Complex prices

My friends know I am intrigued by the energy market, partly because it’s one of the larget expenses of my household, and sometimes I get asked questions like:

“How come the news are full of plummeting oil prices, and we do not seem to experience the windfall at the pump?”

Well, the standard answer is that we are, but they’re hidden by the high tax burden that doesn’t change with oil price.

However, like in may cases, reality is a good deal more complex, because there are at least another two factors to keep into account, and that it is the Euro / Dollar x-rate and the cartel effect.

The x-rate comes into play because a company like ENI sets its retail prices in Euros while it buys oil in Dollars: like with any 2015 03 28 crude vs fuel pricesnet importer, a weakening dollar will therefore help its profits.

The Cartel Effect’ action is more subtle: as I do not believe six or seven oil barons get together in a secret location to plot the future of gasoline prices, this is more the case of a small number of players watching each other continuously: as oil prices plummet, they create the opportunity for price decreases which bring spikes of market share gains; however, these come at the detriment of unit profits. What we experience therefore are periods of players nervous eyeing each other while pressure mounts, followed by price wars that quickly erode the newly found margins, until retail prices catch up with crude prices.

In the chart I plotted the evolution of crude WTI oil in Dollars (blue) and in Euro (red) against the retail price net of taxes and VAT (green), taking these prices as of July, 2014 as 100.

As you can see, the periods July to mid October, 2014 are clearly of careful watching followed by a short but intense price war and another study period (mid October to end November) erupting in a longer and more violent price war which at the end of the year brought net retail price to be LOWER than the actual price of crude.

By end January the strengthening dollar had almost brought the euro crude price to cross again the retail price, prompting a reverse price war; however the crude price does not seem to show any hope to really recover any time soon, and the gap between the green and red line is becoming hard to sustain, which in fact explains the very reversal in the last week or so.

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