Following the news this week that fuel prices have reached record highs, the cost of filling up a petrol or diesel vehicle has continued to rise.

Ever since the Russian invasion of Ukraine, the price of fuel has constantly increased, adding to the current cost of living crisis affecting millions across the UK. Despite the increased prices, there are hopes that the UK might be at a turning point and the cost of diesel and petrol may fall. However, with little sign that records won’t keep being broken in the immediate future, the price of diesel is reaching worrying levels for UK drivers.

What affects the price of fuel?

The price we pay for our fuel at the pumps is affected by a variety of factors, including:

  • the global price of crude oil, the oil price chart below shows how this is changing
  • supply and demand for crude oil
  • refinery production and capacity
  • the pound to the dollar exchange rate, as refined fuel is sold in US dollars
  • distribution costs
  • the margin fuel retailers decide to take
  • fuel duty charged by the Government
  • VAT charged at the end of every forecourt fuel transaction

While some of these stay largely static, such as the fuel duty rate and VAT, others such as the oil price and dollar to sterling exchange rate can be very volatile. These affect the wholesale price of fuel, the price retailers pay to buy the fuel before they sell it at forecourts and explain why prices rise and fall.

While fuel retailers base pump prices on the wholesale cost of petrol and diesel, there is typically a two-week ‘lag’ between pump prices moving to reflect any change in the wholesale price, as this is the time it takes for fuel to work its way through the supply chain to the forecourt.

What are the highest ever recorded petrol and diesel prices?

Petrol and diesel prices were hitting regular daily records as of June 2022, around 178p per litre of petrol and 185p per litre of diesel.

How low can fuel prices go?

There is a limit to how low prices can go as tax, fuel duty, plus VAT charged on the total price, make up the lion’s share of the price of a litre. Even if the fuel was given away and the retailers didn’t make any profit (take a margin), the price of a litre would still include duty and VAT.

This high level of tax affects the price of a litre of fuel significantly. And, when the price of oil is falling it can also create a perception that pump prices are not reducing as much as they should because the lower the pump prices fall, the greater the percentage of tax. The Government also makes more in VAT when fuel prices are higher.

How does the oil price change?

Generally speaking, higher oil prices lead to higher petrol and diesel prices at UK forecourts, and in theory, at least, lower oil prices should lead to cheaper pump prices. But there are other variables that affect what we pay when we fill up, including the strength of Sterling compared to the US dollar (since oil is traded in dollars) and retailers’ willingness to pass on wholesale savings they make to drivers.

How is fuel taxed?

The total retail price paid at the pump includes a significant amount of tax, currently 52.95p per litre in fuel duty and 20% VAT.

But the total proportion of tax we pay to the Treasury varies depending on the pump price. For instance, with fuel at 120p a litre at the pumps, 65% of the cost is tax. But at £1 a litre it rises to 75%, meaning 75p in every litre sold goes to the Treasury.

Fuel duty rises more than £26bn a year, which together with VAT charged on fuel, vehicle tax and ‘showroom’ tax totals, means motorists contribute more than £40bn a year to the Government’s coffers.

How often do pump prices change?

Pump prices change when there are significant and sustained increases or reductions in the wholesale price of petrol or diesel. Retailers can reflect these savings as often or as infrequently as they like.

In reality, though the retail fuel market tends to be led by the supermarkets, as despite only having around 16% of UK forecourts they are responsible for some 44% of total fuel sales, so we often see widespread cuts being passed on at the pumps at the same time.

The other factor which affects when forecourt prices are changed is how frequently retailers buy their fuel. Retailers who use greater volumes tend to buy more frequently and therefore tend to alter their prices more quickly.

What is the ‘rocket and feather’ effect, and is it true?

This is a term often applied to fuel prices to describe how they always appear to rise faster than they ever come down, i.e. they go up like a rocket but fall like a feather.

Before 2020, retailers had a reasonable record of passing on reductions in the wholesale price of fuel to motorists at the pump, but there were occasions where we thought this could be carried out more quickly.

For instance, retailers often seem to take more encouragement to reduce their prices when oil prices are falling than they do when oil goes the other way.

Of course, the longer they hold off cutting pump prices when oil’s coming down, the better it is for their margins, and the reverse is also true: when the cost of a barrel of oil rises, the more they stand to lose if they don’t raise the forecourt price quickly.

Why do prices vary by region?

Prices can vary dramatically from region to region and even in towns that are only a few miles apart.

Sometimes fuel can even be cheaper in a more rural location than in an urban one.

Local retail dynamics also play a part. Local prices are very often driven by the presence of supermarkets keen to compete on price or an independent forecourt retailer that is determined to offer the cheapest fuel. If local supermarkets selling fuel don’t compete strongly on price this can in fact leads to motorists paying more.

Why are rural prices often higher?

While delivery costs tend not to play too large a part in the overall pump price, excessive distances from fuel terminals can have a significant effect on prices in rural locations.

It is, for this reason, the Government has previously taken action to help some of the country’s most rural communities where the price of fuel is deemed to be negatively affecting residents.

In 2012 it introduced a 5p rural fuel duty discount in the Inner and Outer Hebrides, the Northern Isles, and the Isles of Scilly. In March 2015 this was extended to 10 rural mainland communities.

How many forecourts are there in the UK?

According to the UK Petroleum Industry Association (UKPIA), there are around 8,300 filling stations. This number has reduced drastically from 1970 when there were more than 37,000.

Supermarkets dominate fuel sales, despite only operating around a fifth of the forecourts. Conversely, independents operate around two-thirds of the country’s filling stations but are only responsible for just over a third of all fuel sold. The remainder is accounted for by sites owned by the supplying oil company, whose name appears on the brand sign (Shell, BP, Esso, Total etc).

How much petrol and diesel is sold in the UK?

The UKPIA reports that each day, 46m litres of petrol and 74m litres of diesel are sold in the UK.

According to HM Revenue and Customs data for 2019, 44bn litres of fuel were used by drivers, 28bn litres of diesel and 16bn litres of petrol.