Caltex by leader6


									8 June 2001

Mr Paul Baxter
Senior Commissioner
Independent Competition and Regulatory Commission
GPO Box 975

Dear Paul

Thank you for meeting with Caltex in Sydney on 16 May to discuss the inquiry into
motor vehicle fuel prices, which provided an opportunity for Caltex to put its views to
you in relation to each of the terms of reference.

The attached submission summarises our views and provides some data that may
assist you with the inquiry.

Please contact me if you would like further information (tel: 02 9250 5357 or 0411
406 379, fax: 02 9250 5664, email:

Yours sincerely

Frank Topham
Government Affairs Manager

Copy to: Jason Richards, ICRC
Caltex submission to Independent Competition and Regulatory
Commission inquiry into motor vehicle fuel prices, May 2001
(1) Whether an efficient retail price for petroleum is being delivered in the ACT.

Australia’s petrol prices are the fifth lowest in the OECD including tax and the lowest in the
OECD before tax, as shown in Chart 1. The reason for this is the highly competitive petroleum
market in Australia, which has resulted in both low costs and low profitability.

The annual Downstream Oil Industry Financial Survey conducted for the Australian Institute of
Petroleum by Ernst & Young shows that over the 5 years to 1999 (the 2000 survey is not yet
published), the industry reduced operating expenses in real terms and on a unit cost basis.

In the same period, the Survey showed net profit after tax in the range $212 million to $484
million (adjusted for stock gain and loss caused by movements in world oil prices) on assets of
about $10 billion. Clearly, the oil industry is not making excessive profits – if anything, profit is
inadequate considering the assets employed.

Industry cost efficiency has been created by substantial rationalisation of assets over the past 10
years or more, particularly reduction of numbers of service stations, terminals and depots, and
employees. The merger of Caltex and Ampol in 1995 created substantial increased efficiency,
all of which has been passed on to consumers through lower prices. Caltex operating expenses
decreased from 6.0 cents per litre (cpl) in 1995 to 4.5 cpl in 2000. Caltex net profit of $36
million in 2000 was the lowest of the five years 1996-2000.

(2) Whether there is a higher average cost of fuel in the ACT compared to other capital cities and
    neighbour Queanbeyan.

Chart 2 shows prices published by Informed Sources Pty Ltd for Canberra and Sydney unleaded
petrol over the period September 1998 to April 2001 – the data is adjusted for the difference in
freight rates between the two locations by subtracting freight rates from the published data. The
chart therefore represents the difference in prices due to factors other than freight.

Chart 3 shows similar data for Canberra and Queanbeyan, without freight adjustment as freight
rates are the same or very similar to both locations.

Canberra prices (freight adjusted) were typically 1 to 3 cpl higher than Sydney in the period to
the first quarter 2000. Since then, prices have typically been 0 to 2 cpl higher. Since the middle
of 2000, Canberra has experienced deep discounting similar to many parts of the Sydney market.

The higher price in Canberra is readily accounted for by the substantially higher lease costs in
Canberra, which are a direct consequence of historical ACT government policy to restrict service
station sites. This is well documented by the ACT Assembly 1992 Working Group inquiry into
petrol prices and in Chapter 4 of the 1997 report of the ACT Assembly Select Committee on
petrol pricing.

Confidential Attachment 2 lists head lease costs for Caltex service stations in the ACT and for
similar service stations in Sydney. It is difficult to nominate a typical difference in head lease
costs because of the range in values. However, a lease cost difference of $300,000 per year and
a service station throughput of 6 million litres per year would equate to a 5 cents per litre
difference in costs.

If half the lease cost were allocated to shop sales and half to fuel (and any allocation is
necessarily arbitrary), the difference in lease costs between Canberra and Sydney would account
for all of the difference between Canberra and Sydney petrol prices, apart from freight.

Queanbeyan prices were on average 0 to 1 cpl cheaper than Canberra over the period September
1998 to June 2000 then became a further 1 cpl or more cheaper. The reduction in Queanbeyan
price relative to Canberra in mid 2000 coincided with introduction of the 1 cpl Fuel Sales Grant
to Queanbeyan from July 2001. Differences in lease costs would account for the remainder of the

(3) Whether there is efficient competition in the ACT distribution and retail sectors.

Caltex distribution to ACT service stations is efficient as service stations are supplied directly by
road tanker from Sydney, avoiding double handling at depots. Road haulage contractors are
selected by competitive tender. Most other service stations in the ACT, with the exception of
Shell, are supplied with petrol directly from various Sydney terminals by road tanker.

About half of Caltex service stations in the ACT are highly efficient in terms of sales, with high
fuel throughput of about 450,000 – 600,000 litres per month. About half are inefficient with low
throughput of about 100,000 – 200,000 litres per month. In comparison, average Australian
petrol throughput for Caltex sites is 260,000 litres per month, which is internationally

Many of the smaller sites would have been closed some time ago but for the ACT legislation
restricting disposal of service station sites – in effect, service station sites can only be sold for
more profitable use if there is no prospect of their retention as service stations. In this way, ACT
regulation is contributing to inefficiency in petrol retailing.

However, large volume sites drive price levels in the ACT, so retail prices can be considered
representative of an efficient retail sector.

A number of service stations incorporate large convenience stores, which help reduce fuel prices
by spreading overheads, including high lease costs. However, restrictions on convenience store
operations at service stations in the ACT discourage full development of these operations or
make their establishment difficult.

Market structure is also indicative of an efficient retail sector as there are six major retail chains
with significant presence: Caltex, BP, Shell, Mobil, Woolworths and Gull. Woolworths has 5
sites but has a substantial effect on the market because of its practice of linking petrol discounts
to supermarket purchases. Gull has only two sites but is a leading discounter in the ACT, which
gives it influence on prices beyond its numbers.

Most service stations in the ACT are company/owner operated or commission agency operations.
Very few are franchised sites at which fuel is supplied at wholesale and franchisees are legally
responsible for determining the retail price; a substantial number would be franchised sites at
which fuel remains in the ownership of the supplier and is sold by commission agency.

Of Caltex’s 11 sites in the ACT, 4 are company operated, 3 are commission agency and 5 are
franchised (purchasing fuel at wholesale).

The structure of operations is particularly relevant to any consideration by the inquiry of forms
of regulation, as wholesale price controls clearly are not relevant to a market where very little
fuel is sold through wholesale arrangements.

(4) Whether the fluctuation of ACT fuel prices, particularly prior to public service pay days and
    peak holiday periods, is indicative of a failure in the retail market that disadvantages

Caltex rejects the implication in the terms of reference that fuel prices increase prior to public
service paydays and peak holiday periods – surely this is something that should be subject to
examination of facts, not simply assertion.

Chart 4 shows retail petrol prices in Canberra for the period January through April 2001. Prices
are highly variable, with no clear pattern evident. Although analysis of the data shows some
price increases occur in the week before public service paydays, there is no apparent pattern of
price increases related to paydays.

In the January – April period, prices increased by more than 2.5 cpl (i.e. a substantial price
increase) in Canberra on the following days with the frequency noted:
Monday – 0
Tuesday – 4
Wednesday – 3
Thursday – 1
Friday – 1
Weekend - 0

It follows that petrol price increases are not related to public service paydays. If that were the
case, prices would increase on Thursdays, not on Tuesdays or Wednesdays.

Similarly, prices do not rise because of public holidays, even though they may on occasion
increase before public holidays:
 there was no price increase ahead of the Australia Day long weekend;
 prices increased sharply ahead of Easter but this followed two weeks of discounting, which
    reached an unsustainable level in the days preceding the increase – the increase therefore was
    a result of the deep discounting, not Easter;
 prices increased before Anzac Day but once again this occurred following a two week period
    of discounting which reached an unsustainable level.

In general, most major petrol markets follow one or two week cycles which may be quite
regular. Canberra price cycles tend to be irregular but quite pronounced. It is inevitable that
some upward price movements at the end of periods of discounting will occur before public
holidays or public service paydays.

There appear to be two fundamental causes of price cycles in the Australian market: over-
capacity of petrol in Australia’s refineries and the unfortunate heritage of previous price
regulation by the ACCC.

Australian refineries have the capacity to supply all of Australia’s petrol needs, so that supply is
available to large independent retail chains, such as Woolworths, Gull and Liberty, at a price that
is competitive with the marketing operations of the refining companies . In addition, the market

is open to imports of fuel through independent terminals. This creates a highly competitive, low
cost petroleum market.

Prices decrease as service stations chase market share – this can last up to two weeks. In this
period, oil companies subsidise their franchised sites through rebates or cut margins at their
commission agent or company operated sites.

Net wholesale prices often go well below cost at the bottom of a cycle until one competitor
withdraws rebates or raises pump prices. Competitors often follow within hours to stop the
financial pain of discounting. Prices don’t all increase at the same time. Competitors react over
hours or even days once they see what the opposition is doing.

The market is very efficient in delivering the lowest possible prices over the course of the price
cycle but the volatility is a concern to some consumers. Others recognise that by buying fuel at
the low point of a cycle, they can save money.

The ACCC regulated maximum wholesale prices up until 1998, when the regulation was
recognised to be ineffective and even counterproductive to the government’s objective of
restraining country prices.

An effect of the ACCC cap on wholesale prices was to increase volatility of city prices. The
reason is that the cap was calculated to cover wholesalers’ costs and provide a reasonable return
on investment. However, the market-clearing price was often well below the cap, particularly in
capital cities.

As a result, the cap created price cycles. Companies tried to sell at a price based on the cap but
found this price could not be sustained in a highly competitive market. When the pain of
discounting became too great, the price jumped back to the ACCC maximum.

People often ask how it is that everyone moves up to the same price at the end of a cycle and
they often allege some form of collusion or price-fixing. The answer is quite simple – pricing
follows a methodology established by the competition regulator.

The ACCC price regulation has gone but the market still follows the pricing methodology it
established – it is very difficult to change pricing structure when competitors and customers
behave according to the old rules.

In this sense, there is a failure in the retail market – but it is regulatory failure (or the vestiges of
regulation) not failure of the competitive market itself. The solution is not more regulation but to
allow the market to normalise itself as old regulation-induced practices disappear from the
market over time.

(5) The efficacy of the Petroleum Products Pricing Amendment Act 2000 passed in Western
    Australia and whether similar reforms would provide a net benefit to the community as a
    whole in the ACT.

The Petroleum Products Pricing Amendment Act creates a number of measures intended to
improve price transparency at terminals (but not all of the Act is yet in operation):
 posting of terminal gate prices for spot market sales;
 posting of prior month price data at terminals;
 posting of maximum wholesale prices (if applicable) at terminals;

   information on invoices;
   roadside price boards at service stations; and
   the requirement for a retailer to advise the government of the price of fuel the retailer intends
    to sell for the next day - the so-called FuelWatch scheme. (It was intended that the notified
    price would be the only price that fuel could be sold for the next day but a fault in drafting
    means that retailers have the choice of the nominated price or the previous day’s price. This
    fault will be corrected by legislation currently before the WA Parliament.)

While not part of the Act, the government has also implemented a maximum wholesale price at
the terminal gate under the Petroleum Products Pricing Act.

Measures for price transparency at terminals are not relevant to potential ACT regulation as most
petrol is supplied to service stations, apart from Shell service stations, directly from terminals in
New South Wales. ACT regulation can not impose transparency requirement on New South
Wales terminals.

A maximum wholesale price is not relevant to potential ACT regulation as little petrol is sold at
wholesale – almost all petrol is sold though company operated or commission agency sites. A
maximum wholesale price would apply to a handful of franchised sites – mostly Caltex – and
possibly a small number of dealer owned sites; it would have no effect on ACT petrol prices.

This leaves a WA-style FuelWatch arrangement as the only aspect of the WA Act that could be
implemented by ACT regulators. However, Caltex would be strongly opposed to such an
arrangement as anti-competitive and against the interests of consumers.

FuelWatch is intended to reduce fluctuations in prices but the level of prices in WA is to be
influenced through maximum spot market wholesale prices and regulated, in certain country
towns, through maximum retail prices. FuelWatch is not intended by the WA government to
affect the level of retail prices.

However, limiting retail price movements to once per day greatly inhibits discounting as one
competitor must wait for 24 hours before trying to undercut another. Given the prevalence of
discounting in most city markets, any limitation of discounting seems certain to increase prices
relative to an unregulated market.

Experience in WA to date is that fuel suppliers are still coming to grips with pricing strategies
under the FuelWatch system. Discount cycles have continued, although less regular than before.
Within the cycles, the pricing behaviour of individual suppliers has been much more erratic, with
large swings in prices from day to day. This has created significant problems for service station
operators, with large swings in fuel and shop sales from day to day.

In summary, it is too early to draw any firm conclusions from WA experience, particularly as the
regulation itself is flawed. However, it remains likely that prices will increase over time as
volatility is reduced.

(6) Whether there are tied arrangements between retailers and distributors in the ACT fuel
    market that have the effect of restricting competition.

As previously discussed, most service stations in the ACT are directly operated by oil companies
or independent chains or operate under commission agency arrangements. As the fuel remains in
the ownership of the fuel supplier until sale to the motorist, there are no tied arrangements

between the retailer and distributor or supplier. In the case of the few franchised sites that
purchase fuel at wholesale for resale to the motorist, supply is tied. Most, if not all, of these
would be Caltex sites – a total of 5 sites.

Arguments have been put forward in WA in favour of so-called “50-50” legislation, under which
a franchisee may purchase up to 50% of fuel from other than the franchisor. This legislation,
which does not apply to existing contracts, is currently before the WA Parliament.

Caltex’s key arguments against 50:50 legislation in WA are as follows. These arguments are
relevant to such legislation generally.

 Threat to fuel quality: Caltex is able to maintain tight control over fuel quality through
  exclusive supply arrangements to its franchisees. Inevitably, 50:50 legislation will increase
  the risk of substandard fuel being sold as franchisees will not be in a position to know the
  quality of fuel received from some other suppliers. Fuel substitution has been a major
  problem in eastern states and we believe it is essential, for reasons of environmental
  protection and vehicle operability, to avoid such problems in Western Australia. Caltex will
  not be responsible to any customer in respect of contaminated fuel unless it can be shown the
  product sold and dispensed to the customer was in fact supplied by Caltex to the premises for
  sale. In the absence of this proof, the customer will need to rely solely upon remedies against
  the retailer.
 Contrary to brand image: Caltex has put substantial resources into building its brand, which
  gives us a benefit against unbranded or minor brand competitors. We could not allow our
  brand to be compromised by franchisees selling fuel of unknown origin and quality through
  franchised service stations. Branding would have to be removed from any service stations
  that did not sell Caltex-supplied fuel exclusively.
 End of franchising: because Caltex could not allow fuel from other suppliers to be sold
  through its branded sites, franchising could not be continued once current contracts expired.
  This would greatly disadvantage the 98 Caltex’s branded and franchised service stations,
  which are run by independent small business people.
 Loss of investment: Caltex does not invest millions of dollars in service stations so that they
  can be used to sell competitors’ fuel. It is most unlikely, if 50:50 legislation were
  implemented, that Caltex could continue to invest in service station acquisition or
  refurbishment in Western Australia. This, together with debranding, would lead to a
  lessening of competition in Western Australia.
 Increased market power to large, vertically integrated chains: although Labor’s legislative
  proposals appear to apply to all retailers, only franchised service stations will be affected.
  This is because other sites are either company owned and operated or commission agents
  (which have consignment stock) and neither of these types of service stations purchase fuel.
  50:50 legislation would concentrate market power in the hands of large vertically, integrated
  chains. Franchisees of major oil companies and small single-site or multi-site independents
  would be squeezed out of the market.





Reference for Investigation Under Section 15

Pursuant to subsection 15(1) of the Act, 1 refer to the Independent Competition and Regulatory
Commission (the "Commission") the matter of an investigation into motor vehicle fuel, including
petroleum, diesel and gas, prices in the ACT.

Specified Requirements in Relation to Investigation Under Section 16

Pursuant to subsection 16(1) of the Act, 1 specify the following requirements in relation to the
conduct of the investigation:

The Commission is to have regard to the following in its report on the Inquiry:
(1)      whether an efficient retail price for petroleum is being delivered in the ACT;
(2)      whether there is a higher average cost of fuel in the ACT compared to other capital
         cities and neighbour Queanbeyan;
(3)      whether there is efficient competition in the ACT distribution and retail sectors in
         the ACT;
(4)      whether the fluctuation of ACT fuel prices, particularly prior to public service pay
         days and peak holiday periods, is indicative of a failure in the retail market that
         disadvantages consumers;
(5)      the efficacy of the Petroleum Products Pricing Amendment Act 2000 passed in
         Western Australia and whether similar reforms would provide a net benefit to the
         community as a whole in the ACT;
(6)      whether there are tied arrangements between retailers and distributors in the ACT
         fuel market that have the effect of restricting competition; and
(7)      any other related matter.

In undertaking the inquiry, the Commission is to:
 (i)        conclude the Inquiry by 30 June 2001 and report as soon as practicable thereafter;
 (ii)       note the ACCC Inquiry and restrain (sic) from unnecessarily inquiring into those
            issues under reference to the ACCC;
 (iii)      focus the Inquiry to those changes that have occurred since previous Inquiries into
            the ACT motor vehicle fuel, including petroleum, diesel and gas, market; have
            regard to the Government's view that the reasonable costs of the Inquiry ought not
            exceed $60,000; and
 (iv)       have regard to the Inquiry report being advice to the Legislative Assembly.

Dated this 14th day of April 2001

D:\Docstoc\Working\pdf\a8eb6bf7-2d5d-4a39-bd29-4bd8abf88e86.doc 03/06/2003 3:36 PM   Frank Topham

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