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Paying up at the pump

by Said Ghusayni

Car drivers around the world usually agree on one opinion: gas prices at the pump rapidly shoot up when world crude prices increase but slip much less eagerly when crude rates head back south. In the period immediately after the world oil market relaxed from its $42/barrel (bbl) peak in late May, the reality in Western Europe and the US fit that view, as pump prices after one week relaxed only by about $0.04/ liter, or 2%, in Europe’s largest market, Germany, and rates in the US took until June 14 to drop back below $2/gallon. One can credit both stronger market confidence and improved balance of the supply-demand logic for allowing international crude oil prices to dip back below $40/bbl last month, following the June 3 Beirut OPEC meeting to increase production quotas by 2.5 million barrels per day (bpd) and legalize already existing overproduction, and subsequent physical increases in production from Saudi Arabia and the UAE (total around 1 million bpd) that brought a corrective factor onto record high prices. But although prices at the gas pump eased slightly in the second half of June also in Lebanon, vital concerns over the cost of fuel to both the Lebanese economy and the individual consumer remain.

In Lebanon, gasoline prices are government mandated, with weekly reviews of price ceilings that in all practical terms translate into the effective sales price that the consumer pays at the gas station. As the state thus exerts double influence on gasoline prices through taxation and price determination, the demand to lower retail prices for fuel became a central rallying point in the country’s May 27 general strike. However, while economic hardships make them more than understandable, demands for capping the maximum amount that Lebanese consumers have to pay at the fuel pump must in the end remain wishful thinking. The reasons behind high gasoline prices are too complex and the implications of reduced revenue from gasoline taxes are too vast to allow for such a “simple solution.” One may never forget that the first driver of the consumer gas bill is the supply situation. All mineral fuels are refined from crude oil and so the price of a gallon of gasoline derives directly from the price of crude oil. It has been well established that a number of reasons have influenced the high prices of crude oil, which soared as high as $42/bbl in trading on the New York Mercantile Exchange by late May 2004. Such a high price of oil will inevitably be passed along the refinery chain to gasoline prices and thus affect the end user. What then were the causes behind the recent oil price rally? It was spurred on by a combination of angst over potential supply shortages, strong demand, and aggressive speculative buying. Looking at the details, most analysts agree that the following main factors influenced the market in the first half of 2004:

· Instability in Iraq

· Terrorist threats to producer nations in the Middle East (including Saudi Arabia)

· Increased global demand, particularly from China

· Lower-than-expected non-OPEC production

· Shortages in spare refining capacity available to OPEC (and non-OPEC) producers

· Aggressive fund buying (more significant in the early stages of rally).

The large extent to which the war in Iraq added instability to the markets must not be underestimated. Attacks and acts of sabotage have hampered reconstruction efforts designed to rebuild the country’s archaic oil industry. At the time this article went to print, an attack on the Northern Kirkuk pipeline to the Turkish Mediterranean port of Ceyhan, and two separate attacks on the southern export terminal of Basra completely halted Iraq’s 1.8 million bpd of crude exports; repairs are expected to be completed around the second week of July. Kidnappings of foreign nationals hindered progress and prompted some foreign organizations to withdraw their employees, including construction companies who are in need of valuable experience for the reconstruction job at hand.

Iraqi exports had averaged 1.8 million bpd, around 1.6 million bpd of which is from the Basra oil terminal, while the remainder came from the northern Kirkuk pipeline that leads to the Turkish Mediterranean port of Ceyhan. Resistance to the US occupation and terrorist attacks against the country’s political and security infrastructure have been stiff, dimming the prospects for a successful performance of the Iraqi Interim Government in the second half of 2004. Numerous local leaders have openly opposed US plans for the handover of power in local elections, thus making additional violence and continued instability very likely. Terrorist threats to other Middle East producers have also pushed markets higher and are adding a premium to crude prices. An attack by gunmen against a Saudi Arabian refinery complex in Yanbu that killed six workers in May and further terror strikes against foreign oil workers in June underscored the threat against the security infrastructure in the world’s largest producer. If attempts to restore security at Saudi oil facilities and ward off terrorist groups are not successful, future supply fears could grow to levels that would make crude oil prices of $35 to $40/bbl seem cheap. In trade developments over the past year, crude markets have become increasingly affected by heavy speculative non-commercial buying, primarily by investment funds. Large speculative net long positions have pushed markets higher as well as raising the possibility of a massive sell-off when investors decide the market has topped off. NYMEX WTI net non-commercial longs hit a 15-year high of 87,000 lots in February, although this has now fallen back to 40,000 lots. Estimates of the impact of the funds on the market vary greatly but on average, traders see the impact as comprising around $4/bbl in the composition of current prices. However, it is important to note that the last $4 rise in the market (from $37 to $41 on WTI) has not been driven by fund buying. This reduces the likelihood of a large fund sell off as the funds are all heavily in the money. It also means that demand from buyers does not seem to have been significantly impacted by current high prices.

As for the demand outlook, figures are also not in favor of significantly lower oil prices. In its monthly OIL MARKET REPORT, the International Energy Agency (IEA) raised its forecast for global oil demand in 2004 by 360,000 bpd to 81.1 million bpd, reflecting the largest absolute increase in global oil demand in 24 years. The report cited stronger than expected energy consumption among industrialized nations, which was bolstered by explosive demand growth in China, as the main cause of the increase. The IEA forecasts world consumption will rise 3.8 million bpd from the second quarter’s 78.7 million bpd to 82.5 million bpd in the fourth quarter of this year. The upward revision adds to worries that increased demand will continue to prevent inventories from accumulating and cause disruptions in the supply of products such as gasoline. The IEA also said that non-OPEC producers are failing to pump as much as expected this year, increasing reliance on OPEC for extra crude. The IEA raised its forecast on the call of OPEC crude by 500,000 bpd to 26.4 million bpd for this year. However, numerous producing nations are currently producing at maximum levels leaving little room for any additional output to help ease prices. While predicting oil price developments is a fickle business, the combination of the above elements makes it seem unlikely that dropping crude oil prices could drive gasoline prices down to levels global consumers enjoyed in the late 90s. Here, it is also important to remember that as high as they are, nominal (inflation adjusted) crude oil prices today are far below their highest levels, reached in 1980 (see table).

But this fact cannot be a total comfort to Lebanese consumers. Apart from global market developments, end prices for gasoline are determined to a very significant portion on the domestic front. As stated unmistakably by a survey on global gasoline prices (undertaken in May by research firm AirInc for CNN Money), “the main driver of price disparities between countries is government policy.” In one word: taxes.


Different tax burdens contribute greatly to the fact that gasoline prices for a 20 liter tank filling in May 2004 could range up to $35 in the United Kingdom, Hong Kong, and Germany, while US drivers would have paid not much over $10 and motorists in some countries – try Azerbaijan –

could get away with filling up for as little as $6 to $8 per 20 liters. In Lebanon, the tax burden on motorists has increased substantially over the past four years, first through a hike in gasoline tax and then through addition of Value-Added Tax. The sum of tax levies on each 20-liter filling thus today easily exceeds 50%. The ratios fluctuate somewhat according to the rate decisions taken at the ministry of water and electricity (at the beginning of June, for instance, the ministry reportedly reduced the excise tax on gasoline by LL2,000 to curb pump prices at LL23,000 but in subsequent weeks it re-raised the rates by LL800 when supply costs dropped). But in essence, fuel tax rates in Lebanon are the highest they ever were and extremely unlikely to drop by any significant percentage.

In addition, under the regime of Saddam Hussein, Lebanon had import/ export agreements with Iraq that offered it crude oil at significantly below the market price. Although the legality of the Iraqi exports, and alleged related provisions to political leaders, has yet to be analyzed by a reliable source, the deliveries of Iraqi oil were relieving the Lebanese consumer of paying the true price of crude and helped in protecting him from abrupt price shocks as we see today. One can always question whether these levies were instituted with sufficient foresight on their macroeconomic and socioeconomic effects, which were exacerbated greatly by the rise in crude prices. Under a principle that applies equally to mature and developing economies, transportation-related taxes and fees are means to steer development, avoid wastage of fuel resources and limit pollution. Due to contradictory impulses, the Lebanese system of car registration fees and fuel taxes gives grounds for questions also in this context. But there can be no doubt that the fragile Lebanese fiscal situation today would be very negatively impacted by a massive contraction in revenue from fuel taxes.

The third force in determination of fuel prices are distributors. Local importers and distributors of gasoline are frequently accused of acting as cartel and bearing responsibility for the high gasoline prices. But although they are licensed to trade mineral products for profit, Lebanese importers and distributors of fuel oil play a much smaller role than the state in the setting of prices for end consumers.

Lebanon’s fuel importers and distributors say they are not benefiting from the high fuel prices and even claim that they put them at a disadvantage for several reasons. Regardless of the pump price, their government mandated dealer margins are fixed (at $0.20 per 20 liters) and remain unchanged. Costs in importing, such as obtaining letters of credit and pre-paying customs, and distribution-related costs, namely extension of credit lines to their buyers, are on the other hand being driven up by higher product prices. In addition, higher prices impact consumption and importers predominantly describe motorists as monitoring their consumption more than before. Some see mitigating effects in new cars and increasing tourism but overall, the sector speaks of stable to slightly negative developments in sales. Moreover, fuel distributors can only compete in very limited fashion, mostly through discounting in times of falling supplier prices. The limited leverage to set prices coincides with the limited buying power of Lebanese oil importers, restraining their ability to obtain good prices in international markets.

On the other hand, it appears undeniable that the Lebanese scenery of a few local and no multinational operators has reduced pressures that would normally give incentive to firms to develop, rationalize and become more competitive. Some traders admit that abolition of government fuel price mandates would most likely be immediately followed by a practice of price-fixing among distributors, since cartel structures already exist in several respects. Local refining capacities for oil remain theoretical and the small market – which lacks transparency in governmental pricing policies as well as in industry structures – seems not able to attract multinational firms to come in and develop local product chains to the end consumer. All these factors can be attributed with contributing to the very sluggish development of Lebanon’s domestic gas station culture, which is currently characterized by high service levels but a scarcity of modern efficient filling stations with associated retail marts. In conclusion, the issue of whether or not increases in global crude prices are affordable to the Lebanese consumers should not be a case for the treasury and its meager reserve but rather a case for alternative modes of transport, increased investment in public transport facilities, and perhaps a reduction in the number of cars the average household chooses to have. As inexpensive individual transportation (with emphasis on individual car ownership) does not qualify as either civil right or absolute economic necessity, the consequence is inescapable: if you want to drive it, you need to pay for it. Whether or not one can afford a private car is not a case for a depleted treasury to address, but rather a case of re-evaluating options. Said Ghusayni is the Energy Derivatives trader at Mitsui Bussan Commodities LTD in London.

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