Over the recent week, the price of petrol has moved up close to its all-time record high, in nominal terms, and is sitting at around $2.20 per litre. Yet at the same time the New Zealand dollar is also close to an all-time high vs. the US dollar, sitting at around 85c. This raises an interesting question of what petrol prices would be like if our exchange rate wasn’t so good for imports. The good thing is we can make an educated guess thanks to the work the Ministry of Business, Innovation and Employment do in their weekly oil price monitoring. At a high level the price of petrol is made up of three components, the cost to import the fuel, our taxes and levies and the importer margin (which covers everything from distribution and retail costs to profits).
It is the first of these components – the cost to import the fuel – that is most directly affected by the exchange rate, and handily in its weekly data the MBIE include the average weekly exchange rate. From that we can work out what the cost per litre would be in US dollars and then reconvert that to NZ dollars at a different exchange rate. I worked it out for each week over the last three years for two scenarios – if our exchange rate vs. the US was 5c and 10c less than it is now. I have then applied the extra GST that would be paid to that figure to get a result. Averaged out over 3 years, this shows that if all other components stayed the same, with the only thing changing being the exchange rate, an exchange rate drop of 5c would see petrol increase by ~7.5 cents per litre. A drop of 10c would see petrol increase by ~16c per litre.
There are a few key things that could cause the dollar to drop. The first is if the NZ economy weakens, the second if the US economy improved. Not only would this see our exchange rate drop but it would also see the demand for fuel in the US increase. The third thing that could happen is a major economic or political shock overseas, for example a political crisis in the Middle East. As we know these things can happen quite fast and when they do, investors run away from higher risk currencies like the NZ dollar to the perceived safer economies such as the US, Japan and Europe.
In the case of a middle east crisis, that would have a double whammy of increasing the cost we have to pay not only due to the exchange rate but also in the raw cost as investors become worried about supply issues (there could actually be a triple whammy if we also had improvements in offshore economies, particularly the US as that would also drive up demand). If such things were to happen it would be hard to say just what price our petrol could rise to, but it is interesting to note that we have seen it before.
Back in the middle of 2008, just before the GFC hit, higher raw costs combined with a lower exchange rate (9-10c lower than now) saw the importer cost peak to 20-30c per litre higher than it is now. At the time the price at the pump reached $2.12 and the reason it was less than we have now is due to the other two main components – the taxes and levies, and the importer margin.
Looking at the taxes first, a couple of key things have happened since that time 4½ years ago. Increases in the Fuel Excise Duty (FED), along with the introduction of the Emissions Trading Scheme have seen fixed taxes increase by almost 9.5c per litre. Another key aspect is that over this time period GST has increased from 12.5% to 15% and of course GST is applied on top of both the importer costs and the other taxes.
There has also been quite a change in the level of importer margin. Remember that this isn’t just the profit margin but is used to cover the rest of the oil companys’ local operations, such as distribution and retail costs. Back in 2008 it was as low as 9c per litre however the long term average prior to that (and for a few years after) saw the margin sitting at around 14c per litre. In fact it didn’t reach over 20c per litre until the middle of 2010. In recent years this has changed – the average over the last few years has been ~21c per litre with the average over the last year up at ~24c per litre. I don’t know if the increase is due to a rise in the bottom line for these companies or if it is due to increased costs or perhaps compensation for the proliferation of discount fuel vouchers that are now in the market.
Thinking about the future there is one other factor that needs to be taken into account. Just before Christmas the government announced that starting 1 July this year – petrol would increase by 3c per litre every year for three years. It is to help pay for many of the uneconomic RoNS projects and is also partly to combat falling tax revenues due to people driving less. What all this means is that in a few years time we could quite easily see the price of petrol increase by as much as 30c per litre. That would put the price of petrol up around $2.50 per litre. This isn’t meant to be a kind of alarmist post and is really just to highlight that petrol could quickly rise. If this were to happen, it would be interesting to see what impact that would have on people’s preferences to drive. It’s also a great reason why we should be investing in modes of transport that give people more choice in how they get around.
One last point before anyone starts commenting that we are over taxed for petrol. The MBIE also produce this graph quarterly which shows that the fuel taxes we pay are still much lower than most other developed countries.