ACCC petrol report may point to Woolworths and other structural changes in retail fuels market

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In its most recent quarterly report on the petrol market*, the ACCC said ‘annual average gross retail margins were the highest since … 2002’. Responses from major retailers to the ACCC indicated these record margins ‘were influenced by significant and ongoing falls in wholesale prices in the first eight months of 2015-16, and higher operating and regulatory costs’.

The explanation from retailers is quite plausible: historical data shows that retail margins increase when wholesale prices drop sharply and are compressed when wholesale prices increase sharply; and regulatory (including environmental) costs are increasing, most notably in NSW and Queensland.

However, closer examination of the data (see below) raises the possibility of another major factor: structural change in the retail sector of the Australian petroleum market e.g. changes in service station ownership. It is quite reasonable to expect that when an asset (in this case, a chain of service stations) is being readied for sale or has recently been acquired, or there is a step change in the competitive environment, that an increase in margins will occur if competitive conditions are favourable.

Favourable conditions will occur if most or all significant competitors are prepared to be less aggressive with retail pricing for some period, or several competitors are undergoing structural changes that would benefit from improved profitability.

Consider the current state of the retail petroleum market:

• The Australian Financial Review (AFR) reported on 11 August 2016 that Morgan Stanley has been mandated to sell Woolworths' petrol station business and has reached out the interested parties
• The AFR reported on 3 June 2016 that Viva Energy (which purchased Shell’s Australian refining and service station assets in 2014 and is owned by the world’s largest independent energy trader Vitol) is planning to spin off its service stations into a real estate investment trust
• The Australian reported on 18 May 2016 a statement by BP that it ‘has made significant strategic changes to its business in Australia over the past 18 months to increase its competitiveness and strengthen its position as a leading fuels retailer’
• Chevron’s March 2015 sale of its 50 per cent share of Caltex Australia set Caltex free to pursue a wider range of business opportunities but also increased pressure to perform for an increased number of institutional investors
• The Australian reported 7 September 2015 that Puma, a subsidiary of global oil trader Trafigura, ‘plans to move more aggressively into retail fuel, opening more Puma-branded sites, and expanding into Victoria’. Puma had acquired the Ausfuel and Neumann Petroleum retail networks in 2013. 

In each of the above cases, retailers would benefit from higher retail margins, at least through the period of structural adjustment. A permanent shift would be more beneficial but the Australian retail petroleum market is highly competitive, so whether a long-term (i.e. lasting several years) shift in margins can occur remains to be seen. The key question for individual retailers will be the balance between price competitiveness to maintain market share and the need to recover costs and improve long-term financial performance.

No doubt the ACCC will be watching with interest. However, there is nothing anti-competitive about higher industry margins and somewhat higher margins may also be desirable to sustain the thousands of franchised and independent small businesses in the retail petroleum sector that mostly operate under major brands.

The rationale for this speculation is derived from the chart below. The chart shows indicative gross retail margins for regular grade petrol (ULP) averaged across the five largest capital cities for the period since January 2012 (red line). The blue line is the average terminal gate price (TGP) for the same cities. Note that the indicative retail margin is defined as the retail price (not shown on the chart) minus the TGP.

Data: Australian Institute of Petroleum

Margin expansion with falling TGPs and margin compression with increasing TGPs (the shaded bands) is evident on close inspection. When world oil prices collapsed in late 2014, TGPs fell with a lag of a few days. Retail prices also fell but the speed of the fall in wholesale prices in the December quarter of 2014 meant there was a sizeable gap until TGPs bottomed in January 2015.

Retail margins were compressed initially on the TGP rebound but since March 2015 there has been a clear upward shift in retail prices relative to TGPs. It is this shift, which unusually has persisted through both upward and downward TGP cycles, that may be linked to structural changes in the retail market.

It will be interesting to see whether the ACCC is able to obtain more information from retailers about changes in corporate financial objectives and pricing targets that might help explain whether these are factors behind the apparent margin shift.

* Report on the Australian petroleum market – June quarter 2016 (published August 2016)

This oil market blog does not constitute commercial or financial advice. Readers should seek independent advice before making any decisions that need to take into account information on oil markets or regulation.