Petrol prices: The problem with price dropping to 80c a litre

Petrol is the cheapest its been in 20 years. But while it may be good news for motorists, it could cause major problems down the track.

Who remembers the year 2000? Sydney had the Olympics, Cathy Freeman was the fastest woman in the world on the 400 metre track, and the price of petrol was around 80 cents.

If you were born too late to enjoy the first two, at least now you can enjoy the third one.

Because the price of petrol is going down. Way down.

The price of oil even went negative in America last week. That has never happened before.

Sellers had too much oil and nowhere to put it, so they had to pay buyers to take it.

While the oil price has risen since, the event has still blown up the global oil market.

Saudi Arabia is producing loads of oil – more than usual – while the world is using much less oil than usual because of the coronavirus. It’s a perfect storm.

There’s lots of kinds of crude oil in the world, but the one which is most relevant for Australian petrol prices is called Malaysian Tapis.

Tapis held out against big price falls for a while, but now it has fallen to below $20 a barrel. That’s extremely cheap – Tapis cost four times as much a year ago.

How the Malaysian Tapis fell below $20 a barrel this month. Picture: Oilprices.com

A fall in the price of oil won’t come through to petrol prices completely – petrol prices include shipping costs, retail margins, taxes, etc.

You can’t expect the price of petrol to fall by 75 per cent just because the oil price has. But when the price of crude falls this much, it’s fair to expect petrol prices to fall a lot.

This is one little bright spot for the Australian economy. Fuel is an input to loads of industries, not least all the delivery drivers who keep coming to my house.

When the price of fuel falls, life gets easier for any business that makes deliveries, or pays for staff travel, or runs machinery on diesel. Their costs fall and their profits rise.

It makes it easier for them to put on more staff. Of course, this is not going to help cafes and airlines at the moment because they have shut down.

But for agriculture, logistics and some manufacturing businesses, cheaper fuel should help a lot, starting right now. And if low oil prices last longer than the lockdowns, then petrol at 80 cents a litre or lower will be good for the whole economy.

THE NEGATIVE SIDE

But lower petrol prices will hit one of Australia’s big economic indicators: Inflation.

When we see consumer price inflation for this three-month period, it will be a big fat negative.

The rapidly falling price of petrol – along with the government’s decision to make childcare free – will be big enough that they will likely push the annual CPI well into the negative.

Which is to say the price fall for the past three months will wipe out any inflation that happened in the preceding nine months.

That doesn’t happen often. In fact, Australia hasn’t had a 12 month period of negative inflation since last millennium, as the next graph shows.

Australia’s annual inflation.

Interestingly, negative inflation will make the petrol price go down even further, because the tax on petrol is indexed to CPI.

Petrol tax goes up whenever inflation goes up. This time the tax will fall as inflation falls. That will be a double bonus to any of us with cars, (although it will make the government’s budget balance look even worse).

But the petrol tax change is not the most interesting point about negative inflation. The problem with negative inflation is it depresses everything.

A lot of wages are tied to inflation. So are government payments like rent assistance, family payments, and even some pensions.

Once consumer prices start falling, earnings follow them down, and we can end up in a negative spiral.

You’ve probably heard about hyperinflation and how it makes people spend money as soon as they earn it. Deflation is the opposite. Why spend money now when prices will be cheaper in future?

In a time of falling prices, people save more and spend less and the result is a negative.

Avoiding this spiral is precisely why the RBA tries to encourage inflation in the first place.

Its job is to keep inflation in a low steady range, between 2 and 3 per cent a year.

This year, it definitely won’t be achieving that. Usually, it cuts interest rates to try to spur inflation. Now it has no interest rates left.

The recession we are almost certainly experiencing will also drive down inflation.

Rents will be weaker, property prices lower, and companies will be forced to cut prices to compete.

In these cases falling prices will be a sign of economic weakness, not a reason to celebrate.

It might not be long before we start reminiscing fondly about the era when petrol cost more

than a dollar.

Jason Murphy is an economist. He is the author of the new book Incentivology |@jasemurphy