Price cycles and signalling in the petrol industry: what other markets can tell us
Sunday, May 27, 2012, 08:35 PM | Source: The Conversation
The way petrol is priced in Australia has been a perennially vexed issue.
Earlier this month, the Australian Competition and Consumer Commission (ACCC) announced it would launch an inquiry into price-sharing arrangements in the petrol industry, saying it was concerned petrol retailers could “quickly signal price movements, monitor competitors’ responses, and react to them”, reducing competition.
Although media reports at the time mentioned “price fixing”, the issue here is actually price signalling among major retailers.
In the spotlight is the private company Informed Sources, which offers a widely used database which claims to accurately report petrol prices at site level.
Research undertaken in 2011 by Queen’s University Professor Roger Ware and I in Canada found that petrol stations monitor each other “on the ground” intensely enough such that dominant chains in cycling markets can coordinate price restorations, and maintain stable price cycles, without websites like Informed Sources.
Nonetheless, my and others’ research on petrol price cycles generally supports the ACCC’s concerns over price signalling in petrol markets, and whether Informed Sources causes a substantial lessening of competition in Australian petrol markets.
Petrol Pricing in Canada
My joint paper with Professor Ware analyses daily station-level petrol price data for more than 100 markets in Ontario, Canada.
The paper examines the characteristics of markets that exhibit petrol price cycles, and investigates petrol stations’ pricing strategies within cycling markets.
We found large urban markets like Toronto exhibit “cost-based” pricing, where day-to-day petrol prices move in lockstep with daily wholesale prices. Intermediate sized markets - roughly with 25,000 to 100,000 people - have petrol price cycles. Price cycles are characterised by weekly drastic price jumps (“price restorations”), followed by a sequence of daily price decreases (“the undercutting phase”).
Our examination of branded and independent stations’ pricing strategies within cycling markets also yielded a number of insights.
Branded stations are those that operate under the name of major oil companies that also own oil refineries. In Ontario, there are four major brands: Esso, Petro-Canada, Shell, and Sunoco.
We found that during price restorations, brands lead in initiating price jumps and setting prices, while independents follow. During the undercutting phase of the cycle, independents lead and are aggressive in undercutting prices, while brands are non-aggressive in price undercutting.
We further showed dispersion in petrol prices across stations evolves over the price cycle. At the top of the cycle just after a price restoration, there is little dispersion; all stations price to the same point.
As the undercutting phases ensues, market-wide price dispersion grows. Brands appear to leverage their large networks of stations to periodically initiate price restorations, and coordinate all stations’ prices to a higher level. As the undercutting phase ensues, prices depart from their restoration levels and variability across stations’ prices rises.
Our findings, along with those in a recent International Journal of Industrial Organisation article by Matthew Lewis of Ohio State University for the US market, represent the first formal statistical analyses of stations’ pricing strategies in markets with petrol price cycles.
The key insight from these studies is that cycling markets tend to have dominant retailers who operate a large network of stations relative to the size of the market. Having price leaders in a market is crucial for establishing a stable petrol price cycle.
In large markets like Toronto, brands do not have a large enough presence relative to market size to consistently coordinate price restorations, and stations instead adopt a cost-based pricing strategy.
Lessons for Australia
These insights are relevant for the ACCC’s current investigation into Informed Sources, a website that Australian petrol companies use to share information on each other’s stations’ prices. A related issue, which was raised in the ACCC’s 2007 petrol inquiry, is that of price signalling amongst petrol companies (though price signalling laws in Australia currently only apply to banks).
To be clear, this investigation has little to do with price fixing, or agreements amongst petrol companies on price setting. It directly relates to our finding from cycling markets in Canada that brands leverage their large networks of stations to raise prices and initiate price restorations, and have confidence that their competitors will follow.
Informed Sources facilitates how dominant petrol retailers signal price restorations since major brands can easily monitor and react to price jumps easily with this website.
For the ACCC, the key questions will be: how would petrol prices look in a world without Informed Sources; and would such a world be substantially more competitive than what we currently see?
David Byrne does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.