The Impact on Québec s Budget Balance

Transcription

1 ISSN Volume 1, no. 2 August 17, 2005 Higher Fuel Prices The Impact on Québec s Budget Balance Summary 1. The increase in the price of gasoline at the pump since 1999 is due primarily to the soaring price at the rack. 2. Fuel demand is highly inelastic, which means that price increases have little effect on the amount consumed. 3. The government does not benefit from a jump in oil prices. A 5 increase in the price of fuels brought with it losses of approximately $22 million for the Québec government in This is because the additional amounts obtained by the Québec Sales Tax were more than offset by the increase in the government s fuel and heating expenditures and by the reduction in specific fuel tax revenues. 4. The increase in the price of fuels can also jeopardise economic growth and affect other sources of government revenue. This article evaluates the impact of an increase in the price of fuels 1 on the financial equilibrium of the Québec government. It begins with an overview of the fuel market in Québec. It then presents the evaluation methodology used and describes the extent of the impact that a price shock has on government revenues and expenditures. 1 Fuels in Québec In 2004, the gasoline 2 sales in Québec reached 12 billion litres (8.4 billion litres of standard gasoline and 3.6 billion litres of diesel). Private individuals bought nearly 90% of this gasoline and 5% of the diesel, diesel being used more for commercial and industrial purposes. 3 Between 1999 and 2004, gasoline consumption increased by an average of 1.5% annually. In 2004, heating oil sales came to 1.95 billion litres and natural gas sales came to 5.7 billion cubic metres. Between 1999 and 2004, heating oil sales increased annually by an average of 2.5% and natural gas sales decreased annually by an average of 1.4%. Several factors influence fuel consumption. An increase in economic activity leads to higher fuel demand, particularly for vehicles used for commercial purposes. In addition, growth in the number of vehicles in circulation increases fuel sales. In this regard, demand is also influenced by the fuel efficiency of vehicles. According to the Office of Energy Efficiency, 4 the average fuel consumption of new vehicles manufactured between 1990 and 2002 remained steady at approximately 8 litres per 100 kilometres, despite the increase in the average power of vehicles. Also according to the Office of Energy Efficiency, 5 if the average power of vehicles had remained the same throughout the 1990s, the average consumption of new vehicles would have decreased by 33% For purposes of this analysis, the term fuel refers to gasoline, diesel, heating oil and natural gas. For purposes of this analysis, the term gasoline refers to standard gasoline (petrol) and diesel. As we will see in section 3, consumption by private individuals is distinguished from consumption by businesses because the latter are entitled to an input tax rebate. 4 5 Office of Energy Efficiency: Energy Efficiency Trends in Canada, 1990 to 2003: Ibid.

2 TABLE 1 Fuel consumption per sector in Québec in 2004 (in millions of litres) Gasoline Private individuals Businesses 837 Diesel Private individuals 181 Businesses Heating oil Residential Commercial 709 Industrial 116 Natural gas Residential 722 Commercial Industrial (1) In millions of cubic metres Sources: Statistics Canada, Ministère des Ressources naturelles et de la Faune and Ministère des Finances du Québec. The relative price of fuels also affects the consumption growth rate. Over the past five years, fuel prices have soared, due in particular to the increase in the price of oil. Between 1999 and 2004, the cost of all goods and services combined grew by 12%; during that time, the prices of diesel and standard gasoline increased by 36% and 35% respectively. Even worse, the prices of heating oil and natural gas skyrocketed by 70% and 95% respectively between 1999 and Fuel price components The retail price of a litre of gasoline or diesel is made up of the following components: the cost of crude oil, the refining margin, the cost of transportation, the retail sales margin, the federal excise tax, the specific Québec tax, the Goods and Services Tax (GST) and the Québec Sales Tax (QST). The cost of crude oil varies according to the barrel price and the value of the Canadian dollar in US currency. The price of a barrel of crude oil is determined internationally by supply and demand fluctuations. Furthermore, any increase in the Canadian dollar s value in US currency helps bring down the cost of crude oil. The refining margin represents the difference between the price at the rack and the cost of crude petroleum, i.e., the profit margin realized by the refinery for covering its expenses, in particular its operating costs. As Graph 1 shows, the rack price in the port of New York strongly influences the rack price in Québec. Because gasoline products can be freely imported and exported between Canada and the United States, American refineries are able to compete with Québec refineries. GRAPH 1 RACK PRICE OF REGULAR GASOLINE IN MONTRÉAL AND NEW YORK (in cents per litre) New York Montréal Sources: Energy Information Administration and Régie de l énergie. The retail sales margin covers administration, operating and marketing expenses. This component is closely tied to local market conditions, in particular population density and the average amount of gasoline sold at service stations. Regarding taxation, the Québec government is currently applying a general tax of 15.2 per litre of standard gasoline and 16.2 per litre of diesel. 6 In the Montréal region, gasoline has been subject to an additional tax of 1.5 per litre since January 1, 2006 for funding the Agence métropolitaine de transports (AMT). The federal government collects an excise tax of 10 per litre of standard gasoline and 4 per litre of diesel. Specific taxes levied by the two levels of government have not increased since 1996 for diesel 1998 for standard gasoline. Standard gasoline and diesel are subject to the GST and the QST, as are heating oil and natural gas. The amount of GST and QST applied to gasoline and diesel varies according to their before-tax prices. The QST is calculated according to the total cost, which includes the duty-free price, the federal excise tax, the specific provincial tax and the GST. Factors explaining the increase in the price of gasoline Table 2 explains the increase in the price of gasoline in Montréal 7 between 1999 and 2004 with a breakdown 6 7 Border regions are entitles to a reduced gasoline tax because of the lower tax levels in the United States and Ontario. The Québec government also provides tax rebates in specific peripheral regions in order to bring gasoline prices there closer to what is found in larger urban centres. The analysis is based on the price in Montréal because of the large size of the region s market. 2

3 of the components that influenced the price at the pump. During that time, the price of gas jumped from 63.3 per litre to 85.5 per litre (an increase of more than 22 ) between 1999 and TABLE 2 Breakdown of components making up the average price of regular gasoline in Montréal (in cents per litre) GRAPH 2 PORTION OF QUÉBEC TAXES IN THE PRICE OF GASOLINE AT THE PUMP FROM 1991 TO 2004 (in percentages) Variance Cost of crude oil Refining margin Rack price Transportation costs Retail sales margin Price before taxes Federal excise tax Québec specific tax AMT tax GST QST Total taxes Price at the pump Sources: Ministère des Finances du Québec and Régie de l énergie. The increase in the price at the pump is explained essentially by the increase in the rack price. Two-thirds of this increase is due to the sharp increase in the price of crude oil spurred by sustained demand, low reserves in the United States, geopolitical instability in the Middle East, and a much less flexible market than before. The increase in the refining margin is due to limited refining capacity and is strongly correlated with the rack price in New York. Only 13% of the increase in the price at the pump is due to the increase in tax revenues collected through the two government sales taxes. Even though the amount of QST collected per litre was increased a few years ago, Québec taxes (specific tax, AMT tax and QST) are accounting for a lower and lower amount of the price at the pump. Between 1999 and 2004, these taxes portion in the price of gasoline decreased from 33.4% to 26.5%, the lowest level since This decrease is due to the fact that the specific tax and the AMT tax do not vary, as opposed to other components Source: Ministère des Finances du Québec. Price elasticity of demand Price elasticity measures the impact of an increase in a good s price on the quantity consumed. In general, this elasticity coefficient is negative; if the price of a good increases, the quantity consumed goes down. A good or service is considered to be inelastic if a price increase of 1% leads to a corresponding decrease in demand of less than 1%. The Ministère des Finances du Québec has developed a model to forecast demand for gasoline and diesel and to evaluate their price elasticities. It incorporates several factors that influence the consumption of these fuels. These factors include the price, the level of economic activity, the number of motor vehicles on the road and their average energy consumption, and real GDP. Because of the functional form used to model demand, price elasticity is considered to be constant over time. According to the estimates from the model, a 10% increase in the price of gasoline leads to a reduction in gasoline consumption of close to 2.4%, and a 10% increase in the price of diesel leads to a reduction in diesel consumption of about 0.8%. The price elasticity of diesel is three times smaller than that of gasoline, because diesel is used primarily for commercial purposes, which makes any reduction in its consumption more difficult. The Ministère has also developed a second model based on a typical consumer s behaviour to estimate how much of this consumer s budget is devoted to the purchase of various types of goods and services, including gasoline. The estimates produced by this model make it possible to determine the amount of gasoline purchased by this consumer and to estimate 3

4 a price elasticity that varies with the price of gasoline. The model also allows a comparison of gasoline s price elasticity with that of other goods. GRAPH 3 EVOLUTION OF GASOLINE S PRICE ELASTICITY AND THE AVERAGE PRICE OF REGULAR GASOLINE IN QUEBEC FROM 1981 TO 2003 unit value 0,30 0,25 0,20 0,15 0,10 0,05 0, Price elasticity Price of ordinairy gasoline Sources: Ministère des Finances du Québec, Statistics Canada and Régie de l énergie. Graph 3 presents the evolution of gasoline s price elasticity between 1981 and 2003 and of the average price of gasoline in Québec (expressed in Canadian dollars in 2003). According to the estimates of our second model, a 10% increase in the price of gasoline has led to a reduction in consumption of approximately 2.4% in 2003, which confirms the results presented above. The demand for gasoline is highly inelastic compared to other goods and services. By way of illustration, the model s estimates show that a 10% increase in the price of semi-durable goods led to a reduction in their consumption of close to 14% in As Graph 3 shows, price elasticity depends strongly on price level, because consumers are more sensitive to a price variation when the price level is high. The price elasticities of demand for heating oil and natural gas have been estimated by Natural Resources Canada. According to these estimates, a 10% increase in the price of heating oil leads to a reduction in consumption varying from 1.8% for the commercial and industrial sectors to 2% for the residential sector, whereas an equivalent increase in the price of natural gas reduces consumption by 1%. 3 Impact on the government s budget balance This section quantifies the impact that an increase in the price of fuels has on the financial equilibrium of the Québec government. The methodology used here consists in measuring the impact of a fuel price increase on the quantities consumed with the price-elasticities, in comparison to a reference scenario cents per litre Table 3 presents the reference price scenario for The reference prices for standard gasoline (85.5 per litre), diesel (82.3 per litre) and heating oil (54.1 per litre) correspond to the average price recorded for Québec as a whole in 2004, according to the Régie de l énergie. Natural gas prices correspond to the unit prices in the first nine months of 2004, as provided by Statistics Canada. TABLE 3 Price of fuels per sector in Québec in 2004 (in cents per litre) Price elasticities Reference prices Proposed variation in per in % litre Gasoline Diesel Heating oil Natural gas 1 Residential Commercial Industrial (1) In cents per cubic metre Sources: Régie de l énergie, Statistics Canada and Ministère des Finances du Québec. The price elasticities of demand allow us to quantify the reduction in quantities consumed due, for example, to a 5 increase of the price of fuels. A 5 increase in the cost of standard gasoline, which represents a 5.8% increase compared to the reference price, would thus lead a reduction in gasoline consumption of 113 million litres ( 1.4%) from the level initially forecast. A similar increase in the price of diesel (+6.1%) would lead to a reduction in consumption of 18 million litres ( 0.5%). Finally, the same increases in the prices of heating oil and natural gas would reduce their amounts consumed by 35 million litres ( 1.8%) and 72 million cubic metres ( 1.3 %) respectively. Decrease in specific tax revenues An increase in the price of gasoline and diesel slows down the sale of these fuels and consequently lowers tax revenues. Calculations by the Ministère des Finances show that a 5 increase in gasoline and diesel prices reduced consumption of these fuels by about 131 million litres in The corresponding fuel tax revenues decreased by an amount equal to the reduction in the quantities consumed multiplied by the rate for the specific tax (15.2 per litre for gas and 16.2 per litre for diesel) 8. A 5 increase in the price of gasoline and diesel thus reduced specific fuel tax revenues on gasoline and diesel by an estimated $19 million in The statistics are adjusted to take account of quantities in certain regions that are eligible for rebates. 4

5 Increase in QST revenues Conversely, the increase in the price of fuels helps to increase the QST revenues obtained on them by the Québec government. The impact of this price increase can be broken down into three effects: the quantity effect, the price effect and the cross-effect. We note here that since November 1996, businesses have been entitled to an input tax rebate for on their fuel expenses. The quantity effect represents the QST revenues lost due to the reduction in quantity, according to the base QST obtained for each litre (or cubic metre) initially sold. Calculations by the Ministère des Finances show that the quantity effect accounted for a loss of $8.6 million in QST revenues for the Québec government in The price effect represents the impact that the price increase has on the amount of QST obtained per litre (or cubic metre) initially sold. The price effect thus accounts for a gain of about $42 million in QST revenues for the government in Lastly, the cross-effect measures the combined impact that an increase in QST revenue obtained per litre (or cubic metre) and the drop in quantities consumed has on QST revenues. For purposes of our analysis, the cross-effect accounts for a loss of approximately $600,000 for the Québec government in When we combine these three effects, we find that a permanent increase of 5 in the price of fuels increased QST revenues by about $33 million in 2004 But when the $19 million reduction in fuel tax revenues is deducted from that amount, a permanent increase of 5 is seen to have increased government revenues by about $14 million in TABLE 4 Impact of a 5 increase in the price of fuels on Québec government revenues (in millions of dollars) Specific tax QST Total Quantity effect Price effect Cross effect Overall effect Source: Ministère des Finances du Québec. which went to heat hospitals, schools and other government buildings. For purposes of this analysis, it is assumed that a short-term increase in the cost of fuels will not affect consumption by the Québec government, which must continue to offer public services. Consequently, an increase of 1% in the price of fuels will increase the government s fuel expenses by 1%. 9 TABLE 5 Impact of a 5 increase in the price of fuels on the budget balance of the government (in millions of dollars) Impact on revenues 14.1 Specific tax QST 33.1 Impact on expenditures Overall effect Source: Ministère des Finances du Québec. Thus, a 5 increase in fuel prices is calculated as having increased government expenditures by close to $36 million in Overall, when we factor in other forms of revenue, which are obtained for the most part through the QST, the Québec government lost nearly $22 million in Impact on other sources of government revenue The increase in the price of fuels can also affect other government sources of revenue. According to a study by the Canadian Department of Finance, 10 an increase of 20% in the price of petroleum would lead to a drop of 0.8% in Québec s real GDP within one year and to a drop of 1.4% within two years. Historically, Québec government revenue growth has proceeded at the same rate as that of economic activity. A reduction of 1.1% in economic activity would reduce government revenues by close to $400 million. A permanent increase in the price of fuels could also increase the goods inflation rate, due primarily to higher production and transportation costs. Increase in government expenditures An increase in the price of fuels also affects the expenditures of the Québec government. These expenditures correspond primarily to the cost of heating government buildings and of providing fuel for the government fleet of motor vehicles (public security, ambulance services, service vehicles, etc.). For , the Secrétariat du Conseil du trésor estimated these expenditures at $341 million, more than 85% of 9 10 In considering the long-term situation, we note that a permanent increase in the price of fuels could lead the government to reduce its consumption of them at the same rate as other economic stakeholders. If the government did so, it could realize savings of close to $1 million per year. Department of Finance Canada, Working Paper : Le prix de l énergie et l activité économique au Canada (available in French only). 5

6 5 Conclusion Contrary to what is commonly believed, the government does not benefit from an increase in fuel prices. Higher QST revenues stemming from higher fuel prices are more than offset by the increase in the government s fuel and heating expenditures and by the reduction in fuel tax revenues, which follows the decrease in consumption. The government s annual net loss for 2004 was estimated at close to $22 million for each 5 increase in the price of fuels. Furthermore, higher fuel prices reduce the purchasing power of households and the profits of enterprises, thereby putting the government s financial situation at further risk. Produced by the Direction de l analyse et prévision des revenus autonomes, with contributions by Stéphane Girard and Xavier Camisa. For more information, please contact Simon Bergeron, director, at (418) This document is available on the website of the Ministère des Finances at the following address: 6