Business

All eyes on Commerce Commission’s fuel study

The Commerce Commission's first market study will wade into the complex fuel market. Here's what you need to know.

All eyes will be on the Commerce Commission on Tuesday morning when it releases a draft copy of its first ever market study.

The commission was given the power to undertake regulatory investigations into markets by the Government in October. 

The first sector to go under the microscope was Prime Minister Jacinda Ardern's punching bag at the time: fuel companies.

On October 8, she told reporters that "consumers, in my book, are being fleeced" by companies like Z Energy and BP, and went on to accuse gas companies of profiteering.

Jonathan Young, National's energy spokesman, said Ardern's remarks were "a very strong statement. I would never have stated that."

After the blistering attack, Z's NZX stocks dropped from $7.16 a share to a low of $5.18.

While the shares have recovered somewhat in value - hitting $6.70 last week, the highest since October 5 - they're at risk again depending on the commission's report.

Margins matter

For their part, fuel companies explained away rapidly increasing profit margins as returning to historical averages after a decade of price wars, from 1998 until the creation of Z in 2010. Since then, Z has had the publicly-stated mission of increasing margins to a sustainable level.

Prior to 1998, margins on regular petrol fluctuated between 20 and 80 cents per litre, but mostly remained between 30 and 40 cents.

That year, however, Gull and Challenge entered the fuel market, driving prices and profits downwards.

Margins hit a low in 2008 of around three cents per litre, and remained sub-20 until the formation of Z Energy from the remnants of Shell.

Regular petrol and diesel importer's margin

Since then, margins have rebounded upwards, hitting a 21st-century high of 41 cents per litre just a couple of weeks after Ardern's profiteering comments.

After October, profits dropped a bit, and have hovered around the high-20s and low-30s while anticipating the commission's report.

So while Ardern isn't wrong to point out that profits have on average doubled between 2008 and 2017, that misses some of the historical scope, economist and former Commerce Commission member Donal Curtin says.

Moreover, profits as a factor of overall fuel price still have yet to return to pre-1998 levels. In 1989 and 1995, for example, about a quarter of the price of fuel went to profits.

In December 2018, the latest for period which data is available, that number was around 16 percent. That's double 2007's eight percent, but still a far cry from two decades ago.

Wellington suffers

In addition to examining profit margins, the commission is looking into regional price differences.

According to a 2017 paper from the Ministry of Business, Innovation, and Employment (MBIE), fuel prices from the three major gas retailers in New Zealand - BP, Mobil and Z Energy - are far higher in Wellington and the South Island than the rest of the country.

This is colloquially called the Gull effect. Cheap, self-service retailers like Gull and Hamilton-based Waitomo offer competition across the North Island, but have yet to expand in the South Island or - excluding a brand new Waitomo station in Upper Hutt - Wellington.

Therefore, MBIE suggested, the big three companies might be charging customers in Wellington and the South Island more in order to subsidise their competition with Gull and Waitomo elsewhere.

The chart below, from MBIE's paper, demonstrates this.

According to the chart, BP, Z and Mobil earned a full 10 cents per litre more in profits from Wellingtonians and South Islanders than the rest of the country.

But profits aren't the only considerations that the commission is making.

As noted, profits as a proportion of prices remain below pre-1998 levels. But this has less to do with the profits themselves - which, in 2018 dollars, are around the same level as pre-1998 - and more to do with the high price of fuel.

Although New Zealand's petrol price dropped slightly following deregulation in 1988, by 1993 it was back on the rise. New Zealand's pre-tax price of fuel consistently ranks among the top three in the OECD. 

According to AA, that isn't because of the cost of shipping fuel to New Zealand. That only makes up around two percent of the cost of a full litre - so under five percent of a pre-tax litre.

"The issue that we had to confront is, fuel is expensive compared to what? We were asked if fuel prices are reasonable and we had to ask back, how do you define reasonable?"

Part of the Commerce Commission's mission is to figure out why these prices are so high and what can be done about them.

But Richard Meade, an economist who worked on the 2017 MBIE paper, says that this isn't the right question to be asking.

"The issue that we had to confront is, fuel is expensive compared to what? We were asked if fuel prices are reasonable and we had to ask back, how do you define reasonable?" Meade says.

"For us, that comes down to if we could come up with a better industry structure in New Zealand that would deliver better outcomes to customers and would it be net-positive on a cost-benefit basis to try to shift to that alternative arrangement?

"Unless you can say that we could do all of that, you've gotta live with what you've got."

What could we see?

The 2017 MBIE report was unable to determine whether there was any anti-competitive behaviour in the industry because a number of companies declined to divulge requested information.

With its new powers, the Commerce Commission can force companies to hand over what it needs, meaning that one way or another, it's likely to come to a conclusion.

"I think it's good that the Commerce Commission is able to look deeply and require the companies to provide information so that can get data on as consistent a basis as possible," Meade says.

"There were other things that we couldn't get our hands on at all in the 2017 study which the Commerce Commission should be able to get their hands on."

Curtin says that, if the commission determines that companies are profiteering or engaging in other anti-competitive behaviour, it will likely turn to "standard competition law", while Meade believes the commission may have to recommend the Government pass new legislation to deal with any problems.

"It's not clear, for example, that the Commerce Commission could necessarily say the fuel industry needs to go and create a wholesale market," Meade says, The wholesale market was an idea brought up by the MBIE paper.

Regardless of what the commission determines in Tuesday's release, the report will just be a draft. It will then take consultation on the draft before putting forth its final recommendations.

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