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The Markets for Gasoline and Diesel in British Columbia

Dr. Henry J. Kahwaty July 17, 2019

C5-9

Outline

–Introduction to competition analysis

–There is a functioning retail market for gasoline and diesel in BC

–There is a functioning wholesale market for gasoline and diesel in BC

–Factors that have contributed to increases in retail prices for gasoline and diesel in BC since 2015

–Impact on consumers from wholesale and/or retail price regulation

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Competition Analysis

Economic analysis of market performance

–Market power is the ability profitably to maintain prices above the competitive level for a significant period of time

(Competition Bureau Merger Enforcement Guidelines at ¶ 2.3)

–Markets are viewed as functioning well if the competitors in the market lack substantial market power

› Sufficient number of competitors or lack substantial barriers to entry

› Number of competitors v. market concentration

–An exercise of market power requires a firm or group of firms to take actions that restrict supply or erect artificial barriers to entry

–Prices that do not cover capital costs are not sustainable long-term

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Retail markets for gasoline and diesel in British Columbia

Retail Market Analysis: Significant Agreement with Deetken –There are numerous retailers of gasoline and diesel in BC

› At the end of 2018 there were 1,368 gas stations in BC offering at least 29 brands marketed by 24 companies › No marketer has control over the retail price for more than 12.6 percent of the gas stations in BC › Many are independent gas stations (“dealer stations”) › Commercial fleet operators have cardlock options too; additional price setters

–No significant barriers to entry › The time required to build a gas station is not substantial; there has been a track record of retail gas station entry

–Prices respond to factors that typically affect either supply or consumer demand in the manner expected in a well-functioning market › Retail prices are closely linked to wholesale prices › There is no reason to expect retail prices to respond symmetrically to increases and decreases in upstream prices (e.g., price of crude oil)

–No evidence of collusive or cartel conduct by retailers; difficult to coordinate conduct › Price cycles › Common price movements are not evidence of collusion because wholesale price changes affect all retailers

There is a functioning retail market for gasoline and diesel in British Columbia.

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Table 10: BC Retail Gas Stations by Marketer, Dec. 31, 2018

Marketer Type BrandsMarketer Control

Dealer Control

TotalShare of Supply

Share of Price

ControlParkland Fuel Corporation Refiner-Marketer Chevron, Esso, Fas Gas Plus, Race Trac 173 100 273 20.0% 12.6%Unidentified Marketers or Dealers Non-Refiner Unbranded/Unknown 0 204 204 14.9% 0.0%Suncor Energy Products, Inc. Refiner-Marketer Petro-Canada 116 60 176 12.9% 8.5%Shell Canada Limited Refiner-Marketer Shell 89 49 138 10.1% 6.5%Husky Energy Inc. Refiner-Marketer Husky 80 45 125 9.1% 5.8%7-Eleven Canada, Inc Non-Refiner Petro-Canada, Esso, 7-Eleven 124 0 124 9.1% 9.1%Federated Co-operatives Limited Refiner-Marketer Tempo, Save on Gas, Co-op 0 77 77 5.6% 0.0%McDougall Energy Non-Refiner Pump, Esso, Unbranded/Unknown 0 65 65 4.8% 0.0%Super Save Group Non-Refiner Super Save Gas 25 15 40 2.9% 1.8%BCP IV Service Station LP/BG Fuels Non-Refiner Mobil 39 0 39 2.9% 2.9%Proctor Petroleum Non-Refiner Gas N Go 24 0 24 1.8% 1.8%Centex Petroleum Non-Refiner Centex, Unbranded/Unknown 2 16 18 1.3% 0.1%Couche-Tard Inc. Non-Refiner Mac's, Shell, Petro-Canada, Esso, Husky 14 0 14 1.0% 1.0%Sobeys Capital Inc. Non-Refiner Safeway 10 0 10 0.7% 0.7%Gas Plus Inc. Non-Refiner Gas Plus, Unbranded/Unknown 2 7 9 0.7% 0.1%Canco Petroleum Non-Refiner Canco 0 7 7 0.5% 0.0%Costco Wholesale Canada Ltd. Non-Refiner Costco 7 0 7 0.5% 0.5%XTR Energy Company Limited Non-Refiner Gulf, XTR 0 5 5 0.4% 0.0%Canadian Tire Petroleum Non-Refiner Canadian Tire 4 0 4 0.3% 0.3%Domo Gasoline Corporation Ltd. Non-Refiner Domo 3 0 3 0.2% 0.2%Shell Pilot Flying J Joint Venture Refiner-Marketer Shell and Flying J 3 0 3 0.2% 0.2%BVD Petroleum Non-Refiner Petro-Canada 1 0 1 0.1% 0.1%G&B Fuels Inc. Non-Refiner G&B Fuels 0 1 1 0.1% 0.0%GTI Petroleum Ltd. Non-Refiner GTI 1 0 1 0.1% 0.1%

717 651 1368 100.0% 52.4%

Marketer Share by Station Count

Source: “2018 National Retail Petroleum Site Census,” Kent Group Ltd, June 7, 2019.

Marketers and Brands Sold Number of Stations by Control

Total

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Numerous Independent Dealers

–651 of the 1,368 gas stations in BC are controlled by dealers › 47.6% of the gas stations in BC are dealer stations

› The dealer controls the price it charges to its customers

› Many separate entities set retail prices in BC

–In addition to refiners, marketers like McDougall and Global compete to supply independent dealers

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Additional Comments –Numerous retail competitors in Vancouver

› Shell, Husky, Petro-Canada, Parkland/Chevron, 7-Eleven, Safeway, Co-op, Costco › No evidence of market power for individual retailers

–Additional retail market characteristics: › Low levels of concentration as measured by both CR4 and HHI (Deetken July 10 Report, pp. 19 – 22) › No significant changes in concentration over time (Deetken July 10 Report, pp. 19 – 22) › No evidence of significant market power for individual competitors or the creation of market power over time

–The Deetken Report explains retail margin differentials based on factors such as land values and credit card fees › Retail margins need to cover operating expenses and capital expenses, including opportunity costs › Unexplained differentials are not due to the creation of market power

–No evidence of retail supply restrictions

–No evidence of collusive or cartel pricing; no evidence of coordinated retailer conduct

There is no economic basis for the regulation of retail prices/margins or for price transparency regulation.

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Wholesale markets for gasoline and diesel in British Columbia

Wholesale Market Analysis – It appears that Deetken and I agree on the sources of supply in BC

– Refiners: diversity of supply sources in wholesale markets › British Columbia refiners: Parkland and Husky › Alberta refiners: Imperial Oil, Suncor, NWR, and Shell › Washington refiners: BP, Phillips, Marathon, U.S. Oil & Refining Co., and Shell

– Non-refining wholesalers: independents that sell fuels to dealer stations › McDougall, Global, Parkland › Recent entry: Global had supplied 123 gas stations in ON, QC, NB and recently entered BC › Other potential entrants

– Vertically-integrated marketers that supply their own stations › Costco (7), 7-Eleven (124), Sobeys/Safeway (10)

– Numerous entities can arbitrage price differentials with Alberta and Washington

– Prices respond to factors that affect either supply or demand in the manner expected

– No evidence of unilateral supply restrictions (e.g., high capacity utilization rates for BC refineries)

– No evidence of collusive or cartel conduct; difficult to coordinate conduct

There is a functioning wholesale market in British Columbia, and there is no economic basis for price, margin, or transparency regulation in that market.

Figure 22 Estimated Percentage of Total British Columbia Refined

Products Demand Supplied By Refinery Location

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Marginal and Infra-marginal Supply

–Agree with Deetken that in well-functioning markets, prices are determined by marginal supply sources, not infra-marginal sources

–The BC refineries are infra-marginal due to location

–Most of the supply from Alberta refineries is infra-marginal due to scale, access to crude oil, and low-cost transportation via pipeline › But pipeline capacity is limited and TMP is on apportionment due to excess

demand › TMP transports refined products and transports crude oil to the Burnaby refinery,

refineries in Washington, and exports to the U.S. west coast and Asia

–The July 10 Deetken Report indicates that marginal supply is trucked product from Edmonton

–Reductions in infra-marginal supply via TMP results in increased supply from higher-cost sources over time

–Comparing wholesale prices in BC to BC refinery margins is not informative of the extent of competition or whether pricing reflects market power

Trans Mountain Pipeline Average Throughput Allocated to Refined Products

Per Year In kb/d, 2006 - Q1 2019

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Deetken, Arbitrage, and Unexplained Variances

–The Deetken Report analyses the pricing differentials between Vancouver and both Edmonton and Seattle

–Prices are determined by many factors in the markets

› Costs of marginal supply source

› Volume supplied by infra-marginal sources

–There are many entities that are positioned to arbitrage the market

–If there are unexplained differentials, this is likely because entities do not see additional arbitrage opportunities

› Differences between costs that are modeled and costs faced by actual suppliers in the market

› Modeled costs omit costs faced by actual suppliers, e.g., complexity associated with provincial-specific regulatory compliance

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Question 2D(i): Rack prices and the market for supply to retailers

Answer:

– Rack prices are list prices for purchases at a terminal. Some transactions occur at rack prices, but others occur at a discount or premium to rack (e.g., rack + $0.02/L, rack – $0.01/L). › An entity that purchases a large volume of gasoline or diesel may have a contract that provides a volume discount, for example, and that volume discount can be

expressed as a discount relative to rack.

– With transaction pricing tied to rack, a wholesale provider that sets its rack in a manner that would lead to above-market transaction pricing would see diminished sales and harm to its brand.

– For spot transactions, an above-market rack would lead to an immediate loss of sales.

– For sales under long-term contracts, a rack that would lead to above-market transactions prices would lead to diminished sales in the near term as downstream retailers supplied by the wholesaler are competitively-disadvantaged relative to its retail rivals.

– Over a longer horizon, pricing to dealers at above-market rates would lead dealers to switch suppliers over time when contracts are up for renewal, eroding a wholesaler’s business. Parkland, Shell, and Suncor supply a total of over 200 dealer stations in BC; Imperial Oil serves numerous dealers as well. Developing a reputation for charging above-market rates would erode their dealer supply businesses.

– Prices cannot profitably be maintained at supra-competitive levels for an extended period of time.

Question

To what extent does the competitiveness of the wholesale market provide assurance that the rack prices are competitive?

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Question 2I(i): Refining capacity in other Provinces

Answer: – Three provinces have no refining capacity – Manitoba, Nova Scotia, and Prince Edward Island – Prince Edward Island receives refined product from the Irving Oil refinery in Saint John NB (by far the largest refinery in Canada) via

marine transport. – Nova Scotia has access to refined products from the U.S., Europe, and the Saint John refinery via marine transport. Marine tankers

offload refined product at a large terminal located at the site of the former Dartmouth refinery. To the extent that small volumes of gasoline are shipped by truck from the Saint John refinery, the road distance from Saint John to Nova Scotia is substantially shorter than the road distance from Edmonton to Vancouver. › The road distance from Saint John to Halifax is about 415 km › The road distance from Edmonton the Vancouver is about 1,160 km

– Manitoba receives refined products from Alberta via the Enbridge pipeline (by far the largest pipeline in Canada) and from Saskatchewan via rail or truck. › The road distance from the Regina, SK refinery to the major population centers of Manitoba is substantially shorter than the road distance from Edmonton to

Vancouver(Winnipeg 575 km, Brandon 360 km).

– To the extent that Manitoba or Nova Scotia receive marginal refined product supply via truck, the distance and transportation cost is substantially less than trucking refined product from Edmonton to Vancouver.

Question:

BC has low [refining] capacity but there are other Provinces with no refining capacity. Why are retail prices lower in provinces with no refining capacity?

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Question 2I(i), continued: Figure 27 Comparison of Gasoline Taxes

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10 10 10 10 10 10

8 7.5 6.8 5.6 5.5 6

8.514.5 14.5 15.5

9.714

11.2

11

17 5.5

8.9

8.9

8.9

0.9

4.4

4.4

52.4

46.4

40.243.2

40.6

34.4

0

10

20

30

40

50

60

Vancouver Victoria BC NS PE MB

Cent

s per

litr

e

Federal Excise Tax Federal Sales Tax Provincial Excise TaxProvincial Sales Tax Transit Tax Carbon Tax

Source: Bowes, Jeff, “21st Annual Gas Tax Honesty Day Report,” Canadian Taxpayers Federation, May 2019, available at http://www.taxpayer.com/media/2019-GTHD-EN.pdf.

Question 2I(ii): The potential for new refining capacity

Answer:

– Refining is a very capital-intensive business. A new refinery would take many years to design, permit, build, and bring into operation. It would take even longer to earn a return on investment. The current business climate does not support devoting substantial capital resources to the development of a new refinery in BC. › “Refining has long been the least favoured child of the integrated oil company’s portfolio. Low return, low growth, capital intensive, politically sensitive and

environmentally uncertain – the industry has perhaps appropriately been described by one leading refiner’s CFO as one of the world’s least attractive industries.” (Herrmann, et al., 2010)

› A new refinery in BC would require access to crude oil. Given current TMP capacity limitations, rail transport of crude oil would likely be required. › Provincial policy is to reduce the carbon intensity of fuels and overall discourage the use of gasoline and diesel while promoting alternatives. These policies call

into question the long-term demand for a new refinery, especially if the business case for the refinery is based on earnings arising from high BC refining margins.

– Between 1991 and 1996 about half of the integrated refiners in AB and BC closed “due to high operating costs and the lack of economies of scale” (Baum, et al, 1998)

– The new North West Refining Sturgeon (operations commenced in 2017, commissioning continues), AB refinery cost $9.7 billion and was only able to open after the Alberta government provided substantial subsidies.

– Proposed BC refineries › The proposed BC Kitimat Clean refinery would cost over $20 billion. Its proponents indicate it would take two years to obtain regulatory approval and five years to

construct. In addition, the refineries backers indicated they would need the federal government to guarantee loans in order to obtain financing for the project. › Pacific Future Energy (PFE) has also proposed building a new BC refinery between Kitimat and Terrace. In 2016, PFE estimated building the refinery would

require a capital expenditure between $12 -$14 billion. The project has not yet received regulatory approval. › The business cases for both involve processing Western Canadian oil sands bitumen into refined products for export to Asian markets

Question:

If refinery margins are high, then why does there seem to be no interest in building new refineries in BC or expanding existing refineries in BC?

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Question 2I(ii), continued: Risk Associated with Declining Demand “In addition to the effect of rising transport costs emerging from higher carbon and energy prices, several other factors exert downward pressure on transport demand over the projection period. The primary reason is vehicle emissions standards. Canada enacted passenger vehicle GHG emission standards that extend from 2012 to 2025, and more recently GHG emission standards for medium and heavy-duty vehicles. Both standards mandate fuel economy improvements in vehicles sold in their respective periods, reducing fuel demand. Macroeconomic factors influencing transportation demand, such as GDP, population, and income, generally grow slower than historical levels, as discussed earlier. A modest uptake in electric vehicles (EVs) also contributes to demand reductions because of the relative efficiency of EVs to internal combustion engine (ICE) vehicles. The Technology Case, discussed in Chapter 4, provides an analysis of greater EV adoption.”

Source: National Energy Board, Canada’s Energy Future 2018: Energy Supply and Demand Projections to 2040, Chapter 3 https://www.neb-one.gc.ca/nrg/ntgrtd/ftr/2018/chptr3-eng.html

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Question 2K(ii): Effects of US refinery outages on BC prices, Pt 1. Question:

Where there have been refinery outages in the US, what has been the impact on their wholesale prices and how determinative is this with respect to BC pricing?

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Prince George Pipeline Fire Gasoline Wholesale and Select Crude Prices, H2 2018

Answer: The chart shows daily wholesale gasoline prices during H2 2018, when the Prince George natural gas pipeline fire occurred. An effect is seen for gasoline prices in Vancouver and Washington. The pipeline was fully repaired by October 31, 2018, and pipeline operations gradually ramped up from Q4 2018 to Q1 2019. “[Several] oil refineries in Washington state [have been] forced to shut or curb operations after natural gas supply to the facilities was disrupted by a pipeline fire in Canada[.] The shutdown follows actions by two other refineries, and sent fuel prices in the Pacific Northwest region and across the West Coast soaring.” – Thomson Reuters, 10/11/2018 “Gas prices in Metro Vancouver broke records on Oct. 13, 2018 after a natural gas pipeline ruptured near Prince George, B.C.” – CBC News 3/17/2019

Question 2K(ii): Effects of US refinery outages on BC prices, Pt 2.

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California Refinery Shutdowns Gasoline Wholesale and Select Crude Prices, H1 2019

Answer: The chart shows daily wholesale gasoline prices during H1 2019, during which several outages have occurred for California refineries. A steadily increasing effect is seen for gasoline prices in both Vancouver and California. “[A] recent refinery fire in the Los Angeles area will likely lead to even more pain at the pump. Fuel experts anticipate prices moving up about 10 cents a gallon after Phillips 66 shut down a crude unit at its [Carson] refinery in Los Angeles because of a fire that broke out last Friday night.” – The San Diego Union Tribune, 3/20/2019 The Valero Benicia refinery was off-line for at least 40 days after a malfunction forced the shut down of the facility.

Question 2K(i): Differential impacts on gasoline and diesel prices

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California Refinery Shutdowns Diesel and Gasoline Wholesale and Select Crude Prices, H1 2019

Question: Allan and Eliesen commented that “what is unclear is how refinery shortages in far off markets can be used to rationalize price spikes in gasoline, but when it comes to diesel there does not appear to be a corresponding impact despite the fact both gasoline and diesel are produced from every barrel of crude in relative to proportion” Please comment on this statement. Answer:

– In the same example related to the recent California refinery shutdowns, California gasoline and diesel rack prices exhibited different behaviour

– Gasoline and diesel have different demand factors

– Gasoline and diesel have different supply characteristics

– Different markets

– Diesel impacts similar in California and Vancouver

Question 2K(ii): Effects of US refinery outages on BC prices, Pt 3.

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Anacortes Refinery Shutdown Diesel Wholesale and Select Crude Prices, 2010

Answer: –An additional example relates to an

outage at the Washington Anacortes refinery

–Price effects are more pronounced for diesel prices

–Diesel prices in Vancouver track those in Washington

–Markets are interconnected and interrelated

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Factors that have contributed to increases in retail prices for gasoline and diesel in British Columbia since 2015

Factors Contributing to Retail Price Increases since 2015 – My report addressed changes in prices in BC; the Deetken report

addressed comparisons of BC to AB and WA – Increases in crude oil prices – Reduced availability of TMP to transport refined products into BC – Since January 2015, gas taxes in Vancouver have increased 3.72

cents/L, with a further 2.23 cents/litre scheduled (not including the federal goods and services 5% tax on these taxes); for diesel, these are 4.06 cents/L and 2.55 cents/L

– Increases in credit card fees (see Deetken July 10 Report) – Changes in costs, including increasing land values in Vancouver (see

Deetken July 10 Report) – Increasingly stringent low carbon fuel standards – Supply shocks (e.g., inability to fully secure sufficient feedstocks for

Burnaby) – Potential demand growth

Figure 34 Value of the Crude Oil Included in 1 Litre of Regular Gasoline

Q1 2015 – Q2 2019

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Even if a cost factor is the same in BC and AB (no differential), growth in that factor would lead to increased fuel prices in BC over time. For example, the Bank of Canada reports estimates of annual wage growth. Labour Force Survey quarterly estimates range from 1.9% to 3.7%.

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Impact on consumers from wholesale and/or retail price regulation

Impacts from Regulation: Response to Navius and Allan/Eliesen

–Regulating retail prices to be below levels that would otherwise prevail would lead to excess demand › Market not permitted to clear › Diversion of supply to alternative geographies › Mechanism to ration or allocate supply among buyers › Effects exacerbated over time due to reduced incentives to maintain and invest in refineries and other downstream assets

–Regulating wholesale prices or margins would lead to higher retail prices, not lower retail prices › Reduced production and diversion of supply to alternative geographies › Reduced supply must lead to increased prices for consumers › Scarcity would generate increased retail margins

–Price transparency regulation has no economic basis › The Navius report details the enormous amount of information needed to achieve price transparency › There would be significant costs associated with this type of regulation with potentially limited (if any) benefits; the Navius report

neither assesses these benefits nor determines whether the benefits (if any) would outweigh the costs › Price transparency regulation could harm competition › Price transparency regulation is an extraordinary remedy in a market such as the wholesale supply of gasoline and diesel in BC

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