Petrol pricing - the plain facts

• About 40% of the cost of an average tank of petrol is tax
• Petrol in Australia is among the cheapest in OECD countries. Pump prices in Australia follow the same trends as European and US retail petrol prices.
• The landed price of crude oil does not determine the retail price of petrol in Australia – rather, the price of petrol in Singapore forms the basis of the price of petrol in Australia. Pump prices closely follow international prices with a lag of one to two weeks.
• Pump price responses to international prices are symmetrical ie they are not "quick to rise and slow to fall", instead they are "slow to rise" and "slow to fall".
• Notional gross margins (the difference between pump prices and international prices) vary up and down with international price changes but these differences are not sustained over time.
• Retail prices do not respond exactly to international prices (MOPS95) on short time scales (up to several weeks).
• Price cycles are the outcomes of competitive tension between "discounters" typically driving prices down and "non-discounters" (or "price followers") typically driving prices up when discounting becomes unsustainable.
• The supermarket alliances operate the largest number of service stations that are aggressive discounters. In most markets, non-major oil company brands play a minor role.
• Petrol prices don’t all increase at the same time and Caltex is not aware of any collusion in pricing – only fierce competition that benefits consumers.
• Daily petrol sales respond to price cycles, to the benefit of consumers. About 55% of petrol is sold on low-priced days of the week in the three east coast capital cities compared with high priced days.
• 60 per cent or more of consumers take price into account when buying petrol, so benefit directly from price cycles.
• Prices in Brisbane, Adelaide, Melbourne and Sydney did not jump because of the Easter and Queen’s Birthday long weekends in 2006 and 2007.

About 40% of the cost of an average tank of petrol is tax

Excise is 38 cents per litre and GST is included in the total price.

Pump prices for petrol have increased by about 30 cents per litre since early 2005 – mostly due to higher crude oil prices. Australian petrol prices rise and fall in line with world prices. About 15% of our petrol is imported.

Because of strong competition, prices in larger cities are heavily discounted, typically on a weekly cycle. By watching the price cycle consumers can save by filling up when petrol is cheapest. Prices are higher in many country towns because there is less competition plus higher freight and distribution costs and lower service station sales volumes.

Australia’s petrol prices are among the lowest of developed countries. When Australia is $1.30 per litre, the US is $1.10 but Japan is $1.50 and Europe averages about $2.30 per litre.

Caltex’s average profit (on a replacement cost of production basis ie. excluding the effect on prices of inventory) across all petroleum products, including petrol, in 2006 was only 2.2 cents per litre.

The expected profit for 2007 equates to approximately 2.2 to 2.3 cents per litre on average for all petroleum products sold.

Petrol in Australia is among the cheapest in OECD countries

Australia has consistently had cheaper petrol than most other OECD countries. The chart shows that the North American countries that do sell the cheapest petrol have a lower tax component when compared to Australia's rate of about 40%.

The lower, green bar shows petrol prices excluding tax. When prices excluding taxes are compared, Australia is still among the cheapest (10th out of 29) of OECD countries, reflecting the efficient and highly competitive nature of Australian refining and marketing, notwithstanding our long supply chain.

Pump prices in Australia follow the same trends as European and US retail petrol prices

When the weekly price cycle in Australia is averaged out, pump prices reflect the same trends over time as found in Europe and the United States.

Pump prices in Australia are about A$1 per litre less than typical for Europe and about 20 Acpl more than typical for the US.

The landed price of Tapis crude oil does not determine the retail price of petrol in Australia

The price of petrol is related indirectly to the price of crude oil as a result of its underlying effect on Singapore petrol prices.

The chart shows the price of Tapis crude oil since 1998 in US$ and A$ per barrel (159 litres). Tapis, a low density, low sulfur (light, sweet) Malaysian crude oil is used as the benchmark in price negotiations for supply of light, sweet crude oils in the Asian region.

Australian dollar crude oil prices were typically in the range A$40 to 50 per barrel from 2000 through to early 2004, although there were significant downward and upward movements within this period and a rising exchange rate moderated the impact of rising US$ crude oil prices through to early 2004.

The public’s perception of historical petrol prices relates to this period before 2005, under $1/litre in most states and under 90 cpl in Queensland. Since then, crude oil prices have risen by about A$35 per barrel or 22 cents per litre. It is this strong upward trend in crude oil prices, not refiner margins or wholesale or retail margins that has been the main driving force in increasing petrol prices relative to the public’s historical perceptions.

The price of petrol in Singapore forms the basis of the price of petrol in Australia

The chart shows Singapore petrol price (MOPS95) over the same period as the crude oil price chart. MOPS95 is industry jargon for the market price of generic quality 95 octane petrol quoted by Platts (a subscriber based information service) ex Singapore refineries. MOPS stands for Mean of Platts Singapore. Other octane grades are quoted (92 and 97 octane) but MOPS95 is the most common benchmark price. Australian quality petrol attracts a premium over MOPS95.

The pattern of prices over time is similar to crude oil, with prices typically in the A$50 to 60 per barrel range from 2000 to early 2004. A spike in March/April 2003 marks the Gulf War and another spike in September 2005 marks Hurricanes Katrina and Rita. From mid 2004, prices rose sharply due to underlying crude oil prices.

The ex-refinery price of petrol is based on the Singapore market price for petrol, adjusted for Australian fuel standards and freight to Australia; the price is not regulated but instead determined by market forces.

The reason Australian petrol prices follow Singapore market prices is that Australian refineries must compete against petrol imports (overall 18 per cent of Australia's petrol was imported in 2006) and Singapore is a major source of petrol for importers.

The crude oil markets and the petroleum product markets are completely separate, distinct markets. Traders in these markets influence the prices based on supply and demand, real and perceived shortages and geopolitical instability. This is the same as for any international traded commodity such as agricultural or mineral commodities or currencies.

The prices of Singapore petrol and Tapis crude oil do not necessarily rise or fall at the same time or to the same degree

The chart shows Singapore petrol price (MOPS95) and Tapis APPI crude oil price, both in Australian cents per litre (Acpl). The petrol price spike caused by Hurricane Katrina in the US is clear but so is the rapid decline almost immediately after the peak. Within two weeks, the price increase completely dissipated, with refiner margins (the difference between petrol and crude oil prices) lower than before the effects of the hurricane.

In September and October 2006, refiner margins were negative ie. petrol prices ex-refinery were lower than the cost of crude oil used to make it. This also occurred in February 2006 and mid-2001.

The Singapore refiner price is a market outcome, and the resultant margin is calculated as the difference between the selling price of petrol ex-refinery and the cost of Tapis crude oil, not determined by refiners

The chart shows that the average Singapore refiner margin from 1998 to 2002 was about US$3 per barrel. Since 2003, the average has been about US$5 per barrel, which is about US$2 per barrel or 2 Acpl greater than the earlier period.

The refiner margins shown are gross margins ie. selling price of petrol minus the cost of crude oil – profits will depend on costs of refining.

The price of petrol is a market outcome – it is not ‘set’ by refiners on a ‘cost-plus’ basis. This is demonstrated by the negative margin for petrol in September 2006 – you could buy petrol cheaper than Tapis crude oil.

From mid-2003, Chinese demand for petrol from fast-growing new car sales pushed up product demand until mid-2004 when demand controls applied by the Chinese Government eased petrol demand and as a result Singapore petrol prices. From 2Q2005, northern hemisphere summer demand (driving season) pushed up petrol refiner margins with Hurricane Katrina striking on 30 August. Margins quickly returned to more normal levels.

Margins fell in early 2006 due to weak demand and increases in underlying crude oil prices, then increased sharply as demand recovered in the run-up to the northern summer (when demand increases) and many refineries in the region undertook planned maintenance.

While petrol refiner margins in mid 2007 were higher than on average early this decade, the increase is not significant in explaining the large increase in pump prices – that is mostly due to higher crude oil prices as discussed earlier.

Case study on petrol refiner margins

The quality premium for Australian petrol has increased with the introduction of tougher Australian fuel quality standards

Tougher national fuel quality standards mandated by the Australian Government to help reduce vehicle exhaust pollution have meant that petrol produced for the Australian market is now required to contain a maximum of 1% benzene, down from the previous (unregulated) range of 2 to 3%. Since 2003, petrol standards have also been mandated for the content of MTBE, olefins and aromatics, and final boiling point, which are tougher than former voluntary industry standards. These new standards will significantly improve public health and, in the case of MTBE, safeguard water quality.

Caltex has invested about $500 million dollars in upgrading its Kurnell and Lytton refineries to enable them to produce higher quality petrol and diesel.

Tougher petrol standards have increased Caltex’s wholesale price of petrol by about 2.5 cpl since 2003.

Metropolitan and regional pump prices closely follow terminal gate prices which closely follow changes in international prices

Caltex's terminal gate prices (TGPs), which are published daily, are calculated based on the cost of imports to Australia, terminal costs and a wholesale marketing margin plus excise/subsidies and GST. TGPs are therefore a good indicator of how changes in international prices flow through to ex-terminal wholesale prices in Australia.

TGPs are spot prices for bulk supply of fuel ex-terminal and are therefore a reasonable proxy for wholesale prices. Actual wholesale prices typically include charges for brand, credit, and site and equipment rental but also may be discounted according to competitive conditions in various markets and customer size.

In the charts, monthly average regional and metropolitan prices (AIP data prepared by Orima Research) are shown, together with capital city Caltex TGPs. The differences between regional and metro prices are due to wholesale and retail margins and freight.

The data for the charts is as published by the Australian Institute of Petroleum (AIP) on its web site. (Note the Queensland TGP does not include the state retail subsidy of 9.2 cpl including GST, so pump prices appear low relative to TGP.)

The charts, being state averages, do not show the variation between individual country towns, which are often the subject of media and political interest. In almost all cases, these differences are the result of local competitive factors, including site volumes and site density, the presence of discounters including supermarkets and the impact of new entrants seeking to establish volume.

Retail margins (pump price less wholesale price) are typically higher in the country compared with major capital cities, mainly due to lower fuel volumes and shop sales over which to spread service station operating costs.

Distribution costs (included in the wholesale gross margin) may be significant for country areas where fuel must be stored in depots and double-handled, rather than being delivered directly from coastal terminals.

Freight is typically 1.5 to 3 cpl greater for country than city delivery.

As shown in all the charts, there is a very close correlation between pump prices and international prices (represented by TGPs) over time.

It is clear that pump prices do rise and fall with international prices. The turning points of each price series are closely matched and all states and territories show a similar close relationship.

However, close examination shows that as international prices increase, gross margins (represented by the difference between pump prices and TGPs) tend to be compressed, with losses being recovered through higher notional gross margins when international prices fall.

The increase in margins is often larger for regional prices than metro prices but in both cases, the increase is not sustained over time and the close correlation is restored.

Case study on impact of Hurricane Katrina

There is a one week lag between changes to international prices and their impact on metropolitan and regional pump prices

There are two issues in examining the response of pump prices to international prices – the timing of the price changes and the size of the price changes.

This chart analyses the timing of price changes. (The next chart analyses the size of price changes.) The first chart considers the correlation of national average metro and regional pump prices (weekly average across all brands) one week after a change in the Singapore price (MOPS95) plus freight (since the calculated import parity price includes freight to Australia).

As shown, changes in Singapore petrol prices or Australian/US dollar exchange rates typically take one week to flow through into either increases or decreases in pump prices. These changes are often masked by weekly cycles in pump prices in major capital cities.

A criticism commonly levelled at oil companies by the public is that petrol prices are quick to rise but slow to fall in response to international prices. This is clearly not correct – prices change equally fast in both directions, with rare exceptions.

The one week lag could be explained by wholesale pricing formulas. Caltex uses a 7 working day rolling average to smooth out daily MOPS95 fluctuations when setting wholesale prices and time required for stock turnover at service stations could further extend the response time. Other companies may also employ similar averaging of MOPS, which was used by the ACCC in price regulation up until 1998.

The week on week difference chart shows changes in pump prices (with a one week lag) and Singapore prices are well correlated, with matching of turning points in most cases. However, the amplitude of metro price changes tends to be less than MOPS changes and regional prices show less amplitude than metro prices ie. country prices respond quickly in both directions but the response is damped.

While the correlation with international prices is quite strong, other factors can greatly affect the correlation on a week by week basis, including weekly competitive price cycles.

Notional gross margins vary up and down with international price changes but these differences are not sustained over time

The chart shows national average metro and regional pump prices minus MOPS95, shipping, net excise, GST and freight ie. retail and wholesale gross margins.

It shows that as international prices increase, gross margins fall. As international prices decrease, gross margins recover. Some commentators tend to focus on periods in which margins are increasing but fail to make public comment on periods when margins are falling. However, it is clear from the chart that margins return to a historical level over time.

In metro areas, the variations are smaller than in regional areas. Caltex can’t offer a definitive explanation for regional pump price behaviour as we operate very few sites in the country. However, a plausible explanation is as follows.

There is less competition in regional and rural areas than in metro areas where major supermarket chains have a strong presence. While benefiting motorists through lower prices, supermarket chains have built volume at the expense of smaller, typically independent, service stations and they also have a stated policy of pricing against the lowest competitor in a country town.

As a consequence, the volume gained by any non-supermarket service station from discounting could be short-lived as a result of the pricing responses of competitors, so the net result of discounting could be no volume gain but a reduction in retail margin. For this reason, pump prices, through normal competitive forces, are likely to move slowly in response to a decrease in wholesale prices with a consequent impact on retail margins.

Similarly, when Singapore prices fall, hence wholesale prices (the two are typically rigidly linked), country pump prices follow more slowly than in the city. A similar effect occurs when wholesale prices increase as a result of increasing Singapore prices – an individual retailer cannot raise pump prices easily without loss of volume, so retail margins are compressed. Note that changes in CRP are rigidly linked to wholesale prices to resellers, so Caltex wholesale prices to resellers respond quickly to falling international prices. However, as discussed earlier, this decrease in wholesale prices may take longer to flow through to customers because of the need for retailers to recover margins lost when prices increased.

The large price spike induced by Hurricane Katrina and considerable uncertainty about the global supply outlook may have had a greater impact than normal on margins, as retailers anticipated a prolonged period of high wholesale prices. Higher margins may have been necessary to cover higher cash costs for petrol deliveries, particularly if additional working capital was difficult to obtain from lenders.

Price arrangements and price support

Case study on how daily petrol sales respond to price sycles, to the benefit of consumers

Petrol prices don’t all increase at the same time and Caltex is not aware of any collusion – only fierce competition that benefits consumers

Petrol prices are often discounted in major capital cities – and heavily – as a result of intense competition for customers. Service station dealers concentrate on petrol discounting to drive overall petrol sales volumes and associated shop sales. Supermarkets also use low petrol prices and shopper dockets to drive supermarket sales.

Petrol prices don’t all increase at the same time - but sometimes it does look like this because, once a price increase is made by one competitor, other competitors may follow very quickly, as shown in the chart. The data in the chart is from Informed Sources.

Pump prices often appear to jump up together after they have been discounted heavily for several days. Both discounting and price jumps are the result of a highly competitive and price-sensitive market where competitors' prices are readily visible on price boards.

In a competitive market, what goes down must come up. Deeply discounted prices on a Monday or Tuesday benefit the 60 per cent of motorists who take price into account when buying petrol. Petrol is "on special" every week – but the early week discounts are unsustainable.

Some petrol retailers – in particular the supermarket chains – are discounters. We believe they discount petrol to drive sales through supermarkets or service station convenience stores, as well as increasing petrol volume.

Other petrol retailers don't lead discounting but follow very close behind and match the prices of the discounters. Caltex receives electronic data on the market prices of competitors every 30 minutes from an independent price monitoring service and reviews its prices several times a day. Australia's consumer watchdog, the Australian Competition and Consumer Commission (ACCC), receives information daily from the same monitoring service.

The market works in various ways but the following is typical. At the high-priced point in a cycle, pump prices in an area will be similar, with the operators of all service stations closely watching their competitors' price boards. When one station reduces its price to increase sales, competing service stations act quickly and also reduce their prices to avoid losing sales to a competitor with a lower petrol price. This pattern is repeated over several days.

Not long into the cycle, oil companies will often provide discounts (known as "rebates" or "price support") off the initial wholesale purchase price paid by franchised dealers in order to help them meet the competition and cut prices at their sites.

Without rebates, franchised dealers would soon face losses as pump prices fell. With rebates, over the course of a discount cycle, dealers' retail margins typically do not vary substantially, although dealers are free to set their own margins. Rebates are available to all franchise locations, both city and country.

After several days of the discount cycle, with prices decreasing, one wholesaler will no longer be able or willing to sustain the low wholesale prices and will advise its franchised dealers that rebates will cease from a particular time. Prices may also increase at company-operated or commission agent sites. Franchised dealers are free to set their pump prices at any level but typically they will increase them in line with the increase in wholesale price. Other wholesalers, observing the pump price increase, may also cease rebates or increase the pump prices under their control, so that all pump prices may increase in rapid succession.

This behaviour is neither anti-competitive nor illegal and in fact results in lower prices on average over the cycle. Consumers benefit as they have the opportunity to buy petrol at the low point of the discount cycle.

The ACCC investigated price variability in its December 2001 report and concluded “it is likely that consumers in aggregate benefit overall from price cycles.” The ACCC also did not support any of the options it considered to limit price cycles as it was concerned that any such intervention could have the effect of increasing prices.

Prices do not jump because of long weekends

In the lead up to, and throughout, holiday long weekends pump prices follow their typical weekly cycles. This normal behaviour is typical of all holiday periods in major metropolitan areas.

The charts for capital cities show that contrary to the assertions of some commentators, pump prices did not jump up because of the Easter or Queen’s Birthday (June) holiday weekends in 2007. (There is no June long weekend in Perth)

In each chart, the pump price at the trough of the cycle is typically similar to the terminal gate price ie. the bulk wholesale price ex-terminal. Pump prices at the top of the price cycle could be 10 cpl or more above TGP, although these prices are rapidly discounted over the course of the week and sometimes two weeks or more.