The Consumer Council has put forward in a research study a package of recommendations that will provide a new impetus and approach for change in the petroleum products market to promote competition and enhance consumer welfare.
In a 160-page study report on Energizing the Energy Market which was released today (January 12), the Council expresses deep concerns about what it describes as oligopolies in the motor gasoline, diesel and liquefied petroleum gas (LPG) markets in Hong Kong.
Characterizing these markets as oligopolies, the study found the oil products industry to be highly concentrated and largely vertically integrated (import, wholesale and retail by same company), with three oil companies holding over 70% of the piped and wholesale cylinder LPG market, 80% of the diesel market and 90% of the motor gasoline market.
The industry is characterized by relatively small total demand for the products under study, limited growth opportunities, and barriers to entry such as the need to achieve economies of scale in storage and retail.
It is noted that Hong Kong has one of the highest retail prices in the world for the petroleum products under study. In the case of unleaded gasoline, the average retail price, excluding tax, was observed to be higher in Hong Kong than those in other countries, particularly in the region.
In this connection, the industry has an obligation to explain why retail prices for oil products are so high in Hong Kong in comparison with its trading partners. For example, how consumption patterns have emerged that indicate consumers' professed preference for higher octane fuel as one of the reasons advanced by oil companies for the higher price and the contribution of high octane rating to the overall pricing of motor gasoline in Hong Kong.
As regards to the public's concern over the uniform pump price and the question whether it is the result of industry collusion, given the limitations in data and information collection, the study could find no direct evidence of explicit collusion (i.e. a cartel) among the oil companies in Hong Kong to fix prices.
Theoretically, even in the absence of a cartel, an oligopoly market can lead to cooperative behaviour based on tacit understanding, which may emerge when the few firms in the market recognize their mutual interdependence and realize that it is not in their interests to constantly drive prices down to marginal cost levels. A typical characteristic of an oligopoly market can be that prices are uniform and above their competitive levels.
In a situation where tacit understanding exists, oligopolistic firms may or may not engage in limited price competition that applies only to specific geographic markets, promotion schemes, product differentiation, and other forms of non-price competition.
In the case of Hong Kong, the Council has observed price discounts based on loyalty schemes, one episode (in January 1999) of price competition within certain geographic markets, the marketing of product with performance enhancing additives, and the giving out of facial tissues and bottled water.
With a very high concentration ratio of market participants, however, there is no guarantee that these forms of competition would be strong or would indeed persist.
It is noted that all but one oil company have, in the last few days, stopped the practice of giving away "free" tissues and bottled water, the remaining company indicated it will cease doing so very soon. Leaving aside the fact that all companies have decided the same on this practice, it does suggest that some savings would arise from the decision, which the Council expects should be passed on to consumers.
The conspicuous absence of any price information boards to inform consumers of the pump price is an indication that price competition is not considered a major marketing strategy by oil companies.
The Government plays an important role in the industry through determining some of the structural conditions that can affect the way in which competition develops in the oil product markets under study.
For example, with regard to motor fuels marketing, it controls the availability of land for filling sites, the insertion of lease restrictions, regulations that govern who is entitled to bid, and the selection of successful bidders for such sites. It also has an important role in developing an energy policy that governs how Hong Kong's overall energy needs are met, of which petroleum products are only a part.
These regulations and policy initiatives cover a range of functions concerned with safety, land planning, certainty of supply and environmental considerations. They are at present carried out through a division of labour by different arms of the Government that requires a high degree of co-ordination. That co-ordination would be greatly assisted by the creation of an Energy Commission that will have as its objective the development of a strategic energy policy for Hong Kong.
While necessary and essential these functions are, the report emphasises that of equal importance is the need for competitive markets which through their effects on prices can be expected to lower the costs of doing business in Hong Kong and alleviate pressure on household expenses.
In the report, the Council has put forward recommendations to bring about changes in the structure of the market and the conduct of market participants. They focus on three objectives:
First, encouraging entry by new operators, through addressing issues relating to site retailing and storage which affects wholesale supply.
Second, inducing price competition, through the provision of more information to consumers and by changing the retail environment.
Third, improving government oversight , through a more focussed approach in devising a long term strategy, and better coordination with regard to regulatory and policy activities.
A total of 11 recommendations were put forward by the Consumer Council having regard to the Government's Statement on Competition Policy which sets out a role for Government bureaux and departments to promote competition within their sectors and for industry action.
Objective - Encouraging Entry By New Operators:
1. Removal of bidding restrictions
- Current regulation requires a bidder to hold an import license or supply contract. This would tend to favour the oil companies as the potential independent entrepreneur would be required to obtain such essential qualification from the parties (oil companies) they would eventually be bidding against for a site.
2. Scrutinize the ownership of petrol filling station sites
- The Council recommends that acquisition and renewal of approved fuels filling site leases should be scrutinized by the government to guard against undue market concentration by the same company within a relevant geographic market.
3. Flexibility in filling sites
- Encourage mixed retailing to enable development of filling sites that incorporate the retailing of other products in addition to motor vehicle fuels.
- Filling sites need not be confined to sites identified by the government. Conversion of land lease should be flexibly entertained.
4. Safeguarding adequate storage facilities
- which involves large sunk costs resulting in pressure for oil companies to compete and enable potential new entrants to lease spare storage capacity from owners of such infrastructure.
Objective - Inducing Price Competition:
5. Ensuring competitive behaviour
- Conditions should be inserted in filling site leases to prohibit collusive anti-competitive conduct.
6. Price information boards
- at filling sites for easy viewing and comparison by consumers.
7. LPG common carrier
- Using common carrier arrangements where piped LPG is installed, through separation of fixed costs of the LPG network and storage area from the variable costs of LPG supply, making it possible for entry of different operators.
8. Standardization of cylinder LPG connecting equipment
- to allow greater mobility and choice between suppliers for consumers.
Objective - Improving Government Oversight:
9. The creation of an Energy Commission
- Such a body would provide an institutional framework for strategic planning of the energy sector, and be required to develop a clear agenda for how the various energy needs of Hong Kong are to be met into the future.
- In the absence of a Competition Authority, which is the Council's first preference to have oversight of competition matters, the Energy Commission could take on the pro-competitive safeguards suggested in the study.
10. Monitoring the industry's profitability trend
- In view of widespread public concern over competition in this industry, which can be viewed in the same light as a major utility, an assessment of profitability in the industry would be instructive as to the state of competition in the industry. High profits can indicate there is little real competition. The Government should monitor the industry by collecting data from oil companies to enable the Government to:
- make trend observations on profitability levels in the industry, along the lines of return on capital or return on assets and
- make trend observations on the difference between import prices and retail prices.
- The Energy Commission would be an appropriate body to conduct such an exercise. The industry is urged to provide such information to the government (or the Energy Commission when established).
11. Competition implications of regulatory intervention
- The Consumer Council has suggested a framework for government bureaux and departments to implement and improve periodic reviews of the competitive implications and impact of their work and policies.
Action is needed on the implementation of these recommendations by the government (no great cost increases will be involved), the industry (to accept these recommendations and to assist with studies on price analyses of oil products) and the consumer (to take an active role in comparing prices and making their views known).
The Council's study is based on information provided by a number of industry participants (including all the oil companies), commentators, and government departments and bureaux. The Council expresses its appreciation to all those who cooperated with the study. The Council views the study as a starting point for relevant government policy bureaux and departments, to carry on with their allotted role with regard to promoting competitive markets within their areas of responsibility, and for industry action. The Council has also suggested an agenda for the future to conclude the report.
For more details of the findings and recommendations of the study, please refer to the paper attached.