Petrol is hitting its all time high at the pump. But why?
The last time petrol was nudging £1.20 per litre was back in July 2008. At that time crude oil was trading around $147. But now crude is only $85, so how come we’re forking out the same for petrol as we were back then?
Let’s have a look to see what’s going on. As always, if there’s a profit opportunity we’ll find it…
First, the Government’s fat hand
Now it won’t surprise you that the tax man is as much to blame as anyone for the high cost of fuel. Back in 1993 the Tories introduced something called the ‘fuel price escalator’ – a tax to tackle climate change. Well, that’s what they said anyway.
As Labour took over the tax levers in ’97 they decided, all for the environment of course, to escalate the price escalator.
Fuel taxes spiralled upwards, but because oil prices had slipped down to as low as $10, the actual price at the pump remained affordable. Nobody noticed these stealthy taxes – then I suppose that’s what makes them stealthy.
As the new millennium dawned and crude prices rose, suddenly the public noticed the vicious tax take. Fuel protests led to the Government dropping the price escalator. But fuel taxes remain as high as they ever have been. In fact Darling has just announced an inflation busting 5% hike in the fuel levy.
So the omnipresent tax machine is a factor in the high cost of fuel, but it’s not the only factor…
Secondly, fuel refining costs are going up
Fuel refining (from crude oil) involves a tremendous investment in equipment. In fact there are only eight of these massive refineries in the UK. As you can imagine, matching production with the demands of consumers and industry is a complicated affair.
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The recession took oil companies by surprise. With the combined effect of recession and the high cost of petrol, demand tumbled. Refinery profits slumped as they couldn’t match output with the lower demand.
So now the oil companies are cutting refinery capacity and clawing back profitability.
But increased tax and the costs of refining don’t explain the massive rise in fuel prices we’ve seen. There’s something else… and it’s our old friend ‘imported inflation’.
Thirdly, we’re suffering imported inflation
The pound has fallen precipitously and it’s brought with it certain side-effects. Imported inflation results from a weak currency. Basically, it takes more sterling to buy our imports, which ultimately leads to higher prices for consumers.
Back in July 2008 (when we last paid £1.20 at the pumps), you got two dollars for every pound. You may remember ‘buy one get one free’ headlines as people jetted off to the US to get their Christmas shopping in early.
The strong pound held back the price at the pumps. $147 oil felt more like $103 in today’s money.
It didn’t last of course. Later in the summer, Lehman collapsed and the full scale of the financial crisis began to hit home. The pound fell as the markets concluded that the UK was in big financial trouble.
But there’s more currency mischief adding to the cost of your fuel.
Boris Johnson points out that imported inflation isn’t limited to things that we import. Shopping for his Christmas tree, he noticed that the price had shot up from the year before.
One would expect the weak pound to push up the price of your Norwegian spruce or German Tannenbaum. But our home-grown Christmas trees are costing more too!
Boris said that it doesn’t matter whether the trees are home grown or not. The fact is that they can be sold anywhere in Europe. If the trees can be exported, then it’s European prices that count.
In the same way, once the oil has been refined, it’s a commodity that can be sold anywhere in Europe. So it’s European prices that count. That means the euro prevails – the weak pound hits us again.
So we’re hit by the dollar on crude imports, then we’re hit by the euro as the refined petrol hits the market.
How to protect yourself from higher fuel prices
As an investor, you can profit from higher fuel prices.
The oil majors own oil under the ground and refineries over the ground. The refineries have been struggling to cut capacity during the recession and haven’t been contributing their share of profits. As refinery earnings recover, the majors will get another shot in the arm.
While oil prices aren’t as high as during the frenzied summer of 2008, they have recovered from the recessionary lows. Oil anywhere above $60 is good news for the oil majors. Currently trading above $80, the majors are sitting pretty.
BP Stock price, year to date
My favourite major is BP (LSE: BP). Its price has been moving steadily upwards as you can see from the chart. On top of BP’s strong fundamentals, the majority of its earnings come from abroad. Sterling weakness pushes BP’s profits higher.
So what you’re really getting is a bonus if oil goes up and another one if the pound gets weaker.
On a P/E of 11 and a dividend yield over 5%, you’re pretty safe with BP – and as petrol prices go up, you’ll be happy that you’re making a profit at the same time.
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This article
was written by Bengt Saelensminde and was first published in the free daily investment email
The Right Side
on 7 April 2010.