In recent years, the global oil market has navigated not only a complex landscape of fluctuating prices and changing production dynamics but also the impacts of geopolitical tensions. A notable instance was the disruptions following Russia’s invasion of Ukraine in 2022, which caused a significant spike in world oil prices. Brent crude oil prices surged to over $US100 per barrel for five months, and from trough to peak, crude oil prices increased by approximately 50%.
The volatile nature of global oil prices, partly driven by geopolitical tensions, continues to pose multifaceted challenges for economies worldwide. Australia, serving as both an oil importer and a liquefied natural gas (LNG) exporter, encounters distinctive economic consequences due to global energy price fluctuations. This adds an extra layer of complexity for its policymakers, who must respond to these potentially unexpected shifts in oil prices. The decisions made in this context can have both short- and long-term consequences.
Australia’s dual role in the global energy market
Australia’s role as an oil importer results in increased living costs for consumers and heightened input costs for businesses when global oil prices surge. At the same time, being one of the world’s largest LNG exporters, Australia primarily exports gas in LNG form to the Asia-Pacific market, where prices are linked to oil prices through long-term contracts.
This dual role exposes Australia to direct impacts from global oil price fluctuations, affecting both Australian LNG export prices and domestic gas prices. Consequently, inflationary pressures intensify for Australian households when global crude oil, and thus refined petroleum, prices rise. Conversely, Australian LNG exporters stand to potentially realise substantial profits. However, these profits predominantly flow offshore due to the high levels of foreign direct equity investment characterising the Australian LNG industry.
Exploring fiscal responses to a global oil supply shock
This situation presents a challenge for Australian policymakers: what feasible fiscal options exist to respond to an unexpected oil price surge arising from a supply shortage? In 2022, across oil-importing and energy-exporting countries, two fiscal responses were evident, each with its own merits:
Fuel tax cuts: This approach aims to counteract the impact of crude oil price pass-through to final prices, temporarily making refined petroleum more affordable for consumers. However, it comes at a fiscal cost. For example, in Australia, the temporary 50% fuel excise cut implemented by the Federal Government in response to the 2022 oil price rise incurred about AUD$5.7 billion in foregone revenue. Moreover, it did not mitigate the increase in domestic gas prices.
Energy profits levy: An alternative option involves taxing and distributing windfall profits accruing to energy producers. As an example, the United Kingdom Government introduced the Energy Profits Levy in 2022. Such policies aim to distribute windfall gains from energy companies to domestic households without imposing additional fiscal pressure on the budget.
Assessment
Our study employs a dynamic general equilibrium model, called VURMTAX (Victoria University Regional Model with Taxation detail), integrating detailed fiscal and industry information to assess the effectiveness of these two fiscal policy responses to oil price shocks.
In the absence of any fiscal response, a one-year, temporary rise in global crude oil prices of 50% above the core forecast resulted in a shock-year increase of 0.29 percentage points in the national unemployment rate, a 0.43% decline in real household consumption, and a 0.15% decrease in real GDP.
Subsequently, we explored the economic merits of fuel tax cuts and energy profits levies amid rising oil prices, considering Australia’s role as an oil importer and LNG exporter. Here are our findings.
Fuel excise cut
A temporary fuel excise cut can stimulate economic activity, but its costliness leads to a revenue shortfall. This implies that the funding sources for this policy can impact household consumption. Specifically, the effectiveness of this policy in supporting household consumption depends on the government’s fiscal capacity to implement a deficit-financed tax cut. If feasible, reducing the fuel tax rate by 50% could decrease the shock-year downturn in real household consumption from 0.43% to 0.05%.
Policymakers must consider the trade-off between short-term relief and the long-term costs of a deficit-financed tax cut, which could increase the burden of national debt and lower future consumption.
Energy profits levy
Implementing an energy profit levy on the LNG and oil sectors could redirect a portion of the windfall gains, generated by soaring energy prices and largely benefiting foreign-owned energy producers, towards domestic households. This redirection could assist households in managing the financial hardship caused by higher energy prices without imposing additional costs for the budget. From an economic welfare perspective, our study indicates that a temporary energy profits levy could serve as a valuable tool for policymakers addressing spikes in global energy prices.
For example, adopting a UK-style policy with the energy profits levy set at 25% and using the proceeds to bolster increased welfare payments could mitigate the downturn in real household consumption to 0.1%, down from 0.43%.
Navigating under complexity
As Australia’s policymakers navigate the impacts of oil market shocks, the decisions they make today will have enduring consequences. Crafting fiscal measures tailored to the economy’s specific energy and industry profile is essential. This requires understanding how Australia’s unique energy demand-and-supply dynamics might result in distinct economic outcomes during periods of oil price spikes, as well as comprehending how various policy measures can alleviate the impact of such shocks on the economy.
Ensuring policy consistency poses a considerable practical challenge, particularly when implementing new taxes designed to tax and redistribute transient supernormal profits accrued by resource producers and exporters during temporary prices hikes. When contemplating the inclusion of windfall profit taxes into the policy toolbox, it is crucial to establish a clear perspective to ensure its role within the broader taxation system is well understood by both direct stakeholders and the general public.
Frequent changes in tax policy in response to market fluctuations could heighten uncertainty, potentially undermining investor confidence in both the short and long term. Imposing a tax on “unexpectedly” higher profits without providing similar relief when profits are “unexpectedly” low might discourage investment, particularly when investors anticipate price fluctuations across cycles. Amidst growing uncertainties in the global economic landscape, these challenges underscore the complexities involved in considering new policy options, vital for nurturing a stable and prosperous future for Australia in a rapidly evolving world.
This article is based on “Liu, Xianglong Locky, Jason Nassios, and James Giesecke, (2024), To tax or to spend? Modelling tax policy responses to oil price shocks. Energy Policy, 185, 113929.” https://doi.org/10.1016/j.enpol.2023.113929
Excellent article!