The current debate over tinkering with government taxes on petroleum products misses one of the major factors in oil pricing in Australia.

In 1977 Australian oil production was about 65% of its domestic requirement and the domestic production price was only a fraction of the world price at the time.

This should have led to Australia being largely immune to the world oil price. The reverse happened. The Australian Government of the day, aka Prime Minister Malcolm Fraser and Treasurer John Howard, signed in 1978 the Oil Price Parity Agreement that raised Australian prices artificially to world levels by 1981 and has maintained them at that level ever since. As John Howard said at the time:

In the light of the budgetary situation and the desirability of improving energy use, the government has decided all Australian-produced crude oil should, from tomorrow, be priced to refineries at import parity levels. This will mean [motorists] will in future pay [petrol and diesel] prices based on world oil prices …

Cheaper petroleum could have been a stimulus for the local economy, but the reverse was argued – that raising fuel prices to the current crippling levels has been an advantage for Australia. High oil profits were held to stimulate domestic exploration as well as encourage more prudent use of the artificially expensive commodity. While these points may be true, one can only wonder whether the extreme and artificial profit margin between the current production price, estimated to be below $5 a barrel, and the current sky-high world price is entirely necessary to encourage these laudable goals.

Given the artificial nature of petroleum pricing in Australia, maintaining a hard parity pricing agreement is problematic. This is especially true when you consider the indirect implications of leaving artificially high petrol prices at the mercy of international markets. If the international price of oil rises, its effect on Australia will be inflationary both through its direct effect (on petrol prices) and its indirect effect (as an input to almost every consumer commodity). The Reserve Bank controls inflation by raising interest rates, but if petrol prices rise as a result of the world price of oil, inflationary pressure also rises, meaning interest rates may also need to raised. This means that “working families” could be hit by a double burden if oil prices are permitted to follow the international market. The RBA has done this before, but it remains a highly questionable tactic that could be very hard on households.

Currently Australia produces about 75% of domestic gross requirements, though international trade in oil is necessary to balance local requirements for the various petroleum products. The current pricing of oil has certainly been sufficient to encourage more efficient use, and there has been considerable exploration since 1977.

However, it is morely timely to re-examine the prudence of absolute international oil pricing parity than argue for diminishing the government slice of what is a highly lucrative domestic product.

Whatever the state takes from petroleum sales is a benefit for the local community, unlike the massive production profits that seep offshore. A modest revision of the oil pricing parity agreement, especially with a view to changing the balance between the benefits to oil companies and the Australian community, would be a wiser strategy than the current push to reduce the Australian participation in profits through taxation.

Obviously the highly profitable oil companies may not agree.

Dr. Garrick Small is an economist specialising in property rights at the University of Technology, Sydney and Director of Consulting for HillPDA. He has contributed to a variety of major projects including the CSIRO initiative “Sustainable Resource Use” and the Pacific Island Forum Secretariat project on commercial utilisation of customary owned land.