Taking the 'ouch' out of pump prices

With pump prices here up 30 per cent to 40 per cent in the past six months, the Government's recent announcement of one-off relief of $150 for eligible taxi main hirers and private hire car drivers - and up to $300 in cash for eligible drivers under the NTUC Freelancers and Self-Employed Unit Relief Scheme - is welcome news.

It comes on top of other help from taxi and private hire car operators such as temporary fare adjustments, rental rebates and discounted fuel.

How to get fuel prices down, and not just provide temporary relief, is a question confronting many countries including Singapore.

What are the options? Theoretically one could raise interest rates, which would reduce the demand for almost everything including petrol. When demand falls, prices should follow.

But the demand for fuel is highly inelastic in the short run, which means that the amount people want to buy is not very sensitive to price changes.

People who depend on their car for their livelihoods, for example, will continue to pay for petrol. And consumers will not replace their vehicles with more fuel-efficient ones overnight.

That is the conventional view, anyway. Some dynamic studies suggest that consumers are more responsive to short-term price fluctuations than earlier assumed.

For example, they may cut back on discretionary driving or switch to public transport, which is widely available in countries such as Singapore.

But regardless of whether demand falls by a little or a lot, a key question is this: how is suppressing demand in the immediate term - which hurts people and the economy even more - a solution?

So the second option is to ease supply-side constraints.

Much has been blamed on the Ukraine war and sanctions against Russia. But prices were already rising before the war: during the pandemic, a lot of production was shut down and some energy companies either folded or consolidated.

It also takes time to drill new oil wells, or to convince producers to bring more oil onto the market.

Here, the Organisation of the Petroleum Exporting Countries (Opec) plays an outsized role.

Opec is widely considered to have the world's biggest reserve of spare capacity, or supplies that can be turned on and off quickly.

While Russia is not a member of Opec, it has coordinated oil production since 2016 with the group through Opec Plus - a coalition of Opec as well as non-Opec oil-exporting countries - which controls more than half of the world's crude output, giving Moscow sway over the oil market.

As the post-Covid-19 recovery began, Opec Plus pumped less oil than the world demanded, even though it had the capacity to pump more. It was only under global pressure that the cartel recently injected more liquidity into the energy market, boosting output in a series of pre-planned hikes.

Another boost will come in August, which on paper would bring production back to pre-pandemic levels. In reality, output is lower because of sanctions on Russia as well as a confluence of supply disruptions, port blockades and political unrest in countries such as Nigeria, Iraq, Iran and Libya.

Opec has waived production requirements in the past for members facing production stresses, including Iraq when it was under sanctions in the 1990s.

Iran, Libya, and Venezuela are exempt from the Opec Plus output deal and therefore not assigned baseline production levels, while Russia has missed its production target, called a quota, for several months. But to ease the energy crunch, France wants to explore ways to bring production from Venezuela and Iran, both subject to US sanctions, back on the market.

Much of the remaining ability to increase production rests with Saudi Arabia and the United Arab Emirates.

Under the terms of their agreement, however, such members with capacity to spare are not permitted to fill the gap left by their struggling coalition partners. UAE Energy Minister Suhail al-Mazrouei admitted recently that "the situation is not very encouraging when it comes to the quantities that (Opec Plus) can bring".

The Group of Seven (G-7) rich nations have acknowledged just as much that increased output will not make up the shortfall, and are behind a US-led push for a mechanism to cap the price other countries pay for Russian oil - a double-barrelled move that seeks to limit Russia's hydrocarbon revenues while minimising the negative impact of high energy prices.

On June 22, US President Joe Biden called on Congress to suspend the federal tax on petrol and diesel - 18 and 24 cents a gallon respectively - until September to stem runaway costs at the pump.

"Together, these actions could help drop the price at the pump by up to US$1 a gallon or more. It doesn't reduce all the pain, but it would be a big help," said Mr Biden.

It may score political points for Mr Biden, who is heading into the mid-term elections in November.

But many economists say slashing taxes has few benefits for consumers and could even make inflation worse.

How so? By inflaming demand which is already far outpacing supply - supply that is not only due to global shocks, but also refining capacity constraints.

Retail prices for products such as petrol have not fallen as fast as crude, due to a shortage of capacity to make fuels.

Some plants in the US that were shut down during Covid-19 due to lack of demand have not come back on, or are not operating at full capacity. Bad weather last year knocked others offline.

Refineries also take a lot of money and time to build, and investors are holding back amid uncertain long-term prospects for fossil fuels. These are all issues which cutting taxes will not resolve.

And if a tax holiday encourages more spending, that could hurt the economy by providing stimulus at a time when governments wish to curb inflation. Put simply, making fuel cheaper allows people to buy more of it, driving prices back up.

In Singapore, Deputy Prime Minister and Finance Minister Lawrence Wong had said in Parliament that cutting or suspending fuel duties, or giving out road tax rebates, would effectively amount to a subsidy on private transport. This would benefit a relatively small but better-off group since fewer than four in 10 households in Singapore, and only about one in 10 among the lowest quintile, own cars.

High fuel prices are also necessary to incentivise consumers to transition to fuel-efficient or electric vehicles.

Professor Robert Triest, chairman of the Department of Economics at Northeastern University and former vice-president at the Federal Reserve Bank of Boston, noted that American consumers turned to more fuel-efficient vehicles in the late 1970s when petrol prices spiked. This happened again in 2008 when fuel prices went up, and manufacturers discontinued many petrol-guzzling vehicles.

There is also another downside to slashing fuel taxes: It could negatively impact revenue generated for other public uses.

In the US, petrol tax revenue is funnelled to the Highway Trust Fund to build and repair critical infrastructure, such as roads and public transportation.

In Singapore, where petrol duties were raised last February, an average of $920 million a year in fuel duties collected over the last five years has gone towards programmes and subsidies, including spending on public transport infrastructure.

Specifically in the US, there are regulations from the second Bush era which require energy producers to mix fuel with renewables. This is especially cumbersome and expensive for smaller refineries, hence some analysts have called for a pause in those kinds of regulations.

But for countries in general, the sensible approach is to boost incentives and speed up the building of infrastructure, to encourage a quicker transition to electric vehicles and public transport. Consumers could also take small steps by cutting down or combining car trips to stores, taking public transport, carpooling, or working from home where possible.

Targeted relief to vulnerable or lower-income households, such as the recently announced $1.5 billion support package, is also not as harmful in terms of its effect on already high inflation. Other measures in this year's Budget include rebates for service and conservancy charges and utility bills, and increased help for the lower-income.

In the end, it is not just what governments do for fuel prices, but also across a spectrum of other items such as food and housing, that will alleviate the real pain faced by their citizens.