Will drivers see a repeat of 2014's gasoline price reprieve?

This article first appeared on Forbes.com on October 31, 2018. 

The average retail gasoline price in the United States is now close to U.S.$3 a gallon, while in Germany, gasoline is retailing at an average of €1.40 per liter. We last saw prices like these in November 2014. Back then, crude oil prices had dropped – dated Brent traded at U.S.$78.90 a barrel – and were still falling.  So, could we see a repeat of the 2014 reprieve? 

At present, European drivers pay roughly double the price their U.S. counterparts do, even though global retail fuel prices are closely coupled. This link is because the basic raw material – gasoline – is a globally traded commodity. Prices between regions reflect trade flows. Shipping costs do not add significantly to prices as they are  low compared to the ex-refinery gate price.

The ex-refinery gate price for gasoline is broadly set by crude oil, as this is by far the largest cost refinery operators bear. European prices are so much higher than those in the U.S. largely due to local and government taxes. The exchange rate can also have an effect, as global commodities are priced in U.S. dollars.

As fuel taxes in the U.S. are low, it means the U.S. retail gasoline price closely tracks Brent prices. Brent is the global price benchmark for crude, setting the competitive environment for ex-refinery gates prices worldwide. In January 2016, when Brent fell to under 30% of its 2014 peak price (U.S.$112 a barrel monthly average in June), U.S. monthly gasoline prices for February dropped to U.S.$2.02/gallon – almost 50% lower than 2014’s highest monthly price.

In Germany, local and government taxes are high. They are also fixed and independent of crude price. Because of this, German fuel prices do not track crude price movements so closely.  In 2014, for example, German retail fuel prices did not fall as steeply, achieving a low of just under 75% of the 2014 monthly high. Since then, retail fuel prices have risen steadily as crude prices have recovered, reaching levels not far from those seen in 2014.

So why is the retail price now so responsive to the global crude oil market? And will we see a repeat of 2014/2015’s weaker fuel prices?

It used to be said that retail fuel prices went up like a rocket, but down like a feather. It was thought consumers did not benefit quickly from crude price falls, as the integrated oil majors behaved as an oligopoly.

That, however, is a thing of the past. Thanks to the transformation of the sector’s ownership structure over the past decade, retail fuel marketing is now fiercely competitive.

Over the past 10 years, oil companies sold retail sites to dealers, but set up long-term supply arrangements for their fuels. This has had two main consequences: ownership in the retail fuels sector has fragmented, and retail pricing is now typically set by a local discounter. These discounters are either very low cost – operating automated petrol stations, for example, which simply sell fuels via credit card with no employees on site -  or they  have a business with a variety of revenue streams – such as hypermarkets, which see fuels retailing as a means to draw in customers to visit the main shop. This shift in how the sector operates has fixed retail fuel margins at a very low level, to the point where they now track ex-refinery gate prices and crude oil price developments.

In November 2014, crude prices were collapsing as OPEC was competing to maintain its global market share. The current crude oil environment is very different. For a start, oil demand is still growing and should exceed 100 million barrels per day before the end of this year.

Coupled with this, U.S. sanctions on Iranian crude purchases will come into full effect in early November, which will significantly curtail Iranian crude oil exports.

While U.S. tight oil supply has grown strongly, it will not make up for the loss of Iranian oil, as infrastructure constraints are choking faster supply growth from the Lower 48.

With the market expected to lose about 1 million barrels per day of Iranian supply, the fundamentals suggest pricing weakness in 2019, as supply growth outpaces demand growth.

That said, the market is looking closely at what happens once further Iranian volumes are taken out of the market and whether OPEC can make up for this loss. But this is tricky - OPEC faces a difficult task formulating an appropriate response in today’s dynamic and politically charged environment.

However, the probability of a U.S.$30 a barrel price drop is low. It is more likely that prices could spike – even to as much as U.S.$100 a barrel or more - if the U.S. adopts an aggressive stance towards buyers of Iranian crude once the full sanctions regime is in force.

For prices on the forecourt to drop, the cost of crude oil needs to weaken. This is something most likely to be triggered by a global recession. Fortunately, the chances of this are, at present, remote. So, in all likelihood, pump prices are likely to stay high for the near term.