Fuel Prices, a Subtle Blend

08/08/2011

The price of gasoline or diesel depends on 5 factors: the price of crude oil, the taxes imposed by consumer states, the exchange rate, oil company costs and margins (refinery and distribution costs and margins) and finally the price of any added biofuels.

How the price of gasoline and diesel is set?

Since the 20th century, the price of crude oil on stock exchanges has fluctuated widely according to certain political and economic events. The globalization of oil trading has exacerbated this trend even further by making prices highly sensitive to financial and geopolitical current affairs such as conflicts involving an oil-producing country, sudden rises in fuel demand, etc. Because of this, these prices can often change unpredictably.

However, the pump price of fuel does not fluctuate to the same extent as the price per barrel of crude oil. For example, between January and July 2008, the price per barrel rose 50%. Over the same period, the pump price in Total service stations rose only 19% for diesel and 11% for lead-free 95 fuel. This difference, which also occurs when prices are falling, is explained by three main factors:

   • The sale price at the pump mostly relates to taxes collected by the state. Thus in January 2011 for 1 liter of lead-free 95 gasoline sold in France, 60.76 euro cents represent the cost of producing the crude, the taxes collected by the producing country, and the refining and transport costs, while 84.99 cents represents the oil taxes paid to the state (i.e. 58% of the sale price). These taxes are both fluctuating and constant: VAT, calculated as a percentage of the price, varies according to the price per barrel while TICPE (domestic duty on energy products), a constant tax set in advance by the state, does not depend on fluctuations in the price per barrel. Consequently, variations in the price per barrel only affect a little over half of the price paid at the pump by consumers.

   • The price per barrel of oil and refined products (gasoline and diesel) are set on different financial markets, and are therefore subject to different laws of supply and demand. Thus, fuel prices may rise during the summer holidays because demand is higher, while crude prices remain stable.

   • In Europe, the markets for crude oil and refined products use different currencies: the price per barrel of crude is expressed in US dollars, while fuel prices are expressed in euros. Variations in value between these two currencies can happen very quickly and this affects the sale price of fuel, independently of the price of crude oil. Thus, when the price per barrel fell from almost 150 dollars to about 120 dollars between July 2008 and July 2011, this was not fully reflected in Europe as the euro had lost much of its value against the dollar.

There is one final factor that affects current pump prices of fuel: the possible addition of biofuels (bioethanol, biodiesel). These are currently pushing overall prices up. Firstly, because their cost price is higher than the price of crude oil. Secondly, because the proportion of these is set to increase due to political backing to develop them.

During the first half of 2008, the world entered an economic crisis, characterized by significant tension on the commodity markets.

The price per barrel rose sharply from 96 dollars on January 2, 2008 to 144 dollars on July 3, 2008, for two reasons:

   • Firstly, high demand, particularly from emerging countries such as China;

   • Secondly, reduced production capacity by OPEC countries to keep crude prices relatively high.

Thereafter, prices slumped following the economic slowdown and expectations of drastically reduced demand. Average monthly prices per barrel fell from 130 dollars to 40 dollars between July and December 2008.

From 2009, as producers reduced production to maintain income levels, the barrel gradually rose to 80 dollars.

In 2010, the economic recovery saw the highest rise in demand since 2004, bringing tension back to the oil market. This tension intensified in early 2011, with the uprisings in the Arab world as markets feared repercussions in terms of production capacity. Against this backdrop, the price per barrel is set to remain above 100 dollars for some time to come.

For example, Saudi Arabia, which depends on oil for 90% of its revenue, has set up an ambitious and costly social program which involves raising public service pay and housing aid. As a result, the "fair price of oil" estimated by the Saudis is expected to rise from 75 to 90 dollars per barrel.

What is the future trend for fuel prices?

Rising demand for oil in 2010 is set to continue in 2011. In the coming years, demand for oil will be sustained by demographic and economic growth. The growing importance of China in the global economy will contribute to this.

Furthermore, a number of factors will ensure that the share of fossil fuels in the energy mix remains constant. Currently at 80%, this will be at about 75% in 20 years' time:

   • The cost of heavy equipment producing energy and electricity may impede the switch to alternative sources.

   • The negative effects of the Fukushima catastrophe on the development of nuclear energy.

   • Competition with food cultivation may impede the development of biomass.

   • The potential for hydropower is already being significantly used in OECD countries.

   • The development of solar and wind energy from a very low base will take time.

To meet these needs, there are today 40 years of proved oil reserves, depending on demand, production costs and current technology. A plateau is expected to be reached in 2020-2025.The attitude of Middle-Eastern OPEC countries (which hold 70% of reserves) should lead to a growth plateau. These countries hope to continue to produce for another 50 years and are prioritizing price over rapid development of their resources. They will therefore seek to balance demand and production, capped at about 95-100 million barrels per day.

This type of trend is in contrast to the Hubbert peak (named after the American geologist who forecast it in 1956). This involves a peak in production prior to a dramatic fall. It occurs in the life cycle of oil reserves, but is not necessarily reflected on a global scale.

This peak should push the price per barrel over 100 dollars if rising demand is not matched by increased production. If this happens, energy will become more expensive although economic growth will still be possible. It will also encourage energy savings.

However, the life of petrol reserves could be extended to a hundred years or more, by:
   • Extracting oil using increasingly costly technologies (deep offshore oil in Africa, Brazil and the Gulf of Mexico, oil sands in Venezuela and Canada, etc.).

   • Improving the recovery rate in known oil fields, where currently only 30% of existing oil is recovered on average.

   • Using biofuels based on sugar cane, palm oil or other biomass resources to supplement oil.


At a time when oil is becoming increasingly scarce, two other factors may also come into play:  
   • Specialized consumption, i.e. where oil is used only where there was no easy alternative, such as the refueling of airplanes.

   • Improving the energy efficiency of vehicles, which will need less gasoline to run.

Alongside all this, economic mechanisms are coming into play: price rises encourage consumers and businesses to save energy and therefore reduce use, thereby prolonging the life of reserves.