Saturday, June 14, 2008

Saturday Forum: What's up with petrol?

If, like most of us, you are worried about the price of petrol, I am the bearer of bad news. You are likely to worry more.

The reason why, has a lot to do with whales.

But before turning to the creatures that used to provide our oil for heating in the days before petroleum, it's worth looking at how we're coping now.

In a remarkably successful attack on the government in recent weeks the Coalition has claimed both that the high plus-$1.50 per litre price of petrol is hurting us and that it is not cutting our use of the stuff.

This is, on the face of it, an odd position to come from the side of politics that says it believes in the workings of markets...

But its environment spokesman Greg Hunt has been arguing it with apparent sincerity.

Tackling the government over the proposed emissions trading scheme which will push up the price of petrol has asked how “whacking a great new 20-cent tax” on petrol would decrease emissions.

“We have serious reservations and scepticism about petrol tax, given that prices have increased four-fold in the last decade and petrol volume hasn't changed at all,” he said, asking “can they explain how a 20-cent tax will decrease emissions?”.

The economics team at Westpac is able to explain it fairly well.

Economist Matthew Hassan has examined how our behaviour has changed over the last three years – when the price of petrol has really been climbing.

He has found that our spending on petrol as a proportion of our total spending has remained relatively steady at around 3 per cent.

That means that the amount we are now spending more on petrol than we used to - $16.90 per week instead of $13.50.

But the amount of petrol we have bought per person has slipped, from 13.5 to 12.9 litres per week.

Figures on the distance traveled per vehicle bear this out. In 2001 the average car drove 14,600 kilometres per year. By 2006 that average had fallen to 13,800 and has probably fallen further since.

Mr Hassan cautions that the cut in distance driven per person may not be as big as the cut in distance driven per vehicle because we have more cars, but he believes that even that has fallen.

He also notes that we are still buying more fuel per week than we were in the low years of 2001 and 1991 when we bought only 12.5 litres.

Our consumption has further to fall, which is just as well.

For some people on high incomes or who live in near their place of work the price increases to date “haven’t even touched the sides”.

For others, the high prices are biting. It is the outer suburbs of Sydney, Melbourne and Perth in which families are most likely to be falling behind in their mortgages, the suburbs in which people need to travel long distances and lack access to public transport.

“While it would be surprising if fuel price rises were the key factor behind the rise in arrears, they will clearly be adding to the stress on already stretched households in these areas,” he says.

Our petrol price has roughly doubled in the last four years from around 77 cents per litre to more than $1.50 a litre.

The bleak news, delivered to both the Treasury and the Reserve Bank this week, is that it isn’t going to go back.

Professor Marvin Goodfriend, an advisor to the US Federal Reserve for 25 years, is visiting Australia as a guest of the United States Studies Centre at the University of Sydney.

Over tea and scones at the Canberra Hyatt on Wednesday after speaking to officials from the Australian Treasury he sketched out the dimensions of the change that he believes is taking place.

It has very little to do with speculators pushing up the price of oil and nothing to do with oil producers attempting to cut supply as they did during the oil price “shocks” in 1974 and 1979.

“China and India are going through a transition that is a one-off in the history of the planet earth,” he told me.

“Roughly Half the planet is becoming modern.”

“We have never had it before in thousands of years of planet earth and we are not going to have it again in thousands of years.”

“Let’s put this in perspective, it has to happen: The relative prices of food and fuel have to adjust.”

Professor Goodfriend thinks we are in the middle of a fundamental shift, a bit like tectonic plates moving as a result of China and India moving quickly toward Western standards of living.

As he puts it: “the scarcity of the goods that nature produces is rising, relative to the scarcity of the goods and services that man produces”.

He adds: “Let me repeat that,” and then says that the price of food and fuel has to rise relative to the price of most other things and that there is nothing than anyone can do to stop it.

“Speculation is adding to that, but the basic fact is that China and India are beginning to modernize very quickly.”

“Nature’s ability to produce food and fuel is limited in the short run, so we are facing a fundamental change in the scarcity of those two products compared to almost every everything else”.

He says unlike other forms of inflation Australia’s Reserve Bank and its kindred organisations are powerless to act against rising food and fuel prices.

If they push up interest rates and try to contain the overall rate of inflation they “have to create deflation somewhere else in the economy so that the aggregate inflation rate is stable.”

“When central banks create deflation it is almost always associated with unemployment. That will in turn push down wages and other prices and in the end you will still get the reduction in the standard of living and the shift in relative prices that has to flow from higher fuel and food prices.”

“The fact is that countries have to live with the rising prices of food and fuel compared to the prices of the industrial goods that they produce.”

Australia is probably in the best position of any developed country to cope with rising fuel and food prices. We export both fuel and food (although we import oil).

The Australian dollar is being pushed up by the tectonic shift and it is shielding us from the full horror of the adjustment.

If the Australian dollar had stayed still rather than risen since the start of last year, the petrol sold at Australian pumps would already be costing $2.00 a litre.

It is likely to head there. The US Federal Reserve has examined spending patterns in almost 180 countries and concluded that a doubling of per capital income more than doubles per capita use of oil.

As it puts it, “big nations moving quickly up the income ladder have huge implications for oil markets.”

Not surprisingly the rapid changes in India and China have caught oil producers by surprise. They are unable to keep up.

Believers in “peak oil” who contend that worldwide supplies have already peaked argue that producers will never catch up.

People concerned about climate change who actually want to cut the use of carbon-emitting fuels argue that producers never should catch up.

So what’s going to happen?

That’s where we might be able to learn from what happened to whales.

Before petroleum there was whale oil.

Writing in the London Financial Times the British historian Edward Chancellor quoted Herman Melville as noting that at the mid point of the 19th century – not that long ago – whale oil was used for “almost all the tapers, lamps, and candles that burn around the world.”

In 1851, the year Moby Dick was first published, more than 10,000 whales were killed and output peaked at around a third of a million barrels.

“Chasing whales was big business. But they became scarcer over time. This drove up the price of whale oil, which made it profitable for voyages to extend further from port and also induced whalers to take greater risks.”

“In 1859, Colonel Edwin Drake struck oil at Titusville, Pennsylvania. In a few days, Drake extracted as many barrels of oil as a whaling ship could gather on a four-year voyage. The price of petroleum soon fell far below that of whale oil. Whaling became unprofitable and was only carried on for the bones which went into ladies’ corsets. Eventually, even these were substituted with flexible spring steel.”

He says that while whales are living creatures and unlike crude oil a potentially renewable resource, the course of the whaling industry provides a guide to the future.

“The history of whaling shows that when demand rises faster than supply, prices rise in real terms. This provides an incentive to search for substitutes. It is hardly a coincidence that the US crude oil industry got going within a decade of the whale oil production peak.”

“As fresh supplies of whale became harder to find and a substitute appeared, the smartest whale merchants left the business and invested their capital in the new crude oil industry. Even without whales, lamps carried on being lit and tapers burnt”.

It’s an optimistic message. But at its heart is the absolute necessity for the oil (and the petrol) price to rise before we are freed of the need to use it.

It looks as if it will keep rising. Nothing – not even FuelWatch or tax cuts – will be able to stop it.

James L. Coleman, The American whale oil industry: A look back to the future of the American petroleum industry?, Journal Natural Resources Research, Volume 4, Number 3, September, 1995