The price drivers - why petrol costs so much

When petrol prices hit $1.76 a litre two weeks ago it focused motorists' minds once more on the strange ways of the fuel market.

Crude oil prices go up, petrol goes up; crude oil prices go down, petrol prices stay up.

And like a flock of starlings, rival petrol retailers seem to have an uncanny ability to move their prices in unison.

All this makes consumers think dark thoughts about cartels and collusion in the petrol market.

So is there a lack of competition in New Zealand's fuel market?

The answer is yes, but not in the way people believe. Most of us think the price of petrol should relate to how much it costs. Economics says otherwise.

Retailers will sell petrol for as high a price as possible, constrained by only two things how much consumers will pay, and the price competitors charge.

In the petrol market, competition is based almost entirely on price. Consumers can't tell the difference between petrol brands, and government standards prevent fuel specifications varying to any appreciable degree.

Advantage might therefore accrue to the marketer with the lowest costs, because they would be able to attract market share with lower prices while maintaining profitability. This is where the New Zealand market starts to show its quirks.

Most of our petrol is supplied by the big four BP, Caltex, Shell and Mobil. They buy their crude oil stocks on the same global markets, ship it to New Zealand in the same ships, process it in the country's only oil refinery, which they jointly own, ship it around the country through a shipping company they jointly own, and store it at terminals they share.

Under the circumstances, it would be surprising if the big four did not have the same fuel prices.

This concentration at wholesale level was a factor highlighted by Australia's Competition and Consumer Commission in its report last month on the petrol industry.

The six-month study, involving 18 hearings in 12 cities, was the 44th and most comprehensive inquiry at state or federal level into Australian petrol prices.

It decided that while the industry was "fundamentally competitive, it became clear in the course of the inquiry that the major refiners have established a comfortable oligopoly".

Australia differs from New Zealand in that there are seven refineries BP, Shell and Caltex have two each, Mobil one.

But the potential competition among them is limited by "buy-sell" contracts through which the companies agree to supply each other.

There is also limited opportunity for independent imports outside the big four, said the report, partly because of limited access to terminals and wharfage.

These factors hold true to a greater degree in New Zealand where the only independent importer is Gull Petroleum, which built its own terminal at Mt Maunganui in 1998 using second-hand storage tanks from Marsden Power Station.

It's interesting to note that in the past 10 years, New Zealand's Commerce Commission has conducted only one study of the overall petrol market, which consisted of asking the petrol companies to explain their pricing decisions during a five-month period in 1999. The commission decided there was no collusion.

In March 2000, Deputy Prime Minister Jim Anderton asked the commission "to investigate petrol prices to see if there is sufficient competition in the marketplace". The commission did not do so, and referred him to its conclusions of the previous year.

Among the usual explanations for petrol price movements is that they are tied to international markets, not just for crude but also for refined products for example, if prices overseas are much higher than in New Zealand, Marsden Point refinery would export petrol rather than sell it here.

The fuel companies are justified in this argument, although there are some details about Marsden Point which suggest they are being economical with the truth.

Firstly, crude arrives at the refinery less than once a week after a journey of at least two weeks if it comes from the Middle East, which most of it does. The notion that petrol companies therefore face daily changes in cost, which must immediately be passed on to customers, is therefore hard to support.

A more likely scenario is that headlines about crude prices are a useful signal for retailers to put up their prices together.

Secondly, the price of petrol is related to the international refining margin, which sets the fee the big four must pay to refine their crude. But while petrol prices have been pushed up by high global refining margins (caused by a lack of refining capacity), New Zealand refining fees are capped under a deal between NZ Refining and the big four. This means motorists are immediately paying for higher refining margins, but BP, Caltex, Shell and Mobil are not.

The benefit of this deal to the big four is currently $US12.4m ($16.1m), small beer in the context of their huge revenues, but helpful nonetheless.

There are other reasons why the connection between local and global prices is not as strong as petrol companies like to make out.

For example, data collected by Westpac chief economist Brendan O'Donovan shows the margin between New Zealand retail prices and the New Zealand price of imported petrol (the importer margin) varies hugely since 1999 the figure has been as low as 7.8 cents a litre and as high as 28.4 cents.

The disconnect between world market prices and retail is nowhere more clear than in Australia, where pump prices vary in a big sawtooth weekly cycle cheapest on Tuesdays, most expensive on Thursdays.

Market monitoring company Informed Sources, which supplies Australian petrol retailers with instant data on competitors' prices, sees this "Edgeworth cycle" as a sign of an absolutely pure competitive market. New Zealand's lack of an Edgeworth cycle, says managing director Alan Cadd, shows it is less advanced and less competitive than Australia.

"In order to get to that Edgeworth cycle you need to have free access of minor players to product," he told the Star-Times.

Until this country gets a more competitive market, he said, Informed Sources will restrict its New Zealand petrol price monitoring to "drive-by" services. Of this country's retailers, only Chevron said it was using Informed Sources price data.

In conclusion, New Zealand's market is not competitive at wholesale level. So although there is retail competition, it makes limited difference to prices.

But let's take heart. New Zealand still has relatively low petrol prices compared to other countries and prices do go down as well as up over time.

One final bit of data is also worth remembering. In January 2000, crude oil represented 29% of the price of a litre of petrol. This month it's 42%. In percentage terms, retail margins are getting smaller, not bigger.

- © Fairfax NZ News