Since post-lockdown, the cost of fuel has been a persistent topic in countries such as the UK news stories including vast lines at petrol stations to households being unable to now afford to use a combustion car due to the cost of complements. There are varying reasons behind each fluctuation in petrol prices which we will detail in this article.
The production of fuel:
Both diesel and petrol is obtained by oil drilling for a mixture called crude oil- a fossil fuel containing large quantities of dead organisms which are then refined and extracted at different temperatures. The UK imports the majority of its gas from other countries including Russia, the Netherlands and some Middle Eastern countries. According to Statista, the UK imported the most from the Netherlands (at 5.4 million metric tons in the year), closely followed by Russia (where the UK imported 5.1million metric tons).
The Cost of fuel:
As shown on the graph above, the cost of fuel has significantly risen since the start of lockdown, where in the past prices ranged from £1.00 to £1.50 per litre now as of November 2022, the cost of petrol has risen to around £1.90 per litre as well as the cost of diesel going up nearing £2.00 per litre, being one of the biggest petrol price increase in 17 years. This means an average household is now paying anywhere from £80 to £120 for a full tank of fuel, adding to the increased cost of living already present.
The price of fuel is made up of three main components- Wholesale, distribution and retail margins, Fuel excise duty and VAT. Retail, wholesale and distribution involve the cost of production for the suppliers including labour, extraction and transport costs as well as the cost of selling fuel at petrol stations. The fuel excise duty is a tax taken from all fuel sold in the UK used for motoring or heating and this is then followed by the standard 20% VAT. At prices such as 80p, suppliers only gain 10% of the whole cost that buyers pay for fuel, but as price per litre increases, suppliers can keep near 50% of the total revenue.
Post-lockdown prices:
Now we have understood how fuel is produced and how the market price is determined, we can look into the economics behind these fluctuations in petrol prices. (We have focused on petrol prices as diesel prices have also had a similar trend in price)
We saw a sharp decline of around 20p per litre for both petrol and diesel in the early months of 2020 due to the lockdown placed in the UK and other countries. This is reasoned due to the sharp decline in demand in the market for fuel as car usage fell as households were unable by law to leave their house unless for essential purposes, reducing demand for complements to cars. This also kept prices for fuel low during the second lockdown due to recurring low demand.
In late 2021, as the nationwide lockdown was lifted, we saw a sudden rise in demand for fuel as households were again using cars more frequently, so prices quickly returned to pre-pandemic levels. But we saw a rise in fuel averaging under £1.50 in the last quarter of 2021- rising significantly over pre-pandemic prices. This rise in prices was due to supply issues which exemplified current demand side surges. The media warned of a rise in prices due to supply chain issues which were caused by a shortage of HGV drivers to transport fuel. But this announcement and coverage by the media aided the increase in prices due to a change in consumer behaviour. Similar to when supermarkets had issues in supplying essential goods during the announcement of lockdown, we saw irrational behaviour from consumers taking place as the media prompted panic buying. Due to this effect, we saw multiple news stories showing the immense queues of cars on the road waiting to go into petrol stations to “stock up” on fuel before reductions in supply were felt. This panic buying created a greater supply issue than the initial supply chain issue due to lack of drivers, causing prices to soar, higher than prices seen before. The government placed measures aiming to reduce prices but this had minimal effects as we saw prices still rise into 2022
Prices nearing £2:
As prices still crept upwards into 2022, we saw an accelerated effect in the cost of fuel as well as the cost of living due to the invasion of Ukraine by Russia in late February. In the aim of stopping Russia’s advances, many countries such as the UK and US stopped purchasing oil from Russia (A country where 60% of exports is oil) and other corporations such as MacDonald’s removed their franchises from Russia aiming to reduce Russia’s economy to decrease money available for Putin to use for military purposes. This caused cuts in production by Opec (the organisation of the petroleum exporting countries) as companies cut ties with Russia. Many countries that cut ties with Russia were forced to switch to other countries supplying oil for a much higher price per litre. This caused prices to increase very closely to £2 per litre for diesel, increasing car maintenance costs for households. This affected small businesses and low income households the most as all costs were rising due to a staggering 10% in inflation while many wages remained the same.
Government intervention and what could have been done:
For the initial rise in prices due to supply chain issues, the government introduced new measures. These included having a small number of military tanker drivers to be deployed if necessary if the supply chain issues increase, Extension to ADR licences, allowing many drivers to continue driving without need for renewals. This was all done to increase the supply of HGV drivers in the labour market to reduce the shortage of labour for transport of fuel. The shortage of HGV drivers was due to the covid-19 pandemic which meant many drivers were unable to conduct driving tests as well as the ageing workforce and lack of drivers domestically in the industry. If the war in Ukraine wasn’t a factor to fuel prices, this measure could have been successful but the unpredictable events of the war in 2022, reduced the effect of these measures.
The government could have also eased migration laws to allow more HGV drivers in the UK in the short run, giving the government time to encourage more people to become HGV drivers by using subsidies or investing in education and training to reduce the reliance of drivers from overseas.
As the UK, with other countries, tried to stop Russia and aid Ukraine’s efforts, at the end of March Rishi Sunak (the chancellor at the time), introduced a 5p cut in fuel duty, according to be “The biggest cut in fuel duty rates ever”. They also introduced a 25% windfall tax in May by Rishi Sunak which taxed profits made by energy companies extracting oil and gas in the UK as we saw companies such as Shell make record breaking profits. But this government intervention only had a minimal effect as prices still kept rising where it saw its peak in the summer.
The government could have also considered trying to move more households to using electric powered cars- by subsidising the production and purchase of these cars, allowing consumers to have cheaper maintenance costs as electricity being significantly cheaper per mile in comparison to petrol, but this can be much harder for Low income households to make a switch affordability wise. But the time scale of this possible measure needs to be taken into consideration as this can take years to see the full effects. In the short run, the Bank of England has increased interest rates in order to reduce spending in the economy to tackle inflation. Slowing down helps reduce the cost of many rising goods such as fuel so in the short run, this measure could be more suitable.
What we have learnt from these rises in fuel costs:
There are many different causes which spiked up petrol prices in the last year and some of these causes can be reduced in effect if these issues repeat.
A key question regarding specialisation is brought up as we question how much over dependence the UK economy should have on other countries (as we are heavily focused on the tertiary sector as an economy and import more goods than we export). The political relationships between countries such as the West and Russia need to be considered, and with a history of varying relationship with communist countries we should consider how much we choose to import from these countries, as even though Russia has an abundance supply of fuel, the West purposefully chose not to purchase from Russia due to the negative relationship caused by the events in Ukraine.
We have also learnt how irrational behaviour by consumers can create excess demand for a good. We saw how a fear in supply chain issues created excess demand which in turn created a more severe supply issue. From the exaggeration of supply chain issues by the media we saw how much power the media has influencing the demand for a good and how one comment made by companies or governments influences this. We also saw the behaviour of consumers repeat from the initial lockdown as they see other individuals save up on goods in fear of future rises in price or shortages and how this causes a knock-on effect as others choose to do the same.
As governments and individuals expect the costs of many goods such as fuel to start to fall due to the recession, we can only hope that the period of the recession helps tackle inflation and reduce the cost of living in the UK.
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