Why is fuel so expensive and will prices go down?

We take a look at why petrol and diesel is so expensive right now and whether that’s likely to change any time soon.

With petrol and diesel prices at some filling stations in Ireland comfortably in excess of €2.10 per litre, it has never been more expensive to run a car. The price of fuel (both for cars and for home heating) is one of the biggest factors driving the current spate of inflation and it’s badly eating into household budgets up and down the country. The tendency over the past few months has been to lay the blame for rising oil prices squarely at the feet of Vladimir Putin and Russia due to the invasion of Ukraine, but, while the war has definitely played a part in driving up fuel costs, it’s not nearly the biggest factor at play.

To understand what’s going on, first we need to look at the breakdown of the cost of a litre of fuel in Ireland. A little under half is made up by taxes including excise duty (62.7c on petrol, 51.9c on diesel, both of which include carbon tax), VAT at 23 per cent and a 2c levy to fund the national oil reserve. Given that the excise rate doesn’t often change, VAT is dependent on the price at the pump and the cut taken by retailers is rarely more than five per cent. The biggest variable in the mix then is the price of crude oil, which is sold in dollars, the latter fact also affecting prices with the euro exchange rate being quite weak against the dollar at present. The cost of a barrel of oil is currently hovering around the $120 a barrel mark, which has a consequently major effect on the forecourt price of petrol. The path to how it got there started in April 2021.

Just as the Covid pandemic began to hit globally, oil prices collapsed due to reduced demand and even briefly went below zero dollars a barrel. OPEC, the international cartel of oil-producing countries that controls 40 per cent of the world’s crude oil supply, decided to severely cap the volume of oil it was producing in response to the lower demand. As economies got back to normal and demand for oil once again increased, output from OPEC countries did not increase at the same rate, leading to relative scarcity on the global oil market, driving up prices. It wasn’t just OPEC either; American oil companies also refused to significantly increase their output despite their capacity to do so and instead of reinvesting record profits back into their oil production and distribution infrastructure as had been the case in previous boom times, they decided to pay out much higher shareholder dividends instead.

As business strategies go, producing less oil with higher margins has been extremely successful. Exxon Mobil, Shell, Chevron and BP all posted record profits in 2021 and their failure to plough those profits back into the business is indicative of an attitude shift. As the world gradually moves towards renewable energy and electrification, the importance of oil will slowly decline, but at least for the oil companies, if they’re able to maintain supply at a level below demand, they can remain profitable well into the future.

What about Russia?

Fuel prices were on a steep upward trajectory before Russia invaded Ukraine in late February. Russia only accounts for around 10 per cent of global oil supply, but because of western financial sanctions on the country, buying and selling that oil to Europe, the UK and US has become slower and more complicated. As a result, many western countries have decided to seek more of their supply from elsewhere. This hasn’t greatly impacted Russia as not only is Russian oil still being traded in the West (apart from in the US), but also Russia has simply diverted some of its sales towards China and India to compensate for the slight fall off in demand elsewhere. OPEC companies have refused to significantly ramp up their oil production to meet increased western demand meaning that, with slightly less Russian oil on European markets than before, the supply gap has widened, sending prices higher.

Will fuel prices fall?

Alarmingly for motorists, there are signs that they might not. Neglecting to reinvest massive profits back into the business is a sign from oil companies that they have no plans to significantly increase oil production any time soon. If companies are making more profit from producing less oil, it makes little sense for them to help hard-pressed consumers by opening the taps. We still have little idea about how long the war in Ukraine will last, but, even if peace was declared tomorrow, that does still leave the EU’s commitment to phase out 90 per cent of Russian oil imports by the end of the year. If OPEC still refuses to budge, even in light of Europe’s attempts to wean itself off Russian oil, that’s also not going to help with the dearth of supply.

Realistically, there’s only so much the Irish government can do in terms of cutting taxes on fuel given that they’re bound by EU rules on areas such as VAT and their own commitments when it comes to carbon taxes. It remains to be seen, however, if the next Budget will reveal any further wriggle room in terms of further cuts to excise duty to help struggling households.

Because of spiralling oil prices and their effect on fuel costs, according to the AA, the cost of running a car in 2022 and 2023 will be around €500 more expensive per year than it was even in 2021. Carzone.ie’s most recent data suggests that 51 per cent of Irish motorists are now considering switching to an electric vehicle specifically due to the soaring cost of fuel. Out of those survey respondents, 87 per cent cited cheaper running costs as the main reason for considering the switch. Yes, electricity prices have been rising sharply too, but not at the same rate as that of petrol and diesel, and if fuel prices remain above or around the €2 per litre mark for an extend period of time (which looks likely), those figures will almost certainly increase.