Tuesday, February 16, 2021

Behind the ups and downs of fuel prices

The cost of crude oil, supply, demand and competition as well as supply disruptions all play a role in determining the price of petrol.

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Between April and May 2020, fuel prices in Malaysia hit their lowest in many years with the widely used RON95 fuel at RM1.25 per litre, the premium RON97 at RM1.55 and diesel at RM1.40.

Fast forward to today, the retail prices of petroleum products have risen drastically and not commensurate with wages or inflation.

As of last Friday, RON95 was priced at RM1.89, RON97 at RM2.19 and diesel at RM2.05.

Malaysia, the second largest oil producer in Southeast Asia, is home to approximately 400 oil and gas fields. It also holds the fourth largest oil reserves in Asia, with oil and gas accounting for some 20% of its gross domestic product.

There are four key authorities responsible for regulating the oil and gas sector: Petronas, the international trade and industry ministry, the domestic trade and consumer affairs ministry, and the Malaysia Petroleum Resources Corporation (MPRC).

National oil firm Petronas regulates all upstream activities while the two ministries regulate mid-stream and downstream activities.

Malaysia, the second largest oil producer in Southeast Asia, is home to approximately 400 oil and gas fields and holds the fourth largest oil reserves in Asia.

Since 2011, MPRC, operating under the Prime Minister’s Department, has been tasked with recommending policies and reviewing existing business regulations and tax incentives.

So why do petrol prices rise and fall?

In the long term, the single greatest factor influencing petroleum prices is the cost of crude oil as this contributes to almost 50% of the retail price of fuel. However, the market forces of supply, demand and competition have a significant effect on the price of petroleum in the short term.

But here’s the concern: most of the world’s oil is located in some of the most politically unstable parts of the world. Supply disruptions, real or perceived, have dramatic effects on the price of crude oil.

When the price of crude goes up, average petroleum prices rise significantly as well.

In its efforts to keep prices relatively low, Putrajaya monitors the changes in world crude oil prices.

The retail price of petroleum is not directly related to crude oil prices. Retail prices follow the price of the various refined products.

One price base used by countries in Southeast Asia is Means of Platt Singapore, an index of average prices published McGraw-Hill’s price assessment agency Platts in Singapore.

It is based on the daily average of all trading transactions between buyers and sellers of petroleum-based products.

In Malaysia, the retail prices of petrol, diesel, and LPG or liquefied petroleum gas are set through the automatic pricing mechanism (APM) implemented in 1983. The change in prices at the retail level through the APM mechanism, made weekly at the discretion of the government, is intended to stabilise the prices of petroleum products.

So why do our fuel prices keep going up?

Despite a sharp decline in crude oil price over the last 12 months, it was not in terms of refined products. The cost used in the calculation of retail price based on APM is the cost of refined oil products, not the price of crude oil.

The slower pace of reduction in retail price is compounded by the fluctuation of the ringgit against the US dollar.

As Malaysian crude is of higher quality and largely exported, oil companies in Malaysia partly import crude oil for their refineries, and companies without refineries mainly import their refined products.

Thus, the exchange rate factor plays an important role in determining the final retail price of petroleum products.

Malaysian oil revenue has been on the decline since 2014. Changes to the retail price of fuel also depend on subsidies from the government.

With oil prices low, government revenue drops and it compensates by reducing or removing oil subsidies.

Optimism about short-term oil prices is subdued as demand for fuels takes a hit amid continuing lockdowns.

The global oil market is in flux all over again. Oil prices hit 10-month highs on the back of extended production cuts from Opec+, but dark clouds have re-emerged on the horizon as the majority of OECD markets appear to be struggling with a new strain of Covid-19 as well as the lockdowns implemented around the world

The new strain, first identified in the UK, has now been reported in China, Japan and other major Asian markets.

Optimism about short-term oil prices is subdued as demand for fuels takes a hit amid continuing lockdowns. A potential new oil glut could be in the making for 2021.

Anyone keeping tabs on the pulse of the oil market knows that current prices are driven by expectations and not by immediate realities. Major forecasters, including the International Energy Agency and the US Energy Information Administration, downgraded their oil demand growth estimates for 2021 in recent weeks.

On April 20 last year, oil price made history when the US benchmark oil contract – known as West Texas Intermediate – ended the day at -US$37/barrel, entering negative territory for the first time. So much oil was available, with so little demand for it and barely any space left to store it, that producers had to pay buyers to take it off their hands.

The crash in oil price is due to its inelastic demand. In simple terms, people buy oil no matter what its price. With people remaining indoors, no matter how cheap fuel is, they are unlikely to travel much.

This year, there was good news for the oil market when Saudi Arabia said it was cutting output by about one million barrels a day, roughly 1% of global demand.

The Saudis’ announcement helped propel Brent crude prices by 7% in two weeks to above US$55 a barrel.

But developments in the world’s two largest economies, China and the US, could cut that joy short.

It is uncertain that demand for oil will pick up any time soon, with Covid-19 likely to stay longer than expected and lockdowns reinstated worldwide.

As volatility continues on the back of one of the largest price shocks in modern times, humbling the industry into accepting “lower for longer” prices, Malaysians best brace for further increases in fuel prices.

Meanwhile, electric vehicle and battery technology development have global carmakers pledging to invest more than US$300 billion. It is worth keeping an eye on.

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