Indeed, some analysts this past week have said there’s no cause for alarm, at least with respect to oil prices. JP Morgan’s commodities team has put a 17 per cent possibility on a worst-case scenario “where supply impact extends beyond the reduction in Iranian oil exports and price reaction is exponential”. “Historically, Iran has refrained from closing the passageway, likely indicating a preference to avoid escalating numerous conflicts from hybrid warfare into full-blown war,” they noted in a briefing shared with us.
Still, Iran could use the possibility of blocking the strait as a “blackmail tool”, warns Joaquin Vespignani, an associate professor of macroeconomics at the University of Tasmania. “If they just keep moving, for example, military forces to this area, that will cause Israel to attack this area or close to it,” says Vespignani, who has studied previous oil price shocks. “That is the big concern – it doesn’t really have to be blocked to feel the effect. If the war moves to this area, even if the channel is not blocked, there will be some consequences.”
What could be the impact for Australia?
For as long as we’ve known its importance, oil has not only fuelled wars but sparked them, as Daniel Yergin writes in his encyclopaedic analysis The Prize. Oil played a fundamental role in both world wars, he writes, not to mention the later Suez Crisis of 1956 when Britain and France saw shipments of oil as one of the key strategic reasons for the canal remaining open.
The first “oil crisis” that saw petrol prices significantly spike worldwide was in 1973 when Arab oil-producing nations embargoed the US and other countries who had supported Israel in the Yom Kippur War, causing prices to soar by 400 per cent – cue queues at the bowser and a rush towards more fuel-efficient vehicles. Another crisis came after the 1979 Iranian revolution, when fear ripped through markets that the social upheaval could spread to the region’s other oil-rich nations. In 1990, Iraq’s invasion of Kuwait – a fellow OPEC member – triggered the first Gulf War and brought on a “mini oil shock” that lasted nine months and contributed to a recession in the US.
“In Australia, given that 90 per cent of our oil consumption – petrol and diesel and all sorts of things – come from overseas we are vulnerable to any international crisis that may affect us, directly or indirectly,” says associate professor Flavio Macau, a logistics expert at Perth’s Edith Cowan University. “At the end of the day, we’re an island. Everything must come by sea.” While we do have our own limited oil reserves, mostly in Western Australia, and the two refineries – Viva Energy’s and Ampol’s Lytton plant in Brisbane – ultimately we have to compete with imports on price.
But Australian prices today are also heavily influenced by three other factors: the strength of the US dollar, the margins that overseas refineries make and the wholesale benchmark in Singapore. The dollar matters because oil trades are made in US dollars. Australia’s dollar is currently about 65 cents to the US dollar. Refiners are turning a “crude” substance into any number of other products including petrol and diesel.
Singapore matters as our dominant regional supplier, home to three major refineries, including one of the largest plants owned by multinational giant ExxonMobil – one of many petrochemical companies that now sprawl over the city-state’s Jurong Island. Because of the volume coming out of Singapore, Australian wholesale prices for petrol are not so much pegged to the price of crude as they are to a Singapore benchmark known as Singapore Mogas 95 Unleaded, or Mogas 95 for short.
Says Shane Oliver: “If you look at the correlation between global oil prices and Australian petrol prices, the $12-a-barrel rise in oil prices so far this month, including the rise since the attacks, could translate to about 12 cents a litre in petrol prices. That’s a very rough rule of thumb but, obviously, it will gradually filter through as oil goes through the refinery process, including in Singapore, and then eventually shows up to the bowser in Australia.”
It takes weeks for any disruption of oil supply to impact Australian motorists, says Joaquin Vespignani at UTas. Hidden costs can include insurance premiums on cargo travelling through dangerous waters; and fuel for transporting food to stores, says Vespignani. There’s yet another factor that influences what we pay at the pump: the all-important and often mysterious “retail price cycle”.
What’s the retail price cycle?
Glance at fuel prices leading into a long weekend and it can be tempting to think service stations hike up the prices when more motorists get on the road. Nevertheless, this is not actually the case, says the Australian Competition and Consumer Commission, which has found that any price increases on public holidays are no larger than at other times of the year.
Instead, it is fierce competition among service stations that drives prices to fall then rise over an average of five weeks in most Australian capital cities, before the cycle starts again – a game of discount leapfrog. Economists call it an Edgeworth cycle (named for the economist who described it, in the 1920s). “I started high, I wanted to take volume off you so I dropped by a cent, and you saw what I was doing so you dropped by a cent,” explains Mark McKenzie, chief executive of the Australasian Convenience and Petroleum Markets Association.
The prices eventually fall low enough to be unsustainable, at least for some. “It’s a bit like looking at each other around the poker table and trying to work out who is going to move first,” says McKenzie. Generally, it’s the larger-volume businesses potentially exposed to bigger losses that will blink and up prices. Average prices can move by up to 45 cents from trough to peak.
“It’s not perfectly competitive but it’s not bad,” says behavioural economist Professor Ralph-Christopher Bayer of Adelaide University. “It’s not that they’re really able to have huge margins.”
In Western Australia, regulation requires fuel prices to be locked in for 24 hours from 6am each day, which has contributed to a seven-day fuel cycle in Perth, where prices are typically lowest on a Tuesday.
McKenzie says a common misconception is that service stations collude over when to put up prices. The 8130 service stations in Australia are managed by around 3500 different businesses. “Individual businesses are making decisions about when they go up,” he says. The margin on regular unleaded fuel is wafer thin. More than half of pump prices come from production costs, another 31 per cent is government tax, and 11 per cent is industry operating costs and margins, according to the Australian Institute of Petroleum. McKenzie says service stations on average make about 2.8 cents a litre on regular unleaded fuel. “They get a better margin on the premium graded product,” he says, which can increase margins up to four cents per litre.
Fuel remains a service station’s main profit source because of the sheer volume sold, but it’s no industry secret they make bigger margins on non-fuel items – chocolate bars, drinks. “If I lose you because I’ve made a silly decision on pricing,” says McKenzie, “it’s a double banger because I don’t just lose the fuel, I lose the opportunity to sell the non-fuel products.”
Oil’s heyday is not over yet. Indeed, the notion of “peak oil” supply, which once implied a plunge into Middle Ages darkness, has become more complicated with the discovery of new deposits and technologies and the need to ensure continued supplies as new types of energy come online. Says Ed Conway: “We’re trying to compress a kind of period of innovation that when you look back at previous energy transitions would have taken probably a century, if not longer.“
This is an updated version of an Explainer first published in September 2023.
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