Factors Driving Low Prices Of Petroleum Products In The UK And Their Short-Term Future

The asymmetric adjustment between wholesale and retail fuel prices in the United Kingdom has generated lingering concerns about the transparency of retail petroleum products prices. However, over the past few years, motorists in the United Kingdom have enjoyed a sustained period of falling pump prices (Energy Institute, 2016).

Critically analyse the factors driving the sustained low price of petroleum products over the past five years and based on your findings, evaluate the possible direction of the price of diesel and petrol products in the United Kingdom in the short-term future.

UK's Position

Mid-January 2015 witnessed the falling down of oil prices in a dramatic fashion. This recent fall has been considered the major in the history, with the equivalent declines being the collapse in the prices of the oil in 1980 and the global financial crisis in 2008-09. The latter factor was inverted quickly, but the former proved to be the long enduring one. There is an amalgamation of factors from both the demand and supply side leading to this sharp decline in the prices of oil. According to Arezki and Blanchard (2014), the supply side observes strong growth in the manufacturing by the non-OPEC producers and the growing production of US shale oil contributing to a general increase in the productivity. Furthermore to this is the obvious strategy of OPEC producers led by Saudi Arabia having inferior cost of production in maintaining the levels of production to preserve and expand the market share through expensive sources that are unconventional in nature. The demand side sees the braking growth in China and the slow recovery of economy in the European Union contributing to the deteriorating demand for petroleum.

UK is known to be the largest oil producer and the second largest manufacturer of natural gas in the European Union. In years of being the net exporter of natural gas and petroleum, UK has become a net importer of crude oil from the year 2005, and from 2013 in the other oil product segments (Appendix 2). The gas and oil segment that consists of the removal of crude petroleum and natural gas and the production of products that is refined petroleum has shriveled to around a third of its size since its crest in late 1990. The sector in the present scenario accounts for less than 2 per cent of UK’s total GVA as compared to 6 per cent in the year 1999.

In 1997, the total volume of retail sales increased from approximately 28 million tones to a max out of 29.4 million tons in the year 2007. Since being at its peak, the total retail volumes have dropped to 27 million tons in 2011, a decline of around 8 per cent in total of over the period of last four years (Gillingham, Rapson and Wagner 2015).

Oil or petroleum has been considered as a risk based commodity that is being openly traded on the world exchanges. The price of fuel has seen a roller coaster ride, the fundamental tendency has been of constancy with few changes in the value of Brent crude oil from the starting point of 2013 till the end of 2014 (Appendix 3). As per Dagher (2014), traders have been influenced at greater rate by apparent events, which may have affected the supply and demand on the global stage that meant that prices could fluctuate in UK although there is lack of obvious reasons for the same.

According to Chitnis et al. (2014), over the last few years one of the major factors that influences the price movement of oils is the economy of the United States and the accessible debate whether or not it was developing apparently for the Federal Reserve Bank to drop the Quantitive Easing (QE) measures positioned to sustain the financial sector. Maintaining high intent of QE support resulted in prices of oil being high with traders retaining much interest in high-risk commodities. However with the economy showing expansion and development, the FED has established its target to move forward with the designed lessening of the QE program resulting in oil prices to be traded at lower prices.

Factors Influencing UK Petroleum Prices

UK’s oil market has been affected by the currency factor, UK demand and supply along with the world oil markets. As currency for trading of oil is US$, variations in the exchange rate between the US$ and the UK£ can also affect the pricing factor both up and down. In UK, fuel retailers base prices of pumps on the cost of wholesale related to diesel and petrol, however, there has been a lag of two weeks between the moving of the pump prices to replicate any modification in the wholesale price (Appendix 1). This is generally the time that is being taken by fuel to move through the supply chain to the forecourt. At the pumps, the overall retail price takes into account a considerable tax amount- 57.95p per liter in fuel duty along with 20 per cent VAT. This is further of the 60 per cent of the price that directly goes to the Treasury, which together with the tax of the car and tax totals of ‘showrooms’ amounts to more than £40bn a year (Baffes et al. 2015).

Low prices of oils help in reducing the living cost of people. Transport related to oil will fall unswervingly leading to lower living cost and lower rate of inflation. Falling in the prices of the oil would result in fall in the UK inflation to 0 per cent. As per Cashin et al. (2014), motorists in UK are being benefited from the lower prices of petrol, which are now below £1 a litre in some places, though they still do not replicate the true value of supplies. Oil companies in UK argue to the fact that the immense majority of the prices of petrol is being made up of taxes but a further subside in the values of crudes would generate a superfluity of despicable redefined products and pressure to pass on cuts. Many such international contracts of gas are tied up with the prices of oil with the wholesale prices dropping by at least a margin of 30 per cent over the period of last eighteen months (Demirbas, Al-Sasi and Nizami 2017). Such lower costs have not been shifted on the householders with the big six UK suppliers fleecing for the immense majority of people. Even with the low prices of crude, the expectations have been growing on the prices of the power that it would stay flat from now until the end of this decade.

The quantity of absorption of those markets and the absence of any sort of competition could clarify the price glueyness and the faster reaction of retail prices related to crude oil. The significance of reputation and the deficient knowledge of the costs of consumers consider the behavior of pricing related to firms. In response to the shock of negative cost, an organization desire upholding the present price until there is a shift in the demand.  The price is being maintained above the level of competition. The firm presents a focal point for the sellers in the oligopolistic market. The ‘trigger price variant’ as modelled by Green and Porter states, the slower feedback displayed by the prices of redefined products to a fall in the prices of crude oil. During times of rise in upstream price, retailers of refineries need to normalize at an express basis of their prices in maintaining the margin and saving the conformity.

Potential Explanations of the Asymmetry

The asymmetry would thereby depend on the members’ coordination taking part in the tacit agreement. Instability in coordination would result in less response of the output prices to constructive shocks on input prices that would be low and slow. Refined products are generally expensive in shipping of the crude oil along with regionalization of those markets. In case of refiners being large, retailers would be competing on a limited space.

 The retail fuel price speeds of adjustment to crude oil price changes symmetric:

This can be considered as the “symmetry of adjustments in prices”. At times when the adjustment rate of retail prices of fuel decreases or increases in similar rates along with the global prices of crude oil, then the adjustment equilibrium in prices is measured symmetric. A symmetric/asymmetric adjustment speed can be explained by the oil industry structure. It is anticipated that the more competitive the retail market is, the more expectation would be on firms not engaging in collusion in maintaining margins of higher profit.

A decline in the price of the petroleum is similar as the tax cut for consumers. It signifies that they have further to expend on other goods and services, though there is existence of some evidence that the car owners of UK are expending some of their handout as they have been increasing the miles they oblige.  A drop in the prices of the oil to $10 would not mean a big plunge in the prices of pumps as for the tax imposed but businesses would get a huge lift from the cheaper oil products. It cuts down the transport cost, along with other benefits like the cheaper plastics, synthetic fabrics and fertilizers. This downward strain on inflation would sway the Bank of England to keep the rates of interest lower for longer amount of time.

 It can be bad news for people who save but can be good for payers of mortgage and high-street spending. The UK government would hope that consumers would be spending more on services and goods generated by the businesses in UK, enhancing growth. However, the economy of Britain have been an open one with trading accounting for approximately one third of the activity related toe economy, so with extra amount of cash going in imports, it will enlarge the deficit existing in trade. Scotland would be suffering with pulling out of more oil firms from the North Sea production. From the perspective of the Treasury, the bad news would be the bigger loss in the revenues of tax that follows inexorably, though could be rewarded by tax receipts from higher rate of growth.  

The biggest supermarkets of Britain have cut down the petrol prices to less than £1 a litre, a first in six years. Companies like Tesco, Asda and Morrisons have slit the petrol prices with prices of oil tumbling and the supermarket chains battling to exert a pull on attracting shoppers. The average prices of petrol have not descended below £1 in the UK since the year of 2009, peaking in April 2012 at £1.42 (Bentley 2016).  Tesco, which is the largest fuel retailer in UK with 500 forecourts, has dropped unleaded to 99.9p along with taking a penny off diesel. Sainsbury’s is following the suit at its own 300 forecourts, though Morrisons has witnessed a tumbling at a staggering 99.7p and diesel to 103.7p. in 20016, Asda joined in during Christmas with its own three day promotion cutting leads to 99.7p and diesel to the same of Morrisons at 103.7p (Kumhof and Muir 2014).

Symmetry and Asymmetry of Fuel Price Adjustment to Crude Oil Price Changes

According to the fuel director of Tesco, Peter Cattell, Tesco knows that their customer values lower prices of fuel having unleaded for 99.9p a litre, providing customers a boost during their biggest festive season. During that period of time the prices of Brent crude dropped down to $40 a barrel causing immense confusion for miners and oil groups, though it is set to assist consumers only in the short run (Juvenal and Petrella 2015).

Pre-tax of prices of petrol in UK are lower than anywhere one could find in EU except for Estonia, though after adding up of fuel duty and VAT the cost of the pump goes b=up by few notches that is highest in the region. Chancellor George Osborne did call on the fuel companies for reducing the charges in the stir of falling prices of global oil. In 2015, the total prices of petrol did rouse after dramatically falling from £1.30 to £1.06 in the year leading upto February.

As per the government’s released data the pre-tax petrol cost has dropped down to 32.4p per litre, the second lowest in the whole of EU. With adding of the tax, the amount adds another 76p per litre, making UK the fifth highest behind Malta, Greece, Holland and Italy. It signifies that tax adds up to 70 per cent of the fuel’s total price of one litre, combined highest with the Netherlands. Since the year 2011, FairFuelUK has prohibited £30bn of hikes in taxes that Labor party has designed if they had been at the helm of the Government proceedings. It has been no coincidence that frozen duty of five years and the latest historic fall in the prices of oil have offered rise to the promising economy of UK. It has been stated in the UK parliament that all the parties have identified that lower prices of pumps are better for the hard pushed 30 million motorists and businesses by producing other taxes having positive growth through lower levy of fuel duty. It has all been about motivating the consumers in not mugging with the costs that are essential in nature. The government’s action since 2011 on fuel duty, pump prices would witness 18 pence drop down than they would have been under the plans of previous fuel duty.

Although the extraction of oil and gas sector is being negatively affected by lowering of the prices of oil, sectors like transport and agriculture would be benefiting immensely from the low prices. Transport related to water and other service sectors would be enjoying smaller positive impacts.  Shipping and airlines companies would love the ongoing saga of low petroleum prices as for these sorts of companies, energy costs symbolize an enormous amount of the total costs of conducting business. Therefore, a fall in the prices of petroleum would facilitate them to improve on their earnings at a rapid speed. A reduced cost helps in facilitating more money to be added for the purpose of investment and growth while bringing in the money from customers who have the ability to spend more on services and goods.

Conclusion:

A drop down in the price of petroleum thus has the ability to provide benefits to certain sectors and consumers, especially who do not spend on other goods and services when the cost is high of petroleum to add fuel to their car’s tank. This report has enabled in reaching to a conclusion that the British supermarkets indulge themselves in heavy war of slashing prices during the festive season to facilitate consumers in spending more.  The government has done enough to balance the situation and let everyone prosper in the backdrop of lowering petroleum prices.

Reference:

Arezki, R. and Blanchard, O., 2014. Seven questions about the recent oil price slump. IMFdirect-The IMF Blog.

Baffes, J., Kose, M.A., Ohnsorge, F. and Stocker, M., 2015. The great plunge in oil prices: Causes, consequences, and policy responses.

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Cashin, P., Mohaddes, K., Raissi, M. and Raissi, M., 2014. The differential effects of oil demand and supply shocks on the global economy. Energy Economics, 44, pp.113-134.

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