Wednesday, 14 December 2011

Why higher petrol prices are a good thing

"Adrian Tink, Senior Media Relations Manager / RAC Motoring Strategist said, ‘It’s a victory for common sense. With people paying in excess of £1300 per year just to go about their daily lives this needs to the first, not the last, step. This is welcome short term relief, but what is the Chancellor’s plan if prices keep going up next year’"

Like most people I have a car which fortunately I don’t drive regularly due the nature of metropolitan life. However with petrol in the UK now above £1.30 a litre there is continued pressure on the government, retailers and oil companies to reduce the price at the pumps. This has led to various short sighted policy responses such as the increase in taxes on North Sea oil producers (something done in such a cavalier fashion that it could have been promoted by PDVSA). I do however agree with a medium term freeze in duties but in general I support the duties and I disagree that fuel costs for consumers are ever a matter of ‘common sense.’

The reality of fuel prices at the pumps in the UK is that most of the cost goes to the government as the illustration from indicates:

When you fill up your government takes the lion’s share of the revenue via duty and they then slap VAT on top of the cost which includes their own duty! Now clearly with duty rises over the past few years alongside a substantial rise in oil prices from greater demand and tighter supply globally many decry the cost of fuel in the UK. I have a great deal of sympathy for those negatively affected by this which is basically; everyone.

I used to feel very strongly that the government tax take was something of a crime but now I feel quite the opposite. The reality is that taxes on fuel reduce demand for fuels in the short term and therefore promote all kinds of innovation in the medium to long term. Fuel efficiency of modern vehicles is astounding compared even to 10 years ago. The other substantial change we are seeing is in downsizing of engines. Where BMW expected the 530d to lead sales 10 years ago today it will be the 520d as customers seek cheaper fuel and tax. Even high powered cars are following the trend with Audi dropping its V10 and V8 powerplants for turbocharged V6 units in its RS cars.

Taxation on transport is clearly a political issue and to my mind one of the most unfair and bizarre aspects of motoring taxation is the Vehicle Excise Duty. VED is a subsidy paid by all those who use their cars infrequenty to all those who use their cars substantially. This is because VED is levied on the emissions per mile of the vehicle regardless of the actual milage travelled per annum. Therefore one could be paying over £400 on VED for a Ferrari which they drive one thousand miles per annum whereas one could also pay £0 VED for a Fiat 500 Twinair which they drive 100,000 miles per annum. Arguably all taxation on motoring should be levied via fuel duties as this would capture actual consumption of fuel and align taxation incentives with environmental concerns to reduce CO2. As clearly the Ferrari owner with a thirsty V12 will produce a lot more CO2 and use a lot more fuel per mile than the Fiat owner. But he will also travel far fewer miles. The production of CO2 and the fuel consumption of an engine are obviously highly correlated and this would be the most fair system to tax motoring. However it is also politically unpopular because clearly people want owners of powerful cars to pay more than those of ordinary cars as its seen as something of a tax on wealth - since a Ferrari is only ever a status symbol and an indulgence.

There is no cure for high prices like high prices.

The popular sentiment appears to be that higher fuel prices are curtailing economic growth and reducing consumer spending and given that the government has substantial pricing power on fuels they should cushion the impact of higher fuel prices. This seems fair but it betrays the economic incentives created by higher fuel prices. Higher fuel prices incentivise investment in public transport (as well as making it comparatively cheaper – although to my mind its still as expensive as driving), they disincentivise wasted journeys and they drive innovation. Why should we have a right to cheaper fuel? Why should it be the case that people need to commute for tens of miles a day to workplace? We should be asking these questions about our use of fuel aside from demanding lower prices.

As an example compare European vehicles with those used in the United States. In Europe high taxes on fuel over the past two decades have driven innovation and promoted thrift. Most cars have four cylinders, engines less than 2litres in capacity and turbocharging alongside being (at least more recently) predominantly diesel. This results in high fuel efficiency and less waste which alongside the huge tax take as a percentage of the price of the fuel cushions the impact of oil price volatility on consumer spending. In Europe as a whole we now use less fuel than 10 years ago which is in contrast to every other region on the planet. 

Contrast this with the United States where taxes on fuel are extremely low. In the US most cars have at least 6 cylinders, the turbo is a rare sight and people drive replicas of an armoured vehicle. Now certainly part of the explanation of US driving habits is geography – distances are far greater and public transport links far weaker. But arguably with higher fuel prices the building of public transport links would become more economically viable creating long term infrastructure investment. The low hanging fruit of all Americans moving to European levels of motoring efficiency would have a massive depressing effect on the price of oil globally. This process is already happening as the twin oil price shocks of 2008 and 2011 have pushed US consumers to more economical vehicle choices especially after the period of moderate oil prices that prevailed between the gulf war and 2007 which caused all sorts of crazy auto buying of V8 SUVs.

The danger of pricing fuel at depressed levels is best illustrated by an extreme example; Argentina. Following the collapse of the economy in 2001 the Argentine government has supressed the price of fuel and natural gas paid by consumers using first their great internal resources of oil and gas and later in the decade fuel subsidies paid for by export taxes. In Argentina one can leave the air conditioning on at home all day, the heating on all winter and drive about in old and inefficient cars because prices are so bizarrely low. (In Argentina I saw cars like the Renault 9  which I haven’t seen in two decades in Europe!) This has meant that over the past 10 years the oil and gas resources of Argentina have collapsed as they have been pillaged by overuse resulting from supply priced at near marginal cost of production levels and of course no incentive to invest in new resources.

Now the Argentine scenario is an extreme case of the government subsidising fuel but I would say the European model of fuel taxes is more progressive for investment in alternative energy sources and in insulating consumers from the volatility of the global oil price. The Argentine system insulates consumers but it is now crippling government expenditures. Clearly the US tax neutral position still encourages good investment incentives but arguably it also leaves the US much more vulnerable to global swings in oil prices.

The reality for oil and fuel is that prices will remain high. Historically consumers adjust to the new high price level. The fuel protests in the UK in 2000 when fuel breached 80p a litre have never been repeated even with prices at £1.30 today. Consumers have adjusted consumption and bought more fuel efficient cars. They have also accepted what may be a reality that higher oil prices are here to stay as are the high taxes which governments rely on in times of austerity. In the short term one suffers but in the long term one adapts. Arguably the UK consumer should be thanking their government for insulating them against price volatility in oil so at least one knows what one is likely to spend on fuel in years to come. The answer is; more.

As a footnote I would also add that arguably a petrol car is a better investment today than a diesel one. The money saved on a diesel car in terms of fuel consumption is predicated on a relatively tight spread of diesel to gasoline. Historically this has been so with Europe net importing diesel and exporting gasoline and the US doing the opposite. However with most emerging markets growth being fuelled by diesel one could expect the spread to widen as diesel demand grows faster than gasoline demand in the future. This could potentially erode the gains of the extra miles per gallon of diesel. In addition your asthmatic children might thank you as petrol produces fewer harmful particulates than diesel (look at what comes out of diesel car when someone puts their foot down!). Diesel does produce less CO2 but in total it is certainly more polluting which is where various environmental groups seem to have missed a trick.

No comments:

Post a Comment