As we’ve all seen in the
Why so high?
First let’s examine why
oil (and therefore fuel) prices are so high. It’s always largely down to supply
and demand, but broken down, the Russia/Ukraine conflict is clearly a big
factor, as is the transition from stringent global Covid restrictions to the
new ‘living with Covid' phase, where demand shot up and supply couldn’t keep up
with that demand. Also, the Covid years saw a reduction in fuel consumption,
which hit income for fuel providers, whose increased prices are, in part, to
compensate for the pandemic shortfall. Production volatility and capacity at
the refineries are a factor, as are increased costs of distribution. The
pound’s performance against the dollar is a factor for
Price dynamics
Given the foregoing, there
are two further things that need saying here about the price increase. The
first is that, except for taking off the tax, there is no real way to lower the
price of fuel and make the situation better than doing nothing. The second is
that, given the truth of the first point, higher prices increase efficiency of
consumption. Beginning with the first point; rudimentary economics suggests we
can't easily lower the price, because oil is a high-demand but an exhaustible
resource. This means that every barrel must be sold at the optimum time for the
supplier - if you sell a barrel tomorrow you can't sell it next week, and so
on. Deciding when to sell barrels of oil is one of the key catalysts for
determining current prices and future prices. And the key inputs to that
decision are the current price and the expected future price.
Government activities will generally (but not always) either bid down current prices and bid up future prices, or they will bid up current prices and subject future markets to unwelcome volatility. If the government starts to bid down current prices and bid up expected future prices, they create an incentive for oil suppliers to sell less now and sell more in the future. But this, of course, reduces current supply and goes on to bid up current prices. As a rule of thumb, in a supply and demand free-ish market, the price of oil ought to rise at the rate of interest. This is because leaving oil in the ground is a kind of investment, and investments are generally actuarial analyses tailored to rates of interest. If governments artificially change the price path by reducing current output and increasing the current price, which is what is happening now, then the expected growth rate is diminished relative to projected future interest rates, inducing suppliers to sell more now and not leave it in the ground. Consequently, the very best thing the government can do as a temporary measure to help its citizens deal with the increase cost of fuel is to greatly reduce the fuel tax and offset the loss with temporary reduced public spending in another sector.
Efficient consumption
In the meantime, I said
that higher prices increase efficiency of consumption, and here’s why. When the
price of a good increases, the people who value it most tend to be the ones who
buy it, where the people who don’t need or want it enough to pay the higher
prices will either go without or look for a substitute. Suppose there’s a
shortage of fuel, and the prices go up because the quantity demanded exceeds
the quantity supplied. These price rises discourage casual consumption, and
they encourage more production until fuel is readily available again at a more
affordable price for more people. If Jeff fills up his car with 60 litres of
fuel and sits idly for 2 weeks, and Bob has no fuel and can’t drive his taxi, then
the 60 litres have been sold inefficiently. While market volatility isn't a
good thing for consumers, if it does happen, like it has in the oil industry,
then price increases that reflect the reality of the supply and demand curves
are a blessing not a curse, because they cut inefficient consumption (like
Jeff’s), safeguard efficient consumption (like Bob’s), and spur on increased
production.
