Petrol and Diesel Prices : From Monitoring to Regulatory Guidelines

We often learn, through local media, that we are paying too much for petrol and diesel at the pump. No one can tell how real these claims are and definitely no one knows how much we are paying higher than what a fair price should be.

The Ministry of Economic Development (MED) is monitoring petrol and diesel prices at its website for years through a system called the “Importer Margin” and they are presenting graphs and figures of this system for the public to see. The Importer Margin System is defined as the difference between retail petrol price (minus GST and government taxes) and landed prices of Singapore Spot Prices (for petrol or diesel of similar quality to NZ specs) including freight and insurance. All prices/costs are converted to NZ dollar.

In general terms, the importer margin equals to:
Retail margin + wholesale margin + other expenses (inside NZ) such as transport and storage.

If you consider that retail margin and expenses are roughly constant, then the daily fluctuations in the Importer margin as we see it in MED’s curves translates to how much oil companies wholesale profits are moving up or down!



The problem with the current importer margin system is the following:
1- It is not possible to calculate the wholesale margin that the oil companies are collecting because of the multiple and inter-related factors embedded in the system.
2- There are many "flaws" in the basic assumptions upon which the system is constructed, most are to the companies’ advantage.

In order to achieve a more fair and transparent pricing system, the MED should consider developing its current system from being “monitoring” to being based on “regulatory guidelines” that the companies should comply with. This can be done and I believe that the Australians (through the appointment of “Oil Commissioner”) are slowly moving in that direction.

Peak Oil or Just Peak Oil Prices?

I append hereunder a comment I sent to Peak Oil Website regarding recent fluctuations in crude oil prices and shall be pleased to receive your feed-back on the subject.

Dear Sir

Regarding the article in the Wall St. Journal published Tuesday 16 September under the heading " Peak Oil or Just Peak Oil Prices",please see the link,
I think it is time to understand that there are no "rights and wrongs" in explaining the reasons behind the seemingly "unreasonable" fluctuations in crude oil prices world wide in the last few months. OPEC are blaming " Speculators" driven by greed, and they are right. Consumers put the blame on OPEC for restricting supply "as a mean of getting higher prices" again, they are right. Environmentalist are certain that we are close to hitting "Peak Oil" and that will be true, sooner or later. Economists are relating all this to the rising demand for crude oil from mainly China and India and that is certainly true. Peace movements are talking about "oil- wars" as the reason behind lack of exploration and production in the Middle East and the Caspian, and that is a factor as well. To sum it up, there is no single reason behind the chaos that we see nowadays in the oil market. Serious attempt by all parties concerned must be made to find a solution to a problem that (if not solved) could entail devastating consequences to humanity as a whole. It is very wrong to leave it to "market forces and supply and demand!" to find the answer. We are talking about an "exhaustible resource" within the boundaries of countries that are "politically unstable", the extensive and unlimited use of which might cause real damage to world environment, yet is extremely essential to the development and prosperity of all nations. The solution must be "part and parcel" of a comprehensive policy of "Pricing and Limiting the use of oil " and move towards the development of sustainable energy resources. It is high time that leaders of the world ( through the UN) realise that this planet can not continue running "indefinitely" to serve the interests of the few, It is high time we address the legitimate concerns of all parties of this equation or else, things may run out of control. Thank you

Mundher Al-Saleem

Guidelines for Better Diesel Fuel Supply Contract

The guidelines bellow are especially useful for Transport fleet companies, Contractors, Fishing fleet, Rail operators and all other large scale (Industrial and Agricultural) consumers of "Diesel Fuel" who contract with Oil Companies for the supply of their fuel:
1-Irrespective of the supplier or the approach used, proper contracting (in writing) yields better results as far as the price and overall cost of fuel purchased.
2-It is always better to invite more than one supplier privately or by tender to submit full written offer on document prepared in advance. An ever-green agreement is easier but may be subject to exploitation by the supplier.
3-Written offers should be studied carefully as there will always be problems due to vague or missing provisions in the agreement. You have to remember that however smart you may be, a contract prepared by the supplier will work to his advantage. He has the expertise to embed sentences and provisions which are carefully worded and formulated to give him that advantage.
4-There will be room to improve on offers submitted in the final stages before contracting especially if you have more than one offer in hand and are aware of the market facts and trends.
5-Put a time frame to complete the contracting process and stick to it as this will be respected by the suppliers.
6-Let suppliers be free to submit more than one option as far as prices or price adjustments is concerned as this will give you a variety of option from which you may choose.
7-Contract duration is very important item in the contract, depending on your situations; you may fix it in the tender document or leave the supplier to determine the duration that suits his economics best.
8-In some cases it may be helpful if suppliers are asked to split the price into two components a- Price FOT depot (or truck-stop) and b- Transport cost to your storage (if you have storage), you will then be able to compare prices at different supply locations and may use your own transport contractor.
9-It is good to be loyal to your supplier, but you got to make sure (through the above procedure), that your supplier is also loyal to you.

New Zealand Petrol Market

Petrol Price , How Fair and Competitive is it?

I refer to the Ministry of Economic Development (MED)report prepared by Hale & Twomey (July 2008) and would like address the two most important conclusions::
1- The price of petrol (in New Zealand) is fair and competitive!
2- Contrary to consumer perceptions,retail prices go down as quickly as they go up (with international changes in crude oil and product prices).
The question that I like to ask is "what is a fair and competitive price"? In my opinion, a fair price is the price of a commodity that attains its optimum value (in an open market where many sellers exist) compared to other products of similar quality.
There is no denial that the New Zealand oil products’ market is mainly run by the Major Oil Companies (in a production and distribution sharing arrangement) and as such, there is no real price competition in the market. The only competition that exists is that for (retail market share) and that is done (not through price discounting) but rather through good house keeping by each company. As long as retail price on “Service Stations’ Boards” is practically uniform, then competition does not exist. No single party is ready to “lose money” but gain nothing in terms of market share (as all the others will have to follow his price example or else lose their customers)
As long as the cost element of all the major companies is roughly the same, by the fact that they own and share all the existing oil facilities (except service stations), then they have no real incentive to deviate from each other’s pricing policies. This is a fully integrated industry (and there is nothing wrong with that, because it is more efficient and saves money for everybody), the question that needs be answered is does that saving is really reflected on the retail price? To answer this question,we need to investigate the "importer margin" and review (MED)'s price monitoring system.
Obviously the government knew very well that the industry is fully controlled by the majors and have in fact tried to break this in 1998 when Max Bradford was the Minister of Commerce; Gull and Challenge were introduced to the market. As we know, "Challenge" experiment was quickly challenged by Caltex and taken-out of a "newly born" competition system (with the blessing of the Commerce Commission!). Gull had partial success but sooner felt in-line (with the major oil pricing policies) to safeguard the market share (less than 5%) it initially managed to gain (through aggressive price discounting).
The Government price monitoring system has been successful to deter the majors from excessive exploitation of its semi-monopolistic position, but had failed to address the basic issue that prices are being imposed and major oil profits (overall) are in excess of what should be under true competitive environment.
Regarding the issue of price rises and falls, I believe that curves only show the trends (over time) but not the true picture (on daily basis) because you only need to advance the sequence by a short period of say two days and delay it by the same period to gain considerable amount of profit. I also think that (MED)’s one week time lag is not enough (as a correction) especially in a rising market, a product you buy today and sell to retail after say three weeks later will increase in value equals to the price differential within that period. Also allowing for storage etc., a well organized company can make a lot of money as a result of price fluctuations.
What needs be done (in the immediate future) is steps by Government to make the “Independents” really independent by transferring the ownership of service stations' storage facilities to the owner of the service station and truly address the issue of facilitating sea import terminals and storage tanks (for petrol and diesel) for the (independents and others) to import products collectively and directly. I have many other points about the import margin which I hope I will cover in a separate article.

Oil and Gas Reserves off Denedin

The Dominion Post in its 9th August Edition published a news report under the heading "Gas and Oil Riches may lie off Denedin" that the Australian Company Origin Energy plans to drill exploration well off the coast of Denedin and that they are looking for a partner to join them in what they say is a high risk-high reward venture. I am suggesting, and in view of the increasing scarcity of crude oil, its high prices and the possibility of future supply disruptions, that the New Zealand Government takes a far reaching inititive and decide to take part in this venture, the rewards will be enormous and to name few, I say first, it will encourage more companies to explore in the New Zealand shores and secondly ,in case of a find, the revenue will far exceeds the investment and most importantly, is that New Zealand share in the crude may be added to a "National Reserve" to be utalised in case of emergency or disruption of supplies.If small size foreign company is ready to take the risk, then why not the New Zealand Government and (for a good reason too!)?

NZ Tui Field Depleting Fast?

New Zealand Oil and Gas (NZOG) CEO David Salisbury was quoted as saying that the Tui Field has produced the year end June 2008 ( first year in production) over 15 million barrels (mmbbls) of oil -see link, making a one year revenue of $234.6 Million from its 15% stake in this "Joint Venture" field. Obviously, this is good news at first glance, however, The the Ministry of Economic Development (MED) has published in its Energy Data Book- June 2008 that the remaining recoverable reserve of Tui Field is 35.4 mmbbls. A quick calculation will show that Tui will be depleted in about 2 years time on present production rate (or slightly more if operators decide to reduce present production rate).
It is quite understandable that "Joint Venture" should make the best out of present crude oil prices, however, this will bring to question the NZ Government Policy (Crown Minerals) regarding rate of depletion of oil fields as a factor concerning National Energy Security Policy and the well being and good management of the fields. If there is no such policy then we think it is time that (Crown Minerals) should put some restraints on the rate of depletion of fields proportional to their recoverable reserve and the nature of each field. It is important to safeguard the interest of all parties, but we believe that the nation has the right and a stake in the way its natural resources being utilised.

Lessons Learnt from Gull and Challenge Entry into Petrol Retail Market

After lodging his investigation to assess barriers to entry in the oil market, Max Bradford the Minster of Energy at the time (1997) accepted the conclusions of the Australian consultants (ACIL) that there were no real barriers to entry in the New Zealand oil products market. There was also a lot of enthusiasm that the subsequent entry by Fletcher and Gull Oil will create a competitive environment and lead to “what may some refer to” as balance pricing structure “fair price” in this industry.
Now and after (10) years, it is useful to look back and examine the impact those two entrants have made on the market?
Challenge commissioned “Service Stations” in the North Island and used its storage facilities in New Plymouth to import and transport fuel to their service stations and customers in the North Island.
Challenge entered the market with noticeable price reduction of 3 cent/liter; however that effect was almost immediately drowned by a government tax increase of the same amount and the decision by the Oil Companies not to pass it to customers. Pump price for Challenge and the Oil Companies was leveled and that quickly nullified the psychological effect of Challenge entry to the market as a competitor to major oil. However, and not long after, Fletcher decided to sell its Challenge assets to Caltex and the whole business felt in line with the Oil Company pricing policies.

Gull Oil had its service stations located mainly in Hamilton and Auckland. They have built a new storage facility in Tauranga and transport their fuel by road.
Gull entered the market with more ambitious approach that is to make a real and effective price challenge to the incumbent majors in order to gain quick ground and market share. To that end Gull reduced the pump price by a sizable discount of 5 cents/lt. for both petrol and diesel.
Incumbents logical approach to Gull’s price discount was to match Gull’s prices (or slightly lower) but only around the limited number of Gull’s Stations where their presence constituted a threat to majors’ market share in that locality, a “policy of containment” one may say.
This meant that while safeguarding their interests and market share in the face of price competition, the majors were not forced to enter in an all out price war that may cause substantial reduction in their overall margins. With Challenge falling in line, it was left to Gull to stand up to the majors; it had two options to choose from
1-To adjust its price to be in line with the majors.
2-To keep its discount of 5 cent/liter for a while to get the support of some motorist who realized that Gull is giving them the benefit by challenging the major oil companies.
Gull decided on the second option and continued for a while until it managed to get a stable market share and then gradually got her price closer to the major oil postings.

Contractor Diesel Oil:
The situation for contract diesel oil is different and rather more complicated for as long as contract prices are confidential, there is a room to maneuver and the majors are competing with each other to gain market share in that very profitable and less exposed market. The entry of independent new suppliers has not a real impact on this market as consumers are mostly tied up by a long term storage and supply contracts with the majors and for some of them, a change of supplier may imply the installation of new storage tanks and possibly the issuance of a new resource consent, hence many are reluctant to abandon their existing suppliers especially as the competitors are still week and have little incentives to offer.

Effects of rising crude oil prices on the new entrants:

At the beginning, Challenge and Gull’s entry into the oil products retail market had created some kind of deterrent and has in fact kept the prices fixed at a time when crude oil prices went up by as much as 40%. That was good for the country and the consumers, bad for the oil majors but very unfortunate for the new comers, unfortunate because they based their entry and pricing on low stable crude oil prices yielding high profit margins even after reducing the selling price for both petrol and diesel. When crude oil prices went considerably high, they had no option but to abandon their discounted price policy and fall in line with the price the major has been imposing on motorist. They have ever since operated as ineffective player with a small market share.

What conclusions can be drawn from Gull and Challenge Entry to the Market?

The problem with that experiment was that the new entrants lost the initiative so vital for new comer to succeed. Their margins became considerably tight especially as they were relying for the purchases of their products on crude oil sensitive “spot market” and they have limited storage capacity to cater for sharp fluctuations in the prices. The majors have of course suffered losses, however their ability to survive while waiting for the good times to come was much better, they have well developed and fully integrated system especially designed to absorb shocks of this kind.
To sum it up I would like to point out the following:
1-It is clear that no company is willing to tolerate a price competition in a market congested with service stations like the one we have in Auckland where the prices of petrol and diesel are published over-head, simply because no company will want to see her market share eroding through price discounting by her neighbour.
2-If we hypothetically consider a scenario where two or more companies try to out-bid each other through price reductions, then a bottom price may be reached where the stronger party (not necessarily the best) will soon throw the weaker out of the market (by causing him huge financial losses). and once dominating the market, he can set price as he wishes.
3-The policy of containment used against Gull was very effective, yet not costly and have succeeded in limiting the portion of market share Gull was able to grab.
4-In the long run (and having taken price competition out) new entrants market share will only be proportional to the number of service stations they operate,
It is now clear that it needs more than few service stations here and there to create the kind of competition the Minister of Commerce was trying to establish in the oil industry. Frankly, Markets will not automatically adjust themselves to create what may “politically be considered as fair price!” through “Free Market Competition “ especially in the absence of clear government policies and guidelines.

Mundher Al-Saleem
30/7/2008

"Cost-Based" Verification Of Petrol Pricing In New Zealand

Abstract
The national media have recently exposed to "public attention", the very important subject of petrol pricing in New Zealand, and as I have special interest in this field, I am of the opinion that a new approach is needed if understanding between the parties concerned (The Government and the oil companies), is to be attained. The problem as I see it from current argument may be summarized as follows:

If it is accepted that the oil companies " In what could be considered as tacit collusion " are setting petrol prices free from outside competition or interference then does the government have the right to intervene in the pricing mechanism?

For example to suggest some "adjustable price formula" to ensure that petrol and other main oil products are sold on fair basis). And will companies accept such formulation? Both parties will argue a case of collusion versus regulations and interference but once all parties agree on a principle then a fair and correct way out could be found.

The other very important issue that needs addressing is the status of the Refinery as an independent enterprise. Here we have two contradicting views, while some argue that the refinery should run economically in a manner similar to say the "Singapore" refineries* and hence to set the Singapore export prices as a benchmark in comparing products cost at "Marsden Refinery" the oil companies could argue that the refinery is more expensive to run and has to continue operating (for security of supply and other strategic reasons).The truth is that the refinery is highly flexible and efficient, producing (high value products) and hence should be highly competitive. Again there is a good deal of truth in both arguments and a mid- way solution is possible.

Note: Full text of this article may be available on request.

The Role of the Independent Petrol Retailers in NZ

Preview
A study I submitted and published by the Ministry of Economic Development (MED) in (2002). To put it in perspective, the average price of crude oil at the time of this study was around US$23.

The Report
NZIER report published in March 2002, titled "The Decline of Independent Petrol Retailing: Rationalisation or Predation?" tackled the problem from the viewpoint that the Major Oil Companies in NZ are operating as competitors! The fact that the Majors hold majority share in the refinery, wiri terminal, the pipeline and coastal shipping makes them more of sisters competing for market share in a friendly environment.

The Oil Companies take the bulk of their profit from the wholesale price, which they freely set. They also decide the retail margin for their owned operated service stations which “in effect” has to be followed by the “independents” since the retail margins allowed were meant to be low enough to leave little room for meaningful (pump price) competition by the retailers. The terms of reference of the review did not touch base on the issue of wholesale, retail margins and pricing hence avoided a pivotal point, upon which MTA based its proposals, I have constructed a model to calculate wholesale cost of oil products in NZ and after six months run, I came to the conclusion that major oil companies are charging at least (5) NZ CENT/LITRE more than what a fair price should be compared to what say the Australian Oil Companies are charging for their wholesale petrol sales. Wholesale price may have been reduced in recent years (as evident from the importer margin curve shown in the report) nevertheless this further show how much more NZ motorists are paying for the liter of petrol they purchase.

The retail margin allowed in NZ at around (5) CENT/LITRE is similar to that in Australia(regardless of the sales volume and service provided). This means that the minimum retail price policy executed by the majors is not for the benefit of the motorist but as a mean of squeezing the independent operators out of the market and prevent them from “price based” competition for market share. I do not want to go into details about service station “rationalization process” which is taking place at the present but will directly come to agree with the conclusion that “in the end” it will mean the demise of most “independent service stations’ and hence bring a closure to a trend that has started since deregulation in 1988.

I believe that Independent Service Stations still have a role to play and the government has a duty to protect them from an “eventual demise” major oil company’s policies are leading them towards. The very existence of these stations gives a window of opportunity to many “new comers” to inter the market and break the near 100% monopoly existing at the present. Without the independents, Gasoline Alley Services (G.A.S) wouldn’t have existed, even Gull and Challenge have gained strength by incorporating some existing independent service stations, and has it not been for the ownership of the tanks by the majors, many more service stations would have joined Gull and Challenge.

Proposals
Given the present state of the oil industry in NZ, it is difficult to legislate to protect the interest of the independent operators in the manner proposed by MTA, however, I believe a simple first step could be a legislation to make it compulsory for owners of a “service station” to own the associated tanks and equipment and hence “free the tanks from the hands of the majors”. Such a regulation will be very helpful for future developments and will remove a burden (and in my opinion a barrier) to free trade in the oil product market. Tank ownership will also strengthen the negotiating position of the independents and remove a barrier to entry for wholesale imports. The regulation could also be extended to apply for diesel in the industrial and transport sectors. Ownership transfer may go either way by mutual agreement between the two parties (oil company and independent) within a time frame to be stipulated in the regulation.

Welcome

Welcome to my New Zealand Blog. My name is Mundher Al-Saleem. I am a B.Sc Chemical Engineer, specialised in International Oil Products' Contrating. I would like to discuss problems facing NZ oil consumers in the face of rising world oil price and demad. I am keen to share my thoughts and views with like minded people and be pleased to give constructive opinion and solutions.