The good and bad of oil price rises

Oil prices have significantly increased recently, impacting household budgets and pushing the rate of inflation higher.  However, is an increase in the price of oil always a bad thing?

Prices rises are “good” when they accurately reflect need and scarcity. Prices rises are “bad” when they do not represent realities of the world in which we live. 

That occurs when artificial constraints are put on supply or competition among suppliers is limited.  That might occur if oil suppliers agree on a minimum price or to limit production.

However, if there are genuine limits to oil production, along with increases in global consumption, then it is good for prices to rise.

Short-term increases in oil prices can create economic instability.  That’s occurred recently, with central banks having to rapidly increase interest rates to try to slow the rate of inflation.  Less than two years ago interest rates were being reduced to record low levels.

Short-term price increases are useful for helping us think about our current use of oil on a daily basis.  New Zealand has a very high rate of car ownership and a high share of journeys to work and education are made by car.  Census 2018 data shows 73% of people drove to work or were passengers in a car, truck or van.  There were 12% who worked at home and just 7% walking or cycling and 6% using public transport.  There were 50% of children and adults who drove or were driven to education.  The share who walked or cycled was higher at 24% and the public transport share was 19%.

But there are alternatives for travel that are good for our wallet and often for our health.  Estimates for owning a car show the fixed costs are usually higher than the variable costs.

Fixed costs are those expenses that do not change or change little regardless of how many kilometres you drive in a year.

Fixed costs include vehicle insurance, Warrant of Fitness, vehicle licensing, vehicle depreciation and interest.

Vehicle depreciation is an estimate for how much the value of your car declines each year.  The average car in New Zealand lives 21 years and is then scrapped.  The annual loss in value is very high for new cars, but low for old cars.

There is an interest cost regardless of whether you borrow to buy a car or you can pay with cash.  The cost is much higher if you borrow to buy a car.  If you have to take money out of a saving account to buy a car, the cost is the interest you might have earnt on those savings.

Variable costs include fuel, tyres and vehicle maintenance and servicing

It’s difficult to produce a simple estimate for the annual cost of car ownership.  It is influenced by how new the car is, how large it is, how far you drive it in one year and how you paid for it.

Broad estimates I have done suggest an annual cost of $6,700 for ownership of a 10-year old petrol car.  The cost will be smaller if it’s a small car or older than 10 years.

The estimates suggested a fixed cost of $3,400 a year and a variable cost of $3,300.  The variable cost estimate was prepared before the recent rise in petrol prices, so the current cost will be higher.

Options for reducing the number of cars you own include:

• greater use of walking, cycling or public transport,
• using a taxi, Uber or hiring a car on the few occasions that an additional car would be useful, or
• borrowing a car from a friend or family.

Peter Crawford