Oil Prices and the Australian Economy

Australia sells and buys its crude oil requirements on the world market. These arrangements followed the Hawke Labor Government’s full deregulation of the Australian crude oil market on 1 January 1988, which effectively ended the import parity arrangements that the Fraser Government had introduced. As crude oil is the principal feedstock for refined petroleum products—petrol and diesel—its price movements have a major influence on the final pump price. In Australia, crude prices make up about 40 per cent to 45 per cent of the final pump price. The remainder consists of government taxes, refinery and retailer costs and margins. Obviously, movements in the exchange rate impact on the price of crude in Australian dollar terms—a strengthening A$ lessens the impact of world price increases in US$, while a weakening A$ has the reverse impact.

Petrol prices are a major component of business and household expenditure (Reserve Bank of Australia). Petrol price increases reduce available budgets for other goods and services. They also have inflationary impacts, which lead to increases in interest rates. While increasing oil and consequently petrol prices are of major concern, the impacts of the increases are much less significant than earlier price spikes. Reasons for this include the enormous growth in the world’s economies, including Australia’s—with oil being a much smaller component with the huge growth of the services sector. Furthermore, there have been rapid the advancements with fuel economy efficiency. For further information on petrol prices, see the ‘Retail Petrol Prices’ brief this section.

World oil prices (yearly averages) US$ per barrel

Sources: 1972–75 Dubai, 1976–2007 West Texas Intermediate. Real prices generated using Federal Reserve Bank of Philadelphia deflator. Note: Yearly average for 2007; an estimate only assuming prices approaching US$100 per barrel in December 2007.

International crude oil movements have been relatively volatile since the early 1970s. Movements in the world price of crude oil are shown in the graph above.

In the past ten years, the price of crude oil has increased from an average of US$14 a barrel in 1998 to US$95.93 a barrel in late November 2007, near an all-time inflation-adjusted peak. Unlike earlier spikes arising from the Arab oil embargo in 1973–74 and the Iranian revolution in 1979–80, this latest spike does not appear to be linked to any conflict or physical shortage. It seems to be the result of physical demand, especially from emerging markets in rapidly developing economies, such as China and India. Other factors driving prices include futures trading.

Where world oil prices will go from here is uncertain. Historically, oil prices have been cyclical. Factors that could lead to a decline in prices include modestly higher production by Organization of Petroleum Exporting Countries (OPEC), a warm winter, and slower US economic growth and a flattening of demand in the United States—which comprises about 25 per cent of the world market. Most respected agencies reporting on energy issues, including the worldwide International Energy Agency and the Australian Bureau of Agricultural and Resource Economics predict a decline in future oil prices.

Contrary views see crude oil as a steadily declining resource leading to ever-increasing prices. Such analyses incorporate what is termed the ‘peak oil’ debate where the rate of consumption runs ahead of declining production associated with a declining resources base.

While there is probably merit in both of these viewpoints, a worrying trend for Australia has been an ever-declining crude oil resource base directly associated with declining production. The shortfall is being made up from increased crude oil imports, leading to an exacerbation of Australia’s current account deficit.

Documentation
BP, Statistical Review of World Energy, June 2007.