Emily Stewart, 02 February 2016

What is behind the fall in oil prices and how is it affecting petrol prices and the economy?

Business reporter Emily Stewart answers four of the most common questions about one of the most important global financial trends since the GFC in 2008.

1. What caused the drop in fuel prices at the bowser?

Petrol prices for Australian motorists have now commonly fallen below the psychological barrier of a dollar a litre – falling about 15 per cent from last year.

At the bottom of the discount cycle, retailers are selling at or below cost.

Sam Collyer, Caltex

The price at the bowser is determined by international petrol prices (namely the Singapore benchmark price of petrol), government taxes and shipping costs.

Today the terminal gate price paid by the retailers is 102.1 cents per litre in Melbourne and 102.6 cents per litre in Sydney.

Caltex spokesman Sam Collyer said most of its outlets are franchisees – and they have seen very slim margins – with the average net profit in the order of 2.22 cents per litre.

“In the metro markets, at the bottom of the discount cycle, retailers are selling at or below cost,” he said.

So what does the price of crude oil have to do with it?

The Singapore international price is influenced by the price of its major input – oil.

The price of oil has recently fallen to 12-year lows – hitting $US27 a barrel – down from highs of $US116 a barrel in late 2014.

So if the total fall in the oil price has not been passed on to consumers – who is making money?

It is the refineries, who are taking a cheaper input, turning it into petrol and selling it.

There are still four refiners in Australia – BP, ExxonMobil, Caltex and Viva Energy.

Caltex foreshadowed its profit results recently, with earnings from its refinery almost doubling to $400 million.

2. What caused this latest shift in oil prices?

It is largely down to the basic economics of supply and demand. In this case, there is a major oversupply of oil with a glut of up to 1.2 million barrels a day flooding the market.

At the same time storage capacity is near record levels. This current round of oil wars started last year when OPEC (made up of 13 oil producing nations and driven by Saudi Arabia) started flooding the market – aiming to take out the competition in US shale oil and Canadian oil sands.

Justin Smirk, senior economist at Westpac, said Saudi Arabia has no intention of reducing supply.

“They’re quite happy to see prices lower at the moment to drive out all the marginal producers in the US and to hurt their foe in Iran as well,” he explained.

To add to the oversupply issues, sanctions on Iran have recently lifted, and the country wants to boost its production by at least half a million barrels a day.

3. What does this mean for stocks, banks and the economy?

January was a horror month for markets around the world – Wall Street suffered its worst performance since 2009, the Australian market fell 5.5 per cent and Chinese shares dropped 22 per cent.

Lower commodity prices within the energy space are impacting negatively on stocks, particularly those with higher debt levels.

Jason Chesters, Patersons Securities

While Chinese growth has slowed, stocks have moved in concert with the falling price of oil.

With oil demand seen as a strong indicator of growth, the oil crash is raising fears about weak global growth.

Patersons Securities resources analyst Jason Chesters said all the major oil stocks are significantly off their highs from a couple of years ago.

“We’re starting to see it in earnings numbers starting to flow through to the bottom line,” he observed.

“Lower commodity prices within the energy space are impacting negatively on stocks, particularly those with higher debt levels – it’s starting to make debt servicing particularly painful for these companies.”

The big Australian banks have taken a hit, with Morgan Stanley saying the big four face up to an 18 per cent increase in losses on loans due to their $31 billion loan exposure to oil and gas companies.

The Commonwealth Bank has the biggest exposure to the oil and gas industry at $11.6 billion.

Morgan Stanley said it expects the fall in the oil price will mean the banks need to raise their proportion of impaired loans by 2 per cent for the half year.

4. What will the oil price do next?

Forecasts vary wildly, with some analysts calling the bottom of the cycle and predicting a recovery to $US50 by mid-year, while others are pessimistic with Standard Chartered bank declaring oil could fall to $US10 a barrel.

Westpac predicts oil is likely to dip back under $US30 a barrel again before finding a new equilibrium point around these levels.

Do not get too excited though – lower oil prices do not mean retailers will automatically pass the savings on to motorists.

You can watch Emily Stewart’s analysis of oil and petrol prices on The Business at 4:30pm and 8:30pm (AEDT) on ABC News 24 or 11:00pm (your local time) on ABC. You can follow Emily Stewart on Twitter@stewart_emily.

Extracted in full from ABC News.