The Commerce Commission report indicated all fuel companies had made 'excess returns' in the three years up to 2018. Photo / AP
The Commerce Commission report indicated all fuel companies had made 'excess returns' in the three years up to 2018. Photo / AP
COMMENT
The petrol industry at home and abroad has been subject to hundreds of competition authority inquiries. The market study by our Commerce Commission took 424 pages to sit on the fence. About the only time a competition authority anywhere finds a smoking gun is when a whistle-blower squeals ona couple of neighbouring petrol stations phoning around to end their latest price war.
The commission found excess profits because if you torture the data for long enough, it will confess.
But first, I digress across the ditch to the hub of the matter. When I worked on the Australian Productivity Commission's 1994 public inquiry into petrol pricing, everyone agreed that the only thing that made petrol special was each capital city could only support one refinery. New Zealand only has one refinery too. If the independents could import rather than queue at the city refinery, jointly owned by the oil majors on terms they dictated, competition was fairly assured. Who was I to know that a mere four years later, Gull would set up in New Zealand to import petrol profitably ever since? Gull proved new entry is easy into the petroleum industry. Instead of risking $3 billion on building its own refinery, Gull imports what it needs to a network that grew to 90 stations.
The commission begrudgingly admits that entry is easy into petrol retailing but nonetheless spent hundreds more pages in its market study looking for excess profits. The commission found excess profits because if you torture the data for long enough, it will confess. But the idea that profits tell you anything about the state of competition died a brutal death in economics in the 1970s. It is not taught in economics classes other than as a famous wrong turn in thinking about competition policy.
The number of firms in an industry is the result of competition, with the more efficient firms growing larger or shrinking if that's the latest way to now survive in competition. High profits signal superior efficiency. The oil majors are leaving retailing rather than seeing it as a wellspring of excess profits.
Petrol prices are volatile because, like the airline industry, the petrol industry has high fixed costs, fixed capacity, the risk of excess capacity and an expensive inventory it must clear soon. Airlines commit to a daily flight schedule and sell seats at whatever set of prices will maximise revenue.
Once a petrol station has its regular delivery, a clock is ticking; it must clear that inventory before the next tanker comes. Other stations know that too and are tempted to cut prices a bit to clear their own inventories. After each price spike from an international oil price rise, prices fall gently as each station undercuts others. Eventually everyone is losing money until one station dares to lift prices.
These price cycles are called Edgeworth cycles and occur around the world. Michael Noel of Edgeworth Economics found that cities with these Edgeworth cycles had lower than average petrol prices. Stations lost money when prices spiked but made enough to stay in business as prices slowly fell.
The commission finally revealed its criteria for markets unlikely to be predisposed to collusion on page 227 of its market study. These were more than a few competitors; an independent interested in price cutting; secret discounting (such as through fuel cards to one-third of the market); strong non-price competition; petrol often seen as a loss leader for the convenience store; and frequent, often big changes in international crude oil prices.
Jim Rose. Photo / Matt Silcock
The history of cartels is a history of double crossing. Even cartels with bog standard products and stable costs are riven with suspicions of secret cheating. Although petrol retailing is riddled with ruinous price wars, their inevitable end is seen as evidence of possible collusion by the commission.
This reminds of Joseph Schumpeter's most famous quote from his Capitalism, Socialism and Democracy: "Capitalism stands its trial before judges who have the sentence of death in their pockets. They are going to pass it, whatever the defence they may hear; the only success victorious defence can possibly produce is a change in the indictment."
• Jim Rose is an economic consultant in Wellington and blogs at utopiayouarestandinginit.com
