What factors determine how much we pay for petrol at the pump?

Petroleum pricing has become a factor of concern to consumers, refiners and producers across the world, and price determination has come under the microscope, especially as crude oil prices were reaching record highs earlier in 2008 and prices at the bowser were sky-rocketing. There is a lot of discussion surrounding petroleum pricing, and the primary point here is that different regional markets have different pricing mechanisms.

For Australia, as part of the Asia-Pacific region, prices are derived in part from the price of Malaysian Tapis Crude Oil and not West Texas Intermediate (WTI) that forms the point of reference for the United States. This is because Tapis Crude acts as a benchmark for the imported oil to Australian refineries. That said, the exchange rate between the Australian and US dollar does come into play, given that the price of refined petrol is priced in US dollars and this will occur whether the petrol is imported or produced locally.

In terms of local gasoline prices, the Singapore benchmark price of petrol and diesel – known as Singapore Mogas 95 Unleaded (MOPS95 Petrol) and gas oil respectively – form the key benchmark prices. This is largely due to the fact that over a quarter of Australian petrol is imported to meet demand, and a large portion of this is sourced from Singapore. For the Asia Pacific region, Singapore is the regional refining and distribution centre and one of the world’s largest.

There are several points of note during the journey of oil from the point of extraction through to point-of-sale. The first is the Australian wholesale price for petrol and diesel which is known as terminal gate prices (TGP), and are closely linked to Singapore petrol and diesel prices, as opposed to tracking the price of Tapis Crude Oil.

According to public statements, Australian fuel wholesalers employ a methodology very similar to that undertaken when the ACCC had the job of regulating prices. The current pricing mechanism is known as import parity pricing (IPP) and means that pricing is based on the cost of importing crude oil.

In terms of the pricing equation, if you add shipping costs and government taxes levied to the price of Singapore petrol, this represents approximately 95% of the wholesale price or TPG in Australia. It is worth noting here, that State Government does play a role in pricing given that policy relating to subsidies and tariffs will affect prices. The remaining 5% is accounted for by insurance costs, a quality premium for Australian fuels standards, and terminal costs. There will often be a wholesale marketing margin built into the price where the competitive pricing landscape allows.

To put this into perspective, if Australian petrol prices were below that of Singapore’s, Australian fuel suppliers would have no commercial impetus to import and the same goes for Australian refiners wanting to export. This balance is a large factor when looking at prices throughout the delivery chain as well as the retail pricing. Given the link to Singapore, it is generally accepted that there is a 1-2 week lag between pricing changes in Singapore and Australia.

In terms of the price lag between Singapore and Australia, if you look at the chart below, then you will see that not only is there a positive correlation, but that it is almost identical. The correlation occurs both for price rises and falls.

Comparison of Singapore Petrol Price (MOPS95 Petrol) with Australian ULP TGP

Source: AIP, facts about petrol prices & the Australian fuel market.

Once the petroleum is making its way to the pump, a different pricing landscape emerges. It is important to note that there are difference between pricing for rural and metropolitan areas, just as consumers will experience different prices at varying times throughout the week. To really grasp the pricing mechanism, it is worthwhile looking at the last stage of the delivery chain, and how market participants affect price.

For metropolitan prices, there is a weekly discounting cycle that has historically ranged up to 12c from floor to ceiling according to the Australian Institute of Petroleum. In major cities the low price point typically occurs earlier in the week.

Petrol prices fall steadily due to aggressive owners discounting prices to undercut their competitors and capture market share. This really points to the competitive landscape that service stations operate in. According to the ACCC, it is estimated that 60% of petrol sales occur below the average price in the cycle. We have seen this recently, with independent petrol retailers offering greatly reduced prices to reinstate public confidence, improve overall sales, and remain competitive.

Major oil companies do set the price in a limited number of service stations in Australian metropolitan areas. It is estimated that this accounts for between 5 and ten per cent of all service stations nationwide. So while there is public debate about who controls the pricing, the assertion that the large oil companies play a large role in price determination is not necessarily correct.

When looking at petrol pricing, you must keep in mind that it is more important to focus on longer term trending as there is heavy short-term volatility seen day-to-day or week-to-week. There are many variables to examine, however to get a good read on prices the first port of call should be the Singapore benchmark in relation to the AUD/USD exchange rate.