“The single biggest factor driving that supply demand balance in the world, offsetting the loss of production from the Strait of Hormuz, is China’s reduction in imports,” he says.
“They’ve halved the amount of imports, and that’s offsetting about 40% of that shortfall.”
They may not do that forever, and when they start rebuilding their reserves, it could have a big impact on what happens to prices in the coming weeks and months, Jones says.
Even though oil prices have fallen sharply since the peace deal was announced, it will likely be “some time next year” before we can say the industry is really back to some kind of pre-war normal, he says.
“There’s still a global industry that’s extremely tight. We’ve got very, very low inventories. We’re going into a period where demand’s going up, and there’s uncertainty about whether it will remain open and actually how much will come out in the medium term.”
That said, there is now “cautious, conditional optimism” in the market, he says.
“We’ve seen the global oil system replumb itself in terms of where oil is going from and to and where that product’s coming from.
“Almost entirely it’s coming from existing stocks or inventory. And that’s not a forever game.”
Real concern
Although the worst didn’t happen, Jones says the crisis was very real.
There were times when the threat of fuel shortage loomed large.
“I was concerned,” he says. “In particular, when you look at the importance of diesel for the New Zealand economy.”
What we actually saw during March, when prices increased dramatically, illustrated that, he says.
“Prices increased very rapidly during those first three to four weeks – twice as quickly as they’ve come off.”
The oil price increased by about 70%, but diesel increased by 200%.
“It was more of a diesel crisis than a fuel crisis,” he says.
Most of us can make some choices about how much petrol we use.
We can cycle, take public transport or just work from home more.
Demand for petrol did fall, he says.
But if you want to keep the economy moving, it is much harder to reduce demand for diesel.
“We actually saw year-on-year demand [for diesel] was higher in March this year than it was last year,” he says.
“When I say demand, actual consumption – vehicle kilometres travelled by trucks. So it just shows how critical that diesel fuel is to the New Zealand economy. Any interruption in the supply of diesel has a disproportionate impact.“
Price crunch
The events of the past few months haven’t been good for Z, despite what the cynics among us might think.
“No one wants high prices,” Jones says.
“We certainly don’t want it – it costs us more to buy and more to sell, it uses more of our balance sheet.
There is often too much focus on the correlation between the crude oil price and the pump price, Z Energy chief executive Lindis Jones says. Photo / Dean Purcell
Okay, but let’s deal with the elephant in the room.
Why does it feel like fuel companies are quicker to put up prices than they are to bring them down?
One answer is that the price equations for fuel companies are more complex than people realise, Jones says.
He argues that there is often too much focus on the correlation between the crude oil price and the pump price.
“The price that matters is not the price of oil,” he says. “Simply put, we don’t put oil into our cars, vans, tractors or aircraft. We actually put product in. So it’s the underlying product price that matters – and that moved very differently to the price of oil.”
Broadly speaking, the prices for refined product increased at more than twice the rate at which they have declined, he says.
“Because the news events that drove it caused concerns around scarcity and hoarding and energy security.”
As the situation has gradually resolved itself, the international price has come off a bit, but that rapid surge in price is still reflected in the pricing in today’s market in terms of what consumers pay.
“The way that we price product into markets is what we call replacement cost pricing,” Jone says.
“The cost of the product that we take into account when we price today is as if we bought the product today.”
“You might ask – why do you do that? You bought this product ages ago, so it should be cheaper.“
But this is the way the industry manages itself globally, it’s the best indicator of margins and performance, he says.
“It takes out the ups and downs in profitability from the value of inventory going up and down. It also makes it possible for entities like the Commerce Commission to actually track what the underlying profitability is.
“Ultimately, we do need to recover those higher costs because we need to fund the next cargo,” he says.
Okay, but doesn’t that mean prices should come down at the same speed as fuel companies use on the replacement price based on today’s market?
“They’ll come down at a speed that reflects the speed at which international prices are coming down,” Jones says.
“And what we’ve seen is the speed at which those prices have come down – because of the ongoing uncertainty – is much slower than the rate at which they went up.”
Through the crisis, we have heard economists talk about a correlation between oil prices and petrol prices of around 1c a litre for every US dollar on the barrel price.
“In normal times, that’s an okay rule of thumb,” Jones says. “But this was a huge stress test for the world energy system. That ratio of $1 of Brent to 1 Kiwi cent per litre completely broke down.”
Z Energy’s average net profitability is about 3c a litre,” Jones says.
“Energy is a very high-volume, low-unit-margin, low-unit-profitability game. So when you’re seeing increases for over a month that are in excess of 5 cents a litre, you just can’t pass that on in a timely way.
“That impacted our profitability very materially during the month of March.
“So as prices come off, we will look to recover that, but it will not be extended, and it will not last longer than the decline in international prices. It’ll just be slightly offset.”
Okay, so prices for consumers didn’t go up as much as they should have (under normal circumstances) in March, and so won’t necessarily fall as quickly as they could now?
“They didn’t go up as quickly as they could have,“ Jones says.
“If you’re running a dairy and you’re selling milk at $2 a litre and you make 3 cents, if the price of the milk you buy to sell the next day goes up to $3, you just can’t put your price up quick enough to recover that margin.
“That’s something we’re used to. But that means that the speed at which it goes up is slightly lagged, and the speed at which it comes down is slightly lagged.
“But does it go up as quickly as it should and down as quickly as it should? Yes!”
Lessons learned
New Zealand, with the rest of the world, does need to learn some lessons from this crisis, Jones says.
“I think there’s a lot that’ll come out of this. If we look back to what happened in the Middle East in the 1970s and 80s, that was a catalyst for a lot of change for energy security broadly, not just oil, in terms of how different countries responded in the use of natural gas or nuclear.”
At a national level, countries will make different choices, he says.
“There’ll absolutely be a premium for security. And so I can only imagine we will see more storage throughout the world.”
Ultimately, New Zealand has fared well, Jones says.
“We were relatively well placed because of the supply chains we relied on. So if I look at the big supply chains that supply New Zealand, we’ve got ExxonMobil and BP, two large multinational companies that are very well connected.
“And Z as part of the Ampol Group, is one of the largest, if not the largest, buyer of fuel in this part of the region, so very well connected.”
That means we’re serviced by reliable supply chains that have invested in New Zealand.
“We weren’t supplied by companies that just trade into another party. Everyone who supplies fuel to New Zealand’s got a vested position in supply continuity.”
Have consumers been served well by fuel companies?
“When I look at other markets internationally, I can absolutely assure the New Zealand public that this is a very competitive fuel market,” Jones says.
“I don’t set the prices for the fuel in New Zealand – my company sets the price for about 15% of the locations where you can buy fuel in New Zealand.
“The breadth and range of competitors is significant, such that the spread in prices is larger than we see in most markets.”
Jones says he welcomes the public scrutiny and the focus from the Commerce Commission.
“If it bothered me, I wouldn’t be in this game,” he says.
“To a great extent, we don’t have the choice about when we purchase energy or how much. So that deserves scrutiny on behalf of the Government, with the Commerce Commission and MBIE. We’re scrutinised by several different entities.”
But despite that competitive market and the fact that our supply chains held together well, the crisis has provided a timely reminder of how vulnerable we can be to global events, Jones says.
“Should we hold more stock for energy security? Absolutely.”
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.
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