Thursday, March 23, 2006
Fuel Prices Explained 2
Article from AIP (Australian Institure of Petroleum)
PETROL PRICES
EXPLAINING PETROL PRICE CHANGES IN OUR CAPITAL CITIES
Price fluctuations at petrol pumps in our capital cities often frustrate motorists. But these fluctuations are a sign that service stations are competing with each other to attract you the motorist. This competition keeps Australia's petrol prices amongst the lowest in the world. This article explains the reasons behind petrol price fluctuations, as well as how motorists can use the discounting cycle to their advantage. Governments have a choice between restricting pump price movements that will result in higher prices, or continuing to allow prices to move freely which keeps prices low.
The Basic Building Blocks of the Price of Petrol
The best way to explain why petrol prices move up and down is to start with the basic building blocks of a litre of petrol and see who gets what. Petrol prices are made up of:
Product cost - 90% of the product cost is the price of purchasing the raw material, namely crude oil. Also included are the costs of refining crude into petrol (the yellow segment in the chart below).
Tax - excise and the GST (the red and purple parts respectively).
Distribution and retailing gross margin - this is the difference between the pump price and the cost (ie product cost plus tax). This is not profit, but the amount the distributors and retailers have to pay all of the costs from the refinery gate to the petrol bowser.
Daily Movements in the Pump Price: "Deciphering the Discount Cycle"
Competition drives the pump price up and down. At the top of the pricing cycle, when the distributor and retailer margin is usually about 9 to 10 cents a litre, one-by-one the individual services stations or brands start to discount their price by small amounts to attract more motorists.
Other service stations quickly match these prices in order to remain competitive. Highly visible petrol pricing boards allow both customers and competitors to observe price changes. In fact part of a service station attendants role is to keep an eye on competitors price boards. Once discounting starts or ends in one area, strong competition means it quickly spreads into other regions.
Prices are normally discounted for about a week (see example of Melbourne pump prices in chart above) and as the Distributors' and retailers' margin falls below 6 cents a litre, selling petrol begins to become unprofitable. Revenue shortfalls are partly offset by shop sales - in fact most service stations in our capital cities make up to 2/3 of their overall profit from selling shop items as opposed to petrol.
A motorist on the way home may notice the price is 6 to 9 cents higher than whey they drove to work and assume it was a smooth transition (and also be annoyed they did not fill up earlier). But in reality the pump price can vary significantly across the network and from service station to service station during the day.
The good news for motorists is that prices are normally discounted for six days or more, and then only go up once a week.
Why the Petrol Market is Different
The pricing cycle outlined above is evidence of the hyper-competitive nature of the Australian petroleum market. But why is this market so different and so volatile?
The reason is the petroleum market has different demand and supply characteristics to other markets that skew outcomes in favour of consumers. These industry-specific demand and supply characteristics include:
Consumers that will change brands for a fraction of a cent. Mesh this factor with highly visible price boards and the fact that customers are actually in their cars when "shopping", means it is very easy to compare prices and swap between brands to get the best price. The costs associated with swapping brands are very low or nil.
Most of the costs in selling petrol (such as rent, utilities and wages) are fixed, therefore when sales decrease, costs do not. Retailers are always competing against each other to get customers, and discounting is the most effective way of doing this. If competitors can drop their price by 0.5 cents a litre and you lose 20% of your customers with your costs remaining the same, you will match your competitors' price to ensure that does not happen. Price changes are quickly matched in the market place and the process continues. Once all the players in the market begin to discount to protect volume, prices quickly fall.
When petrol prices become unsustainably low (say a distributor and retailer margin of 2 to 4 cents a litre) some retailers will raise their price in order to see if they can bring some profitability back into the market. If no other players in the market "follow" the price up, they will reduce their prices back to the discounted level. Oil companies and other petroleum retailers may try and raise the price at one service station or across a network. This is a bit like a group of children playing around holding their breath at the bottom of a pool - once one can hold out no longer and decides to go up for air, the others usually follow.
This combination of factors leads to a very volatile, but highly competitive market and very cheap petrol prices. This is ultimately good for motorists.
Taking advantage of the discounting cycle
"Buy your petrol in Sydney and Brisbane on a Monday, but wait until Thursday in Melbourne and Adelaide."
The distributor and retailer margin varies between 4 and 10 cents a litre during most weeks. AIP encourages motorists to take advantage of the disounting cycle and buy at the bottom of the cycle when prices are low. In Sydney and Brisbane, more often than not this is on a Monday or Tuesday morning. The cycle tends to peak later in the week in Melbourne (see chart above) and Adelaide, normally on a Thursday or Friday afternoon.
But the safest bet is to fill up whenever you see a cheap price and not when your tank is empty. Therefore motorists can take full advantage of the discounting cycle and are less likely to be caught out if prices rise.
A choice for Governments
In 1998, the distributor and retailer margin averaged about 10 cents a litre. In 2001 this margin averaged about 4 cents a litre. This reflects how competitive and unprofitable the market has become.
If Governments wish to limit discounting and price fluctuations, they will have to set the price above this level to allow the industry to cover its costs. However, this is a poor outcome for consumers, as they will pay more for their petrol.
AIP believes a free and open market will provide the best possible outcomes for motorists.
As a survey by the RACV found, motorists are not happy with pricing fluctuations, but prefer them to higher prices:
Of the motorists surveyed in metropolitan Melbourne, 72% were dissatisfied with the current petrol pricing arrangements in Victoria. When asked if they would prefera regulated market which would remove these price fluctuations, 68% agreed. However, of the 68% who preferred a regulated and stable petrol price market, 51% would not support his system if it resulted in a higher average price for petrol, and 48% would not support the system if it removed the opportunity to purchase petrol when prices were low. (RACV submission to ACCC inquiry into price volatility)
This information is published by AIP with a view to helping people understand how and why the market works the way it does. The above article has been based on material sourced from the Shell Company of Australia web site: www.shell.com.au/petrolpricing.
All of this information, plus daily updates, information on city-country price differences and price breakdowns for over 100 suburbs and towns is available at AIP's web site http://www.aip.com.au/pricing/orima.htm.
PETROL PRICES
EXPLAINING PETROL PRICE CHANGES IN OUR CAPITAL CITIES
Price fluctuations at petrol pumps in our capital cities often frustrate motorists. But these fluctuations are a sign that service stations are competing with each other to attract you the motorist. This competition keeps Australia's petrol prices amongst the lowest in the world. This article explains the reasons behind petrol price fluctuations, as well as how motorists can use the discounting cycle to their advantage. Governments have a choice between restricting pump price movements that will result in higher prices, or continuing to allow prices to move freely which keeps prices low.
The Basic Building Blocks of the Price of Petrol
The best way to explain why petrol prices move up and down is to start with the basic building blocks of a litre of petrol and see who gets what. Petrol prices are made up of:
Product cost - 90% of the product cost is the price of purchasing the raw material, namely crude oil. Also included are the costs of refining crude into petrol (the yellow segment in the chart below).
Tax - excise and the GST (the red and purple parts respectively).
Distribution and retailing gross margin - this is the difference between the pump price and the cost (ie product cost plus tax). This is not profit, but the amount the distributors and retailers have to pay all of the costs from the refinery gate to the petrol bowser.
Daily Movements in the Pump Price: "Deciphering the Discount Cycle"
Competition drives the pump price up and down. At the top of the pricing cycle, when the distributor and retailer margin is usually about 9 to 10 cents a litre, one-by-one the individual services stations or brands start to discount their price by small amounts to attract more motorists.
Other service stations quickly match these prices in order to remain competitive. Highly visible petrol pricing boards allow both customers and competitors to observe price changes. In fact part of a service station attendants role is to keep an eye on competitors price boards. Once discounting starts or ends in one area, strong competition means it quickly spreads into other regions.
Prices are normally discounted for about a week (see example of Melbourne pump prices in chart above) and as the Distributors' and retailers' margin falls below 6 cents a litre, selling petrol begins to become unprofitable. Revenue shortfalls are partly offset by shop sales - in fact most service stations in our capital cities make up to 2/3 of their overall profit from selling shop items as opposed to petrol.
A motorist on the way home may notice the price is 6 to 9 cents higher than whey they drove to work and assume it was a smooth transition (and also be annoyed they did not fill up earlier). But in reality the pump price can vary significantly across the network and from service station to service station during the day.
The good news for motorists is that prices are normally discounted for six days or more, and then only go up once a week.
Why the Petrol Market is Different
The pricing cycle outlined above is evidence of the hyper-competitive nature of the Australian petroleum market. But why is this market so different and so volatile?
The reason is the petroleum market has different demand and supply characteristics to other markets that skew outcomes in favour of consumers. These industry-specific demand and supply characteristics include:
Consumers that will change brands for a fraction of a cent. Mesh this factor with highly visible price boards and the fact that customers are actually in their cars when "shopping", means it is very easy to compare prices and swap between brands to get the best price. The costs associated with swapping brands are very low or nil.
Most of the costs in selling petrol (such as rent, utilities and wages) are fixed, therefore when sales decrease, costs do not. Retailers are always competing against each other to get customers, and discounting is the most effective way of doing this. If competitors can drop their price by 0.5 cents a litre and you lose 20% of your customers with your costs remaining the same, you will match your competitors' price to ensure that does not happen. Price changes are quickly matched in the market place and the process continues. Once all the players in the market begin to discount to protect volume, prices quickly fall.
When petrol prices become unsustainably low (say a distributor and retailer margin of 2 to 4 cents a litre) some retailers will raise their price in order to see if they can bring some profitability back into the market. If no other players in the market "follow" the price up, they will reduce their prices back to the discounted level. Oil companies and other petroleum retailers may try and raise the price at one service station or across a network. This is a bit like a group of children playing around holding their breath at the bottom of a pool - once one can hold out no longer and decides to go up for air, the others usually follow.
This combination of factors leads to a very volatile, but highly competitive market and very cheap petrol prices. This is ultimately good for motorists.
Taking advantage of the discounting cycle
"Buy your petrol in Sydney and Brisbane on a Monday, but wait until Thursday in Melbourne and Adelaide."
The distributor and retailer margin varies between 4 and 10 cents a litre during most weeks. AIP encourages motorists to take advantage of the disounting cycle and buy at the bottom of the cycle when prices are low. In Sydney and Brisbane, more often than not this is on a Monday or Tuesday morning. The cycle tends to peak later in the week in Melbourne (see chart above) and Adelaide, normally on a Thursday or Friday afternoon.
But the safest bet is to fill up whenever you see a cheap price and not when your tank is empty. Therefore motorists can take full advantage of the discounting cycle and are less likely to be caught out if prices rise.
A choice for Governments
In 1998, the distributor and retailer margin averaged about 10 cents a litre. In 2001 this margin averaged about 4 cents a litre. This reflects how competitive and unprofitable the market has become.
If Governments wish to limit discounting and price fluctuations, they will have to set the price above this level to allow the industry to cover its costs. However, this is a poor outcome for consumers, as they will pay more for their petrol.
AIP believes a free and open market will provide the best possible outcomes for motorists.
As a survey by the RACV found, motorists are not happy with pricing fluctuations, but prefer them to higher prices:
Of the motorists surveyed in metropolitan Melbourne, 72% were dissatisfied with the current petrol pricing arrangements in Victoria. When asked if they would prefera regulated market which would remove these price fluctuations, 68% agreed. However, of the 68% who preferred a regulated and stable petrol price market, 51% would not support his system if it resulted in a higher average price for petrol, and 48% would not support the system if it removed the opportunity to purchase petrol when prices were low. (RACV submission to ACCC inquiry into price volatility)
This information is published by AIP with a view to helping people understand how and why the market works the way it does. The above article has been based on material sourced from the Shell Company of Australia web site: www.shell.com.au/petrolpricing.
All of this information, plus daily updates, information on city-country price differences and price breakdowns for over 100 suburbs and towns is available at AIP's web site http://www.aip.com.au/pricing/orima.htm.
# posted by Scratchie @ 3/23/2006 01:56:00 am 
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