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How to make petrol even more expensive

This version 8 July 2003, originally published in The Canberra Times, 7 May 2001, p.9.

The Federal opposition thinks they are out to rip us off. The Federal Government, like a child relieved that a bully's attention has at last turned elsewhere, has feebly joined in the condemnation of its 'un-Australian activity'. Professor Fels has launched his Australian Competition and Consumer Commission machinery into the investigating the possibility of collusion.

It seems that just about every official body, and the great majority of private individuals, are united in condemnation of the new Great Satan: the Australian oil industry.

So what have the participants in this industry done? Well, they seem to be increasing their petrol prices to coincide with public holidays and pay days. They have been accused of profiteering at the expense of holiday makers. In an astonishingly weak defence, the industry suggests that its costs are subject to overseas influences.

They are, but it's difficult to accept that foreign pricing fluctuations coincide so neatly with local events. Let us assume for the sake of argument that this is what it looks like: profiteering.

Should the law, therefore, be changed to stop these price fluctuations?

It has already been suggested that to do so would be to increase the average long-term price of petrol to the consumer. We must remember that while the prices may go up for holidays, they come down again afterwards. There would be other consequences as well.

The price of any product performs two functions. The first is the obvious one: it provides the funds necessary for the economic machinery to operate. The money you pay at the pump ultimately keeps the service stations at the roadside offering their services, the oil wells flowing, food in the fridges of millions of employees around the world, and provides a return on investment to the company shareholders.

The second function is less obvious. Prices convey information. Part of this information is how expensive it is to produce and supply the product, but in general too much weight is given to that in the public mind. Many products are priced on a cost-plus basis, but if this were the end of the story, there would be no such thing as specials.

When prices convey information, they are not like a teacher in front of a classroom of reluctant students. The information mechanism provides an incentive to act on the information. So to understand what's going on, we ought to look at what information is being conveyed by these price fluctuations.

They are saying something about the demand for petrol. People travel on holidays, so they buy more petrol. Likewise, when as a kid I worked at Woolies we much preferred the Public Service off-pay week. It isn't surprising that people tend to make their purchases of groceries and fuel when they have money available.

So demand for petrol goes up. That raises costs because extra staff and more marginal (and consequently expensive) resources are required to meet the demand. But even without the increase in cost structure, an increase in the demand would increase prices because oil companies are, sensibly, profiteering. That's what they do. That's what all businesses do. That's what my own modest writing business does. We make money, as we should, for our owners.

The oil industry is in a better position to fine tune its profitability than many other businesses because it is primarily supplying just three liquid products at the retail end (Super, Unleaded and Premium Unleaded) and prices on these can be changed with the flick of switch in the control booth.

But is this all a one-way benefit to the oil companies? Of course not. The other side of a supply and demand graph shows that as price goes up, demand reduces (although I expect the oil companies would far prefer demand to remain at the same level with high prices!) The ability of the industry to increase prices means that it reduces the number of customers seeking to buy petrol. To put it another way, it keeps down the length of queues at petrol stations.

Rationing of all products happens somehow. One way is to make people wait in a long, long line. That's what happened routinely in the Soviet sphere of influence prior to its implosion, and in the United States when the Federal Government set price caps on fuel sales during the oil shocks of the Seventies. The other way is for prices to fluctuate and allow the customer to choose when he or she wants to make the purchase. Those to whom price is very important will avoid buying on holidays and fill up the day before.

The current system is far better than any price controls. If the cost of petrol is a burden each of us has an obvious and easy solution: fill up the day before.

© 2001 - Stephen Dawson