'Trickle up' approach to cutting petrol profits likely to disappoint

Friday, 23 August 2019

Christchurch motorists on petrol prices and the sacrifices they make to drive their cars.

OPINION: The Commerce Commission's draft market study into the $10 billion fuel industry is 424 pages long, but it seems to skip lightly over some evidence about what went wrong in the petrol market and when.

The fuel industry is a textbook example of a problematic oligopoly.

Petrol is pretty much the same and its price is advertised on roadside signs.

If costs go up or down or currencies fluctuate, one oil company can move their pricing, see if others follow, and then quickly reverse that price change if they end up out on a limb.

* Don't be surprised if petrol study ends in a deal, not regulation

* What we are paying for when we buy petrol**

There is no need to peel a sticky label off a litre of petrol. Retailers can just nudge their prices into line without resorting to illegal collusion.

Because no conversations or explicit coordination is required, that is all above board.

The market study released on Tuesday concluded the 'core problem' in New Zealand was the lack of an active wholesale market that was hindering independent retailers from buying fuel from the three majors, Z, BP and Mobil, on competitive terms.

Fix that through a law change or preferably an industry deal, it argues, and the impact would flow through to pumps nationwide as the oil majors were forced to cut their profits to compete with the growing number of independent petrol stations that would then sprout up.

Call it the 'trickle-up' approach.

That's great in theory, assuming the wholesale market is in fact significantly skewed.

But back on page 415 of the report is an admission there is little evidence of the much-vaunted 'Gull effect'.

Wellington motorists react to the finding of a draft market study into the country's petrol prices in August.

'NPD appeared to have the most impact on the majors' prices. There is less evidence that the sites of Gull, Allied and GAS are impacting on the majors,' it said.

This may be because independents aren't often undercutting the majors on a like-for-like basis but just applying a 'no frills' business model based on cheaper sites on the outskirts of towns and more self-service.

The commission's hope that technical tweeks to the wholesale market will significantly bring down pricing appears to rely on a small tail wagging a pretty large dog, especially if we should really be thinking of Gull as being more akin to one of the majors.

The elephant in the room is that motorists have enjoyed low petrol prices in the past under the existing industry structure which has been in place since 1988 and which the commission is now singling out for blame.

It points out profit margins fell between 1988 and 2008, from about 50 cents a litre to what the industry claimed was an unsustainably low margin of about 15c.

It was only from about 2009 that profit margins began their upward climb to the 35c level, which appears to be about 10c a litre more than motorists should pay.

What happened to send margins higher?

As the report states, Shell sold its petrol stations to Z Energy in 2010 and Z publicly stated its intention to increase retail fuel margins.

'Z Energy adopted a strategy where it was comfortable losing some market share in order to increase margins. This strategy was successful and as a result the price of petrol and diesel increased as gross margins grew.

Mobil closed its petrol station on Gore's Main St in April in an early signal of the changes that will hit the industry over the coming decades.

'After a period of comparatively low margins, BP and Mobil effectively followed Z Energy's lead, while Gull sat beneath the price umbrella the major companies created and focused on delivering a slightly lower-frills price offering to increase its market share.

'Prices and margins subsequently rose to a point where retail fuel prices, expressed on a pre-tax basis, were among the highest in the OECD and higher than in some Pacific Island nations.'

So it started with an overt signal from Z that it intended to raise profit margins, and remembering the classic oligopolistic nature of the petrol market, it is not surprising where we ended up.

The commission's decision to approve the sale of Caltex NZ to Z in 2016, despite warnings that would push up prices, will also have contributed to a partly self-fulfilling expectation that profits in the industry would rise, evidenced by the sharp jump in Z's share price at the time.

The petrol industry is not the only market where price signalling risks working against consumers. Former Spark boss Simon Moutter was fond of frequently warning that broadband prices were unsustainable and needed to rise.

But in Spark's case, Moutter was largely unsuccessful in converting those signals into changed market pricing.

Like most countries, New Zealand doesn't have any legislation that explicitly mentions price signalling.

But the role it can have in supporting anti-competitive actions is gaining more attention among competition lawyers around the world.

Australia introduced a law in 2012 that explicitly prevented banks from engaging in anti-competitive price signalling over interest rates and fees.

And competition agencies could weigh in under more general provisions in competition law if they felt comments about future pricing were intended to facilitate prices rises by create an 'understanding' within an industry.

In small countries such as New Zealand where markets are often dominated by a few players, that is always going to be a particular risk.

Could the petrol market have shaped up differently if the commission had raised some red flags before Z's comments to the market back in 2010?

Or was Z perhaps obliged to set out its thoughts on the market it was entering to investors?

These aren't easy questions but ones I think the commission needs to address in its final report.

It might argue that Z's pricing intentions could not have had an effect unless there were weaknesses in the wholesale market to exploit. I am not convinced.

The other significant change that coincided with higher profit margins in the petrol has been the growth of ever more sophisticated fuel loyalty and discount schemes.

These the commission notes are a 'poor substitute' for generalised price competition at the pump, but as yet it appears to be suggesting few remedies.

However, we got here, we are now stuck in the situation where the oil majors are reaping the benefits from a new trust that none among them will let the side down by triggering a price war that sends fuel margins down to where they were 10 years ago.

Instead they are focusing on honing already-tedious discount and loyalty schemes to maximise their profits, cynically shaping their prices around individuals' willingness and ability to pay.

NPD was the only independent retailer the Commerce Commission observed having a clear impact on the majors' pricing.

They will offer changes to the wholesale market that they think are the minimum needed to dissuade the Government from a bothersome and time-consuming law change, safe in the knowledge that any noticeable trickle-up effect from new competition would be years away anyway.

And I bet they will be successful.

Any harder-earned victory for the Government would be politically hollow, hitting like a series of 10-centimetre high tsunamis, with costs savings unobservable amid the usuals swings in pricing caused by oil price changes and currency fluctuations.

So little hope for motorists?

Actually I think there is, but that it will come from an external shock upending the cosy applecart.

The Ministry of Business, Innovation and Employment forecasts petrol sales will fall by 10 per cent by 2027 and 47 percent by 2050.

That prediction was made even before the Government devised its feebate scheme to encourage drivers into EVs and low emission vehicles.

It should become 'dog eat dog' between oil companies as they cut margins to fight for a share of a declining market in an attempt to persuade rivals to be the first to shut up shop in each locality.

Prime Minister Jacinda Ardern and National Party leader Simon Bridges have been trading barbs over who is fleecing who at the pump.

But quite soon politicians will be tearing their hair out about something else; the country's 1300 petrol stations following the likes of banks and post offices and pulling out from local communities.

*Comments on this article have now closed.