Susan Easton: Worried about petrol? Join the queue

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Demand likely to keep driving up fuel costs, writes Susan Easton, senior equity analyst at Gareth Morgan Investments.

Leaving the car at home and squeezing on to a bus will become more popular as petrol prices climb. Photo / Chris Skelton
Leaving the car at home and squeezing on to a bus will become more popular as petrol prices climb. Photo / Chris Skelton

We've all noticed the rising cost of putting a bit of fuel in the tank of late. Ten bucks is really only enough to fill the lawnmower these days, whereas not that long ago it did more than lift a small car's fuel gauge just above the empty level.

The price we pay for petrol at the pump is made up of several parts. There's a reasonably large percentage in taxes and levies and the oil companies also get to add in their margin, but it's the NZ dollar cost of the refined product that makes up roughly half of what we pay. And the key input to the refined product is crude oil.

Lately the US dollar price for oil has been going through the roof.

The two main benchmark crudes, West Texas Intermediate (WTI) and Brent spent most of 2010 trading between US$75-US$95 ($95-$121) a barrel.

Prices started to rise in December and although they are not at the highs reached in 2008, they've been on a tear since the end of January.

Currently the price for Brent is US$125 a barrel and US$112 for WTI.

That has been causing headaches not just for motorists but for investors who worry that the level of oil prices may knock the nascent economic recovery firmly on the scone.

One US estimate ties each permanent US$10 increase in price to a 0.2 per cent reduction in GDP growth for that year.

A small price jump is manageable but generally larger (and more rapid increases) are not. And it's more troubling that the main reasons behind the price spike are supply related. For now the GDP impact is moderate but those warning lights are starting to flash for investors.

It's impossible to know exactly what will happen next, but the evidence does appear to suggest that we may have to put up with higher prices for some time yet. The days of oil at US$40-$50 a barrel look likely to remain distant memories.

The civil unrest in North Africa and the Middle East is the reason for the latest price spike. Libya accounts for around 2 per cent of global oil supply.

The lack of Libyan production might not matter too much on its own. However, the question on everyone's lips is which country is going to be dragged into the fray next?

The Saudis are pumping like crazy to make up the gap left by Libya. That's helpful, even though the oil they produce isn't like-for-like or necessarily interchangeable with Libyan crude.

The problem is mostly that Saudi Arabia is the main source of spare capacity and as Saudi production ramps up, the safety buffer of spare capacity starts to shrink. With supply and demand so tight it means the mere thought of a small disruption elsewhere has the market's nerves jangling.

On that front, tensions don't seem to have diminished in the past few weeks and regimes are under pressure across the region in places such as Oman, Bahrain, Yemen, Iraq, Syria and Jordan. Not even Saudi Arabia has been able to escape and it has cost the country's ruling elite a handsome sum to dampen the discontent.

The pressure on ruling powers to hand out more goodies to the people will ultimately have to be paid for. Higher prices for global consumers may be a consequence of that, irrespective of short-term supply fears.

It's possible that events in Japan following the quake and tsunami may also have been adding to recent pressure in oil markets. Japan gets a significant percentage of its power from nuclear generation. In the area affected by the quake, power capacity has fallen by roughly a third as a result of the crippled nuclear plant.

Nuclear generation is likely to be out for some time and while mothballed capacity can be brought back online, many analysts believe this will not be enough to meet the power shortfall.

This puts the search on for alternatives for both heating and to help get the rebuilding effort off the ground. This will create an additional source of demand for products such as kerosene and diesel.

Global demand is as high as it's ever been, and the inexorable increase in the oil consumption of the emerging economies makes it clear that demand growth will remain robust. While there are untapped reserves to meet our requirements for some time yet, those reserves are increasingly difficult and costly to extract.

Political unrest and natural disasters will lead to price spikes from time to time, but it is the underlying demand growth that is set to keep oil on an upwards trajectory over coming years. Remember that the last spike in oil to over US$140 a barrel was prompted by China's demand, not supply shocks.

The global economy has collectively become heavily dependent on fossil fuels. Even with oil prices at present levels, there are few energy alternatives that are competitive on a cost basis. Time to get used to waiting longer at the bus stop and squeezing in with our fellow passengers as we are forced to be more frugal with the resources we've got.

- NZ Herald

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