How much is petrol worth to you?

People like to whinge about the price of gas just as much as they do about the weather.  This wouldn't be true if we all used our bikes to get where we were going, but I digress.  Virtually every month I read a letter in our local automobile club magazine in which the author argues that the price of gas is fixed by colluding petroleum companies and that there should be a government inquiry into the matter.  Some make a pathetic effort to support their annoyance, claiming things like "On my recent trip petrol (that's what they call it here) was $1.23/L in Tamworth and when I was in Brisbane only a few days later it was $1.18/L.  Clearly this is a sign of price fixing."  Upon reading that line of reasoning I was incredulous; hadn't the author ever noticed that the price of gas at their local station changes daily, if not hourly!

In the most recent issue (October 2006, not on line yet) a reader had very carefully detailed the proportion of a barrel of crude oil turned into the various petroleum products we use.  Since the letter is not on line, I will reprint some of the figures he provided.  It turns out that only about 27% of the 159 liters of crude oil in a barrel becomes petrol.  10% becomes kerosene, 15% becomes diesel, 22% becomes lubricating oils, 16% becomes cylinder oils, and 10% becomes tar.  By his calculations, you get 42 liters of petrol from a barrel of crude.  He goes on to argue that the price of petrol should increase by 0.6 cents per liter for ever dollar increase in the price of a barrel of crude and that the daily changes of 5 cents per liter are evidence that the market isn't working freely and government action is required.

Now, I applaud this person's detailed research and math, but he failed to do a reality check.  Could it be that the price of petrol changes more when the price of crude changes because people want it more than the other petroleum products?

How much is a liter of petrol worth to you?  Are you buying it now, at $1.10-$1.15AU/liter?  Were you buying it when it was $1.25/liter?  Would you pay $2.00/liter?  No, you say?  What did you say about $1.00/liter a few years ago?  How much you're willing to pay probably depends on what you are using your vehicle for; If your business relies on moving things around, for example, then you have to figure out how to pay for the more expensive fuel or close up shop.  But if you're driving to work, maybe you'll find a different way to get there rather than waste valuable fuel on it.  What you can see, though, is that the value of fuel is not something you determine, or the petroleum companies determine, but all the people who buy the petrol.  If you think that a liter of petrol is only worth $1.00 and everyone else agrees it's worth at least $1.10, then you're just going to have to go without.

The price of petrol is volatile because it the market is so competitive.  There is no other good in Australia or the US for which the price is so well advertised, so easily determined without even leaving your car.  At some intersections you have the choice of two or even three different petrol stations, all of whom have their prices clearly displayed in front of the shop in writing that even my half blind grandmother can read.  And even though most people would willingly part with far more money to fill up their tank, they are always looking for a deal.  In an environment like this, of course the price of petrol is going to jump around.

As we saw recently in our discussion about banana prices, there are some goods that people just won't substitute.  Petrol is one of them.  Vaseline is not.  When was the last time you thought, Gee, Vaseline is getting very expensive, but there's nothing else I can use instead.  Economists call this elasticity.  Bananas and petrol (incidentally, the two items blamed for Australia's high second quarter inflation) have inelastic demand curves, meaning the price can increase a lot before people change their consumption habits.  In contrast, Vaseline has an elastic demand curve.  Besides, many of the products made out of petroleum, including Vaseline, are really just by-products, an opportunity to reap some financial gain from the left-overs of petrol production.  Kind of like trying to sell the tops off your celery stalks.  So when the price of crude increases, the change will be borne disproportionately by the purchasers of petrol, because the purchasers of Vaseline will just buy cocoa butter instead.

The volatility of petrol prices is certainly annoying, and makes planning difficult, but it's not in itself a sign of price fixing.  Even so, why is a government inquiry the solution?  Wouldn't we all be better off if the government used their time and energy to figure out how to promote alternatives to petrol and other petroleum products.   By increasing incentives to use alternative fuels and more fuel efficient technology, the government could reduce the demand for petrol, which would cause the real price of petrol to decrease.  By supporting investment in alternative energy, the government could reduce the country's dependence on unpredictable foreign suppliers, which is significant for both economic and security reasons.  The government could and should provide a boost to the economy by supporting the growth of technology associated with alternative industries.  And finally, these actions comprise a few of the many ways the government could be acting to reduce the country's greenhouse gas emissions.

But the price of petrol must still be too low because the government doesn't appear to be doing much at all.