Government

Q+A: Will the fuel probe find profiteering?

The Commerce Commission has been told to do a market study of fuel retailing. But what will it find and then recommend? Jacinda Ardern suspects profiteering, but that's not clear, as Bernard Hickey explains.

Two months after announcing plans to give market study powers to the Commerce Commission and accusing fuel companies of profiteering, Prime Minister Jacinda Ardern has confirmed the Commission's first study will be of the petrol market.

It will have a year to come back with a final report on whether the market is fully competitive and, if not, what the Government could do to improve it.

But will it find that profiteering? It's not obvious, and the market may also change before the report is back in. The Commission may also recommend a series of tweaks, rather than the big hairy Government intervention some may be think is necessary.

Are they really fleecing their customers?

It's rare for any politician to accuse companies of deliberately over-charging their customers, but that's what Jacinda Ardern did in early October as the Government moved to blunt the political damage of fast-rising fuel prices.

"Consumers, in my book, are being fleeced," she said in October.

Ardern referred to a doubling of fuel company margins between 2008 and 2017, and she repeated that comment yesterday.

"That represents a transfer of wealth from petrol consumers to producers to the tune of hundreds of millions of dollars a year," she said.

On the face of it, this looks correct, as this chart of the oil company gross margins reported by MBIE shows from early 2010.




The chart above courtesy MBIE shows a near doubling in fuel industry margins from 2010. (Updated to substitute MBIE chart for Interest.co.nz chart)

That was when Infratil and the New Zealand Superannuation Fund bought Shell's service stations and embarked on an openly-declared plan to end a price war at that time with other firms. The renamed Z Energy said it wanted to increase profit margins to make the industry sustainable in terms of shareholder returns and reinvestment in infrastructure maintenance and safety.

Price wars since the arrival of Gull and Challenge in the late 1990s drove returns to such low levels that Shell and other global oil firms considered pulling out of New Zealand.

Is it the Commerce Commission's fault?

Since then, Z Energy has bought Caltex's network of service stations from Chevron to attain a 45 percent share of the market. The acquisition was waved through by the Commerce Commission in April 2016 despite the opposition of one of the four commissioners on the grounds it would reduce competition.

If the Commission wants to start its study close to home, all it needs to do is to look at pages 109-120 of its own Z Energy-Caltex takeover approval.

Commissioner Dr Jill Walker, who had previously worked as a commissioner at the much tougher Australian Competition and Consumer Commmission, wrote a dissenting report. It was attached to the final Z Energy-Caltex. It reads like a prediction of what was to happen after the merger.

"I am not satisfied that the acquisition will not have, or would not be likely to have, the effect of substantially lessening competition due to coordinated effects in the supply of fuel to retail customers through service stations," she wrote two and a half years ago.

The market had developed a 'leader-follower' pattern whereby Z Energy had led industry profits higher as part of a deliberate and public strategy, she wrote.

"In my view, there is currently evidence of such tacit coordination among petrol retailers which follows a leader-follower pattern.

"The result is prices that are above what they would otherwise be if more effective competition were taking place. In my view, the evidence from retail fuel markets in New Zealand suggests that tacit coordination has contributed to increased fuel firm margins.

"The evidence shows that industry margins and those of individual competitors have approximately doubled since Z purchased Shell in 2010, in line with Z’s publicly stated strategy."

So there's a start for the Commission. Its own Commissioner said in April 2016 Z Energy had led a doubling of profit margins and that its takeover of Caltex would further reduce competition. And that seems to have happened.

The last couple of years have seen the margins continue to rise.

So what does the industry say?

The industry argues that the rise in margins simply brings profits back to a longer term equilibrium and that comparing with the trough in 2008 is misleading. It argues it has reinvested some of the profits in improving the quality of stations and the safety and reliability of the infrastructure, including terminals, tanks and pipes.

This chart below from MBIE's Fuel Market Financial Performance Study from last year shows how margins have risen and fallen over the last 30 years.

MBIE found in that study that retail margins had risen 13 cents a litre between 2013 and 2017, and that it could not be explained by capital expenditure (ie it went straight into profits and dividends). MBIE found that margins had risen for retail fuel for motorists, but not in other markets such as aviation, marine, bitumen and commercial.

However, it's clear a Gull effect has developed, whereby prices in Wellington and the South Island are significantly higher. Gull does not operate in these areas.


What does the Gull effect look like?



MBIE found in its fuel market study last year that margins had risen even faster in Wellington and the South Island, where Gull and other independent stations do not operate because they do not have access to fuel terminals, which are owned by the bigger players. Gull and others do have access to a terminal at Mt Maunganui for imported fuel, but don't have access at Wellington or Lyttelton.

There has been some evidence that the big three, Z Energy, BP and Mobil, have been cross-subsidising areas that compete with Gull with lower prices at the expense of higher prices in Wellington and the South Island.

The 11.5 cents per litre (including GST) fuel tax imposed on Aucklanders from July 1 may also have added to the pressure for cross subsidisation.

The chart above from an NZIER/Grant Thornton/Cognitus study for the MBIE report shows the divergence between Gull and non-Gull areas over the last four years.

The end result of the change of Shell ownership and strategy, the takeover of Caltex and the Gull Effect has been a rise in margins so that New Zealand now has the highest pre-tax fuel costs in the OECD, as shown by this chart from the same NZIER study.



So what is Labour doing about it?

The Government prioritises the passing of the Commerce Amendment Bill last month.

The long-awaited amendments to the Commerce Act allowed the Commerce Commission or ministers to nominate a sector to be subject to a market study into anti-competitive behaviour. It brings the Commission's powers into line with similar bodies overseas such as Australia's ACCC.

One of the problems MBIE had with its study last year was that Mobil and Gull did not provide full information, which meant MBIE said it could not conclude if the market was not competitive, even though there were reasons to suspect a problem.

So what might the Commission recommend?

Potential regulatory options could include somehow creating some sort of wholesale market for fuel whereby independents such as Gull and Waitomo were allowed to buy access to fuel through the Wellington and Lyttelton terminals, although there is also a new $30 million independent terminal being built at Timaru (photo supplied below) over the next two years.

The Government could also order that the big three (BP, Mobil, Z Energy) give access to the pipeline for fuel refined at Marsden Point that fills big tanks at Wiri.

It could also stop the big retailers from blocking others from coming in when they shut down smaller and older petrol stations. Sometimes covenants are put on the sales to stop them from being used as petrol stations again.



Could National have done more?

Several National ministers were also advised over the last three years of the expansion in fuel margins and at various points they tried to jawbone margins lower.

Then Energy Minister Simon Bridges warned oil companies about high margins in a letter in February 2015, which led to a temporary reduction. His successor, Judith Collins, then set up the MBIE inquiry in 2017 and also then recommended the market studies powers be used.

However, they weren't in place and National had not made any progress before the election. Then-Commerce Minister Paul Goldsmith announced in November 2015 that the Government would consult on giving the Commerce Commission market powers. Nothing much happened after that from the Government's point of view.

The Productivity Commission recommended the introduction of market studies in June 2014. The Government did nothing over the next three years to make that happen, apart from embark on consultation. Many of its largest corporate supporters opposed the introduction of market studies.

Now National Leader Simon Bridges is now calling on the Government to abandon its fuel excise increases of 10.5 cents a litre over the next three years. But he has also not ruled out keeping the levies in place if he were to win power in 2020.

National introduced similar sized fuel levy increases during its time in power to help pay for Roads of National Significance. Labour is using its levy increases to help pay for rail and other public transport, along with road safety improvements.

Could the industry fix itself before the Government gets the chance?

Some in the industry argue that the natural forces of competition will mean the problem fixes itself as new competitors will compete away the margin.

Gull and Waitomo have both announced plans to set up stations in Wellington to take advantage of the Gull Effect, while others are keen to use the new Timaru terminal, which is not tied to any of the big three retailers.

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