It may not have been noticed outside the Gauteng area but recently petrol stations started running out of diesel and unleaded petrol. The CEO of the South African Fuel Retailers Association said it was the result of the massive drop in fuel prices that took effect a few days earlier. As he saw it consumers rushed to fill up their tanks and the supply was inadequate to meet the demand at the price set by the government. And that really is the problem.
Every month the government, using an antiquated apartheid-era formula that really has no bearing on South Africas fuel situation, establishes the fuel prices for the next month. There is only a very rough relationship between the price of fuel and the supply of and demand for it. And for the next month it is assumed that supply and demand remain at unchanged levels until the time comes to establish another new price. In general the government is simply making a rough guess at what fuel prices ought to be, given conditions at the time.
In essence the South African government is attempting to do what the Soviet Union tried unsuccessfully to do for many years: mimic the market price of goods by bureaucratic guess work. It just doesnt work. So every month consumers wait in dread for the announcement that fuel prices will jump again. But maybe well be lucky and the next month theyll drop massively due to a miscalculation the previous month. So we go on a wild roller-coaster ride where petrol prices skyrocket or dip once a month.
Unfortunately government established prices and market prices what prices would have been on an open and competitive market rarely coincide. So if the government sets the price of fuel too high then demand drops relative to supply and retailers sit with unsold stock. That increases their capital requirements and makes it difficult for them to make a living. On the other hand if the price is set too low, relative to supply, then filling stations find they dont have the petrol to meet consumer demand and shortages develop.
Government mandated prices ignore one of the most fundamental rules of basic economics: the price of a commodity is determined by supply relative to demand. And it really doesnt matter what is happening in Singapore or at some other refinery. What mattes is the supply of fuel in South Africa relative to demand for fuel in South Africa. In fact, to be more precise, what matters is supply and demand in the locality not the country as a whole. And the more sophisticated the formula that is used to guess market prices, the more likely it is to be wrong.
World fuel supply and demand fluctuates constantly. It doesnt change by a large amount once a month. It changes daily, hourly, and almost by the second. And in a free market, fuel prices at the pumps would change regularly as well. So whats the difference? Firstly, theyll change in smaller increments and on a regular basis instead of increasing by 13 cents per litre in one month and then plunging 26 cents per litre in the next. This allows consumers to constantly adjust their demands for fuel and these myriad adjustments smooth out market fluctuations. Secondly, the prices will be set by the market in response to changes in supply and demand for fuel and not by the vagaries of bureaucratic calculation.
Removal of price control on fuel would allow filling stations to reduce their prices to increase their volumes. This would make inefficient retailers very unhappy but consumers would benefit from better service and prices. On the other hand, retailers in out-of-the-way places would be able to increase prices to make supplying petrol a worthwhile business, so providing new services in remote rural areas. Removal of other controls on the sale of fuel, such as requirements for the provision of high-cost facilities, would also improve the supply of fuel to rural consumers.
Price controls on petrol in the U.S.A. lead to long queues at the petrol stations. When prices were deregulated, the petrol industry and various lovers of controls predicted disaster. They argued that prices would skyrocket out of control and greedy oil companies would rip off consumers. What actually happened was a slight price increase, followed by more efficient fuel usage by consumers, and followed by a steady decline in prices. Today prices, adjusted for inflation, are lower than they were when prices were deregulated. In fact the control-lovers started complaining that prices were dropping too much and demanded higher taxes on fuel.
Government officials are often motivated by the best of intentions. But no official, no matter how smart, can take into account all the factors necessary to determine the right price of fuel, or anything else for that matter. All they can do is guess. Deregulating the price of petrol, and allowing free competition between petrol station owners, is absolutely necessary if we are going to make the most efficient use of scarce petrol resources. The consumers will benefit and so will efficient retailers.
Source: Jim Peron is a freelance writer. This article may be republished without prior consent but with acknowledgement. The views expressed in the article are not necessarily shared by the patrons, council, or members of the Free Market Foundation.
FMF\14 August 2001
