels out of Singapore (commonly referred to as MOPS95) that is the real determinant of the impact of currency movements on retail fuel prices.

“Before everyone accuses our industry of using yet another ‘Jedi Mind Trick’ by shifting the focus from TAPIS (crude oil price) to MOPS95 (finished fuel price), it needs to remembered that Australia is becoming an increasing importer of finished product as a result of recent Australian refinery closures”, said Mark.

This means that differences in the exchange rate don’t simply affect the buy price of crude oil for Australian suppliers – they also impact significantly on the price of securing finished product (i.e. petrol and diesel) for the Australian market.

In recent days, ACCC has made much of the fact that the margins currently levied by refiners are higher than the long term average and, by any objective examination, they are right.

What, however, can an Australian Regulator (or the entire Australian Government for that matter) do about these international margins given that they are determined by global and regional supply and demand factors?

The answer is nothing.

Suggestions made by a small number of commentators that Australian refineries could undercut the international refiners’ prices begs the questions of why they would logically do that, given that our market has operated on the principle of international price parity for more than 40 years as a means of ensuring Australian refining businesses remain globally competitive.

“These suggestions are politically reckless as they remove the ability of one of the few remaining manufacturing sectors in Australia to capture the benefits of a lower oil price as a means of keeping the industry viable and protecting jobs into the future”, said Mark.

3. Profit is not a ‘dirty word”

All of the above conversation has related to costs only.

The third significant influence on the retail price of fuel is, of course, the size of the profit margins charged by the various businesses that comprise the part of the fuel supply chain between the refinery gate and the bowser – that is, the distributors, wholesalers and retailers.

“Unfortunately, selective and incomplete media reporting of recent comments made by the ACCC Commissioner about growth in the average difference between the wholesale price (TGP) and the retail price has generated a level of community outrage and opportunistic media attacks by federal politicians”, said Mark.

“Instead of acknowledging the impact of the two influences cited above, uninformed commentators and ill-educated politicians have openly stated that the reason that oil prices were not going down at the same rate as crude oil prices was because ‘greedy’ service station operators were making ‘obscene’ profit margins”, said Mark.

If these politicians and commentators had taken the time to actually read the ACCC Quarterly Report – and the numerous associated volumes of detailed industry data that has been meticulously prepared by the Commission over the last 8 years – then they would have readily been able to see the falsehood of their claims.

“The recent ACCC reports suggest that the difference between the wholesale price (TGP) and the retail price – referred to as the Gross Indicative Retail Difference (or GIRD) – has increased over long term average trends”, said Mark.

The observation is irrefutable but it is worth actually noting that the ACCC is talking about the gross difference between wholesale and retail price which includes both cost and profit – and not simply profit, as many commentators appear to have inferred.

“No one is denying that the profit margins being captured by fuel retail businesses are better than the long term average, but it needs to be remembered that the margins over the past decade have been wafer thin and have not been sufficient to support necessary capital investment in equipment upgrade – nor the increasing compliance costs associated with ever changing state government regulation”, said Mark.

In fact, ACCC data reveals that profit margins on fuel sales have averaged just 2cpl over the past decade which translates to around 80 cents profit per average customer fill of 40 litres.
“This long term average amounts to a net profit margin on fuel sales of just 1.7% per vehicle fill and is clearly unsustainable without serious supplementation of revenue from convenience store sales”, said Mark.

“The fact that retail fuel businesses have taken the opportunity to capture some of the benefits delivered by lifting their net profit to a short term average of somewhere between 4% and 6% is not ‘obscene’ and nor is it inconsistent with a retail enterprise operating in a volume market”, said Mark.

Fuel retail businesses, like any business, have a responsibility to their owners (many of whom are typical Australian families) and employees to ensure that they charge prices that ensure the financial viability of the business in the long term.

Capturing increased profit when oil prices are low is far more responsible than doing it when oil prices (and retail fuel prices) are so high that they are deemed to be retarding economic growth.

“The current low oil prices means that fuel businesses can pass on most of the price benefits to consumers in the form of lower retail fuel prices, while simultaneously capturing a small increase in net profit to prepare their business for any stormy times that may lay ahead”, said Mark

Put simply, profit is not a dirty word.

Making increased moderate profit is also not an indication of a failure of competition– it can simply be an indication that an industry is emerging from a sustained period of financial hardship created by consistently high oil prices and/or an indication of an industry that is just as worried about the near term future economic climate as consumers are, said Mark.

“If people believe that the high prices are due to a failure of competition in our market then they should detail the nature of that failure and our industry will work with the ACCC and others to allow the matter to be fully and transparently investigated – as we have consistently done in the past, Mark said.