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Fixing a dysfunctional fuel market

The final version of the Commerce Commission's report into the fuel market, which comes after a year of work, recommends the Government address a dysfunctional wholesale market largely governed by Z Energy, BP and Mobil.

Thursday's report says consumers "are currently paying higher pump prices for petrol and diesel than could be expected in a competitive market" and validates Jacinda Ardern’s assertion in October of last year that consumers were being “fleeced” at the pump.

Z Energy, BP and Mobil - known in the industry as the majors - control 90 percent of the fuel imported into New Zealand and have free access to each other's importing infrastructure. At the same time, resellers like Waitomo are locked into arcane, secretive contracts that the Commission says decrease competition.

Consumers are also struggling at retail petrol stations, which the Commission says conceal the price of premium petrol and encourage consumers to make bad financial decisions with discounts and loyalty programmes.

The report finds that “many fuel companies are achieving a level of profitability in New Zealand that is persistently higher than what we estimate a reasonable return would be in a workably competitive market”. In the Commission’s view, “the core problem is that an active wholesale market does not exist in New Zealand. This is weakening price competition in the retail market”.

As it stands, resellers sign complex contracts in order to purchase fuel from the majors, while the majors operate a borrow and loan arrangement. This allows each major to use as much fuel as it needs from another major’s terminal as long as it contributes an equivalent amount elsewhere.

In essence, the majors contribute to and draw from a joint pool of fuel, taking advantage of widespread shared infrastructure. The advantage these companies have over Gull – the other 10 percent of the importing market with just one facility in Mount Maunganui – is visible in the chart below, which comes from the commission's report.


 

High profitability indicates non-competitiveness
The Commission identified several factors relating to profitability that point to a non-competitive market. The first, that the profit margin for importers has doubled since 2008, has been disputed by the majors in the past.

Fuel companies insist that this statistic is misleading, since 2008 saw historical lows in returns after a decade of price wars, but Commission chair Anna Rawlings told reporters in August that it's still a useful metric.

The 20 percent return on investment that fuel companies see is more than double the 6.9 to 8.6 percent that the Commission would expect in a competitive market. New retail sites are increasingly exceeding even the fuel companies’ expectations when it comes to profitability.

Margins are high as well, the Commission says. The Ministry of Business, Innovation and Employment estimates that importer margins are around 30 cents per litre and haven’t dropped below 25 cents since 2015. For diesel, MBIE estimates margins of just under 49 cents per litre.

An independent analysis submitted to the Commission by financial consultants Ireland, Wallace and Associates found the majors earned $469 million in excess profits in 2017.
 

Anti-consumer practices
In addition to a non-competitive wholesale market and overly-high profitability, the regulator highlighted several anti-consumer practices. One of the top ones was discounts or loyalty schemes, which the Commission said was “not a substitute for more generalised price competition”.

In 2018, 41 percent of petrol and diesel sales were made using discounts. That figure has almost doubled since 2011, correlating with higher profitability. Moreover, the Commission observed a correlation between high discounts and high board prices, possibly indicating that retail outlets increase the price of fuel when they offer particularly good discounts.

“Board prices appear to increase slightly when discounts increase and decrease slightly when discounts decrease for the years between 2016 and 2019,” the Commission wrote.

Consumers are also more likely to make decisions based on the size of a discount instead of the price of petrol, the Commission said. People might choose to purchase gas from a major retailer for $2.20 a litre with an eight cent discount instead of buying from a reseller offering just $2.05 per litre.

Margins on premium petrol were also an issue for the Commission, which said “the premium petrol margin has increased faster than regular petrol. The extra margin fuel companies are earning on this product does not appear to reflect actual cost differences between premium and regular petrol.”

“We believe one explanation is that premium petrol prices are seldom displayed on price boards, making it difficult for consumers to compare prices.”
 

Terminal Gate Pricing
The regulator put forward two key recommendations to fix the wholesale market, which Commerce Minister Kris Faafoi has pledged to implement in legislation that will be passed by mid-2020. The first of these recommendations is the creation of a Terminal Gate Pricing system.

Under the new system, the borrow and loan arrangements could remain in place but other companies will be able to purchase fuel from the majors’ import terminals at a transparent spot price.

The TGP system has been used in Australia and the Commission said that Z Energy, Mobil and Gull all supported it. “BP did not accept that intervention was required to promote wholesale competition, but did not oppose a TGP regime during discussion at the consultation conference,” the report added.

However, the Commission acknowledged that the TGP system could meet roadblocks. In particular, there is a “risk that majors do not offer competitive [prices at the terminal]”.

Only 6 of the 13 cities in the map above have multiple different importers that could be induced to compete with one another for wholesale customers through lowering prices.

In order to ensure the majors follow through with competitive prices, the regulator recommended the Government prepare a Plan B regulatory regime “that can be brought into force should competition not deliver competitive TGPs within a reasonable period of time”.

“We consider that a credible threat of further regulation if a TGP regime does not facilitate competitive wholesale prices would incentivise the majors to offer competitive TGPs.”

Z Energy Chief Executive Mike Bennetts said that his company supported the TGP and a code of conduct. “As we’ve said before – we believe that Terminal Gate Pricing, supported by a robust industry code, will assist in creating a more observable wholesale market and enhanced competitive conditions,” he said.
 

Code of conduct for supply contracts
The regulator’s second recommendation for fixing the wholesale market is the establishment of an enforceable code of conduct governing the wholesale market and, in particular, contracts between the majors and resellers.

Resellers like Waitomo and NPD find themselves locked into long-term and opaque contracts, the Commission said.

These contracts lack transparency, which means that resellers can’t see the prices that their competitors are paying and negotiate better deals for themselves. The length of these contracts, which Rawlings said could stretch beyond a decade, also poses problems, particularly when the contract forces the reseller to buy exclusively from a single supplier.

The Commission also observed “other disincentives to switch suppliers, including restrictive covenants and restraints of trade, requirements to pay liquidated damages upon switching suppliers, rights of first refusal and renewal clauses at the supplier’s option”.

In order to address this, the Commission asked the Government to regulate new contracts, making them transparent and removing onerous and exclusive provisions from them. Faafoi has pledged to do so.

For resellers already locked into contracts for five or more years, the Commission recommended a transition period to introduce the new code of conduct, after which they would be able to break the contract after supplying reasonable notice.

The Commission also put forward a handful of smaller, non-regulatory recommendations like encouraging the majors to review the non-competitive aspects of their own borrow and loan arrangements. The regulatory measures that it proposed would be enforced by MBIE, Faafoi said.

Consumers to also see relief
The Commission's third tranche of recommendations dealt with the anti-consumer practices that retailers of all stripes engage in. The headline proposal, which Faafoi has promised to implement, is requiring retailers to post the price of premium fuels on price boards, a move that Z Energy has said it is already acting on.

Rawlings said that the Commission found some consumers purchased premium fuel when their vehicles did not need it. Understanding the difference in price between premium and regular fuel and promoting competition between retailers on the price of premium fuel would be beneficial for consumers, the Commission said.

Another way to reduce unnecessary use of premium fuels would be to mandate the inclusion of stickers on car fuel caps stating what fuel the car needed. The Commission recommended that the Government introduce this regulation but Faafoi only said he would examine it.

When the Commission released its draft report in August, it took particular aim at discounts and loyalty schemes. After the report, Consumer NZ Head of Testing Paul Smith told TVNZ that “it would be better for every consumer to be offered the same price, a fair price, rather than expect consumers to jump through hoops and for some consumers to access quite large discounts while there are consumers who aren’t accessing such large discounts who are effectively cross-subsidising them”.

The Commission didn’t make any regulatory recommendations regarding discounts in its final report, noting only a need to monitor them, but Faafoi told reporters that the Government might still crack down on them in its new legislation.

“It’s in the mix but I think they put more emphasis on the wholesale market. I think that’s where the substantive change can be made,” he said.

Australia banned the posting of discount prices on retail station price boards in 2017. “We believe that it’s false advertising, it’s deceitful. That behaviour has been banned in Australia so we think the Commerce Commission should have been a bit firmer on that. They came out and said that they’re going to monitor it but we believe they should have been banned,” Waitomo managing director Jimmy Ormsby told Newsroom.

Reaction in industry and Wellington
While Gull, Waitomo, Z Energy and Mobil all hailed at least some aspects of the report, BP New Zealand declined to comment beyond acknowledging the report.

“We look forward to assessing the Commission’s recommendations in full and continuing to work with Government and officials to progress next steps in the interests of consumers and the market,” BP New Zealand’s managing director, Debi Boffa, said.

Mobil was more charitable. “We have already publicly indicated our support for a number of [the Commission’s] recommendations, such as improving the transparency of premium petrol prices, introducing a ‘terminal gate price’ at fuel storage terminals, and increasing public understanding of the different fuel grades available,” a Mobil spokesperson said.

Gull’s general manager Dave Bodger told Newsroom that “the thrust of [the report] is, let’s open up the wholesale market and terminal gate price is the way to do it, and that, to us, has been common sense for a significant amount of time”.

The Government greeted the results of the market study enthusiastically, with Faafoi pledging to implement most if not all of the recommendations. Government members see the survey as vindicating Ardern’s October 2018 pronouncement that fuel companies were “fleecing” consumers.

Energy Minister Megan Woods said the Commission’s study found a lack of competition in wholesale markets. "We’ll be introducing the best options to increase competition at a wholesale level, which will filter down to the retail market and prices on the forecourt.”

“A more competitive wholesale market means that low cost brands, like Waitomo and NPD, would be able to access cheaper fuel and pass these benefits onto consumers. Other retailers would be forced to adjust their prices or risk losing customers,” she said.

Across the aisle, the National Party has blamed the Government for the high cost of petrol, pointing out that taxes make up nearly half the price of petrol.

“New Zealanders are being ripped off at the petrol pump and it’s the Government who is picking their pockets through all the fuel tax hikes it has introduced these past two years,” National transport spokesperson Chris Bishop said.

But according to the AA, New Zealand's taxes on petrol are low when compared with other countries. The AA's website says that "in many OECD countries, taxes account for around two-thirds of the price" of fuel.

While New Zealand's pre-tax petrol price is consistently among the top three among the OECD, its taxes on fuel are the sixth-lowest in the world. That leaves New Zealand 19th for overall petrol price.

Bishop also wouldn’t commit to repealing the fuel taxes added under this Government, other than the Auckland Regional Fuel Tax, if National wins the election.

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