Matt Delarue | Improving the crude signal that is the retail price of fuel

Few retail products are subject to such pricing volatility as fuel – the petrol and diesel that we purchase at the servo. In the past 3 months alone, unleaded petrol has ranged from 87cpl to 148cpl in Brisbane, and fluctuations of up to 30% are common in a single week. Prices can differ widely between service stations, even within the same brand.

At time of writing, service stations in metro Brisbane were offering 1 litre of unleaded at anywhere from 107c (Costco, Northlakes) up to 135c (BP, Wynnum). The spread within the BP chain was a whopping 26c – from 109c at various BP servos on the south-side to 135c at Wynnum and Cleveland. That’s a nearly 25% variance, between franchises that share a common terminal-gate price and nearly identical delivery costs.

Now, this is not necessarily a problem – it’s just the invisible hand of the market at work – and various websites allow price comparisons. Obviously there are many complex factors which inform the pump price – the price of oil, refining costs, storage costs, transport costs, fluctuations in currency exchange rates, right down to the franchisee’s assessment of what his local competitors are doing, and what the hyper-local market will stand on any given day.

In theory, it’s a balanced and competitive market: sellers are free to set prices, and buyers have a wide choice of fuel outlets. In practice, you take what’s on offer, with no possibility of negotiation or control over prices (unless you’re a trucking company, or bulk fuel trader)

But could this market be improved? Could price volatility be reduced, and competition further improved, giving consumers more certainty and lower average prices?

My proposal (for your ill-informed criticism and abuse) is a secondary futures market for retail fuel. Such a market already exists for every conceivable bulk commodity (including oil and wholesale petrol of course), where it serves an important function in spreading risk and reducing volatility. So why not extend this to retail fuel?

Essentially, customers would be able to purchase an option to take a certain volume of petrol, at a certain price, at a future date. This option could be in the form of a redeemable voucher, or (more likely) a unique PIN or QR code. Importantly, the options would be infinitely divisible, and transferrable at a price to be determined by the market. The trading platform would be a smart-phone app, perhaps similar to an online gambling or share-trading service.

For example:

1. The advertised price at XYZ brand servos is 120cpl.
2. I purchase an option to take 100 litres at 125cpl, open for 7 days.
3. Tomorrow, the advertised price increases to 130cpl.
4. I could either:
   • Fill up my car, using my option for 125cpl;
   • Sell my option (or the unused portion) on the app, at a price between 125cpl and 130cpl – making a small profit, and saving the purchaser a few cpl off the advertised price; or
   • Forget, and let the option expire.

The price of options would initially be set by the fuel company, and the spread from the advertised price would depend on volume, the expiry date and the fuel company’s forecasting of future costs. To extend the above example, you might be able to purchase options for:

• 100 litres at 125cpl, open for 7 days
• 100 litres at 130cpl, open for 1 month
• 1,000 litres at 125cpl, open for 3 days
• 10,000 litres at 128cpl, open for 6 months
• 1 million litres at 130cpl, open for 6 months

I imagine this would create a tertiary market for options, as a few traders with deep pockets make bulk purchases and then sell off portions to retail customers, who then trade those portions.

For big trucking and construction companies, who spend millions of dollars on fuel each week, would end up employing full-time fuel traders to forecast and manipulate the market to their advantage.

Small retail traders (ie: mums and dads filling up the Tiguan) would probably see it as akin to online gambling – I can imagine Karen on the train home, getting an alert that her order for 2500 litres at 137.52cpl has been partially filled… she immediately swipes up on the app to trigger her preset preference to on-sell 2000 litres at 139.00cpl, realising a $25 profit to pay for a bottle of sav-blanc with dinner.

Some further considerations for discussion:

• Would this actually have any impact on prices? As the initial issuer of the options, the fuel company would also have visibility on their expiry dates and could set option prices accordingly. There would have to be a reasonably large percentage of daily volume hedged to make it worthwhile for the fuel company to lower prices to meet the options market.

• The owner of the trading platform would take a very small percentage of each trade. There’s a big incentive for a third-party to set up such a system, but why would the fuel companies opt in?

• Because there is no requirement to actually take physical delivery of the fuel, it is highly likely that some options (or part thereof) will simply expire without the fuel ever being taken. This volume would then be sold on the “spot market”, ie: the advertised price at the servo. Maybe that’s sufficient incentive for the fuel companies to get involved?

---

First, the author adds:

I initially approached this idea from the perspective of the app developer/market maker, and perhaps that’s where it’s greatest potential lies – as a quasi-gambling app that gives consumers an illusion of choice, while funneling profits to the market maker and third party advertisers. Thinking about it, fuel prices probably wouldn’t change.

Next, some sniping from the wings:

Yes, what the world has been waiting for is yet another way to trade value that doesn’t really exist and make smart and lazy people wealthy on the back of the less privileged! No, sir. Just ride your bike to work and fuel up in a small town on the weekend – they can use the extra business.

Probably only taken up by a small number of overall numbers given financial risks involved and knowledge required… one of the more practical things here. So I vote this author be banned for bringing this place into ridicule!

Finally, Rhea Worded failed to poke holes in the proposal but muses:

Who would have the incentive to implement it?

Wholesale pricing of fuel in Australia is fairly well internationalised now. In 2010 we were already importing 83% of our crude oil so there’s a good chance that the fuel in you put in your tank this morning about 10 weeks ago was under Saudi sand. At that point only half our fuel was locally refined so it was a coin toss as to whether or not 5 weeks after that it was in an Asian oil refinery. As such, Australia is always at the mercy of the international parity price for fuel which follows crude oil prices reasonably closely.

Contrary to popular belief, fuel retailing is actually a low-margin business. The most profitable part of the oil supply chain is getting out of the ground* – the ‘downstream’ parts of refining and marketing have historically been very competitive in Australia. This leads to some interesting market strategies namely follow the price quickly up and slowly down or value add by retailing other products alongside fuel. This is one of the reasons supermarket and convenience chains have got so heavily into fuel retailing as they can increase margins on product lines they already have. In fact, the supermarket chains have realised that they can used fuel as a loss leader to gain customer loyalty – whilst customers won’t drive down the road to save 4c they will attend a particular supermarket that is to do the same – and by doing so their market share has increased to 50% and continues to rise.

Supermarkets aren’t likely to be the one’s to encourage more rational fuel buying behaviour. Volatility is what the existing refiner/marketing organisations exploit to make any money so would be hesitant to allow their consumers to take advantage of it – though the possibility of ‘free’ money for sale of options that expire without being taken could pique their interest. Possibly the independents which make up 20% of the market could use it as a point of difference but have less capital to risk in setting such a system.

Seeing RACQ seem to be prepared to risk their brand on banking, I see no reason why they couldn’t be the one’s to implement this. They already spread the risks of breakdown amongst the driving public, why not the financial rollercoaster of the weekly fuel tank?

*The most extreme example is the Ghawar oil field which produces crude at about $4/bbl – hence why the House of Saud is estimated to be worth $100 billion.