The soaring cost of gasoline captured headlines across the country this summer, culminating in the surge to above $1 a litre after Hurricane Katrina disrupted refinery output in the US late in August. At the same time, the increasing cost of all types of energy has households concerned about the cost of heating their dwellings this winter. And of course rising energy prices raise the cost of doing business for most firms.

This paper focuses on the impact of rising energy prices on consumers, and why consumption has continued to increase into the first half of 2005 despite the hike in the cost of filling up. It pays particular attention to the role of government taxes in prices. It concludes with a brief overview of home fuel bills and which industries are most affected by rising energy costs, especially for gasoline.

Gasoline Prices and Consumption

Gasoline prices have been one of the most volatile components of the CPI over the past decade. After a brief spike during the Gulf War, they rose steadily from 1994 to 1997, before giving back most of these increases after the turmoil of the Asian crisis in 1998 depressed demand and lowered the price of crude oil. Gas prices then rose by nearly a third in 1999 and 2000, before a slump in the world economy reined in prices in 2001 and 2002. Since then, they have accelerated every year, fuelled by strong global demand.

Figure 1

Gas consumption rose even as prices accelerated. From 1990 to 1996, motorists bought 4.6% (or 0.8% per year) more gasoline in Canada (they may have purchased more in the US at the height of the cross-border shopping spree in the early 1990s). Gasoline consumption subsequently jumped 15.5% from 1996 to 2004; at 1.9%, annual growth was more than two times as fast as the previous six years. Lower gas prices sparked 2.5% more gasoline demand each year from 1997 to 1999, a trend encouraged by the shift to larger vehicles during this period.

Figure 2

Soaring prices temporarily dampened sales growth in 2000, but since then annual growth has averaged 1.7%, with no signs of slowing even as prices soared in 2004. It is worth recalling that retail gasoline prices first hit a peak in May 2004. They only surpassed this record starting in April 2005, despite a steady rise in the price of crude over much of the intervening year. This is because the May 2004 spike in prices was caused by a shortage of refinery capacity in North America. Since then, crude oil prices have risen faster than gasoline, partly because the latter includes a variety of costs that fluctuate less (such as taxes, transport, margins, etc.).

Table 1: Retail Gasoline Consumption and Prices

Despite higher prices at the pump, gasoline demand in the first three quarters of 2005 was the same as last year (diesel continues to grow).

One reason demand has accelerated in recent years is that fuel economy stopped improving, even as the number of vehicles on the road increased. Fuel economy has been hampered by lower overall fuel efficiency for vehicles and the continued shift to light trucks and SUVs. Fuel efficiency for both cars and light trucks has stalled in recent years. For cars (measured by litres needed to drive 100 kilometers), it improved almost 10% from 8.4 litres in the mid-1980s to 7.7 in 2000, but has since only edged down to 7.6.¹ Meanwhile, the fuel required to power trucks actually rose from 10.0 litres in the mid-1980s to 10.7 in 2003. Together with the ongoing shift from cars to trucks and SUVs, (which rose from 36.2% of the fleet in 2000 to 42.9% in 2004), this lowered overall fuel efficiency of the stock of vehicules.

Figure 3

Total fuel consumption also has risen because of a sharp rise in the number of vehicles on the road. In 1990, there were 12.98 million personal vehicles, or 0.47 per Canadian.² By 2003, the number of vehicles rose 38% to 17.89 million, or 0.57 for every Canadian (population growth was 14% between 1990 and 2003).

Higher prices did prompt a shift away from premium and mid-grades of gasoline in favour of the cheaper regular grade. The popularity of premium and mid-grade gasoline has fallen steadily since 1994. There was a brief upturn in sales of higher grade gas when prices fell in 1998, but the share of regular gasoline rose sharply when prices jumped in 2000 and has hovered near 90% since.³ This shift saved consumers over $1 billion in recent years, based on CPI data that shows about a 7 cent gap between premium and regular.

Figure 4

The proliferation of vehicles illuminates one reason why gasoline consumption barely slowed after prices soared in 2000 – consumers had the income necessary to afford it. Figure 5 shows that consumers spend relatively little of their income on gasoline. Despite the recent hike in prices, gasoline consumed 3.5% of after-tax income in the second quarter of 2005, up only slightly from 3.1% early in 2004 and 3.2% in 2000. This partly reflects the steady growth of incomes at about 4% a year over this period.

Figure 5

Taxes

Governments tax household gasoline consumption in two ways. All federal and provincial governments have a flat excise tax on fuel consumption. A few provinces also levy their sales taxes on gasoline to siphon off a percentage of revenues. The 7% federal GST was applied to gasoline when it was introduced in 1991.

Variations in the price of a litre of gas across the country largely reflect long-standing differences in provincial and local taxation. Using the average price of regular unleaded so far this year, prices were highest in the Atlantic provinces and BC. This is because provincial fuel taxes were above-average in these jurisdictions. As well, all the Atlantic provinces except PEI collect the 15% Harmonized Sales Tax on gasoline, while Vancouver has a 4 cent and Victoria a 2.5 cent a litre transit tax. Quebec also has above-average prices, as it collects the PST on gasoline while Montrealers pay an additional 1.5 cent a litre tax. All the other provinces had below-average prices because they have relatively low fuel taxes, did not apply their PST to gasoline and have no transit taxes in large urban areas.

The federal fuel tax has always been a flat charge per litre of gasoline. It was raised from 8.5 cents a litre to 10 cents in 1995, where it has stayed. The provinces switched from a flat rate to an ad valorem tax in the 1980s. But the volatility of gasoline prices soon led governments to change these taxes back to a flat rate to make revenues more stable and predictable.⁴ These taxes range from a low of 9 cents a litre in Alberta to 14.7 cents in Ontario and 15.2 cents in Quebec to a high of 16.5 cents in Newfoundland.

At about $5 billion, the fuel tax accounted for 2.4% of all federal revenue last year. Fuel taxes were slightly more important to the provinces, totaling $7.5 billion or 2.8% of their revenues. Less than half of fuel taxes are paid by persons (the rest is paid by industries). Provincial fuel taxes have risen faster than federal fuel revenues. This reflects several hikes in the rate applied by cash-strapped provinces: PEI and BC raised their tax in 1997, New Brunswick in 2002, while BC brought in its urban transit tax in 1999.

Using as an example a producer price of 40 cents a litre across the country, Figure 6 shows how the different federal and provincial fuel and sales taxes produce different prices in each province (the actual price would be different, depending on margins, transport, etc.).⁵

Figure 6

While the flat fuel tax portion of revenues only moves with gasoline consumption, the revenue raised from provincial sales tax and the GST rises with prices. Table 2 shows federal GST and provincial sales tax (PST) revenues from fuel (these include other fuels like diesel, aviation and motor oil, but 94% are from gasoline according to the Input/Output tables). Federal GST revenues are consistently 3 times as high as provincial revenues. This is because no province west of the Ottawa river levies the PST on gasoline (Alberta, of course, has no PST at all). Newfoundland, New Brunswick and Nova Scotia collect revenues from the Harmonised Sales Tax, which combined the federal GST and provincial sales tax into one 15% rate. Quebec applies its 7.5% PST to gasoline (except in some areas bordering on other jurisdictions) while there is a tax on gasoline sold in Montreal. PEI is the only Eastern province not to collect the PST on gasoline. BC collects transit taxes in Victoria and Vancouver.

Table 2: Federal GST and Provincial Sales Tax Revenues from Personal Motor Fuel Consumption (millions $)

Those provinces that apply the sales tax to gasoline have seen these revenues rise 79%. The faster increase than federal collections reflects the higher ad valorem rates of the PST in these eastern provinces than the 7% federal GST.

To put these taxes in perspective, note that the gasoline bill for motorists rose from $15 billion in 1997 to $24 billion in 2004. Of this $8.0 billion increase, $0.8 billion or one-tenth reflected higher collections of federal GST and provincial sales taxes.⁶

Taking the example of the cost of a litre of gas in Toronto, Figure 7 shows the part going to taxes in 1997 and in July 2005. In 1997, government taxes accounted for nearly half (28.7 cents) of the 57.8 cent cost for a litre of regular gasoline. In July 2005, government taxes had risen to a total of only 31.1 cents, because all taxes except the GST were flat rates. As a result, the government share from a litre of gasoline fell sharply to 33.8%.

Figure 7

Home Energy Use

Energy for dwellings consumes about 3% of household incomes. This share has been more stable than gasoline. This stability reflects the necessity of energy for heat and many household tasks, as well as the lower volatility of electricity than oil prices. Nation-wide, electricity supplied 59% of home energy, including nearly three-quarters in New Brunswick and Quebec and over half in Ontario, Manitoba, BC and Newfoundland.

Figure 8

And unlike gasoline, the share of disposable income directed to home energy use has not hit new peaks so far this year, partly because electricity rates have not risen markedly in most provinces. Conversely, natural gas and fuel oil prices have risen faster than gasoline prices in recent years.

Figure 9

Industry Demand

Overall, industries spent $91.4 billion on energy in 2002, 4.1% of all their inputs. The Input/Output tables can be used to look at which industries are the most affected by rising energy prices. This question can be phrased in two ways: which industries have the largest energy bill? and which industries use energy the most as a share of all inputs? The answers are broadly similar to both questions.

First on the list of energy users is the energy industry itself. In absolute terms, petroleum refiners are by far the largest purchaser of energy at $26.6 billion in 2002, 80% of all its inputs. Not surprisingly, $25.2 billion took the form of crude oil purchased to be refined into gasoline and other oil products. Other energy industries also were large consumers of energy, notably electric utilities ($4.2 billion, nearly evenly-split between natural gas and coal) and oil and gas producers ($2.1 billion). All of these industries are well positioned to pass on the rising cost of their inputs of energy.

But thereafter there are several large, energy-intensive industries where energy makes up more than 10% of their costs. Transportation of all types requires considerable energy. Trucking leads this list, consuming $4.4 billion (almost all diesel fuel), or 16% of all its inputs. Air transport is also vulnerable with a fuel bill of $1.9 billion representing 15% of inputs, but water, rail and taxis all use fuel extensively.

Several manufacturers have energy bills of at least $1 billion, a cost that represents over one-tenth of all their inputs. Pulp and paper leads the way at $2.7 billion (10% of inputs), mostly electricity and natural gas. Petrochemicals spend $1.7 billion on energy (mostly $1.5 billion for liquid petroleum gases), a whopping 36% of its costs. Fertilizers are in a similar position, spending almost $1 billion on energy, for 40% of their inputs. Iron and steel and smelting and refining each spend about $1.5 billion on energy (although the mix is different), just over 10% of their inputs.

Two other industries allocate nearly 10% of their inputs to energy: agriculture and travel and entertainment. Energy accounts for 7% of farming inputs (including 9% for crops): its total demand of $3.3 billion is the sixth highest of any industry, and is about evenly-split among diesel, gasoline and electricity. The travel industry uses energy for 8% of its inputs, with almost all of this $2.1 billion for gasoline purchases.

Finally, fishing and iron ore both use energy for one-tenth of their inputs. Dry cleaners and auto garages, garbage removal and religious organizations use the most energy among services.

Most of the remaining large sectors that consume energy are less vulnerable to price hikes. While they spend a lot on heating and gasoline, they represent 5% or less of their inputs. Wholesalers and retail trade rank fourth and fifth in total energy bills at nearly $3.7 billion each, but this is only 4% of their inputs. Wholesale spends relatively more on motor fuel, retailers on heating. Heating also is the biggest share of energy costs for housing and municipal governments, accounting for 5% of inputs. Schools and hospitals too have large fuel bills due to heating, although this represents only 3% and 1% of their budgets.

Conclusion

In a break from their boom-bust cycle of previous decades, oil prices have climbed steadily over the past two years. Up until this summer, however, consumers have not responded by cutting consumption, which continued to rise as fuel efficiency declined and the number of vehicles on the road proliferated. Strong income growth helped cushion the impact of high gas prices. While not a major factor in the recent price increase, taxes do explain most inter-provincial differences in prices.

Spending on fuel for the home has not risen as fast as gasoline. This reflects the fact that most homes rely on electricity, where prices have risen less than 3% in the past year.

The largest industrial consumers of energy are energy-related, leaving them in the best position to pass on rising costs. At the opposite end of the scale, energy accounts for a relatively small portion of inputs for most industries (largely heating and cooling buildings). In the middle are the most vulnerable group, such as transportation, pulp and paper, primary metals, farming, and travel, who spend about 10% of their inputs on energy and may not be able to full pass on their higher cost. Industries that rely on automobiles are also adversely affected, notably taxis, auto rentals, couriers and real estate agents.

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