The Commerce Commission says its assessment of competition in the retail fuel industry will include whether some geographies or parts of the business are more profitable than others.
The regulator says persistently high prices and excess returns at an industry level may be a sign that competition is not effective. But even where competition is effective, some individual firms may achieve above-normal profits if they offer superior products, or are better at controlling costs.
It says it will need to consider the source of any high profits being made and their impact on the prices being paid by retail consumers. It noted that fuel is an essential and “significant” purchase for households with an average petrol spend of about $1,500 per car a year.
“High levels of profitability at one level of the supply chain – e.g., the wholesale level, or one area – e.g., the South Island, may suggest the factors affecting competition are more significant in that level or area,” the commission said in a paper setting out its approach.
The market study is the first the commission is undertaking under new powers granted by the government last year.
The government’s move was a direct response to a 2017 study led by the Ministry of Business, Innovation and Employment which found pricing in some parts of the country may not be reasonable. Among issues highlighted was the major firms’ control of most of the fuel storage around the country and independent retailer Gull’s complaints that its efforts to gain access to some of that on commercial terms had been rebuffed out of hand.
Fuel prices then became a political football last year as rising crude oil prices and a weak New Zealand dollar contributed to record pump prices. That also highlighted the growing price disparity between areas where Gull operates and where it doesn’t – Wellington and the South Island.
Earlier this month Gull announced plans to open six outlets in the South Island during the next two years, after securing access to a new fuel terminal being built at Timaru. Fellow discount fuel retailer Waitomo plans to open its first South Island outlet in Christchurch this year.
The commission says profitability and prices will be an important part of its work. It wants to understand how suppliers’ returns compare with other local companies, international suppliers and firms’ own cost of capital.
It also wants to understand how and why prices and margins vary around the country, how input costs are passed through to consumers, and whether that has changed over time.
Other factors affecting competition – such as industry structure, existing infrastructure sharing agreements among the major players, and wholesale fuel supply terms will also be considered.
The commission says it also needs to understand consumer behaviour and firms’ pricing strategies.
“Why do retailers use selective price discounting, loyalty and bundling strategies, and how do consumers respond to these?
“Why has discounting increased, and why have importer margins risen at the same time?”
The commission acknowledged the difficulties in assessing profitability and the need to consider industry returns over time.
It noted that retail fuel prices had been relatively high before Gull and Challenge entered the market in 1998. Low margins in the 2000s saw a decline in infrastructure investment and the departure of Shell. By 2017 pre-tax fuel prices were among the highest in the OECD and higher than in many Pacific Island states, it noted.
“In recent years there has been a growing number of new retail sites, retailers, and increased investment in the industry – this entry and expansion may reduce future profitability.”
The commission plans to consider gross margins and returns on capital employed, but will also complement that by reviewing expected returns and cashflows from more recent investments to better understand actual returns and replacement costs in the industry.
The commission noted that many fuel firms’ activities extend beyond just the retail petrol and diesel sales the market study focuses on. Accordingly, their systems may not be able to provide the level of accounting detail preferred.
It plans to rely on existing information where it can. It believes the differing size and scope of the different firms can be catered for, given the commission is aiming to assess the profitability of the widest range of players as possible and isn’t relying on a single approach to do that.
It will also seek to estimate returns over the long term, “having regard to the availability of data and being mindful of the costs to firms from sourcing data over long periods of time.
“Engagement with NZ fuel firms indicates that there are practical and cost limitations on their ability to supply data over extended historic time periods.”