Academic journal article The Reserve Bank of New Zealand Bulletin

Oil Prices and the New Zealand Economy

Academic journal article The Reserve Bank of New Zealand Bulletin

Oil Prices and the New Zealand Economy

Article excerpt

This article looks at New Zealand's oil consumption at a disaggregated level and discusses the consequences of movements in international oil prices for inflation, taking into account New Zealand's industry structure as well as the tax treatment of different fuel types. Relative to the size of its economy, New Zealand uses a comparatively large amount of oil as transport fuel. The evidence suggests that the indirect (cost-push) effects of higher oil prices on consumer prices could be quite large, substantially driven by higher transport services costs. How large they turn out to be, and whether they matter for medium-term inflation and monetary policy, will depend on factors such as the state of the economic cycle, the degree of competition in particular industries, and the extent to which inflation expectations are anchored.

1 Introduction

Since 1999, US dollar oil prices have more than tripled, rising from under US$20 a barrel to over US$60 a barrel. Since 2003 alone they have more than doubled, driven up by growing world demand, by tight production capacity, particularly in refining, and, more recently, by the disruptions caused by Hurricane Katrina in the southern US. In inflation-adjusted terms, US dollar oil prices are at levels last seen after the second oil shock in the early 1980s (see figure 1 below). In New Zealand dollar terms, the current level of world oil prices is not quite as high relative to history. When adjusted for inflation, New Zealand dollar oil prices have only very recently exceeded their previous highs in 2000, when they were pushed up by a cyclically low exchange rate, and remain well below levels seen in the first half of the 1980s. Nevertheless, the rate of increase since 2004 has been considerable, and local petrol prices have also risen sharply from just over $1 per litre in 2003 to as high as $1.50 per litre in 2005 (see figure 2 below).

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These recent price increases make it timely to examine the importance of oil to the New Zealand economy and the way in which changes in world oil prices affect us. In this article, we look at New Zealand's oil consumption across different sectors and compare it with consumption patterns in other OECD economies. We then examine how changes in the behaviour of international oil prices can influence prices here in New Zealand, taking into accounts factors such as the use of fuel in different industries and the tax treatment of petrol and other types of fuel.

We find that, relative to the size of its economy, New Zealand consumes a comparatively large amount of oil as transport fuel. A relatively large part of New Zealand's transport fuel use consists of diesel and jet fuel, rather than the petrol predominantly used to fuel private cars. Consistently with this, we calculate that the indirect effect of a change in oil prices on consumer prices (through higher costs of transport services and other goods and services, as opposed to the cost of petrol itself) could be quite large. However, how large these indirect effects turn out to be will depend very much on how persistent the higher fuel prices are expected to be, the state of the economic cycle, and the degree of competition in individual industries. The effect on medium-term inflation will also depend on how higher international fuel prices affect domestic and external demand, and on how anchored expectations of medium-term inflation are by the monetary policy framework.

2. NZ's oil dependency in international comparison

To begin, we look at how sensitive the New Zealand economy is to high oil prices compared with other OECD countries--how much oil (in the form of petrol, diesel, jet fuel, and other refined petroleum products) we consume, for what purpose, and what this suggests for the ease with which consumption can adjust. (1) The comparison suggests that while one cannot unambiguously say that New Zealand's total use of oil is unusually large relative to the size of the economy--it depends on how one measures the size of the economy--we do seem to use a relatively large amount of oil for transport fuel. …

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