Tue | Dec 6, 2016

The price of finished petroleum products rises faster than it falls

Published:Friday | January 30, 2015 | 12:00 AM

Kevin Harriott, GUEST COLUMNIST

When it comes to Jamaica's energy options, the narrative is changing.

In December 2014, Nestlé Jamaica Limited announced that it would cease some local production in January 2015, due to unfavourable energy costs. Reducing the price of energy has been an unwavering demand of both residential and commercial consumers alike.

There is a noticeable shift, however, in the nature of the discussion surrounding the way out of Jamaica's energy crisis as short-term policy proposals are now being introduced into the hitherto bag of long-term prescriptions.

The price of oil on the global market is largely under the influence of a powerful group of sovereign oil-producing nations, formally known as the Organization of Petroleum Exporting Countries (OPEC). Given the position held by OPEC, it was reasonable for the public to presume that the price of imported petroleum in Jamaica is ostensibly outside of the influence of domestic suppliers, since domestic demand for petroleum products is satisfied entirely through importation.

Accordingly, previous prescriptions aimed at alleviating the high cost of energy in Jamaica were confined to long-term proposals such as calls for the Government to diversify its energy base to reducing its dependency on fossil-based fuels, thereby avoid the relatively high price of finished petroleum products. Other proposals called for a restructuring of the electricity sector to ensure that our energy needs are satisfied more efficiently from fossil-based fuels.

GAME-CHANGING TRENDS

Recent trends in the price of crude oil have 'fuelled', for want of a better word, a change in the tone of this important conversation.

The presumption that the price of finished petroleum products is outside the control of domestic suppliers appears to be no longer tenable among key stakeholders in the business community - the narrative has changed.

Pointing to alleged discrepancies between movements in the ex-refinery price from Petrojam and the price of crude oil on the global market, the Private Sector Organisation of Jamaica (PSOJ) has implicated Petrojam's pricing strategy as a significant contributor to the high price of finished petroleum products in Jamaica.

In particular, the PSOJ argues that the percentage reduction in the ex-refinery price during the latter half of 2014 was not commensurate with the percentage reduction in the price of crude oil over the same period.

In December 2014, the PSOJ called for a more transparent pricing mechanism - one which allow for a greater reprieve for consumers when the global price of oil declines. In what follows, we demonstrate that competition offers the best environment to encourage such transparency in prices.

COMPETITION AS SHORT-TERM SOLUTION

Using the jargon of competition law, the PSOJ is arguing that in the absence of proper competitive constraints, Petrojam has been exercising significant market power in the upstream or wholesale market to the detriment of its customers in the downstream or retail market.

While not commenting on PSOJ's argument, the main purpose of this note is to document the influence of competitive constraints on the transmission of cost movements in the ex-refinery price on the retail price.

In particular, we compare movement in the ex-refinery price on the movement of pump prices in three areas in Kingston: Norman Manley International Airport (NMIA), Heroes Circle and Liguanea, as outlined in Table 1.

In the Heroes Circle area, we track the prices of four dealers operating in proximity. At the Liguanea location, we track the price of six dealers operating close to each other. At the NMIA, we track the price of the sole dealer location, with its nearest rival located approximately eightkilometres away at the Harbour View roundabout.

These areas were selected for comparison due to the difference in localised competitive dynamics operating therein. All other things constant, greater competitive constraints should be reflected by lower average prices and smaller price differentials among competing dealers.

Using monthly data on pump price for 87 octane fuel gathered January-October 2014 by the Consumer Affairs Commission, we observe at least three trends which are consistent with the common perception that dealers in the Heroes Circle region face greater competitive constraints than dealers in the other areas.

First, we observe that the average price in the Heroes Circle area is consistently below the average price within the other two areas. In particular, the fuel in the Heroes Circle was, on average, $6.49 per litre more affordable than the fuel sold at the Airport, and $8.60 per litre more affordable than the fuel sold in the Liguanea area.

Second, we observe that the fuel sold at dealers located in the Heroes Circle area was more affordable than identically branded locations in the other two areas. Specifically, the Petcom-branded location at Heroes Circle was, on average, $6.60 per litre more affordable than the fuel sold at the Petcom-branded location at the airport.

Similarly, the Total-branded location at the Heroes Circle was, on average, $8.22 per litre more affordable than the fuel sold at the Total-branded location in the Liguanea area. Finally, the difference between the most affordable and the least affordable dealers, the 'price differential', was on average 64 cents per litre in the Heroes Circle, while it was as much at $1.35 per litre in the Liguanea area.

PACE OF GAS PRICE PASS-THROUGH

The central focus of the recent discussions is the pace at which changes in the global oil price is reflected domestically at the point of consumption by motorists, electricity producers, manufacturers, and others.

The data show that there was a general upward trend in the ex-refinery price of 87 octane during the period January-June 2014. During this period, the ex-refinery price increased by $12.08 per litre. It is also observed that during this period, dealers in the Heroes Circle area increased the pump price within seven days - 'immediately' - by $0.80 per litre, on average, for every dollar increase in the ex-refinery price.

By way of comparison, the dealers located in the Liguanea and airport areas increased pump price immediately by $1.04 cents per litre, and $0.82 per litre respectively, for every dollar increase in the ex-refinery price.

The data also confirm that prices tend to increase at a faster pace than they tend to fall. In particular, during July-october 2014, the ex-refinery price of 87 octane fuel decreased by $12.99 per litre.

During this period, dealers located in the Heroes Circle reduced pump prices by $0.70 per litre for every dollar reduction in the ex-refinery price, whilst dealers in the Liguanea and airport areas reduced pump prices by $0.71 per litre and $0.68 per litre, respectively, as seen in Table 2.

Although dealers generally pass through increases in the ex-refinery price at a faster pace than they pass-through reductions in the ex-refinery price, there is a noticeable variation in the magnitude passed through to consumers.

Another important observation from this study is that the pass through rate is more favourable to customers of the more competitive dealer locations than to customers of less competitive locations.

To the extent that the cost of energy will be priced into most, if not all goods sold in Jamaica, the magnitude of the reprieve consumers might reasonable expect from the reduction in the global price of oil might be stunted if competition is not allowed to organise the Jamaican economy.

Dr Kevin Harriott is competition bureau chief at the Fair Trading commission. kharriott@jftc.com