Wednesday, 7 January 2015

George Osborne: Knows sweet FA about how prices are set

From The Daily Mail:

The Chancellor insisted it was ‘vital [that the fall in the price of crude oil] was passed on to families at petrol pumps, through utility bills and air fares’.

‘The Government is conducting studies of industries like the utilities and the airlines. We are examining if any action needs to be taken,’ a Treasury spokesman said.


How much the price of a) petrol, b) domestic energy bills and c) air fares fall when oil prices fall are three entirely separate topics.

a) Petrol is the easiest. The market is highly competitive, and falls in the price of oil are passed on in lower prices almost immediately (even though demand is fairly price-insensitive).

In round figures

July 2014

Pump price £1.32, knock off VAT = £1.10, knock off 59p fuel duty and 10p profit margin for the transporters/retailers = residual cost of actual oil = 41p/litre.

Crude oil $110/barrel, convert to £ at 1.70, divide by 159 litres = 41p/litre.

January 2015

Pump price £1.10, knock off VAT = £0.91, knock off 59p fuel duty and 10p profit margin = residual cost of oil = 22p/litre.

Crude oil $55/barrel, convert to £ at 1.55, divide by 159 litres = 22p/litre.

b) With domestic energy, it is nigh impossible to calculate by how much prices will fall for umpteen reasons which have nothing to do with the price of oil. Generators also use coal, gas and nuclear; generators and customers are locked into various fixed price contracts, there is little ease of substitution etc, so let's not bother.

UPDATE: VFTS in the comments reminds us that according to Energy UK, only 1% of UK electricity is generated from oil. i.e. in practical terms none at all.

c) Air fares are set according to what the market will bear.

This bears very little relation to costs in the short or even medium term. Some flights are run at a loss because the airlines don't want to forfeit their landing rights (they hope that things will pick up in future); some flights are hugely profitable.

International travellers will pay a lot more to land at a London airport than elsewhere in the UK, even though the total distance flown is much the same, etc. UK travellers have to pay a lot more to fly to a major European city rather than somewhere in the back of beyond.*

If this were not the case, then landing slots at London airports would not be bought and sold for such huge amounts of money. What the purchaser is paying for is the scarcity-monopoly-rental value. Airlines just try to sell as many tickets as possible for the highest price possible using a variety of auction methods (i.e. trial and error).

So the overall impact on air fares will be minimal, although we would expect a modest reduction overall; it will be negligible at London airports and larger at regional airports which are running at two-thirds capacity on average.

* Thanks to the miracle that is the internet, we can quickly establish that flights from Leeds-Bradford to Geneva start from £86 (British Airways); a similar distance flight from Heathrow to Munich starts from £141 (also British Airways).

19 comments:

Steven_L said...

With more money in their pockets, consumers might increase demand for flights. The most popular seats could well rise in price as a result surely?

As a sidenote, I wonder what $50 oil will do with regard the amount of cash flowing into the prime London property market?

Lola said...

I really cannot decide whether Osborn is a lying twat or just a stupid twat. Or he may be neither and just a twat. Whatever, we are now in an age of endemic lying by the whole political and state bureaucratic establishment.

View from the Solent said...

Almost no oil is used for retail electricity generation in UK. Gas is important and its price used to be linked to that of oil, but not since it started flowing freely from the ground in the USA.

I tend to favour Lola's lying twat.

Demetrius said...

Politically, it is an imperative with an election coming up to tell people holidays will be a bit cheaper.

mombers said...

Funny how the twat would never suggest looking into why plummeting mortgage costs haven't been passed onto renters?

John M said...

I am waiting for someone - anyone - in the media to write an Op Ed piece focussing on how petrol is now effectively taxed at 110%.

Mark Wadsworth said...

SL, in theory yes, but yer average motorist is still only saving about £5 or £10 a week, it won't really make much difference to anything.

L, twat is sufficient.

VFTS, excellent point, I didn't realise it was that little and have updated the post.

D, they probably will be cheaper because EUR is quite low against GBP at the moment. That's absolutely true and GO would be perfectly within his rights to say it out loud.

M, ah, that's different, because, er, er…

JM, 110%?

At present, petrol is taxed at something like 300% i.e. to get up from 22p plus 10p real costs up to £1.10 pump price. Diesel is probably 400%.

That said, fuel duty is one of our least bad taxes.

Bayard said...

"b) With domestic energy, it is nigh impossible to calculate by how much prices will fall for umpteen reasons which have nothing to do with the price of oil"

Not when you heat your house by burning oil, it isn't. The fall in crude prices is reflected in the fall in domestic heating oil prices the same as petrol.

Mark Wadsworth said...

B, yes of course, but what % of the population do that? My grandad's house in Germany was thus heated, but I've never seen it in the UK.

Lola said...

MW. Erm, you need to live where I do. Oil is how we heat and cook....

Mark Wadsworth said...

L, I said that I'd never seen it (which is quite true). I didn't say it didn't exist :-)

Out of interest, how do you cook using oil? Gas, electricity or wood I can understand, but oil? Doesn't the food taste a bit funny?

Lola said...

MW. Oil fired Aga. Cooks brilliantly.

Bayard said...

Mark, anywhere more than a couple of hundred yards outside a town or a major village and you're not going to be using gas unless it's the expensive, bottled variety.

Lola said...

B. And FWIW I also have my own sewage plant...

Lola said...

MW. It's just occured to me that you must be a real urbanite...

DBC Reed said...

Loads of adverts for oil-fired central heating on Net.Knew someone who used to deliver heating oil: went to repo a non-payer and emptied tank at wrong address.

Ben Jamin' said...

There can only be one reason landing slots are worth tens of billions of pounds.

Everything else follows.

It's really disheartening that our "leaders" are so badly advised.

Unless they are corrupt.

Ben Jamin' said...

BTW,

Capitalised value of landing slots, like all monopoly rents, cause a deadweight loss.

So, as you say, stuff like half empty aircraft, low capacity aircraft, queuing etc

Why aren't the Greens vociferously campaigning to get those slots auctioned?

This is worth a watch

https://www.youtube.com/watch?v=8s4-dbWv-N8

Bayard said...

BJ, why don't you email Natalie Bennett and suggest it? You'll probably get a load of hogwash if you get a reply at all, but you never know...