Draft, subject to changes.
COLLUSIVE OLIGOPOLY AND GASOLINE PRICE REGULATION IN NOVA SCOTIA
P.L. Arya
Saint Mary’s University
Halifax, Nova Scotia
Canada
In response to complaints of consumers and some gas station owners, the government of Nova
Scotia regulated the fuel prices from 1st July 2006. The present paper examines the effectiveness
of gasoline price regulation when suppliers of gasoline are acting as collusive oligopoly. The
effectiveness is studied with respect to effects on consumers and gasoline retailers.
There are two studies which evaluate the petroleum product pricing in Nova Scotia. The one is a
two year review prepared by Gardner Pinfold Consulting Economists prepared for the Service
Nova Scotia and Municipal Relations. This study points out that most objectives of gasoline
price regulations are met. The other study is by Bobby O’Keefe of Atlantic Institute for Market
Studies (AIMS). This study points out that Nova Scotians are paying more for gasoline under
regulation than they would have paid if there was no regulation.
Although there is some merit in both the studies, the present paper points out that the collusive
oligopoly market structure has important implications for the price of gasoline and may well
explain the ineffectiveness of regulation.
Introduction:
The rise of gasoline price as a result of hurricane Katrina in August 2005, which disrupted the oil
supply, led consumers in Nova Scotia to demand price regulation. The variations in price from
morning to afternoon on one day frustrated drivers. At the same time, gas retailers, particularly
in the rural areas, were finding it hard to keep afloat. The decline in demand coupled with
decline in retail margin had a negative impact on their business. The pressure on the government
of Nova Scotia to regulate gasoline prices was building since 2004. The government hired
consultants and formed committees to study the impact of regulation. The gas price regulation
became a reality from 1st July 2006.
According to the government of Nova Scotia, regulation is aimed at solving the following
problems: (1) Increase in price volatility, (2) declining dealer margins and rural infrastructure
and, (3) wide variations within the province. From the consumer perspective, the one objective
missing was high price of gasoline. According to the government of Nova Scotia, the
wholesalers would be assessed a fee of 0.0009 per litre sold to cover regulatory costs. The
Department of Service Nova Scotia and Municipal Relations (hereafter called the regulator) is
the interim regulating authority of gasoline prices.
Pricing Formula
The regulator takes the average of New York harbor’s daily spot price of gasoline for one week
(initially for two weeks) as the benchmark price. The spot price is taken from Platt’s daily spot
price data. The U.S. dollar value is converted to Canadian dollar and a wholesale margin of 6
cents per litre is added to the benchmark price before adding federal tax and provincial tax to
obtain “fixed” wholesale price. Transport cost of carrying gasoline from refinery to a particular
zone is added. For Halifax it is 0.3 cents and for other zones it is higher. Then retail margin of
minimum 4 cents per litre is added to get the minimum regular gasoline price at the pump. For
mid-grade gasoline additional 3 cents per litre and for premium grade gasoline additional 6 cents
per litre is allowed at the wholesale level.
For self serving pumps the maximum price of regular gasoline is fixed too. It is 1.5 cents above
the minimum retail price. For full service gasoline pumps there is no maximum limit. As an
example, the price fixed for gasoline by the regulator on 17th September 2008 was as follows:
Benchmark price for regular gasoline
Add wholesaler’s margin
Add federal tax
Add Provincial tax
Equals Fixed Whole sale Price
Add min. retail markup for self serve
Add max. retail markup of self serve
Add 0.3 cents for transport cost to Halifax
Add 13% of provincial HST
Min. price of regular self serve gasoline
Max. price of regular self serve gasoline
Min. price of regular full serve
Max. price of regular full serve
83 cents
06 cents
10 cents
15.5 cents
= 114.5 cents
4 cents
5.5 cents
=118.8 min. and 120.3 cents max.
15.44 cents min and 15.64 cents max.
= 134.2 cents
= 135.9 cents
= 134.2 cents
= 999.99 cents
In rural areas most gas stations are full serve and sale volume is low. Initially a cap was placed
on the maximum price which full serve gas stations could charge. After a protest by the rural gas
station owners, this cap was removed. At present, full service gas stations are not subject to
maximum price ceiling.
Although price for self serve gasoline is allowed to vary by 1.5 cents per litre, all gas stations in
the neighborhood charge the minimum price set by the regulator. In rural areas the gas stations
are far from each other and charge higher price.
The benchmark price includes adjustment for forward averaging. If the wholesaler has bought
the supply and next day price fell, his margin might have reduced if he sold at the fixed regulated
price. The regulator makes an adjustment in the benchmark price so that the wholesale margin is
not reduced. Similarly, if prices are rising and the wholesaler has bought at a lower price a day
before, a downward adjustment in the regulated price is made so that the wholesaler gets the
determined margin and not more. The forward averaging is used to give wholesaler a fixed
regulated margin.
Interrupter and Catastrophic clauses: Market forces determine the spot price. If the average
spot price changes 4 cents per litre, the regulator changes the regulation price even if is not
Friday, the regular day of change. If there is a sudden large change in the market price due to
some catastrophic event, the regulator changes the regulated price immediately. The regulated
price reflects sudden market fluctuations.
Opting out clause: The parties involved in gasoline distribution may opt out of regulated
margins if they decide to do so. For instance, a fully integrated company, Imperial Oil (Esso),
which has its own refinery and run many of its own gas stations, has opted out of the regulated
margins. Similarly, the Imperial Oil has leased out its gas stations to other retailers and has
contracts with them. These independent retailers have opted out of the regulated margins because
accepting them would mean violation of their contractual obligations. In the case of companies
which have opted out, the regulator sets only the final selling price of the gasoline and leaves the
margins as per existing arrangements.
Effects of Regulations
Gardner Pinfold’s Two Year Review
The Effects of regulation are studied in relation to the stated objectives. The detailed study of the
effects of regulation is done by Garner Pinfold Consulting Economists for Service Nova Scotia
(the regulator) in their two year review.
The first objective of regulation was to stabilize price. (i)All parties know that the price would be
fixed on Fridays and that it would last for one week unless unforeseen event prompts the
regulator to use catastrophic or interrupter clauses. (ii) The regulated price changes are less than
the price changes in the unregulated markets in North America. (iii) Regulation has removed the
price differences in various regions of Nova Scotia. The regulated price differences reflect
transport cost differences. (iv) Even though price variation is allowed between minimum and
maximum regulated price of self serve gasoline, competition among gas stations drive the price
to the lower limit.
The second stated objective was to halt the decline of service stations, particularly in the rural
areas by regulating their margins. (i) According to the “Two Year Review”, about 50% of the
rural retail gasoline dealers indicated that they are better off with regulated margins, 25% stated
that they are worse off and another 25% stated that they are just the same. (ii) The decline in
rural gas stations has slowed down. (iii) Higher labour costs and credit card costs are eroding
margins. The regulation formula does not take these costs into consideration. (iv) Some company
owned gas stations give coupons or price discounts or have other loyalty schemes. These
schemes have adverse effects on the sales and hence viability of independent dealers. (v) About
60% of the independent dealers opted out of regulated margins. This is on the top of company
owned stations, all of which have opted out of regulation. This according to Pinfold “does not
represent a reliable indicator of the merits of regulatory program from a dealer’s perspective.”
The third stated objective of regulation is to minimize cost to consumers. According to Pinfold,
“Regulation in Nova Scotia has fixed margins, serving to constraint the ability to pass on the
rising costs industry faces.” At the same time Pinfold states, “The average marketing margin
across Nova Scotia has risen by estimated 0.51 cpl in two years since the regulation was
introduced.” Pinfold asserts: “Regulation in Nova Scotia was not intended to reduce prices, but
to stabilize them without adding significantly to the price level.” (Pinfold, 2008, p.47).
Pinfold’s all estimations are before tax. When we talk of the retail price, we generally talk of
price paid by consumer at the pump which includes all taxes. For this reason, the fuel focus
reports of Natural Resources Canada are more relevant.
As a result of regulation there are no price fluctuations within a week except when catastrophic
or interrupter clauses are used. But over a week as a whole, consumers pay more than the free
market price. The additional price may be considered as insurance premium paid by consumers
to avoid intraweek fluctuations in prices.
As for as objective of controlling the decline of service stations in the rural areas is concerned,
we are not sure if the decline has reduced because of regulation or after a large decline, it trickled
down own its own. No mention is made in the Pinfold’s study of a direct question to the retailers
suggesting if they would have exited the market had there been no regulation.
The third objective of minimizing cost to consumer is simply not true. As Pinfold’s review itself
suggests that consumers pay more for gasoline after regulation.
Atlantic Institute for Market Studies’ Review
The AIMS study was done by Bobby O’Keefe. The focus of this study is on marketing margins
before and after gas price regulation. He takes Pinfold’s figure of 0.51 cents per litre and
converts into how much extra money buyers of gasoline have paid in Nova Scotia after
regulation.
Estimated gasoline sales volumes and extra consumer costs
Under regulation in Nova Scotia
________________________________________
Extra cost before tax (cents/L)
0.51
Extra cost including tax (cents/L)
0.58
Total consumption under regulation
to February 1, 2009 (millions of L) 2985.2
Total extra cost of regulation from
1 July 2006 to 1 February 2009
$17,868,951
Total extra cost per year
$6,745,313
_________________________________________
This table is taken from Bobby O’Keefe, “What’s Missing From Your Wallet”, AIMS
Background Paper, February 2009.
Since O’Keefe’s study builds on Pinfold’s assertion of cost of regulation, it does not add any
thing new to enhance the knowledge. However, it gives consumer the idea of total cost of
regulation as against per litre cost. Can the government of Nova Scotia regulate the price of
gasoline which reflects the cost of production rather than controlling only the dealer’s and
retailer’s margins? The answer is no. The price of gasoline depends on its demand and supply,
the latter depends on several factors including the structure of the market.
Market Structure of Gasoline Industry in Nova Scotia
The gasoline market is concentrated. There are a few large gasoline suppliers. The major
suppliers of Nova Scotia gasoline market are: Irwin, Imperial (Esso, owned by Exxon Mobil),
Petro-Canada, Shell and Ultramar. The additional player in the gasoline market is Wilson Fuels,
which is the wholesale supplier for Esso and owns Esso brand and its own brand retail outlets.
These companies together supply to more than 90% of the Nova Scotia market. The four firm
concentration ratio (CR4) is over 70 percent. The Hirschman-Herfindahl index (H-index) is
about 2000. Both CR4 and H-index point to the existence of oligopoly in the gasoline market.
The entry in the market is restricted by resource ownership and high cost of starting a business.
There is only one refinery in Nova Scotia. It is owned by Imperial Oil and is located in
Dartmouth. This refinery supplies gasoline to all gas stations in Nova Scotia irrespective of their
brand name. Thus Ultramar, Esso, Petro-Canada gas stations, to name a few, buy gasoline from
the same refinery. Imperial Oil, Shell and Petro-Canada are vertically fully integrated companies,
producing oil, transporting oil to refineries, refining oil and are also involved in wholesale and
retail distribution. Irvin and Ultramar buy oil from market and refine before selling. There are
also independent wholesalers and distributors who have their own retail outlets. Also there are
small retailers in the rural areas.
Some “big box” stores, which sell merchandise and food, also sell gasoline. Examples are
Superstore and Canadian Tire. These gas stations, though limited in numbers, have a high sales
volume because of the various schemes to attract customers. They have also lower operating
costs than others because of economies of scope (joint products).
The price of the crude oil is determined by the demand and supply factors in the world market.
Since New York harbor market (NYMEX) is the nearest international commodity market, price
there affects the price in Nova Scotia. Refineries not associated with fully integrated oil
companies make contracts with oil producers for long term supply at fixed price (futures
contract) or purchase on the spot market if they need supply of oil immediately. If spot prices
rise in NYMEX and regulated price is lower in Nova Scotia, then the Imperial refinery in
Dartmouth sells gasoline in NY rather than in N.S. Therefore, if a hurricane affects the supply of
gasoline in MYMEX, then the price of gasoline rises in Nova Scotia as well. Similarly if, for
some reason, like a fire in Ontario refinery, there is supply obstruction in Ontario and the price of
gasoline rises there, the impact of this event is felt on the price of gasoline in Nova Scotia. Since
the demand and supply in the international market determine gasoline price, the government of
any province cannot regulate the price of a supplier. The jurisdiction of a provincial regulator is
confined only to regulating the margins.
Even though the government regulated the margins, several companies used opting out clause.
At the inception of regulation all the corporate owned outlets opted out of regulation. Also all
outlets owned by agents of the corporations also opted out as they did not want to change their
existing contracts with the supplier. Only 50 percent of the independent marketers opted in
regulation in 2006. Their number dropped to 40% in 2008 (Pinfold’s “Two Year Review”, p. 44).
Overall, 101 gasoline retail outlets out of 428 (or 24%) opted in regulation.
Although competition determines price in NYMEX, there is no competition among the gasoline
firms in Nova Scotia. All companies in Nova Scotia buy their gasoline from Imperial Oil refinery
in Dartmouth. Most of the gasoline is supplied to its destination by private trucking companies
(like RST Dartmouth), rather than by corporate trucks, for reason of cost efficiency. Some
independent wholesalers, like Wilson Fuels, have their own trucks.
Not only companies are involved in buying gasoline from the same refinery irrespective of the
brand and use contracted (and in many times the same) trucking company, they do product
swapping. CTV, in its news of May 10, 2004 reported:
“McTeague led the government task force in 1998-99 on gasoline pricing. He says the
Bureau won’t be able to find collusion or price fixing because there is no competition in
Canada’s oil industry to begin with.
“He says the major oil companies share product from region to region so when you go to
Petro-Canada station you could very well be buying Esso’s refined product. And he says is
where the problem lies.”
(CTV.ca: “Competition Bureau to investigate Gas prices”, May 10, 2004)
The Nova Scotia’s big oil companies sell same types of gasoline (categorized by different
octane levels), use contracted trucking companies for transporting gasoline, and swap product in
different provinces, their collusive nature is evident. Even prior to regulation, price charged by
different big companies on the same street gas stations was same. The price variation in distant
gas stations or gas stations in different localities was the result of differences in transport cost,
competition conditions, income levels and the like factors. After regulation price charged in
different towns and rural areas is different. The difference after regulation results from difference
in transport cost in cities and, in rural areas, also on competition, and sales volume.
The competition among the gas stations prior to and after regulation has been by way of
coupons, use of “Value Max” card, free coffee, air miles, credit toward grocery and the like.
The regulator may high fixed the maximum and minimum price of self serve gasoline, the use of
the “Value Max” card at Ultramar lowers the price of gas by 2 cents per litre. Similarly, Esso gas
outlets give Aeroplan miles. These methods are done to develop customer loyalty.
Unexplained change in Prices:
Generally, consumers in Nova Scotia know on Thursday through radio and television how much
price the regulator would change on Friday. The media generally keeps track of the market and
given the formula, very much correctly predict the price for Friday. The media is also helped by
price of gasoline in New Brunswick, where gasoline price is also regulated and there price
changes every Thursday. In New Brunswick, the maximum price of gasoline is determined by the
regulator.
On May 7th, 2009, the maximum price of the regulator in New Brunswick for self serve regular
gasoline was fixed at 90.9 cents per litre. The price was 89.1 cpl on 30th April 2009. The increase
in price was 1.8 cpl. The media in Nova Scotia was quick to point out that price in Halifax
would go up 3 cents per litre on Friday. But when the regulator in Nova Scotia set the price it
was increased from 90.7 cpl for self serve and 92 cpl for full serve on May 1, 2009 to respective
96.3 and 98 cpl on May 8th 2009. The increase was 6 cpl.
Considering that both Nova Scotia and New Brunswick use the price prevailing in NY harbor for
calculating their base price, both convert it into Canadian dollars and both have same GST and
federal except provincial tax, which is lower in New Brunswick, price increase in Nova Scotia
seems excessive. If we take the fact that New Brunswick price includes transportation cost of 2.5
cents per litre maximum and Halifax price includes transportation cost of 0.3 cents, the gap
between maximum regular price of gasoline between them appears to be higher.
There is general feeling in Nova Scotia that prices rise quickly and come down slowly. When
prices have downward spiral, in order to give fixed margins to the wholesaler and retailers, the
regulator is slow to reduce prices. When prices are rising, by the same argument, they should
also increase slowly. But it does not happen. For instance, on 19 February 2008, price of regular
self serve gasoline in Toronto was 105.6 cpl and in Halifax it was 111.0 cpl. On 26th February
2008, price in Toronto rose to 106.1 cpl and in Halifax it rose to 117.7 cpl. The forwarding
average method by the regulator is not done by a fixed formula, it is rather done by the
impression of how much price should rise to keep margin same. The impression of regulator is
subject to market speculations.
Price Setting Authority:
Another issue connected with the above analysis is that in New Brunswick the weekly price is set
by New Brunswick Energy and Utilities Board, an independent body, while in Nova Scotia it is
done by a branch of the government (Service Nova Scotia and Municipal Relations). At the
inception of gasoline price regulation, it was made clear that price fixing authority would be
transferred from government to the Nova Scotia Utilities and Review Board, an independent
body. But so far, the government has resisted it on the ground of cost efficiency. In The
Chronicle Herald interview Mr. Muir, the minister in charge of the concerned department, said:
“But Mr. Muir said there will be an administrative cost if the review
board takes over, and the price at the pump would likely look the same
as if the government were still setting it.”
(The Chronicle Herald.ca 20th September, 2008)
If the price is set by an independent body, the public has greater input and the process is more
open. Even if price at the pump would remain the same, the public can understand it better.
Halifax and Toronto Prices
In this section a comparison of gasoline prices is made between Toronto, the unregulated market,
and Halifax, the regulated market. Data for this comparison has been taken from Natural
Resources Canada. Figure-1 shows the rack prices of Halifax and Toronto. The lines in the
graph show similar patter, Halifax having lower rack prices than Toronto. This may be due to
higher demand for gasoline in Toronto than Halifax.
Figure-2 shows the gasoline prices which consumer pays in both cities. This price includes all
margins and taxes. The sum of margins and taxes is higher in Nova Scotia. This is reflected in
the fact that Nova Scotia retail prices are higher than Toronto. However, whenever price
increases in Toronto, price increase in Halifax appears to be higher. Only in one event (6 January
2009) price in Halifax was lower than price in Toronto. This was because of margin adjustment.
But once that week passed, prices in Halifax were higher than Toronto again. When prices rose
in Toronto because of the supply bottlenecks, Halifax prices increased more. This may be due to
speculative fixing of wholesale prices by the regulator.
Since the regulator does not control the supply of gasoline, the prices before tax go in synch in
Toronto and Halifax. Even the retail price movement is in the same direction, the magnitude of
variation depends on margin adjustment in forward averaging, which due to lack of any formula
in Nova Scotia, is subject to speculation.
Fig-1
Rack Price of Regular gasoline in Halifax and Toronto, March-May, 2009
Source: Natural Resources Canada
Fig-2
Retail Price of Regular gasoline in Halifax and Toronto, May 2008-May, 2009
Source: Natural Resources Canada
Reaction of public to price of gasoline
Gasoline price regulation in Nova Scotia is a result of consumer reaction to rapidly increasing
price level in the first half of 2006 when price increased from less than one dollar per litre to
about $1.14 per litre. Consumers did not find any relief in the formula of regulation and the price
of regular self serve gasoline increased to $1.22 per litre in early August 2006. The regulator
could not and did not aim at reducing the level of prices.
Late August 2006, price of gasoline fell below $1 per litre and the call for reduction in prices
subsided. Again, when price of regular self serve gasoline reached $1.46 per litre in July 2008,
consumers’ outcry was loud.
Judging from the media interviews, consumers are pretty much comfortable with price of regular
self serve gasoline about $1 per litre. The increase in price from 90 cents per litre to 96 cents per
litre does not draw much attention of consumers. But as the price surpasses $1.10 per litre,
consumers’ reaction gets stronger and stronger as price gets higher and higher.
Conclusion
The collusive oligopoly nature of the market structure in gasoline industry gives little leverage to
the provincial regulator to meddle with prices, except eliminating intra-week fluctuations. The
role of the provincial regulator is limited to regulating margins and taxes. Reducing taxes
adversely affects government finances. Therefore, the regulator in Nova Scotia is involved in
manipulating margins to stabilize prices in 7 day period. In order to achieve this objective and
keep the margins constant, it uses forward averaging method, the consequence of which is higher
price for the consumer at the pump.
The objective of maintaining industry infrastructure has not been fully achieved as the gas
stations still go out of business. A large number of gas stations have used opting out clause and
have retained their existing margins and contracts with the gasoline suppliers.
The regulator in Nova Scotia has not given the authority to Utilities and Review Board, an
independent body, on the ground of cost efficiency. The regulator does not give details of how
it arrives at the benchmark price.
References:
Evaluation of Petroleum Products Pricing Regulation in Nova Scotia – A Two Year Review:
Prepared for Service Nova Scotia and Municipal Relations by Gadner Pinfold Consulting
Economists, November 2008.
“What’s Missing from Your Wallet? – How Gas Price Regulation Robs Consumers”, AIMS
Background Paper, prepared by Bobby O’Keefe, February 2009.
“Competition Bureau to Investigate Gas Prices”, CTV.ca News Staff, May 10, 2004.
New Brunswick Energy and Utility Board’s data on petroleum product prices.
Petroleum Products Price Regulation in Nova Scotia – A Six-Month Review: Prepared for
Service Nova Scotia and Municipal Relations by Gadner Pinfold Consulting Economists, March
2007.
Economics of the Nova Scotia Gasoline Market: Prepared for Service Nova Scotia and Municipal
Relations by Gardner Pinfold and M J Erwin & Associates Inc., September 2005.
Gasoline Price Changes: The Dynamics of Supply, demand and Competition, prepared by U.S.
Federal Trade Commission, 2005.
The Chronicle Herald.ca 20th September, 2008
Data on Toronto and Nova Scotia from www.fuelfocus.nrcan.gc.ca
Data on Nova Scotia from www.gov.ns.ca/snsmr/petroleum
Data from New York Commodity Exchange: www.nymex.com
Data on Nova Scotia from: www.aims.ca
Also data from: www.mjervin.com