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Why petrol prices are skyrocketing

19 Oct 2012

Sydney Morning Herald

By Tony Webber

Associate Professor Tony Webber has written on the topic of the recent fuel price hike across Australia, in the Sydney Morning Herald.

Petrol prices leapt sharply upwards yesterday, in some instances by upwards of 30c per litre. Are those prices higher than one would expect?

Modelling of historical monthly average unleaded petrol prices in the Sydney metropolitan area suggests that the average price for the month of October should be in the order of 152.7c per litre.

If you're a Sydneysider and you filled your tank up with petrol at a price that is less than 152.7c per litre yesterday than you're beating the benchmark.

How is this benchmark computed? It is based on understanding the drivers of the movements in the unleaded petrol price in Sydney between May 1998 and August 2012.

Petrol drivers

Almost 97 per cent of the movements in Sydney metropolitan unleaded petrol prices are explained by two forces - the average price of gasoline out of Singapore and the value of the Australian dollar against the US dollar.

History shows that Sydney retailers lift their prices in the current month (October) in response to higher Singapore gasoline prices in the current month and the month before (October and September), and in response to a weaker Australian dollar against the US dollar in the month before (September).

Lower prices expected

The average Singapore gasoline price rose by around $US2 per barrel in October and fell by $US1.59 per barrel in September. These gasoline price movements would have had little net effect on the unleaded petrol price in October - the net impact is estimated at less than 1c per litre.

The Australian dollar actually strengthened against the US dollar in September by around 1.6c. This should have led to a decline in prices at the bowser by 1.1c per litre.

In net terms, therefore, we should have expected a small decline in average prices at the bowser in October in Sydney, not a substantial rise.

So what has driven the skyrocketing price overnight?

Catch-up effects

The average unleaded petrol price in the Sydney metropolitan area has been lower than "benchmark" for more than 1.5 years.

The very sharp movement in October therefore, may be the start of a period of significant profit catch-up.

Whether that is the case or not appears to depend on perceptions about the strength of the economy. Evidence suggests that Sydney bowser prices tend to fall below benchmark more often when the economy is in a depressed state.

Yield management

The rapid growth in retail prices overnight may also signal the start of further rounds of intra-week cyclical pricing - in other words, prices peaking on one day during the week before slowly sliding down to a trough on another.

There is no evidence of these intra-week cyclical patterns in Singapore gasoline prices and the exchange rate, so they are exclusively attributable to the pricing decisions of retailers.

My theory is that petrol suppliers in Sydney, and elsewhere across the country, have copied some of the sophisticated pricing tricks used by airlines and hotels.

Airlines and hotels use yield management systems to try and extract the maximum amount of money that a passenger or visitor is willing to pay. They realise that they are leaving cash on the table if a passenger or visitor pays a discount price of $75 when they are willing to pay $150.

In the case of airlines, they realise that the willingness of passengers to pay is higher the closer they book tickets to departure. In response, they usually charge higher prices on the day of departure or the day before, compared with a month or two before departure.

The analogy with petrol stations is that motorists have a higher willingness to pay when they get low on petrol. Petrol stations will put the price up on those days when the majority of passengers start to run low on petrol, which is likely to be one or two days after the weekend or one or two days before the weekend.

November benchmark

What benchmark price for Sydney unleaded is expected for November? If Singapore gasoline prices don't change then we would expect the Sydney average price to rise to 155.1c per litre in November.

Remember this is just an average. The deviation around this average can be significant, depending on a whole range of forces, particular the catchment of retail petrol price competition at a location, how far petrol must be driven from the refinery gate to the retailer, the extent to which non-petrol sales can subsidise a lower petrol margin and the overhead costs that the petrol station faces, which is often geography specific.

Tony Webber is an Associate Professor at the University of Sydney Business School.

First published in Sydney Morning Herald




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