Fuelwise
Guide to Oil
and Fuel Prices

Understanding Fuel Prices

At Fuelwise we want you to know how and why the price of oil effects what you pay for diesel. Below are some categories that you will find useful, just click on the link to jump the story in full.

• Who is OPEC? - OPEC: The oil cartel in profile
• Oil markets explained
• Oil prices through the decades
• United Kingdom fuel tax
• Republic of Ireland fuel tax

 

OPEC: The oil cartel in profile

The Organisation of Petroleum Exporting Countries (OPEC) is an association of oil-producing nations set up in 1960 with the express purpose of influencing oil prices by controlling supply.

Founder Members of the Organization are those countries which were represented at OPEC's first Conference, held in Baghdad, Iraq, in September 1960, and which signed the original agreement establishing OPEC. Full Members are the Founder Members, plus those countries whose applications for Membership have been accepted by the Conference.

Associate Members are the countries which do not qualify for full membership, but which are nevertheless admitted under such special conditions as may be prescribed by the Conference.

Things have changed a great deal for the cartel in recent years.

In 2000, it adopted a price band of between $22 and $28 a barrel, levels a world away from current prices. If the price went below $22 a barrel, production quotas would be cut. If it went above $28 a barrel, production would be raised. OPEC abandoned the price band in 2005 and now has no official price target. When its members meet, they try to co-ordinate future production with their predictions for demand.

Financial sector

OPEC's official position is that there is plenty of supply in the market. It says rising prices are the fault of investors in the financial sector, who are buying oil contracts in order to sell them on without ever planning to take delivery. Clearly there are limits to the amount production can be raised, and OPEC also sees dangers in increasing supply further. Producers fear that the financial sector will decide that there is over-supply in the market and move into other investments, according to experts from the Centre for Global Energy Studies.

If there is a sudden change in sentiment like that, then the price could collapse. That problem is magnified by the time delays in the system.

If producers in the Gulf, for example, decide to increase production, it will be about three months before any extra oil reaches the market. If the announcement of extra production caused a big fall in prices, then the extra oil actually hitting the market three months later would inflate the problem. And the members of OPEC have a great deal at stake.

Uniquely vulnerable

Many of the oil-rich states are rich in very little else. Crude oil is their only export, making them uniquely vulnerable to world oil prices. When prices fell to $10 a barrel in 1998, their economies were hit hard.

In the US, OPEC is viewed as a cartel and therefore something to be smashed, which is not a helpful way of thinking about it. The one thing the OPEC countries all have in common is their absolute reliance on one product - oil.

OPEC History

• 1960 - founded by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela
• 1965 - Moves from Switzerland to new headquarters in Vienna, Austria
• 1973 - Opec embargo causes oil price shock
• 1990 - Iraq's anger at Kuwaiti over-production sparks Gulf War
• 1998 - World oil price drops to $10 a barrel
• 2000 - Opec introduces $22-$28 a barrel price band
• 2005- Price band abandoned
• 2008- Indonesia decides to leave Opec

OPEC countries cannot afford to treat oil "as just another commodity”. When the price falls, it creates real pain. They have to feed and give welfare to their people, the same as Western countries. On the other hand, of course, when OPEC members decided to stop supplying oil to countries they said were supporting Israel in the Yom Kippur War of 1973, a great deal of damage was done to the economies of the targeted countries. Differing strategies

More recently, OPEC has improved its reputation, with attempts made to provide some stability to the oil market. But since the 1970s, OPEC's power has waned, with its control over oil prices being questioned. There have been continuing disputes about whether member countries are actually sticking to their agreed quotas.

Also, strategies favoured by countries such as Kuwait and Saudi Arabia, which have enormous oil reserves and relatively small populations, are often at odds with those of countries such as Iran and Nigeria, that have bigger populations and few other exports.

Indonesia has announced that it will leave OPEC when its membership expires later this year. The official reason is that it is no longer a net exporter of oil. But the cartel's only South East Asian member is also understood to have been upset that there have not been greater increases of production to try to bring prices down from their record levels.

Another factor weakening the cartel is that as oil prices have risen, reserves that were not previously worth tapping in non-OPEC countries have now become viable and Russia has become a particularly significant supplier.

World Crude Oil Reserves

OPEC Share of World Crude Oil Reserves 2007

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Oil Markets Explained

Big movements in the oil price have significant ramifications around the world. But just what makes the price move and how do the oil markets work?

Crude oil, also known as petroleum, is the world's most actively traded commodity.

The largest markets are in London, New York and Singapore but crude oil and refined products - such as gasoline (petrol) and heating oil - are bought and sold all over the world.

Crude oil comes in many varieties and qualities, depending on its specific gravity and sulphur content which depend on where it has been pumped from.

If no other information is given, an oil price appearing in UK and other European media reports will probably refer to the price of a barrel of Brent blend crude oil from the North Sea sold at London's International Petroleum Exchange (IPE).

Futures contract

This would commonly be in a futures contract for delivery in the following month.

In this type of transaction, the buyer agrees to take delivery and the seller agrees to provide a fixed amount of oil at a pre-arranged price at a specified location.

Futures contracts are only traded on regulated exchanges and are settled (paid) daily, based on their current value in the marketplace.

The minimum purchase is 1,000 barrels. World benchmark

Because there are so many different varieties and grades of crude oil, buyers and sellers have found it easier to refer to a limited number of reference, or benchmark, crude oils. Other varieties are then priced at a discount or premium, according to their quality.

Brent is generally accepted to be the world benchmark, although sales volumes of Brent itself are far below those of, for example, some Saudi Arabian crude oils.

According to the IPE, Brent is used to price two thirds of the world's internationally traded crude oil supplies.

In the Gulf, Dubai crude is used as a benchmark to price sales of other regional crudes into Asia.

This is not because there are more supplies of Dubai crude oil than of any other grade - there are not - but because it is one of the few Gulf crudes available in single, on the spot, sales as opposed to long term supply contracts.

However, if supplies became extremely limited and price swings became exaggerated, a new benchmark would have to be found.

US benchmark

In the United States, the benchmark is West Texas Intermediate (WTI). This means that crude oil sales into the US are usually priced in relation to WTI.

However, crude prices on the New York Mercantile Exchange generally refer to 'light, sweet crude'.

This may be any of a number of US domestic or foreign crudes but all will have a specific gravity and sulphur content within a certain range. 'Sweet' crude is defined as having a sulphur content of less than 0.5%. Oil containing more than 0.5% sulphur by weight is said to be 'sour'.

Slightly confusingly, the Organisation of Petroleum Exporting Countries (OPEC) - a cartel of some of the world's leading producers - has its own reference.

OPEC basket

Known as the OPEC basket price, this is an average of 15 different crudes.

The oils included are Saharan Blend from Algeria, Girassol from Angola, Oriente from Ecuador, Minas from Indonesia, Iran Heavy, Basra Light from Iraq, Kuwait Export, Es Sider from Libya, Bonny Light from Nigeria, Qatar Marine, Saudi Arabia's Arab Light, Murban from the Emirates and BCF 17 from Venezuela.

OPEC aims to control the amount of oil it pumps into the marketplace to keep the basket price within a predetermined range. In practice, the price differences between Brent, WTI and the OPEC basket are not large.

Crude prices also correlate closely with each other.

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Oil prices through the decades

Click this link to take a look at fuel prices through the decades in an animated graphic produced by the UK Guardian newspaper.

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United Kingdom fuel tax

Fuel tax is an imposed sales tax put on the sale of fuel. Frequently, fuel tax is looked upon as a source of general revenue, with some being put towards the maintenance of roads and highways.

Fuel Tax in the UK

Fuel tax in the UK is constantly changing and has risen steadily over the last 15 years. Between 1993 and 1999 there was a rapid increase with duties on fuel increasing by 3% above inflation. This was due to a major change in petrol taxation in 1993 when the Conservatives introduced the Fuel Price 'escalator'. This was a way of the government making money and also to help protect the environment by discouraging people from using their cars.

Fuel Escalator Forces Prices Up

This fuel escalator forced prices up from one of the lowest in Europe to now one of the most expensive. When it was first added, fuel prices rose by 3 pence a litre and tax contributed to 72.8% of the total cost. By 1997 the escalator had added 11.1p to the cost of unleaded petrol and was at 75%. It didn't get any better when the conservatives left office and Gordon Brown took over, as the escalator increased and 3 pence was added per litre. This took tax up to an incredible 81.5% of the total price of fuel.

Fuel Tax and the 2000 Fuel Protests

Despite the fuel escalator being abandoned in 1999, fuel prices did continue to rise rapidly, with a 2 pence a litre rise after the 2000 budget, contributing to the fuel protest. These rises were however argued by the government to be as a result of increasing oil costs rather than tax increases. This argument does hold some truth when we look at the graph above, showing that although the overall price of fuel has risen; the percentage of tax has stayed relatively constant and even dropped slightly this year.

In April 2005, tax on petrol and diesel were charged at 47.1 pence a litre which with VAT added also, the total taxation makes up a huge 69.9% of the price we paid for unleaded and 67.3% for diesel.

British drivers pay two taxes on petrol they buy at the pump and fuel campaigners complain about the fact that VAT is charged on the cost of fuel and the duty and feel it should only be calculated on the cost of the fuel for a fairer petrol price.

2007 Fuel Tax Figures

Duty on fuel in the UK increased again on 1 October 2007, with an increase of 2.00 pence a litre on unleaded and diesel and an even greater increase on LPG and natural gas. See the fuel duty for all fuels below:

2007 fuel duty (as of 1 October 2007) in the United Kingdom is:

• 50.35 pence per litre for ultra-low sulphur unleaded petrol/diesel
• 53.65 pence per litre for conventional unleaded petrol
• 56.94 pence per litre for conventional diesel
• 30.35 pence per litre for bio-diesel and bio ethanol - low tax to encourage consumer conversion
• 16.49 pence per kg for gas other than natural gas (LPG)
• 13.70 pence per kg for natural gas used as road fuel.
• 9.69 pence per litre for rebated gas oil (red diesel)
• 9.29 pence per litre for rebated fuel oil

As of 1 October 2007 effective rates of duty for non-road fuels increased by 2 ppl. These rates are set to be increased by the same percentage as the main road fuels on 1 April 2008 and again on 1 April 2009.

From 1 October 2007 duty rates for unleaded petrol, leaded petrol, aviation gasoline and other heavy oil used as road fuel were increased by the same percentage as the main road fuels.

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Republic of Ireland fuel tax

Set out below are the main components that add together to make up the price of petrol at the pump. These include the price of product, which is determined in the international marketplace and the two taxes imposed by the Irish Government. As oil is traded exclusively in US Dollars, the strength/weakness of that currency against the euro also impacts on pump prices. Particular national disasters may have short term consequences but of far greater lasting impact is the continuing increase in demand from China and other rapidly emerging economies. Irish consumers benefit from having an intensely competitive retail market.

Taxation

In the Republic of Ireland, tax (excise duty and VAT) is by far the single largest component of the pump price. Following the Budget statement of 7 April 2009, the excise duty on petrol remained at 50.88 cent per litre but the excise on diesel was raised to 40.93 cents per (both excluding VAT). The levy imposed by the National Oil Reserves Agency (NORA) on petrol and diesel is 1.00 cent per litre for both diesel and petrol. After excise and the NORA levy have been imposed, VAT is then added at 21.5% (from 1 December 2008).

Source: Automobile Association Ireland, June 2009

Cost of product

Crude oil is a commodity traded on international markets and from it a whole variety of products are refined including petrol, diesel, heating oil, jet fuel. The producers of crude oil range from national states, most of whom operate under the banner of OPEC, to small independent production companies. Crude oil prices are dependant on market forces - principally supply and demand, which in turn can reflect such issues as the producing countries’ income needs, global growth patterns and others matters.

The individual companies in the Irish petroleum industry buy refined products and the cost of supply to Ireland is driven by the cost in dollars per tonne of refined products traded out of Rotterdam. For each of the refined products such as petrol, motor diesel and heating oil, there is real time tracking of market information - in effect the price at any moment - known as the Platts Quote. This is based on trades done in that product – similar to the way the Stock Market reflects prices for a company’s shares at a point in time. Irish oil companies importing petrol and diesel into Ireland have generally done so taking into account the relevant Platts quote for trade out of Rotterdam for North West Europe.

While the long-term trend in the price of crude oil has generally had an effect on the price of refined products, there is no strict correlation. The pressures of supply and demand for refined products have tended to lag those of crude oil and can be affected by other forces. One obvious example is that heating oil prices have tended to rise during winter as a result of increased demand. Other influences have included the level of stocks of oil in the USA, such as the demand for petrol in summer, etc. Similarly, the supply and demand for one refined product have sometimes followed different patterns to another. Traditionally, diesel in Ireland was always slightly cheaper than petrol on the forecourts. The main reasons for this were because the customs duty rates on diesel were lower than those on petrol while the international prices for both products were normally within the same range.

However, this has changed recently as there is a shortage of diesel at European refineries. The average barrel can only produce so much diesel and European diesel demand has far outgrown that production. Our latest estimate is that Europe imports 25 million tonnes of diesel per annum, mainly from Russia. Also, the increased demand for aviation fuel has also had a limiting effect on diesel production. In addition to this, product prices in Ireland have fluctuated with changing monetary exchange rates. Both crude oil and finished refined products are traded in US dollars. In Europe there is therefore the added variant of the relative strength of the euro versus the US dollar that has served to move the price of product coming to us either upwards or downwards.

This process was understood by the National Consumer Agency in their

Investigation into Petrol and Diesel Price Movements, published in December

2008."There is little evidence to suggest unwarranted delays in the passing on of wholesale price changes to the consumer at the pump. Direct comparison between fluctuations in crude oil prices and petrol and diesel pump prices is inappropriate and does not reflect the reality of the petrol and diesel supply chain. To more accurately assess flow through of price changes in refined oil products (such as petrol and diesel) to the consumer, it is necessary to compare fluctuations in Platts prices, these being the prices for Refined oil products such as petrol and diesel paid by wholesalers, and prices at the forecourt pump….Examination of the accounts of the larger oil companies in Ireland suggest there is relatively modest profit to be made in the downstream supply of refined oil products. Further along the supply chain, statistics measuring the numbers of service stations and fuel outlets in the country point to sustained shrinkage year on year, which would further suggest this is not a highly profitable area in which to operate, at least at the level of fuel supply only."

Petrol is inexpensive when compared to other liquid products. Through investment in technology and expertise, the oil industry has managed to hold down the cost of petrol and diesel. The raw product – crude oil - must be searched for beneath the surface of the Earth, extracted, transported across oceans, refined into petrol and other products which are then freighted to Ireland, stored and delivered locally. Compare the cost of petrol going through that journey and those processes with locally produced milk or bottled water:

Competitive Irish market

There is a very competitive Irish motorfuels market. So competitive is the market that pump prices on different company forecourts have often moved up and down almost simultaneously, reflecting movements in the major components of the petrol price – tax (announced on Budget Day each year), refined product prices and the exchange rate – which generally affect all supplies into Ireland at the same time.

The Irish Government removed the Maximum Prices Order in 1991 and deregulated the market, following a public Fair Trade Inquiry into the industry. Since then, average pump prices have generally moved in line with the cost of product to the industry and the taxation that is added to this. The very open competition between retailers ensures that consumers get good value. Since 1997 it has been obligatory on all motor fuel retailers to display prices on signage with large numerals near the roadway. Consequently, unlike most other things consumers buy, petrol and diesel prices are clearly visible from your car before you even enter the premises.

The Automobile Association survey of petrol prices in the eurozone countries shows Ireland at about midway. http://www.aaireland.ie/petrolprices. As in any free market, there may be variations in price between different retailers and different parts of the country for logistical and other reasons. It is a matter for any retailer to balance the benefits of high volumes against low margins. However, intense competition has taken its toll and many stations have been unable to remain in business.

Number of retail outlets 1997 to 2007

The above table reflects the number of sites of IPIA members. While there are other retail sites in Ireland, the pattern over the past decade is clear.

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