Why Gasoline Prices Don't Fall Along With Oil, and How to Calculate the Price Using a Formula

A little more on gasoline and pricing.

I have been reading the comments on my calculations, and one of them asks: why, when the price of oil fell from $110 a barrel to $50 a barrel, did the price of gasoline in Kazakhstan fall by only 30 tenge per liter rather than 60?

I will try to explain this as simply as I can.

First, you need to understand that when oil was above $100 a barrel, the state held down domestic oil prices by creating an artificial supply on the Kazakhstani market and by capping the price of gasoline by law.

Without those measures, AI-92 gasoline would have cost about 140–150 tenge per liter.

A seller of oil will always choose the highest available sale price. At present, the state obliges subsoil users, through the terms of their subsoil use contracts, to sell oil on the domestic market. To export oil, they need permission from the Ministry of Energy. Bureaucratic delays in granting export quotas can also increase supply on the market. In this way, the state saturates its own market with oil. To keep domestic prices down when world prices are high, a maximum sale price is set for the main grades of fuel. The result is as follows. The retailer sets the maximum price and, after subtracting his own costs and margin, works out the price at which he will buy from the wholesaler or the producer. The producer, in turn, determines the price at which he is willing to buy from the subsoil user. And since the subsoil user is legally required to sell part of his volume on the local market, he accepts whatever price the producer or wholesaler offers.

That is why fuel prices in Kazakhstan were low during the period of high oil prices.

However, this approach led to gasoline shortages in the country. With domestic prices so low while oil prices were high, it was unprofitable to import volumes from Russia or China, and everyone remembers the period when we had problems with fuel supply.

To understand the issue, one must know that the price of gasoline depends on crude and non-crude costs. Non-crude costs, including the trader's margin, are roughly constant per liter of gasoline, whereas the cost of crude depends on world prices. At present, about 60–65 tenge of each liter goes to fixed costs, and the rest is the cost of crude.

To avoid such problems, I would propose establishing a formula in law: 60 tenge, plus a base cost of crude (currently, say, 39 tenge), plus a delta that depends on the oil price on world markets. A $1 rise in the oil price would translate into a 1 tenge increase in the price. The formula should also be differentiated by price level, to allow for a discount reflecting progressive taxation, and the fixed component should vary by region (logistics costs differ). Then people would know that the price is determined by the market, not by officials.

Fuel production has a time lag of roughly 1–2 months, which is the time needed for delivery and refining. Accordingly, pricing should use the average oil price of the previous month, and the maximum price for the current month should be set automatically.

Each year, the base component is reviewed and reset for the year.

To avoid sharp jumps when the market is highly volatile, a market mechanism could be built in, with partial influence on the price through KazMunayGas (KMG).

The law could also set a maximum price cap for the year, in case oil prices rise significantly.

To reduce the fixed component of the gasoline price, we need to increase refining depth. At present, we obtain high-octane gasoline mainly by adding additives, and part of the loss on sales of fuel oil is shifted onto fuel prices. To prevent this, no fuel oil should be left over at all. For example, in Kazakhstan, 1 ton of oil yields on average 40–50 percent fuel oil, whereas modern Russian refineries produce only 10–20 percent dark residues (mostly bitumen or tar). For example, the sale price of 1 ton of high-octane gasoline is $500–600, while fuel oil sells for $200–250 per ton. Closing this gap would significantly lower the cost of fuel. Various isomerization and reforming units make it possible to produce high-octane gasoline directly, without additives, which also lowers the cost of gasoline.

That is roughly it.