THE PETROL INDUSTRY:DEREGULATION, ENTRY AND COMPETITION

Michael Pickford* and Cameron Wheeler**

NZ Trade Consortium Working Paper No. 12

2001

THE NZ TRADE CONSORTIUM IN ASSOCIATION WITH

THE NZ INSTITUTE OF ECONOMIC RESEARCH (INC.)

8 Halswell St. Thorndon

P O BOX 3479 WELLINGTON

Tel: (04) 472 1880

Fax: (04) 472 1211

* Chief Economist at the Commerce Commission, Wellington. The author stresses that the chapter wasnot written in his official capacity, and any views expressed do not necessarily represent the views of theCommerce Commission. Information used in this chapter has been taken purely from the public domain,and no use has been made of information supplied to the Commission in confidence, or which is otherwisenot publicly available.** Analyst, Ministry of Social Policy, Wellington.The authors acknowledge the assistance from FRST grant number 98-IER-13-6379.

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TABLE OF CONTENTS

INTRODUCTION ....................................................................................................................................................... 3HISTORY....................................................................................................................................................................... 3

The Companies......................................................................................................................................................... 3The Refinery.............................................................................................................................................................. 4

REGULATORY BACKGROUND ......................................................................................................................... 8Nature of the Regulations...................................................................................................................................... 8

Supply Restrictions............................................................................................................................................... 8Separation of Wholesaling and Retailing Functions ...................................................................................... 9Price and Margin Controls .................................................................................................................................. 9

Deregulation ............................................................................................................................................................ 11Developments Following Deregulation ............................................................................................................ 14

BACKGROUND CONDITIONS .......................................................................................................................... 16Demand Conditions .............................................................................................................................................. 16Supply Conditions ................................................................................................................................................. 20

MARKET STRUCTURE......................................................................................................................................... 24Nature of the Product ........................................................................................................................................... 24Market Concentration.......................................................................................................................................... 25Vertical Integration............................................................................................................................................... 28Barriers to Entry.................................................................................................................................................... 31

MARKET CONDUCT ............................................................................................................................................. 36The Structure of Prices and Price Trends ...................................................................................................... 37Pricing in Oligopoly .............................................................................................................................................. 40Price Leading and Following .............................................................................................................................. 43Collusion................................................................................................................................................................... 47New Entry ................................................................................................................................................................ 51Non-Price Competition......................................................................................................................................... 54Conduct Regulation .............................................................................................................................................. 57

MARKET PERFORMANCE ................................................................................................................................. 58Company Performance ........................................................................................................................................ 58The Refinery............................................................................................................................................................ 59Efficiency and Service Levels ............................................................................................................................. 60Price Trends ............................................................................................................................................................ 61Welfare Implications of Price Trends .............................................................................................................. 65

CONCLUSIONS ........................................................................................................................................................ 67REFERENCES ........................................................................................................................................................... 69

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INTRODUCTION

The petroleum industry was deregulated with the enactment of the Petroleum

Sector Reform Act 1988. The objective of deregulation was to increase

competition within the industry, and thereby to bring to the economy the benefits

of greater efficiency and lower prices. The effectiveness of this policy has been

difficult to gauge. For example, some people suspect that the oil companies have

colluded for years, and have made supernormal profits at the expense of

consumers. They point to the fact that a price change by one company typically

is followed by identical changes by the others, with the result that competing

service stations in the same areas invariably charge identical prices. On the other

hand, deregulation appears to have led to improved quality of service at service

stations, and recent new entrants seem to have stimulated price competition. The

purpose of this paper is to use a market structure-conduct-performance framework

to analyse the industry, both before and after deregulation, as a means of judging

the impact of deregulation in terms of competition and welfare.

We start in the following section with a very brief history of the industry in New

Zealand, and follow this with an examination of the regulatory framework which

applied until 1988, and developments post-deregulation. Then the background

demand and supply conditions which underlie structure and behaviour in the

industry are considered. This is followed by an examination of the industrys

structure, which covers the nature of the product, market concentration, vertical

integration, and barriers to entry. Conduct patterns in the industry with respect to

the nature of competition, price and non-price behaviour, and entry, are then

discussed. This culminates in an assessment of the performance of the industry,

with particular emphasis being given to the impact of recent entry on pricing.

Finally, we draw together our conclusions.

HISTORY

The Companies

There are currently six wholesale suppliers of petroleum products in New

Zealand, although seven have previously entered the market. In order of entry

(with dates), they were (using their current names) Mobil (1896), Shell (1912),

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Caltex (1920), Europa (1931), BP (1946), Challenge (1998), and Gull (1998).

The early entrants were importers of the products of their overseas parents. It

was only with the completion of the Marsden Point refinery in 1964 as a joint

venture by the original five entrants that the country became a producer of refined

petroleum products.

BP entered in 1946 by forming a local company in which the Government held a

51% share, although commercial control rested with BP. A network of storage

depots was built, with imported products first arriving in 1949. In 1955, the

Government sold its 51% share to the London-based parent. The company

acquired a 60% share in Europa in 1972, and the remaining 40% in 1977. By the

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