Australias petrol problem: what not to do

Is it just me, or does 2022 suddenly feel a lot like the 1970s?

Putting Abba to one side, there is a lot we can learn from the past on how to manage some of these problems.

But so far, at least when it comes to rising oil prices, we are proposing solutions that either won't work or will have terrible trade-offs.

Luckily, there are better ways to ease prices and support Australian households and businesses.

First, it must be said that now is not a great time for rising oil prices.

Prices of goods and services are already high across much of the economy. Supply chain challenges and surging post-lockdown consumer demand are making many things more expensive.

Higher oil prices threaten to take away the thing we want (the consumer demand that's fuelling the post-COVID recovery) and give us more of the thing we don't want (even higher prices through even higher cost pressures).

This threatens the economy from both directions.

As petrol prices rise, consumers will cut their spending elsewhere in the economy so they can keep filling their tanks.

Ordinarily this reduced spending would cool off the broader inflationary pressures we are seeing in the economy.

But if higher oil prices push up the cost of transport, delivery, and logistics, we risk seeing yet another relic of the 1970s - stagflation - the unusual combination of weak economic growth combined with high prices.

Money, money, money, as Abba would say.

So, what should we do? Petrol has a lot of problems.

One problem is that people tend to have inelastic demand for it. Like cigarettes and alcohol, this means people keep buying it even when the price goes up.

Some people can find alternatives - bike sales are currently booming - but sadly most of us are stuck with high petrol prices until we can afford a Tesla.

So, if we can't reduce our demand for petrol, at least in the short-run, can we increase supply?

Here things get even trickier.

The world's future capacity to produce oil isn't what it used to be. There has been a significant fall in investment in oil projects since the collapse in oil prices back in 2014, particularly in shale oil in the United States.

This wasn't an accident.

After all, you'd be out of your mind to invest in a big, multi-year oil production project when at the same time countries are committing to net zero, the US government is banning shale oil extraction in many areas, and companies like Nissan are committing to 100 per cent electric vehicles in their biggest markets in under 10 years.

This lack of investment - and lack of long-term incentives to invest - makes it difficult to quickly ramp-up oil production in the short-term.

Again, history has some advice.

When the global financial crisis struck in 2007, leaders of the G20 countries searched high and low for ways to boost the global economy. One solution was to make oil cheaper.

Working with Saudi Arabia - a fellow member of the G20 - these countries reached an agreement that Saudi Arabia would boost the global supply of oil to get prices lower and stimulate the global economy.

Geopolitics makes this difficult to repeat today.

Joe Biden has shunned the Saudis since he became President. The war in Yemen and the murder of journalists has put US-Saudi relations in the deep freeze. Biden is now awkwardly crawling back to the Saudis to ask for more oil.

He isn't having much luck.

According to the Wall Street Journal, the de facto leaders of both Saudi Arabia and the United Arab Emirates have refused to take his phone calls.

Other oil producing countries - like Venezuela - aren't any easier. Venezuela is a strong ally of Russia and the US has shunned diplomatic relations with Venezuela for years.

Thawing out these relationships during an oil crisis is unlikely to be easy. It's also unlikely to be free. These countries will want something in return for giving up their high oil prices.

Most countries in the International Energy Agency have strategic stockpiles of oil - about 90 days of their imports. Releasing these will buy time, but won't have a major effect on prices over the medium-term given commodity markets will correctly identify them as being temporary.

Geopolitics is difficult, but it is likely our best bet. Some quick diplomatic footwork, ideally working through the G20 while Indonesia is host, is probably the best bet.

What should Australia do? Right on cue, the policy solution being advocated the loudest is also the worst: cutting the excise tax on petrol.

We tax petrol because it is an efficient tax. The inelastic demand people have for petrol means the government can raise money without significantly reducing demand in the short-term.

And if people do reduce their demand for petrol either in the short or long-term, that's good too.

Petrol is what economists call a 'public bad'.

Economists follow a simple rule of thumb: subsidise public goods (like education) and tax public bads (like cigarettes).

Petrol is squarely in the latter category given its enormous contribution to climate change, to say nothing of the health and environmental problems it leaves in its wake.

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Cutting the excise tax on petrol would hurt the government's budget, it would make our tax system less efficient, and it would increase the consumption of a public bad, with all the negative health and environmental consequences that would follow. It's also a permanent solution to a temporary problem. As CEDA economist Ian Hamilton, points out, it would take months for any change in the excise tax to flow through to prices anyway.

Australia needs to adopt a two-pronged approach. First, it should use multilateral forums to work with like-minded countries to increase the supply of oil to ease global pressures. The G20 is the logical forum for this. It includes oil-producing nations, most notably Saudi Arabia, and has coordinated such actions before. Indonesia has built a strong relationship with Saudi Arabia in the G20 which, as this year's G20 host country, puts it in a strong position to lead on this issue.

Second, Australia should support households using the welfare system, not through inefficient, expensive, and environmentally-destructive changes to the tax system. These measures should be targeted towards low-income households and be temporary to avoid overheating an already hot economy.

To be sure, calls to reduce the excise tax aren't new. They come about every time petrol prices go up. Mumma Mia, here we go again.