20 February 2013

Zimbabwe: Exploring Determinants of Fuel Prices


THE recent rise in fuel prices has become topical not only in Zimbabwe but the world over. The current hike in prices is being attributed to the improved economic outlook, reduced output due to seasonal maintenance by refineries, and escalation in tensions in the Middle East.

In this article, I wish to explore questions like, generally, what are the determinants of fuel prices?

How does Zimbabwe's fuel compare with other countries'?

What are the future fuel price projections?

There are five major determinants of fuel prices. The first one comes in the form of the cartel of oil producers, the Organisation of the Petroleum Exporting Countries (OPEC).

OPEC's investment and production decisions affect fuel prices because the cartel controls 80 percent of the world's oil reserves located in its 12 member states. The cartel makes production decisions in a way that ensures oil remains a valuable liquid, usually by reducing output in order to increase prices.

The second determinant consists of production and investment decisions by non-OPEC oil producers.

Petroleum supply by non-OPEC producers has declined and there is a theory that this is because they have passed their peak production such that no matter the price incentive, production will remain unchanged or decline since oil is an exhaustible resource.

The price of an exhaustible resource increases over time.

Improvements in technologies for extraction and cost cutting offer hope in the medium to long term.

North America and Europe, for example, are expected to be self reliant in terms of oil in 30 years time due to non conventional oil drilling methods like oil shale which will lead to reduction of OPEC power and also global pressure on prices.

Extra supply from the unconventional oil drilling methods is said to have potential to reach up to 12 percent of total oil production, which could curb fuel price increases by 60 percent in 20 years time.

Current and future world demand for oil has recently been the major driver of fuel prices.

Recovery of the global economy driven by the United States' and the emergence of Chinese and Indian economies have led to supply shortfalls.

The IMF forecasts growth in the global economy of 4.1 percent from 3.5 percent in 2012. This will result in further increases in fuel prices. OPEC forecasts an annual growth rate in the demand for fuel of around 1.12 %.

Financial Markets are also being blamed for pushing up fuel prices by way of speculation. Speculators influence the price of fuel through their participation in oil derivatives market.

A derivative is a financial instrument that derives its value from that of an underlying commodity, oil in this case.

Fuel prices can thus change as a result of changes in oil futures markets since they have an impact on spot markets where real oil is sold without any changes in economic fundamentals. The gradually weakening US dollar has also led to increases in fuel prices.

International conflicts also affect fuel prices and the rising tensions in the Middle East has played a significant role in the current increases in fuel prices. For example, the clashes between Israel and Hamas in November last year led to increases in oil features by 1.4 percent.

This affected oil prices for fuel deliveries of December. Other determinants include wholesale costs which retailers sometimes absorb on behalf of consumers but

depending on pricing strategy, sometimes pass them on. An example is the recent rise in fuel in the UK at a time when refineries where complaining of excess fuel supplies.

Retailers justified this by arguing that there has been a rise in wholesale costs such that the increase was not a means to increase profits.

Government can use fiscal policy tools to cushion or worsen consumer burden in terms of subsidies and taxes. The two tables here, adopted from a Bloomberg report, show how Zimbabwe fares in comparison to other countries which cushion or tax citizens on fuel prices. The first table shows countries with the most expensive petrol prices per litre.

These are figures are based on the cheapest price available in the month of January.

Zimbabwe, not included in the sample, had an average price of $1.47 around that time, while South Africa was ranked number 41 on the list of most expensive fuel with its cheapest price at $1.11 per litre.

Turkey has the most expensive fuel and this is attributed to the inclination of the government to tax consumption to compensate low government revenue. In contrast to other oil producers who subsidise fuel, Turkey and Norway have the most expensive fuel prices. Norway discourages fuel consumption using oil profits for education and infrastructure development.

Italy uses fuel taxes to raise revenue and control government budget. Portugal uses fuel taxes to protect the environment.

On the other hand, the cheapest fuel is found in oil producing countries of OPEC, excluding Egypt, which use subsidies with Venezuela having the cheapest fuel costing 1 cent a litre.

Using petrol prices from the previous years, a simple time series analysis yields the following forecasts for fuel prices in the next 5 years.

If all conditions that affect fuel prices remain the same as they are, there will be an increase in fuel prices at an annual rate of 11.1% such that the price per litre will hit the $2 mark by January 2017.

However, as highlighted above, there are a number of factors that change anytime such that the prices might spiral from time to time.

Lazarus Muchabaiwa is a lecturer in the Economics Department at Bindura University of Science Education.

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