It seems like every time we stop to fill up at a service station these days, the price of fuel has gone up again. There’s been a number of reasons for this. One of the main ones is that the price of crude oil has been going up, and it’s this unrefined product that is turned into the fuel we use, including petrol, diesel and even jet fuel.
With the war in Ukraine putting pressure on energy supply chains around the world, the cost of crude oil has been increasing for a while now. But for the past month or so, crude oil has been trending downwards. So why then is fuel not going down too?
Before we can answer that question, we need to discuss an asset class you may not have heard of before, commodities. You might have come across the term or heard it on the news, but maybe you’re not 100% sure what it actually is.
A commodity is a raw material or agricultural product that is bought and sold in order to make other goods. As mentioned above, crude oil is a commodity, as are wheat, cotton, soybeans, gold, coffee beans, live cattle and even uranium.
One of the key characteristics that makes something a commodity is that commodities of the same type and grade can be interchanged with another. So if you buy a barrel of oil, it can be valued and interchanged with another one, regardless of whether it originally came from Saudi Arabia, Venezuela or West Texas.
This allows for global trade to be facilitated easily because companies looking for a commodity can find a supplier anywhere in the world.
The prices of commodities can vary quite drastically because the supply and demand can change significantly based on unexpected events. For example, a drought in Australia could destroy an entire year’s worth of wheat. The pandemic lockdowns were another example, with crashing demand for oil with so few cars on the road and planes in the sky.
This can be a big problem for companies that produce commodities and those that use them to make their products. Think about a loaf of bread.
Say a bakery company like Warburtons wants to keep the price at around £1.20. They design their business around this figure. They know how many loaves they need to sell at £1.20 to make a profit and how much they can afford to spend on salaries, equipment, and other costs to run a business.
Built into that price might be 20p to purchase the wheat, water, yeast, and everything else they need. If wheat suddenly goes up to 50p per loaf, they’re in trouble.
One of the ways to get around this is by using futures. These are contracts that allow two parties to agree on a future price for something, usually a commodity. So, in this case, the farmer who grows the wheat and Warburtons agree on a price, maybe a year in advance. Warburton’s now have a price locked in for their wheat, and the farmer has a guaranteed price for his crop.
Both sides of the deal can plan for the future much more efficiently.
The futures market covers all commodities, and it gets a lot more complicated because investors with nothing to do with farming are able to buy and sell futures based on what they think the price is going to do.
For regular people like us, though, that doesn’t really impact what we pay for fuel at the pump.
So now you know how commodities and the futures market work, we can put this all together to understand why the cost of petrol and diesel doesn’t jump about with the price of crude oil.
If the price of oil jumps, that price will apply to oil that’s just been taken out of the ground today. The crude oil that was turned into the petrol you’re putting in your car will have been shipped across the world, gone to a refinery to be turned into fuel, put back on a lorry and then finally driven to the service station.
This whole process could take months.
Slowly, more of the expensive crude oil will start to work its way through the system, and the futures market will adjust based on prices that are rising. It doesn’t mean that the price rises of crude oil aren’t passed on to motorists; it just means that it takes some time for the effects to show.
The way that this plays out for us is that price rises on fuel tend to take a long time to peak and then a long time to go back down again. Overall, it means price rises in crude oil are passed to motorists, but they’re simply spread out over a longer period of time.
Read: Investing for Beginners
Also Read: Best Forex (FX) Trading Platforms in the UK
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