Friday, 6 September 2019

Those high petrol prices - another view

There's a graph, Figure 3.8 on page 82, in the Commerce Commission's petrol market study that's puzzled me. And not for the first time: it also puzzled me when I first saw an earlier version of it, in MBIE's 2017 go at an inquiry into the petrol industry (where it was Figure 4 on p3). Here is ComCom's one.

It shows the price at the pump of a litre of premium petrol in a wide range of higher income countries, standardised by being converted into US dollars. Eyeballing the graph, you see New Zealand is there at roughly US$1.47. At the exchange rate of the time (March quarter '19) of 68 US cents, the price converts into NZ$2.16, which looks right. All good.

Because the price at the pump is heavily affected by local taxes, for competition policy purposes you need to focus on the price ex taxes, which is shown in blue in the graph. New Zealand does not show to advantage, with the third highest petrol price. Cue song and dance about how bad we are.

But what's been puzzling me is the weirdness of the country rankings. Your first inclination is to go looking for some underlying explanatory patterns - transport costs from major oil fields or refineries? - but it's hard to spot any. The three countries at the top - Mexico, Korea, us - are as odd an assortment as you'll ever see. The three at the bottom - Slovenia, Chile, Finland - don't obviously have much in common, either.

The ordering could of course reflect differences in local competitive intensity. You look at Mexico's top billing, for example, and you wonder about Pemex, a state owned monopoly up to 2013 which still has nearly three quarters of the petrol stations. You wouldn't know about the rest of them without some intensive investigation along our own Commerce Commission's lines.

But I'm also wondering whether the somewhat jumbled pattern mightn't partly reflect the fact that the petrol prices have been converted into US dollars at market exchange rates, rather than at purchasing power parity (PPP) exchange rates.

If this whole 'which exchange rate to use' thing isn't your bag, let's backtrack for a moment. If you're comparing, say, the price of an Apple i-Pad Pro 11" Wi-Fi 256GB, you'll find it's on Amazon at US$799.99 and you'll find it's NZ$1648 at JB Hi-Fi. At today's exchange rate (63.7 cents) the Amazon one costs NZ$1256. Good deal cheaper in the US.

But market exchange rates are fickle beasts and move around a lot. Because an iPad is expensive locally today doesn't mean it mightn't be locally cheap next Tuesday if the Kiwi dollar were to fall sharply against the US dollar over the weekend. You shouldn't be drawing any long-term policy conclusions about iPads - or petrol - on the basis of an exchange rate that might make a fool of you in no time.

Which is why these international comparisons are more normally done on a different basis. Supposing you went out and bought a wide bundle of stuff in the States, and it cost you US$100,000. You do the same in New Zealand, and it costs you NZ$150,000. It would then be fair to say that US$1.00 has the same buying power as NZ$1.50. In that case you wouldn't be in the least bit surprised if a litre of petrol cost US$1 in the States and NZ$1.50 here: that's just what you'd expect, because anything that costs a US dollar in the States is on average likely to cost NZ$1.50 here, as we discovered on our shopping expedition.

Long story short, people making international comparisons tend to use that US$1-equals-NZ$1.50 exchange rate, called the purchasing power parity rate (obvs). And here's what happens when you do that same chart of ex tax prices in blue above, but at that PPP rate instead. I've used the latest (2018) PPP rates as calculated by the OECD (you can find them if you fossick here).

In New Zealand's case, the pre-tax petrol price doesn't change much. It was around 77.5 US cents before (again eyeballing the number from the ComCom graph, as I'm not going to pay the €900 the International Energy Agency wants for the exact data). At the March quarter market exchange rate of the time, 68 cents, that was NZ$1.14. The PPP exchange rate wasn't very different: it was 67.6 cents. So our local price translated into US$ at PPP was 77.1 US cents, rather than the 77.5 US cents price you get at market exchange rates. Same diff.

But other countries' prices move around quite a lot when their PPP rates are used instead of their market exchange rates. And the end result is that our relative position drops quite a bit. We were third highest out of 33 on a market rate basis: on a PPP basis we're 14th out of 33. There's a bit of imprecision here, as I've used eyeball data rather than precise ones, so I wouldn't obsess over whether it's 14th or 13th or 15th*. This PPP ordering also makes a bit more intuitive sense than the market rate one: the bottom three, for example (now Norway, Finland, Iceland) look like a more coherent bunch.

There are still good reasons for having a market study look at the petrol market: those rates of profitability that ComCom found, in particular, need some explaining.  But one conclusion from this exercise is that I wouldn't get carried away by the "we're one of the dearest in the OECD" line of argument.On this, entirely conventional, alternative way of making the comparison, we're a little bit on the expensive side of middle of the pack.

*If you want to see the data I've used, and maybe check I haven't got the wrong end of any sticks, it's here (assuming I've got Dropbox working right).


  1. Does it make more sense to use a PPP figure, which will weigh too-heavily the nontradeable items in a basket of goods, or a moving average smoothed exchange rate that looks to the longer term trends and ignores weird exchange rate spikes?

  2. Sure, that would be another way of improving on spot market rates in this kind of benchmarking comparison. Would bypass not just the non-tradables you mention but also the judgment calls that can go into PPP calculations. I'd listen to a long-term average story, too, and might even spin one myself if time was unlimited. Either way, PPP or slow moving average would be better than spot market rates


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