Double, double, oil and trouble

Petrol prices in the March quarter were at their highestlevel, in real terms, since 1986.   This article examines the outlook for oilprices, their effect on people’s behaviour, and the resultant impact onmonetary settings and the broader New Zealand economy.

Always hoping for the best

Recent trends in oil prices have proved difficult forforecasters to predict.   Since early 2002, the market has consistently beenexpecting oil prices to drop back from their current levels.   Graph 8.1 shows forecasts of oil prices from the Consensus publication and compares them with the actual result a year later.   It has been four years since the consensus forecast for 12 months down the track was not too high.   Infact, only once in the last 2 ½ years has the actual oil price fallen within therange provided by contributors to the publication.

Graph 8.1

This persistent bias of underestimating future oil pricesis present in our own forecasts:

  • February2003: "Our prediction is a brief spike to approximately US$45 per barrellasting six months".
  • June2004: "In the short-term (up to the end of 2004) we expect the peak in priceswill be somewhere in the $40-50/bl range".
  • August2004: "Our prediction … was that oil prices would peak somewhere betweenUS$40-50/bl before easing off … We see no need to change this forecast."
  • October2005: "We predict that oil prices will settle consistently below US$50/blwithin the next 18 months".

The jury’s still out on that last forecast.   Events in theshort-term, such as reduced political tensions in the Middle East or Nigeria,or slower economic growth and weaker demand from China for oil, have thepotential to push oil prices lower.   But the medium-term trend in oil prices islikely to remain upward, given the ever-increasing global demand for oil andconcerns about supply.

Higher prices encourage the extraction of crude oil thatwould not be profitable to pursue at lower prices.   Higher prices alsoencourage more efficient use of petroleum products by businesses andhouseholds, and ultimately lead to investment in alternative technologiesallowing users to switch away from oil consumption.   However, these factors helpto cap rises in oil prices over the medium-term; they will not drive the priceof oil lower.

Time to make a change

As we’ve noted on previous occasions, even if world oilprices do retreat from their current levels of close to US$70/bl, the impact onretail petrol prices in New Zealand is likely to be offset by the currentdownward trend in our dollar.   More expensive fuel is something we simply haveto get used to.

So is this leading to changes in behaviour?   In terms ofvehicle-purchasing behaviour, it appears that it is.   Graph 8.3 shows the weighted average cc rating [1]of first-time registrations and real petrol prices.   The 2.7% drop in theweighted average cc rating over the last year is the largest fall since theexcesses of the mid-1980s (share market boom) were being unwound between 1987and 1989.

Graph 8.2

Even more obvious is the turnaround in motorcycle andmoped registrations.   Over the last four years, the number of first-timeregistrations of these vehicles has trebled to 14,200pa.   The number of mopedregistrations has surged almost 500% during that time.

With the exception of the figures for mopeds, the changesin registration numbers are still relatively small by historical standards.  However, the changes in behaviour are much clearer than they were during thepetrol price spike in 2000.   The efforts from households to reduce consumptionare evident in delivery statistics of petrol – down 2.9% for the year ended March(the largest drop in 20 years).

Graph 8.3

Apart from shifting to smaller and more fuel-efficientvehicles, other possible responses to permanently higher fuel prices include:

  • increasedpatronage of public transport (although this relies in part on fares not beingincreased);
  • increaseddemand for housing closer to people’s workplaces – (i.e. close to, or in, thecentre of urban centres);
  • morereliance by businesses on electronic communication rather than face-to-facemeetings.
Inflationary or deflationary?

In terms of monetary settings, one’s initial reaction tohigher fuel prices is to expect tighter monetary policy, to contain thepossible flow-on effects into the prices of other goods and services.   But althoughhigher petrol prices do have a potentially inflationary impact on the economy,they also negatively affect aggregate demand.   Given that household spending onfuel is relatively inelastic (i.e. any significant changes in consumptionpatterns only occur very slowly), the immediate effect on households is thatthey have less money to spend on other goods and services.

The Household Economic Survey from 2003/04 showed that theaverage household spent $30.90 per week on fuel for motor vehicles.   Since then,petrol prices have risen 25%, implying that any household which had not changedits fuel consumption in the intervening period would be spending $7.74 more perweek on petrol.   That represents almost 1% of the average household’s weeklyincome that could not be spent on other things.

With private consumption growth averaging 0.94% perquarter over the last decade, a 1% hit to consumption growth over a two-yearperiod is relatively small.   But the squeeze is now coming at a time when thehousing market is cooling and unemployment is rising.   Slower growth inhousehold spending due to these other factors will be exaggerated by theeffects of high petrol prices.

The surge in fuel prices is certainly not going toencourage the Reserve Bank to cut interest rates sooner than it might otherwisehave done – the Bank is keen for some spare capacity to develop in the economyafter five years of strong economic growth.   But once the initial effects ofthe higher petrol prices have been worked through, inflation may actuallysubside more quickly than would otherwise have been the case.   In this sense,higher fuel prices have a deflationary second-round effect on the economy.

[1] Theweighted average is calculated from cc rating bands published by Statistics NZ:up to 850cc, 851-1,300cc, 1,301-1,600cc, 1,601-2,000cc, 2,001-2,500cc,2,501-5,000cc, and over 5,000cc.

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