Why Are Fuel Prices Rising at All? An Inside Look 0 12

Global oil prices continue to rise, and fuel prices are rising alongside them. The cost of fuel at gas stations in Latvia has already approached the levels of 2022, that is, after the start of the full-scale war in Ukraine.

The Consumer Rights Protection Center has been inundated with questions from outraged residents. A common question is: why have fuel prices increased so rapidly, given that fuel for gas stations was likely purchased before the crisis in the Persian Gulf, meaning at "old" prices? Here’s what expert Alexey Shvedov explained in an interview with bb.lv:

The purchase price in retail fuel sales is determined by a pricing formula, and this pricing formula is based on the quotations from S&P Global (Platts quotation), and these quotations determine pricing both in the Latvian market and in neighboring countries - Lithuania and Estonia.

If we compare it to the quotation from February 27, before the acute phase of the conflict, we get the following values: diesel fuel on the global market has risen by $424, or 56 percent; for gasoline, the increase is almost half as much, plus $227 (31 percent).

But let’s move directly to the Latvian market. If we convert the increase to euros per liter, in theory, this increase should amount to 40 cents per liter for diesel and about 20 cents for gasoline.

- But fuel was not purchased on March 9; there is fuel that was purchased at "old" quotations?

• There are two important points here. First, when we purchase according to the formula, the most popular option in the Latvian market is the average monthly Platts quotation. Today is March 11, and we still do not know what our fuel cost will be at the end of March. Therefore, we must react along with the global market.

The fuel business is about risk management. It’s not about greed or avarice. On the contrary: a fuel trader is interested in keeping the price at the pump as low as possible. After all, the lower the price, the less money needs to be invested: the fuel seller, on one hand, sells fuel, while on the other, he also purchases it. Before the war, a thousand tons of diesel fuel cost $750,000; the same amount a week later was over a million dollars, and a couple of days later, it was one million three hundred thousand. This undermines the liquidity of any trader.

And money in the financial market is not free either: as soon as such spikes in energy prices occur, all markets (not just fuel) start to think about the danger of rising inflation. How do central banks combat inflation? They raise funding rates, and thus for the trader, the money needed to purchase fuel becomes more expensive.

Continuing to answer your question about fuel reserves, I emphasize: reserves at gas stations have an uncertain price, as the price, as I mentioned above, is formed based on the average monthly quotation. Moreover, even if we assume that we have created some reserves at the gas stations, they are, due to objective reasons, very insignificant.

Now a few words about how the cost of fuel is formed.

The cost of motor fuel in the Latvian market consists of three components: Taxes Excise - over 20 years, excise taxes on motor fuel in Latvia have nearly doubled. VAT (PVN) has increased from 18% to 21%. A fee for the strategic fuel reserve has been introduced. This is why fuel at the gas station today is more expensive than in 2008, when diesel prices first crossed the threshold of $1,000 per ton in this century.

According to changes in the legislation of the Republic of Latvia, this winter was the last period when winter diesel fuel did not need to have a bio-component added. Starting April 1, the situation will change. And if in spring and summer, regular RME will be used for mixing, then with temperatures dropping below -10°C, the only option for a bio-additive will be the more frost-resistant HVO, the premium for which is several times more expensive than RME. For clarity, if HVO had been contained in diesel fuel at a rate of 7% this winter, the price per liter would have been higher by about 12-13 cents.

The purchase price is determined by a pricing formula based on S&P Global's Platts quotations. The most popular option is the average monthly of the highest CIF NWE/Basis ARA quotations. In the case of gasoline, it is Gasoline 10 ppm and ULSD 10 ppm for calculating prices for diesel fuel and Agro-diesel. Since global prices are in US dollars, the cost of fuel directly depends on the EUR/USD exchange rate.

What percentage margin to add to the cost of fuel is an individual decision for each seller, which is far from independent, as this decision is made in a highly competitive environment in a country where there is one of the highest numbers of gas stations in Europe per million residents.

Fuel retail is a low-margin business with high capital intensity and risks. The main thing in this business is not the pursuit of an absolute price, but risk management. Even in the case of the same pricing formula based on the average Platts quotation, the retailer's reaction to falling global prices can be completely different. If the drop occurs in the first week of the month, the retailer is more likely to follow the market and lower prices according to the situation. But if a sharp drop occurs in the second half of the month, the inertia in the form of a slow decrease may last until the beginning of the new calendar month. This happens again due to the peculiarities of pricing based on the average of the month, as in this case, sharply lowering prices will be "hindered" by the higher quotations from the beginning of the month. Therefore, price inertia during a sharp market decline is not greed, but risk management.

Retail fuel sellers in the Baltic countries are not interested in high absolute fuel prices, as this negatively affects both the purchasing power of customers and leads to increased costs and risks for the retailers themselves. The average net margin (the ratio of net profit to turnover) for retail fuel sellers hovers around 1% - 2%. This is true both in Latvia and Estonia. And this is very easy to verify. It is enough to review publicly available financial reports from companies in this sector of the economy.