Gasoline Prices and the Public Interest
The Consumer Advocate's Report on Gasoline Prices
in the Province of Newfoundland and Labrador
CHAPTER TWO
Definitions
1. Agency - a mode of operation for a gasoline retail outlet where the outlet operator acts as agent for the company that supplies the branded product.
2. Ancillary service - services provided by a retail gasoline outlet in addition to the sale of petroleum products, such as convenience stores, car washes, vacuums, and fast food outlets.
3. Bulk Plant - a storage facility used in the wholesale segment of the industry, comprised of a gathering of small to medium capacity tanks.
4. Dealer - a generic term referring to a retail outlet operator. There are several different modes of operation used, including company owned, commission retailer, lessee operator, independent branded and independent non-branded.
5. Downstream - the segment of the oil industry involved in the refining and/or marketing of petroleum products.
6. Ex-tax Pump Price - the retail price of gasoline excluding all taxes.
7. Independent - a retail petroleum operator who is not involved in the refining of petroleum products, and therefore must purchase its supply of petroleum product from a third party.
8. Isolated micro-markets - small, geographically defined retail gasoline markets
9. Integrated Oil Company - a fully integrated oil company is involved in the upstream (ie. exploration and production) and downstream (ie. refining, marketing, distribution and retailing) segments of the industry. A partially integrated oil company is involved in the downstream segment only.
10. Pump Price - unless qualified, the self-serve pump price for regular unleaded gasoline (RUL).
11. Outlet - generic term referring to a retail gasoline station.
12. Participant - a company operating in the retail gasoline business in the Province.
13. Retail Margin (Gross) - the difference between the cost to acquire product at wholesale and the selling price of the product at retail, exclusive of taxes. Usually expressed on a per-unit basis, for example, in cents per litre.
14. Rack - refers to the wholesale of gasoline products. Unqualified, the term refers to the wholesale of gasoline products from a bulk plant or terminal location. Qualified as "at the gate rack", the term refers to wholesale purchase of gasoline products at the refinery.
15. Tankwagon - tractor trailer used for short haul delivery from a bulk plant or terminal to a retail outlet.
16. Terminal - storage facility used in the wholesale segment of the industry, usually comprised of a gathering of large capacity tanks.
17. Throughput - the volume of petroleum sold at a retail outlet in a given period, usually expressed in litres per month or per year.
18. Upstream - the segment of the oil industry involved in the exploration and/or production of crude oil, the raw material from which petroleum products are manufactured.
Description of the Industry
The Newfoundland and Labrador market for gasoline is a relatively small one in comparison to the rest of Canada. In 1996, sales of gasoline for this Province totalled just over 580 million litres.(9) By comparison, the Canadian market consumed over 35 billion litres of gasoline in 1996. Newfoundland and Labrador represents less than 2% of the national market.
The Industry is divided into two sectors - upstream and downstream. The upstream sector involves the exploration and recovery of oil and ends at the point of delivery of the crude product to the refinery. The downstream sector begins at the refinery and ends when the consumer purchases the final product at the retail outlet. The downstream sector employs over 100,000 Canadians.(10)
Crude Oil Supply And Refining
Crude oil is the term used to describe oil in its natural state as it is pumped from sea or land based wells and is traded in barrel quantities. One US barrel equals 159 litres. The majority of Canadian crude oil production or upstream activity occurs in Western Canada. It is hoped that this may change with the expectation that the Hibernia and Terra Nova fields will produce a combined 235,000 barrels of oil per day.(11)
The gasoline retail market is one part of a multi-faceted industry. With the recent production of crude oil from Hibernia, Newfoundland and Labrador has joined a select group of provinces that sustain all aspects of both the upstream and downstream segments of the industry. Government will earn substantial revenue from the industry, directly from royalties and taxes and indirectly from revenue earned on corporate and personal income taxes. Accordingly, Government should continue to develop policies that take into account all aspects of the industry, including the crude oil market, as well as the wholesale and retail petroleum markets at the local, national and international level. The Province should maintain a sound understanding of the retail market dynamics so that the benefits enjoyed by the presence of the industry will be maximized for the Province.
In 1996, approximately 118 million barrels of crude oil were imported into Atlantic Canada. Atlantic
Canada is a net exporter of refined petroleum product(12).
Most gasoline sold in this province comes from crude oil produced in either the United States, the North Sea or the Middle East. The price of crude oil is determined by the world market. Refineries not associated with a fully integrated oil company will contract with oil producers for long term supply arrangements at fixed prices or purchase on the spot market and take immediate deliveries.
Similar to the rationalization taking place in the retail segment of the industry, which is discussed later in the report, the number of refineries operating in Canada has dropped from 40 in the early 1980s to 21 in 1995.(13)
The only refinery in the province is located in Come By Chance. It is owned by North Atlantic Refinery, a provincially incorporated company that is, in turn, owned by the international commodity broker and shipper Vitol Refining S.A. Inc. The refinery has a capacity of 99,750 barrels per day.(14) The current owners of the refinery have conducted an aggressive capital improvement program, involving the expenditure of over $150 million dollars in the last four years.
Petro Canada held title to the refinery in the early eighties, when, as a crown corporation of the Federal Government, it purchased the refinery and bore the cost of mothballing the facility.
When Petro Canada eventually sold the refinery it attached a restrictive covenant to the facility which prevented the new owner from selling product refined at the facility to the Canadian market, excepting Newfoundland and Labrador. This restrictive covenant runs with the facility and, as such, binds all subsequent owners, including the current owners. The restriction impedes the ability of the Come By Chance refinery to compete directly with the other integrated oil companies. For example, North Atlantic Petroleum, the retail arm of North Atlantic Refinery, cannot bid on tenders issued by Nova Scotia Power for the bulk purchase of petroleum products.
In response, the refinery has configured its operations in order to produce reformulated gasoline (RFG). RFG produces fewer pollutants when it is burned and is legislatively required in parts of the United States market. Accordingly, the vast majority of the gasoline refined at Come By Chance is sold to the US market. The portion of gasoline refined at Come by Chance that is sold in the Province is distributed under the North Atlantic Petroleum brand, a relatively new entrant to the market.
If North Atlantic Petroleum was free to sell product refined at Come By Chance to the Canadian market without restrictions, it is conceivable that the total volume of gasoline sold would increase significantly. Particularly where the sale is made in bulk, as would be the case for Nova Scotia Power, increased sales could potentially result in an increase in efficiencies by lowering the marginal cost. If these potential gains in efficiency were passed on to consumers, North Atlantic Petroleum may be in a position to retail in this Province at a lower price than at present. In effect, the consumers of this Province are adversely impacted by the presence of a restrictive covenant which limits the competitiveness of the North Atlantic Refinery.
The remaining gasoline sold in this Province generally comes from either the Irving Oil refinery at Saint John, New Brunswick, or the Imperial Oil refinery at Dartmouth, Nova Scotia or from imports of European product.
The Atlantic Canada refineries are capable of producing a combined 419,450 barrels of refined product per day.
In Newfoundland and Labrador, Canadian Tire and Co-op Atlantic are usually supplied with gasoline from either Imperial or Ultramar, or both. At the present time, one of the major oil companies receives the majority of its supply from European refineries. The Irving refinery in Saint John, New Brunswick, services Irving outlets. The majority of the other outlets in the Province, regardless of brand, are supplied from either Imperial Oil or Ultramar.
With the exception of the product sold by North Atlantic Petroleum branded outlets, gasoline sold in this Province is shipped to Newfoundland and Labrador in bulk carriers and stored at terminals or bulk plants located throughout the Province. All terminals are serviced by marine tanker, except for Labrador West which is serviced by rail. Tankwagons then transport the gasoline from the terminals to the retail facilities where the fuel is stored in underground storage tanks.
Crude Oil Price v. Pump Price
Crude oil and gasoline prices do not always follow similar patterns. In the long term there is a direct correlation between the price for crude oil and the pump price for gasoline, but in the short term these prices can become unconnected, sometimes moving in opposite directions.(15)This is consistent with the general proposition that the industry is market driven in the short run, but cost driven in the long run. By example, in early 1997 the price of crude fell to 0.8 cents per litre below the recorded average for 1990. However, the ex-tax pump price for regular unleaded gasoline was down 8.8 cents per litre in the Montreal market and down 4.5 cents per litre in St. John's(16).
Studies have shown that in almost every Canadian city 100% of an anticipated change in the cost of crude is eventually passed through to retail prices.(17)
Imperial Oil reported in 1996:
To assume that the price of crude has a short term impact on the pump price of gasoline is similar to assuming that a change in the price of steel will have an immediate impact on the price of an automobile. As with crude and retail gasoline prices, in the longer term the price of steel must be reflected in the price of the car. However, temporary fluctuations are less relevant.(18)
Wholesale Market
Since gasoline is bought and sold internationally, and moves easily across international borders, the wholesale price in Newfoundland and Labrador, no matter where the product is actually produced, reflects international commodity market prices.
There are several ways in which gasoline is sold at the wholesale level. The largest quantities sold, usually delivered by cargo ships or pipelines, are priced with reference to a spot or one-time price at a particular location. Spot prices are publicly available for many international locations and are published in periodicals such as Bloomberg Oil Buyer's Guide.
Wholesale gasoline can also be purchased either directly from the refineries ("at the gate rack") or from the terminals or bulk plants operated by the major oil companies ("rack"). Many Canadian oil companies publish "rack" prices for gasoline picked up at the refinery gate or the terminal. Each market has a wholesale price which may influence local pump prices. The wholesale price will reflect the commodity price (eg. New York Harbour), local transportation costs and terminal storage charges, and other extraneous factors.(19)
Ultramar is the only company that publishes a rack price for Newfoundland and Labrador. Rack prices are used as a proxy for the ex-tax refinery price even though little gasoline is actually sold at the rack in Canada.(20)Discounts off rack are provided for some high volume customers, with the amount of the discount determined by the volume purchased. Typically, the wholesaler will provide a 1 to 1.5 cents per litre discount. In some instances a wholesaler will charge a premium over the posted rack, usually when the volume of the purchase is low.
For Eastern Canada, the key market is New York Harbour. Over time the wholesale price of gasoline in St. John's correlates with the price in New York Harbour. The wholesale price of gasoline in St. John's also correlates to the wholesale price of gasoline in Montreal, which is to be expected given the influence of New York Harbour on both.
Similarly, the pump price for gasoline in St. John's generally follows the St. John's rack price. The following graph confirms the shrinking gross retail margin experienced by outlets over the last seven years.
The St. John's pump price (ex-tax) compares favourably with the pump prices (ex-tax) for each of the other Atlantic Canada capital cities.
Retail
The province has approximately 545 gasoline retail outlets currently in operation. Just two years ago the number of gasoline outlets in operation was estimated at 643(21). This represents a 15% decrease in outlets during the period.
A key measure of efficiency used in the gasoline retail trade is the number of litres sold by an individual outlet. The calculated average volume, or "throughput", for all outlets in this Province during 1997 is approximately 1.0 million litres annually. This compares with a throughput of approximately 900,000 litres annually in 1995. The average throughput for the Province has been steadily increasing during the past four years. A sampling of industry provided data demonstrates the trend.
However, Newfoundland and Labrador's average throughput is
still below the national average and in fact is the lowest in
Canada. By comparison, the average throughput in New Brunswick is
over 1.3 million litres annually.(22)
Per capita, there are twice as many service stations in Canada than in the United States. Accordingly, the average throughput is almost twice as high in the US (10,000 litres per day) as compared to the Canadian average (6,000 litres per day).(23) Curiously, over 75% of gasoline sales in the United States are self-serve, compared to 25% for Canada.
Over 70% of the outlets operating in Newfoundland and Labrador are branded dealers of either Irving, Ultramar or Imperial. Independents account for approximately 8.6% of the Newfoundland and Labrador market. Newfoundland and Labrador has fewer Independents operating in the market as compared to most other provinces.
Irving, Ultramar and Imperial have a combined 85.6% share of the gasoline market in Newfoundland and Labrador.
The retail industry consists of integrated oil companies (Irving ,Imperial, North Atlantic, Petro Canada and Ultramar) and Independent marketers. These integrated companies are either national or regional in scope and usually provide gasoline to their own network. In some provinces, as is the case for Newfoundland and Labrador, an integrated company may not have access to its own product. These companies enter into exchange agreements with other companies that have terminals. Still other companies sell imported product rather than accessing local wholesale markets. Independents must buy wholesale at a local level or import.
There are different modes of operation employed in the running of outlets. The particular mode of operation chosen, together with the nature of the contractual agreement entered into between the dealer and the supplier will determine who has the authority to set pump prices.
Taxes
While the ex-tax price of gasoline in St. John's compares favourably with the ex-tax price in the capital cities of the other Atlantic provinces, the after tax price is higher.(24) Combined, provincial and federal taxes account for over 51% of the pump price in St. John's.
Nationally, while the price of gasoline, in inflation adjusted dollars, has fallen 25% since 1957, taxes, during the same period, have increased by 60%(25). Still, Canada's average tax rate on gasoline is one of the lowest of the industrialized nations.
Anatomy of a Price War
Over one half of all outlets in Canada operate as lessees or independent dealers, in which case the responsibility for deciding upon the final retail pump price resides at the local dealer level.(26) Because retail petroleum markets are considered local in scope and determination, the implication is that the competitive dynamic pertaining to these retail markets can, and do, vary considerably from one population centre to another.
One of the more visible pricing events in the gasoline retail trade is a price war. A price war can be defined as a short term lowering of prices to substantially below the normal market price. Price wars are normally confined to a distinct geographic area and are triggered when one outlet lowers their price to below normal levels. Competitors in the area invariably match the lower price. The outlet which initiated the drop in prices will often lower the price a second time and the pattern continues until a floor is set, below which none will venture.
A price war often gives rise to consumer suspicion that the oil companies are enjoying robust margins, "as how could they otherwise afford to sell their product at 10, 15 or even 20 cents a litre cheaper than yesterday"(27). This issue is best addressed by examining the pricing structure of retail pump prices. There are four distinct cost components that comprise a final pump price for gasoline: crude costs, taxes, retail margins, and refining and distribution costs.
Generally, for urban centres in Atlantic Canada, the gross retail margin fluctuates between 3.5 and 5.5 cents per litre. From this gross retail margin, the dealer must deduct the costs of operating the service station, including costs associated with rent, utilities, maintenance and labour, and provide for a return on the investment.
During a price war, a dealer may be forced to sell product below cost. In most instances, the major oil company under which the outlet operates will provide pricing support to a dealer during a price war. This helps the dealer sustain the price war, as otherwise the dealer could be forced to exit the market. Pricing support is not provided for the dealer who started the price war.
Although consumers enjoy the immediate benefit of lower gas prices, a price war can have a detrimental impact on the market. This issue is canvassed in greater detail later in the report.
Price Variation Between Provinces
Consumers have noted the sharp variation between pump prices in Sydney, Nova Scotia, and Channel-Port Aux Basques, Newfoundland. The difference in price between these two regions cannot be fully explained by examining the cost structure of the retail sector. Similarly, taxes, although higher in this Province, do not support a 10 to 15 cents per litre difference in price.
As is the case in price wars, outlets, in certain circumstances, will sell below cost. Evidence indicates that a dealer located in the Sydney area consistently sells below cost. This particular dealer uses discounted prices to attract customers on to the lot in the hope that these same customers will purchase other products that the dealer sells. In effect, the dealer uses gasoline as a loss leader. Similar to the market dynamics in a price war, competitors are forced to sell at this same below cost price in order to maintain market share.(28)
This explains why the price for gasoline in the area of Sydney, Nova Scotia, is significantly lower than in Channel-Port Aux Basques, Newfoundland.
9. 9 Petroleum Products Sales in Newfoundland, 1996. Department of Mines and Energy and Department of Finance.
10. 10 Canadian Petroleum Products Institute, Presentation on Marketplace Dynamics, September 27, 1997.
11. 11 Government of Newfoundland, Department of Mines and Energy.
12. 12 Purvin & Gertz Inc., Competitiveness and Viability Impact on Canadian Refining Industry of Reducing Sulphur in Canadian Gasoline and Diesel, May, 1997 (hereafter the "Refinery Report).
13. 13 Natural Resources Canada.
14. 14 Natural Resources Canada.
15. 15 Natural Resources Canada, Motor Gasoline Pricing Dynamics, August 28, 1996.
16. 16 Newfoundland and Labrador, Department of Mines and Energy, Crude Oil and Gasoline Price Monitoring Report, July, 1997.
17. 17 Ken Hendrick, Analysis and Opinion on Retail Gas Inquiry, 1996.
18. 18 Imperial Oil Limited, Presentation to the New Brunswick Select Committee on Gasoline Pricing, July 19, 1996.
19. 19 Canadian Petroleum Products Institute, August 28, 1996.
20. 20 George Lerner, Economic Report In The Matter of the Competition Act and Mr. Gas Limited and Several Other Ottawa Area Gasoline Retailers (Sunys Petroleum Inc. and Seaway Gas & Fuel Ltd.), April 18, 1995 (hereafter the "Lerner Economic Report").
21. 21 Retail Outlets, 1995, Octane Magazine, Fall 1995.
22. 22 Final Report of the New Brunswick Select Committee on Gasoline Pricing, March 26, 1996 (hereafter the "NB Report").
23. 23 Supra, note 17.
24. 24 Newfoundland and Labrador, Department of Finance.
25. 25 Statistics Canada.
26. 26 M. J. Ervin, & Associates, Canadian Retail Petroleum Market Study(hereafter the "Ervin Report") p. IX ; NB: Octane Magazine places this figure at 44%.
27. 27 Consumer submission.
28. 28. Information obtained from industry consultations (hereafter "Industry").
29. 29 Ervin Report, p. 23.
