The Economics of Fuelwatch
Addressing information asymmetries
3.1
Petrol is a very homogeneous product. While the petrol sold by a
Coles Express service station, a BP station and a Gull station may be 'branded',
in many cities it all comes from the same refinery so is really an identical
product. Furthermore, petrol accounts for a sufficiently large proportion of
household spending that it is worthwhile trying to buy it at a good price.
These factors should lead to a very competitive market as customers compare
prices and buy at the cheapest outlet. This in turn should drive prices down to
the level at which petrol retailers are earning just enough profit margin to
stay in business.
3.2
However, this potential competition is impeded, if not thwarted,
by the unusual volatility of petrol prices. There are no other non-perishable
consumer goods, or services, for which prices are so volatile.[1]
3.3
This makes it very hard for motorists to compare prices. For
example, if a consumer is told by a friend that they saw on the way to work
that a particular service station had a low price, this provides little
incentive to divert to that station on the way home as that station and other
stations' prices are likely to have changed (perhaps a number of times) during
the course of the day.
3.4
There are certainly large signs outside service stations displaying
the current price at that station. But this does not tell the customer how this
price compares to that being charged by rival stations at this time and by the
next day it is likely to have changed. Due to the unusual volatility in petrol
prices, knowing today's price is not much help in predicting what the price
will be tomorrow at a given outlet and its rivals.
3.5
This volatility does more than just add 'noise' to the market. It
does not affect buyers and large sellers equally. Rather there is a problem of
'information asymmetry'. The large petrol retailers subscribe to a service from
a company called 'Informed Sources'. The company collects price data from 3 500
retail sites by a combination of paying people to ride around noting down
prices and having their subscribers send price data to them. Informed Sources
then provides its customers with information every 15 minutes about what other
stations are charging. Armed with this information, the large petrol retailers
have a huge advantage over consumers in the market.
3.6
This information asymmetry is likely to mean that the retail
price of petrol is higher than in a more competitive market. Firstly, consider
the case of a normal, reasonably competitive market. Suppose a bookseller is
deciding what price to charge for a popular title in an advertisement in the
weekend newspaper. He notes the book has been selling well and is thinking of
increasing the price. He knows that if other booksellers follow his price
increase, he will lose few sales and so profits will rise. But if none of his
competitors increase their prices for the book, he may lose a lot of sales and
so profits may fall. There is therefore a risk attached to deciding to increase
the price of the book.[2]
3.7
By contrast, the information asymmetry greatly reduces this risk
in the retail petrol market. A petrol retailer who puts up her price will know
that her competitors will be aware of this almost immediately and she will be
aware almost immediately of their response. So if the price rise is not
followed it can be reversed, before consumers become aware that her price is
higher than her peers, and so before there has been much loss of sales. Her
rivals may well follow her lead in raising prices as they know if she changes
her mind and cuts the price again, they can respond immediately.
3.8
The information asymmetry also discourages petrol stations from
cutting prices. A lower price will reduce the profit on sales that would have
been made anyway. Rivals will know of it immediately and may match it, removing
any extra sales to the most price-conscious customers. Many other customers who
might have been attracted by the lower price will be unaware of it, or unsure
whether other stations have also lowered their prices.
3.9
The information asymmetry gives rise to a 'lazy competition'.[3]
Fuelwatch will greatly reduce this information asymmetry. As stations are
required to 'lock in' their prices for 24 hours, they will risk a loss of sales
if they increase their price. As useful information about prices is more
readily available to motorists, they will be more willing and able to shop
around and buy petrol where it is cheapest, increasing the incentive for
stations to cut prices. After 4 pm they will know both the current day's price
and the next day's price at all their local stations. The market will become
more competitive.
3.10
The above argument for the benefits from Fuelwatch was put by the
Australian Competition and Consumer Commission, the state Department
responsible for FuelWatch in Western Australia, independent academics and
others:
By having to quote fixed fuel prices for a 24 hour period,
petrol retailers will have to make better judged and more competitive choices
on fuel prices.[4]
The disincentive to be the first to hike price is much greater
under the 24‑hour-rule. Without the rule, the price leader for a cycle
knows that once its price is hiked, other firms can respond very quickly
(within hours) by hiking their prices as well. If other firms do not respond
quickly, the price leader can quickly retract its price hike to avoid losing
much market share. However, under the 24-hour-rule, after a price leader hikes
its price, other firms cannot respond within 24 hours. The price leader has to
lose market share for an entire day – it cannot retract its price hike either.[5]
3.11
The committee does not believe opponents of the scheme ever
offered a convincing rebuttal of this argument. The logic of the argument is
that over time Fuelwatch will not only help those motorists using it to locate
stations offering cheaper fuel, but the added stimulus to competition will push
down average prices for all.
3.12
It is hard to quantify how large this impact will be. The most
important factor determining the retail price of petrol will remain the
wholesale price, and therefore the world price of oil and the exchange rate
(with about a week's lag).[6]
But even a reduction of a few cents per litre due to a more competitive retail
market adds up to a significant saving for motorists. And unlike a cut in the
excise duty, it is an amount shifted to consumers from large oil companies and
retailers not from other taxpayers.
Could a modified scheme achieve a
similar result?
3.13
An alternative suggested in a number of submissions was making
more pricing information available but still allowing intraday price changes;
'Fuelwatch without the 24 hour rule'. The Service Station Association endorses
requiring stations to notify the ACCC of their opening prices for the
next day, but believes (at least small independent) stations should be able to cut
(but not increase) their price during the day.[7]
3.14
However, such an approach would not get around the problem that
consumers would not know that what they were told was the lowest price in the
area would still be the lowest by the time they made their purchase. It also
weakens the disincentive Fuelwatch builds in for raising prices.
3.15
For these reasons the committee believes the 24 hour rule is an
integral part of the Fuelwatch scheme.
Information costs
3.16
Some opponents of Fuelwatch have either argued that it is too
costly or asked why similar schemes are not being applied to other goods and
services. One response is the points made above that petrol prices are
unusually, almost uniquely, volatile; that the information asymmetry problem is
particularly acute for petrol; and that petrol constitutes a significant amount
of household budgets.
3.17
A more complete answer is to consider what signs there are that
better information is desired and the most cost-effective means of providing
it.
3.18
The committee heard that there is a huge demand for better
information about petrol prices, from both retailers and consumers.[8]
This is despite the large amount of resources currently being expended on
collecting and distributing it.
3.19
The large petrol retailers mainly get data by buying it from
'Informed Sources', a private company that collates fuel price data. Informed
Sources have not disclosed how much it costs them to gather their information
or how much they charge for it, but it is clearly substantial. They stated:
it currently costs in excess of $50k pa for each car and driver
we put on the road in capital cities to collect prices six hours per day across
350 days per annum and with each vehicle covering more than 100,000 kilometres
each year.[9]
3.20
As well as the amount retailers pay Informed Sources for the
data, there are the costs involved in staff sending price information every 15
minutes to Informed Sources to provide the data sold back to them.
3.21
The small independent operators cannot afford to subscribe to the
service. Instead they spend time and money driving around town checking out
rival stations' prices.
3.22
Another private company, FUELtrac, also collates and sells
information on petrol prices.
3.23
Consumers may collect information themselves by driving around
and the extent of these search costs are often neglected in discussions of
Fuelwatch:
Fuelwatch... reduces the search costs that they currently face in
trying to work out where to find the cheapest petrol. Those costs include not
just time; they also include money in the form of petrol driving to places that
they did not want to be.[10]
3.24
Alternatively consumers may use various services set up by
motoring associations or local media.[11]
For example, in Rockhampton, the local television station explained:
About 12 months ago, we got rid of the share-watch segment from
our news across rural and regional Queensland and replaced it with a fuel-watch
segment, which was basically designed to just inform people about fuel prices
during the day...Every day in the markets of Far North Queensland—which is
Cairns, Townsville, Rockhampton, the Sunshine Coast and Toowoomba—our crews,
who are out all day, are basically collating prices from petrol stations in
their region during the day and, of an evening, we just present that
information during the news service.[12]
3.25
While this information is of some value to viewers in
Rockhampton, where petrol prices are much less volatile than in the cities, its
limitations are recognised:
The idea is really just to inform people about what the price
was during the day. We present an average fuel price for the day across the
market and we also present the cheapest .. it by no means predicts what is going
to happen the next day. It is just telling people what the prices were during
the day. [13]
3.26
The motorists' organisation in Tasmania explained:
The RACT has carried out fuel price monitoring, using its own
resources, for around five years and has posted those fuel prices on its
website—RACT.com.au—on a weekly basis on its fuel prices update page.[14]
3.27
It also realised the limitations of its service:
The reason the club supports a Western Australian style
FuelWatch is that it provides additional information to motorists that the club
cannot provide, because it cannot afford to do so on its own, using its own
resources. [15]
3.28
A similar limited service is provided by the NSW motorists'
organisation:
we actually do provide what I would call a limited service. We
have petrol watch on our website. That provides information in the morning and
the afternoon for Sydney and a post event for regional areas on the price of
petrol. But we cannot give it for every site and you cannot actually track.
What we can tell you is where the highest priced petrol was and where the
lowest priced petrol was and what the average price is. That is not a costless
exercise. It is a costly exercise.[16]
3.29
The Royal Automobile Club of Victoria reports that their petrol
price monitoring website had received over 660,000 hits in the past year.[17]
3.30
Yet all these services provide is a patchy coverage of what
petrol prices had been. They do not provide what is actually most useful to
motorists: what petrol prices will be. This is what Fuelwatch can provide.
3.31
The administrative costs of FuelWatch comprise initial capital
costs of $1.3 million and annual operating costs of around $4½ million.[18]
3.32
The compliance costs of the proposed FuelWatch scheme would be
minimal, only requiring petrol stations making a daily call to a toll-free
number or sending an email.[19]
3.33
A cost-benefit analysis of the information on petrol prices
provided by Fuelwatch involves a comparison of the large resources currently
being expended on a variety of different monitoring schemes (involving paying
people to drive around noting down prices) that fail to provide consumers with
the forward-looking information that is useful to them against the costs of a
single agency collecting and distributing information (provided to them by
email or telephone) which would be very useful to consumers and all retailers.
It seems clear that the resources devoted to collating and dispersing petrol
price information will be much less under a national Fuelwatch scheme than
under the current arrangements, and the benefits it provides to consumers much
greater.
Petrol price cycles
3.34
There are regular weekly price cycles in Sydney, Melbourne, Brisbane
and Adelaide. (Price fluctuations are less regular or non-existent in Canberra,
Hobart, Darwin and rural areas.) Typically prices peak on Thursdays and are
lowest on 'magic Tuesdays'.[20]
3.35
It is generally the stations affiliated with a refiner in that
city that lead the price up in the cycle, when the wholesaler announces the
withdrawal of price support to retailers.[21]
However, the large petrol retailers operate sophisticated strategies which allow
them to adjust prices on a localised basis.[22]
Independent retailers used to be more aggressive discounters but this has been
less common since the entry of the supermarkets with their shopper docket
schemes.[23]
3.36
Most customers are well aware these cycles exist. Most motorists
try to buy petrol when they think it is cheapest rather than just when they
need it.[24]
However motorists are limited in the extent to which they exploit their
(imperfect) knowledge of the price cycles.[25]
3.37
One indication of the uncertainty that consumers face about price
cycles is indicated by some 'urban myths' that have grown up around them. One
persistent belief is that petrol prices spike more before long weekends than
other weekends.[26]
However the ACCC's analysis shows this is not the case. Customers also
overstate the extent of the cycle.[27]
3.38
These cycles are much more marked in Australia than in overseas
retail petrol markets.[28]
Despite extensive analysis by the ACCC, 'the causes ... are an enigma'.[29]
3.39
The typical observed pattern of quick price rises followed by
gradual declines is consistent with the Edgeworth cycles theory where a small
number of competing retailers are continuously undercutting each other by small
margins in an attempt to increase market share until a substantial price rise
is required to restore viability.[30]
This theory is supported by the large petrol retailers and Informed Sources.[31]
It does not explain why the cycle has such a regular periodicity. It is also
noteworthy that it is a theory about an oligopoly, not about a perfectly
competitive market.
3.40
Another possible explanation is that refineries are trying to
smooth their production by adjusting (wholesale) prices to even out demand
across the week and this is flowing into retail prices.[32]
However, there is no weekly price cycle evident in wholesale prices.
Furthermore, a problem with the smoothing argument is that sales tend to be
higher than average on the days prices are lower,[33]
which would imply that prices are being persistently over-cut.
3.41
The cycles are most likely a form of price discrimination.
Retailers are trying to segment the market so they can sell at a higher price
to those who buy petrol on a 'when needed' basis but still sell to more price
conscious consumers on the Tuesdays. An analogy might be drawn with cinemas
charging more for tickets on Saturdays than on Tuesdays.[34]
However, unlike in the petrol market, cinemagoers may benefit from this as more
people want to go to cinemas on Saturdays and there are capacity constraints on
how many can attend. In general, price discrimination is a means of increasing
profits at the expense of consumers, rather than an act of altruism on the part
of sellers.
3.42
The committee heard a range of views about whether the existence
of cycles implies a higher or lower average price of petrol. If the cycles are
the result of price discrimination, then this implies that those buying on the
'cheap' day are getting the price that would prevail generally in the absence
of information asymmetries and other market imperfections. The other customers
are paying more than a competitive price. Measures that make the market more
competitive would then tend to reduce prices on the more expensive days but
leave them unchanged on the 'cheap' days, both dampening the cycle and lowering
the average price.
3.43
On the other hand, those who claim that the cycle results in a
lower average price have to explain why the difference between the high and low
points of the cycle appears to exceed the average margin on petrol. This
implies that stations are selling at a loss at the low point of the cycle. The
committee has not heard a convincing explanation as to why stations would
choose to do this persistently.
The 'buying below the average'
fallacy
3.44
A commonly-used argument is that consumers benefit from the cycle
as they buy petrol at below the average price. For example:
Discount cycles favour the consumer, with over 60% of petrol
sales occurring below the average price of the price cycle...more than 60 per
cent of weekly sales were made on the four days of the week (ie. Sunday,
Monday, Tuesday & Wednesday) when the average daily price was below the
average weekly price.[35]
3.45
If consumers bought petrol completely at random, then 57 per cent
of sales would be made on Sunday, Monday, Tuesday and Wednesday (or whichever four
days had the lowest prices). It is not clear what is so impressive about an
extra, possibly insignificantly different, 3 per cent of sales occurring on
these days, which is largely a function of how high is the spike on the most
expensive day of the week.
3.46
If the Committee thought that the goal of the inquiry was to
ensure that a large proportion of consumers paid less than the average posted
price, it would probably recommend that stations be made to charge $1,000 a
litre for an hour a week, so that 100 per cent of sales are made below the
weekly average price. This is absurd of course, but it illustrates the
irrelevance of the proportion of sales made below the average price as a
criterion.
Intra-day price movements
3.47
In addition to the interday movements each week, there are often
intra-day price changes which make it much harder for consumers to compare
prices. This variation is very unpopular with consumers, with a third even
being willing to pay higher average prices if it meant no intraday volatility.[36]
The classic example is a customer who complained that the price had risen by 15
cents while she was waiting in a queue.[37]
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