The UAE is expected to announce September petrol prices on Monday as global oil markets remain volatile amid the nearly seven-month Iran war. Traditionally, petrol prices have moved in synch with those benchmarks but not all the time.
Several factors – including snow and river water levels – influence monthly fuel costs and, although the mechanisms for setting these prices vary by nation, governments can also help control high prices at the pump.
Normally, crude oil and refined product prices are correlated: if crude prices outperform product prices, refinery margins deteriorate, resulting in less demand for crude and less refined products produced, bringing both prices in synch, said Giovanni Staunovo, a commodity analyst at Swiss bank UBS.
“If refinery margins outperform [product prices rising more than crude], the opposite happens, refineries try to produce as much as they can to cash in those margins, resulting in more products being available, and normally reducing the price difference,” he told The National.
“Currently, this is not the case, due to large disruptions on the refinery side. Due to disruptions in the Middle East, China and other countries in Asia and Russia, refinery runs are about five to six million barrels per day below the level of last year.”
The UAE way
Regulations in the UAE allow for an efficient method in determining pump prices.
The cost of fuel in the UAE has been tied to the global oil market since authorities introduced deregulation on August 1, 2015. The UAE Cabinet at the time said the move was aimed at “supporting the national economy, lowering fuel consumption, protecting the environment and preserving national resources”.
The UAE typically announces petrol prices for the coming month on the last day of the current one. Saudi Arabia and Qatar have similar monthly reviews.
“The UAE sits between a fully market-driven system and a subsidised fuel market,” Joseph Dahrieh, managing director at brokerage Tickmill, told The National. “It allows international energy prices to influence consumers but the monthly review mechanism provides some smoothing, reducing the fiscal impact.”
On Wednesday, oil prices were at a near one-month low amid apparent progress in negotiations to cool down the war in Iran, with Brent and West Texas Intermediate down by as much as 3 per cent.
For the week, they have retreated nearly 7 per cent and 6.1 per cent, respectively. Month-to-date, Brent, the benchmark for two thirds of the world's oil, is down 1.7 per cent, while WTI, the gauge that tracks US crude, has shed nearly 4 per cent.
Conventional wisdom would say pump prices would follow suit – but that hasn't always been the case. For instance, in January Brent posted a nearly 14 per cent monthly drop but pump prices in the Emirates still fell in February.
That's because UAE petrol costs don't move in lockstep with day-to-day crude price swings. Instead, a monthly, lagged and benchmark-based pricing formula rather than a real-time market adjustment is used, said Ahmed Zaheer, a consultant at Dubai-based Qamar Energy.
“Instead of tracking spot crude prices directly, the [UAE fuel price] committee benchmarks against international averages for refined products [petrol and diesel, not crude] over the preceding weeks, with an approximate one-month lag factored in,” he told The National.
A dip in global oil prices during a certain week won't show up at the pump until weeks later and, even then, it's diluted by other cost components, or outweighed by changes in refined fuel prices, refining margins, distribution costs and retail margins,” Mr Zaheer noted.
For example, if crude costs $90 a barrel and the diesel refining margin is $100 per barrel, the implied wholesale diesel value is $190 before freight, storage, blending, distribution, station costs, retail margins and any taxes.
“Which means the price the public pays in [for example] August actually reflects average refined product market conditions from earlier in the summer, not the price of oil on the day you fill up,” Mr Zaheer added.
How about elsewhere?
In other parts of the world, even more factors play a role in how pump prices are determined. In the US, there is no centralised formula for monthly costs: rather, costs are influenced by crude oil prices (mainly), refining costs, distribution and marketing, and taxes, according to the American Petroleum Institute.
In Europe, the prices of refined products are strongly influenced by taxes and excise duties. Another factor across the continent is river water levels: lower levels mean ships carry less cargo, thereby pushing up prices, Mr Staunovo noted.
One such case is the Rhine, a vital trade artery flowing from the Swiss Alps through six countries – from Switzerland to Liechtenstein, Austria, Germany, France and the Netherlands – before emptying into the North Sea.
Also, the UK winter season's snow and ice significantly slow tanker deliveries and increase fuel consumption, which are a “predictable yet painful reality” across the country, according to Future Fuels, a logistics firm based in Lancashire, England.
“In the US and most of Europe, prices can change more rapidly, while taxes are a larger share of the pump price. Countries that subsidise fuel prices can encounter budget strain in the case of adverse crude price movements,” Mr Dahrieh added.
What can governments do to tame pump prices?
As a result of high crude oil prices this year, some European governments have decided to cut taxes on the commodity.
“That is one of the elements … the other is via tapping into strategic oil inventories [to increase domestic supply],” Mr Staunovo said.
There are other mechanisms that governments can adopt, although each involves a trade-off between consumer affordability, government finances and market efficiency, Mr Dahrieh said.
Aside from reducing fuel taxes – the most direct way to cut costs – and using strategic reserves, other solutions include providing temporary subsidies, introducing price caps, or compensating refiners or distributors.
However, “these measures do not make the underlying cost disappear; [rather] they transfer the cost from motorists to the government, refiners or taxpayers”, Mr Dahrieh said.
In most countries, the most economically well-designed market-pricing system typically does not involve broad, universal petrol subsidies, Mr Zaheer said.
“It is a combination of an automatic, transparent pricing formula; a temporary tax adjustment or narrow stabilisation mechanism during exceptional shocks and direct support for lower income households and essential services,” he said.
For example, instead of reducing petrol prices by a certain amount per litre for every driver, governments could preserve the market-linked price, provide a monthly mobility payment to eligible households, and support public buses, taxis and emergency services, Mr Zaheer suggested.
“This not only protects affordability, but also avoids an open-ended incentive to consume more fuel,” he said.
“In particular, a broad fuel-price suppression would be a deliberate policy choice to depart from a global market-linked mechanism; a targeted mobility or income measure would reduce household pressure without disconnecting all motorists from the underlying market signal.”
