Petrol Prices Drop To A Three-Year Low

Petrol: The Pump Price Conundrum

Updated: 10:35pm UK, Wednesday 30 January 2013

By Ursula Errington, Business Correspondent

So, the OFT says motorists aren't being ripped off, that the price of petrol on our forecourts is fair and isn't the result of collusion or price-fixing.

Outraged motoring groups still aren't convinced.

The reality is, I don't think anyone knows how to work out the relationship between crude oil and pump price.

From the moment crude oil is pumped out of the ground to when we hand over our money at the till to pay for a topped-up tank, the price of the commodity has been influenced by multiple markets all subject to their own supply and demand idiosyncrasies.

I last worked in oil trading about a decade ago and back then the relationship between the price of Brent crude oil and pump prices was deemed to be pretty sketchy.

Assiduous analysts, whose job it was to structure financial instruments to hedge the bank's customers with exposure to fluctuations in the oil market, pored over oil prices and pump price data looking for a concrete correlation on which to base a safe hedging instrument.

Judging by the collective sighing, teeth-gnashing and head-in-hand gestures, it proved both time consuming and difficult.

Broadly a six-week time lag was identified between a movement in the crude oil price to a correlating adjustment in the pump prices back then but it was considered too statistically patchy to appeal to clients.

So why is it so difficult to find a relationship between the price of oil and the pump price drivers pay?

Firstly, pricing crude oil itself is pretty complicated. Before the black stuff is even out of the ground its anticipated value has been traded on the futures market for weeks, months or years before.

On any one day the oil price is set by taking a combination of a weighted average and straight average up to two months in the future, of all the trades over 600,000 barrels executed on the electronic trading platform the Intercontinental Exchange (ICE).

So it is fair to say that part of the oil price is set by traders who are speculating, who have no intention of allowing their futures contracts to mature and "go physical" (i.e. become related to an actual cargo of oil) but who are buying and selling futures contracts depending on their day-to-day view of the multiplicity of variables effecting the market.

This need not be considered a bad thing. Speculative traders aren't just plucking figures out of the air, they are working on the basis of fine-tuned mathematical models used to assist them in weighting all the factors in play - an outlandish speculative trade based on few decent indicators wouldn't be in their interest at all.

Crucially, these traders add a huge volume of trades to the market, which actually means that big distortions in one trader's view are evened out across the average when the price is set. 

Then there is the shipping market to get the stuff to shore. Highly volatile and as prone to geo-political influences as the commodity itself, shipping deals are opaque because they are over-the-counter and are often based on long-term trading relationships.

The economics of refining are also unhelpfully complex, predominantly because optimising refinery operations is tricky.

Refinery margins (the difference in price between the wholesale value of the products coming out of the refinery and the crude oil from which they were derived) have been surging for many companies of late because of a relative drop in the cost of crude oil and solid demand for products but unscheduled refinery outages, workers on strike, storage costs, changes in the quality of the crude itself - all these things will impact the margin within hours.

And then there's the cost of haulage and the variables at petrol station level, such as a franchise owner's credit rating, local forecourt wars and location.

All of that and we still have some of the cheapest fuel in Europe, according to the OFT.

But it's not over yet - the taxman must also have his share. In the 10 years from 2003 to 2012, prices at the pump increased from 76p per litre (ppl) to 136ppl for petrol and from 78ppl to 142ppl for diesel. Nearly 24ppl of that increase was because of tax and duty.

Is it any wonder then that trying to compare the price of crude oil and the pump price proves a largely fruitless task?

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