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
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