The short-term opportunist politics of petrol prices

The problem of transport fuel costs reflects the level of our dependence on oil, which has deep roots and a long history. Prompted by the persistent super-spike in crude oil prices since 2004, these costs are now higher in real terms than at any time since 1980. Unlike earlier short-term aberrations, the current situation seems set to persist indefinitely. For a problem of such complexity, no sensible instant solutions exist.

In his recent announcement of a new package of measures to respond to petrol price hikes [1], Prime Minister Howard acknowledged this but then proceeded to announce a costly set of pseudo-solutions. He failed to point to government actions that can indeed ease this problem over the longer term – as distinct from cosmetic policies that may appeal to particular regional electorates and provide photo-opportunities for local MPs.

Some back-benchers and lobbyists want to reduce the motor fuel excise, but who is going to pay for this? Howard and Opposition Leader Beazley have got one thing right about the tax on petrol and diesel fuel. As the former rightly says:

“a petrol excise cut that would deliver a 10 cent per litre reduction in the petrol price would blow a hole of about $2.5 billion or more in the budget surplus and reduce our capacity to meet spending priorities in areas such as national security and health or to provide further tax relief.”

The LPG and alternative fuels scam

The key pseudo-solution or con trick is to, in effect, reduce fuel excise revenues by the back door. This is achieved through policies that switch consumption to effectively excise-free fuels such as LPG and fuel ethanol. The result is lost budget revenue exactly as described above by Howard himself, and with precisely the same adverse consequences.

The main reason that LPG is cost-effective for particular consumers (say, high-mileage taxicabs) is that for historical reasons (but not good ones!) this fuel does not bear excise tax. Yet the Howard government has just announced a scheme, enormously costly to the budget, under which capital subsidies of up to $2000 would be paid for conversion of vehicles to LPG out of a total cost of $2500 to $4000. According to one report (link here) this scheme would offer annual savings to motorists travelling 20,000km a year of about $1600 on their petrol costs. Thus, this scheme would involve two types of burden to the government budget: the initial capital subsidy and the subsequent loss of excise revenue. These costs to the budget would have to be made up from higher taxes on other motorists and tax-payers [2]. These are policies to which taxpayers should strongly object.

In addition, real resource constraints in both LPG conversion and ethanol production will mean that the unsubsidized components of these costs of alternative fuel will probably increase rapidly. Further, confusing signals face investors. What would happen to the new and expanded LPG conversion enterprises in the event of another collapse in the price of crude oil? Or if the hue and cry from motorists still using gasoline does result in reduced excise for that fuel, reducing the gains from conversion?

The real answer to increasing fuel bills is to reduce fuel usage

Neither Government nor Opposition acknowledges the other reason that reducing the rate of fuel excise tax (either directly or indirectly via LPG conversions) would be bad long-term policy. Among the OECD states, only the US has lower fuel taxes than Australia. As a result, even President George Bush admits that the US economy is addicted to oil – that is, over-dependent on transport fuel and gas-guzzling vehicles, with over-dispersed suburban land use patterns and poor or non-existent transit systems. Now that crude oil prices are sky-high, ordinary citizens are paying the penalty for these bad policies of the past, just as they are here. More on this later.

The bogey and the reality of Middle East oil

The Middle East accounts for the bulk of low cost proven oil reserves. However, most global oil is sourced from areas other than the Middle East and this will continue to be the case for some time to come. Rhetoric about reducing dependence on Middle East oil, whether from the Government or the Opposition, contains a half-truth or innuendo straight from the song-book of United States neo-conservatives. To the latter, buying oil from the Middle East subsidises Islamist terror. This framing of the issue has to some extent served to justify disastrous US meddling in the region, especially in the post-Cold war era – recently urged on by an uncritical Australian ally.

Historically, US meddling in the region has tended to increase the volatility of crude oil prices, including a series of price spikes since 1973 [3]. Future concerns about Iranian oil [4] now need to be added to the picture – Iran currently exports 2.3 million barrels of oil a day. Heightened tensions with Iran could not be better calculated to maintain a high oil price (and high profits), as is well understood by the major proponent of such conflict, the US energy tsar and former Halliburton CEO, Vice-President Dick Cheney.

Oil price super-spike: due to both global supply and demand factors

Global supply constraints are critical to the oil price spike. For two decades, the management of its spare capacity by Saudi Arabia has been the major factor stabilizing international crude oil prices. On the other hand, the substantial exhaustion of that spare capacity underlies the price super-spike since 2004 entailing record profits for oil companies and high export revenues for oil-producing economies. Despite this, there has been under-investment in oil supply expansion globally, and not just in the Middle East. This under-investment partly derives from the many sources of uncertainty about future market conditions, including future crude oil prices and political instability in source countries.

The other key factor is on the demand side, especially strong Chinese consumption due to both its rapid GDP growth and projected motorisation. As discussed below, this is an international issue to which Australia can contribute constructively given the will.

The discredited objective of greater national self-sufficiency in oil

Another element of Howard’s policy package of 14 August was assistance to R&D on gas-to-liquids and coal-to-liquids, as if these wealthy industries lacked funds or incentives to self-fund such research. S uch policies are gratuitous for an economy that is already a major net exporter of hydrocarbons, including petroleum (mainly as LNG).

Certainly, increased government funding of R&D in oil or gas exploration, however merited, will do almost nothing to reduce global oil prices, or motorists’ oil bills. The obsolete and discredited objective of greater national self-sufficiency in oil ‘draining Australia first’ is a total red-herring in this debate, and can again give rise to an unnecessary drain on the budget.

Rather, in a period of high global oil prices, it is far more important to ensure that the present super-profits of local oil producers are efficiently taxed in order to relieve the burden on ordinary taxpayers. This should be achieved not by changing the rules but by maintaining a long-standing rational tax regime based on capturing resource rents.

Thanks to Bill Leak.

The adverse greenhouse implications of dysfunctional oil security policy

One legitimate consideration that should influence the relative price of liquid fuels is the cost of CO₂ emissions, assuming that such emissions are priced in a regime that imposes constraints at the national level unfortunately not yet the case in Australia. However, on a full life-cycle basis, these emissions can vary widely, especially from alternative transport fuels. Such emission coefficients can certainly exceed those of oil-based transport fuels. This is most obviously the case for liquid fuels derived from coal (the coal-to-liquids favoured by Howard) or from shale. In either case, full-cycle CO₂ emissions per km travelled vastly exceed those from oil-based transport fuels. But the same objection may even apply to fuel ethanol from sugar or starch. In the latter case, there must be a major process energy input, especially at the stage of distillation of the liquor from the fermentation process. Once again, in the most adverse case, if this process energy is obtained from coal, then the CO₂ emissions per km travelled can be much greater than from oil-based transport fuels, despite the renewable aspects of the biological feedstock.

How to minimise fuel bills in the long term

The pain and the reality of high oil prices is a function mainly of a long history of bad past policies on the demand side. These policies (or non-policies) have fostered an addiction to transport fuel. There are many ways of addressing this long-term addiction but they are not prominent in Beazley or Howard’s opportunist electoral strategies.

A more rational approach to reducing future transport fuel bills would be to encourage greater fuel efficiency in vehicles. A historically low rate of excise in Australia has not encouraged a fuel-efficient national vehicle fleet or patterns of urban land use.

At a minimum, Australia needs to resist pressures to reduce fuel taxes, using budget revenues to offset the increase in crude oil costs. Such higher crude costs are likely to be a fixture now that the era of easy oil is over in the view of many experts (though there may well be some retreat from the present peak in the short to medium term).

Second, CAFE-type [5] compulsory fuel efficiency standards should be introduced for new vehicles. Even the US has had these standards since the late 1970s, albeit effectively exempting gas-guzzling SUVs, and failing to tighten these standards for more than two decades. In Australia, it is hardly sensible for governments to remain passive and silent when auto manufacturers like GMH and Ford continue to market and promote large fuel-inefficient caravan-pullers and SUVs that will remain in the national car fleet for 20 years. More recently, China has introduced CAFE-type fuel-efficiency standards but at more stringent levels than in the US. If policies around the world (including our own) were to similarly encourage fuel-efficient vehicles and other fuel-saving practices, then there would be two results:

• The amount of transport fuel required per person would be reduced for a given transport task or living standard;
• Compared with a do-nothing scenario, the international price of crude oil would tend to decline as reduced pressure is placed on available supplies globally.

Hence, fuel bills, which are the arithmetic product of price and volume, would also tend to be reduced – but not merely at the expense of increased taxes of other kinds.

Is there a more optimistic scenario for future oil bills?

The second result referred to in the previous section was about demand-side policies that can put downward pressure on international crude oil prices. To be effective, such policies would have to be put in place globally, not just confined to a small economy like Australia that accounts for only a tiny fraction of global oil consumption.

The present Australian government has at best a mixed record as an international player on energy-related public policy. On the one hand, it fancies its position as an ally of the US, taking part in coalitions of the willing involving gratuitous wars in the oil-rich Middle East – hardly a positive factor in reducing international oil prices. The second and equally unimpressive example is Australia’s collaboration with the US in the joint attempt to scuttle the Kyoto Protocol, partly out of the desire to maintain export sales of climate-threatening hydrocarbons, especially coal.

Yet it is possible to envisage Australia taking a more constructive stance on global energy policy. Such a stance would involve Australia playing a positive role in policies to reduce rates of growth in the global consumption of fossil fuels, including oil – both through the demonstration effect of its own actions domestically and by means of diplomatic initiatives through say, the International Energy Agency (IEA). As shown in economic research and modelling carried out by the IEA, global demand-side management (DSM) can exert significant downward pressure on both oil consumption and oil prices.

Endnotes :

1. Documents relating to Government energy policy are accessible under Energy Reform? http://www.dpmc.gov.au/initiatives/energy.cfm#aug2006. The latest initiatives are detailed under August 2006 Update
2. According to the Prime Minister (7:30 Report, Monday August 14) hundreds of thousands of motorists could be involved, suggesting a cost to the budget of $2000*300,000 or $6 billion over some period of years, and even this estimate does not yet include the foregone fuel excise revenue.
3. These include US assistance to Israel in the Yom Kippur war (1973); the US role in provoking and prolonging the Iran-Iraq war 1980-88; its apparent failure to discourage Iraq’s invasion of Kuwait (1990) and in the subsequent war (1991) that took Iraq’s oil out of the market for a decade; the invasion of 2003 and the subsequent botched occupation. Due to the sabotage by insurgents, Iraqi oil production levels remain at levels short of those prior to the regime change of 2003, despite high hopes from some US quarters of a production bonanza from a new Iraq as the swing producer to replace Saudi Arabia.
4. For example, US plans to use the military to denuclearize Iran, possibly with tactical nuclear weapons. Hersh, S.M., 2006, The Iran Plans: Would President Bush go to war to stop Tehran from getting the bomb? New Yorker, 17 April; Hersh. S.M., 2006, Last stand: The military’s problem with the President’s Iran policy New Yorker, 10 July.
5. The USThe US CAFE scheme is based on Corporate Average Fuel Efficiencies, taking account of all passenger vehicles in the range of a given manufacturer.