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Rockets and feathers: Why competition matters for petrol pricing

It is sometimes claimed that economists are obsessed by competition. The reason is simple.

Competition matters, a lot!

Petrol provides a great example of the effects of local competition. Costco entered the Sydney market selling petrol about a bit over a year ago. And for most consumers, that is irrelevant. But if the Costco outlet is close to you, then it matters a lot.

Following a reader’s comment, I started to track the effect of Costco’s price on the local petrol market around Casula in Sydney’s west. The results (from the Motormouth website) were startling.

For example, in March last year, motorists could save between 3 to 8 cents per litre by filling up at Costco rather than an alternative outside the ‘Liverpool’ area. And the savings were even bigger if you filled up at Costco rather than, say, on the north shore, where the gap could be up to 20 cents per litre.

Now, few people are going to drive from Lane Cove to Casula just to save $5 to $10 on a tank of petrol. The time, effort and fuel used up would eliminate most of the gain.

So the real interest from Costco’s petrol pricing is on local competition.

Not only could you save by buying petrol from Costco, you could also save, for example, by buying petrol at Woolworths in Prestons compared to Woolworths in Seven Hills. Costco’s discount petrol not only drives down its price, but its immediate competitors have to follow it down.

Competition matters a lot in petrol retailing. But, as the Australian Competition and Consumer Commission has long argued, competition occurs in local petrol markets. Cheap prices in one suburb may have little, if any, impact on the other side of our major cities.

The importance of competition is highlighted by the ACCC’s latest petrol reports. At the macro-level, falling oil prices are driving down the price we pay at the pump. This fall was predictable although the speed and size of the drop in the world oil price has surprised pretty much everyone including myself!

So overall motorists can expect lower prices for the remainder of 2015. The oil price will start to edge back up as new projects are put on the shelf, but the increased world supply is not going to suddenly disappear.

But what about at the micro level?

As the ACCC’s charts show, consumers in rural centres, like Tamworth, Toowoomba, and Kalgoorlie have received a lot less of the benefit of falling petrol prices than their cousins in the major metropolitan cities. For example, in July, Townsville drivers paid around 2 cents per litre more than their city counterparts. By December, the gap had grown to 20 cents. Similarly, in July, residents in Alice Springs paid around 26 cents more per litre than in the cities. By December this had grown to 44 cents.

No-one expects regional petrol prices to be the same as city prices. There are extra transport costs and lower volumes through fuel depots in regional areas that push up the cost of supply. And, petrol prices have dropped in regional Australia as world oil prices have fallen. But they have dropped by a lot less than prices in the five largest cities in Australia.

The ACCC is going to investigate this disparity. What they will find is a well-known economic phenomenon called ‘rockets and feathers’.

When oil prices rise, then retail petrol prices tend to rise rapidly, like a rocket. But if oil prices fall, then the retail response of petrol prices is much slower. Petrol prices fall slowly, like a feather. The end result may be the same, but there is a difference in the time taken to get there. And consumers lose on both sides. The fast rising prices mean consumers pay more. The slow falling prices also mean consumers pay more.

Rockets and feathers is not collusive behavior. It is not a deliberate plot by petrol retailers to screw consumers. Indeed, it is not an Australian phenomenon at all, but is found world wide for a range of different products. The level of competition and consumer search drives it.

Rural motorists suffer from slower petrol price falls because competition at the retail level in rural and regional Australia is not as strong as in the cities. In the cities, no retailer can get away with a slow price drop. There are too many aggressive competitors. But the same doesn’t hold true in many country towns.

The ACCC’s investigation will highlight the different levels of competition, but the real issue is what to do about it. There is no point trying to force more retailers into rural areas. This will just lead to bankruptcies or taxpayer subsidies when oil prices stabilize and petrol volumes cannot sustain the number of retail outlets.

An alternative is to try and reduce consumers' search cost. If motorists can easily find the lowest petrol price then this will help competition. But care is needed. Swapping information about petrol prices can help retailers keep prices higher, as the ACCC is arguing in its current case before the Federal Court.

A key is to get information out to consumers in an easy form and in a public way, at the same time as competitors get the information. But even this may lead to unintended consequences.

Perth uses a fuelwatch scheme to help inform consumers of petrol prices and lower search costs. The scheme has two parts – a restriction on retailers varying petrol prices during the day and a system to inform consumers of cheap fuel prices. Perth is the only major city to use this scheme. And as the ACCC’s latest price cycle information shows, Perth is also the major city with the most volatile petrol prices in the last month.

So competition matters a lot in petrol retailing. And there is not a lot that governments can do about it. The best result from the ACCC’s inquiry may be the recognition that rockets and feathers in regional petrol prices are unavoidable. However, that is unlikely to satisfy the politicians.

Helping the vulnerable: Harper to do a Hilmer on human services

The draft report by the Competition Policy Review has signalled a revolution in the provision of human services. But the interest has all been elsewhere.

That is not surprising. The draft report is more than 300 pages long and has 52 recommendations. Only one of these, recommendation 2, focuses solely on human services. And the business journalists who cover the Review are much more comfortable dealing with the ‘standard’ issues, such as removing sclerotic regulation in taxis, pharmacies and planning or changes to specific competition laws.

But the Review’s human services focus has the potential to significantly improve the lives of many Australians.

As the draft report notes, “[t]he human services sector covers a diverse range of services including health, education, disability care, aged care, job services, public housing and correctional services” (p.140).

The sector has not been ignored. You could fill a small library with the state and federal reports into these areas. Another one, into WA prison services, was announced last week.

Reform has not been absent, either here or overseas. But for each reform tried in one jurisdiction the opposite reform is being tried somewhere else. Success is hard to measure and opinions and vested interests are both strong.

So what has the Review chaired by Professor Ian Harper done differently?

Two things.

First, it has not tried to specify individual reforms for specific services, but rather to set up a framework for reform. The framework reflects the broad principles that have worked well in other areas where the government is key to service delivery – emphasise choice; separate funding, regulation and service delivery; allow for diversity in providers; and encourage innovation.

These principles may sound obvious to those working outside human services. They are not. And 25 years ago they were not obvious to other areas either!

Remember telecommunications in the 1980s? Australia had a single, integrated government-owned-and-operated telecommunications company, Telecom Australia. Its prices were high and its service standards were woeful. You could have any telephone you liked, as long as it was the one Telecom Australia gave you.

How about utilities? We complain about service provision now, but remember the old state-owned electricity monoliths like the State Electricity Commission of Victoria (SECV)? It controlled everything from the mines in the Latrobe valley to the wires into your house. Costs were high and the system was run by and for the engineers, not the public.

The reform to government utilities flowed from the Hilmer report into national competition policy in the early 1990s. It recommended a framework to allow all levels of government to work together and principles for reform. Now the Harper review aims to do the same for human services.

In human services, the approach where the regulator, funder and supplier are either the same or are closely related, is still common. This model has been eliminated in other areas of government service delivery.

Why? Because it promotes capture by the insiders, leads to a one-size-fits-all outcome and stifles innovation. Separating out these three functions leads to transparency and improved choice.

Why choice?

Choice is something that many of us take for granted. But uniform service delivery limits choice. That harms service recipients. In contrast, choice can empower. For example, the Review quotes a service recipient surveyed by the Brotherhood of St Laurence:

“Direct payments give me control. I now have a say in what I eat and drink, what I do and when I do it. I can choose carers that can help me to live my life. I can have continuity instead of a different carer every day.”

Well-designed choice in human service delivery can enhance lives. But choice must be cost effective and balanced. Too little choice reduces recipient welfare but too much can overwhelm. As the report notes, “[a] consumer choice model is not the right one for all services”.

Choice and funding are not separate, and groups who currently receive guaranteed funding will oppose choice. Choice means the ability for a service recipient to choose an alternative service or service provider. “In introducing choice-based models, an important element is to ensure that funding follows people’s choices so that providers have signals to better tailor services to individual and community needs” (p.154).

There is currently diversity in some areas of service delivery, including government, for-profit and not-for profit providers. This diversity can be further encouraged, both across services and by innovation in service delivery, such as through cooperatives and mutual groups. It can be encouraged through contractual arrangements. Public private partnerships already exist in some areas of human services. Do they work? What else works? What can we learn from overseas? How can we innovate?

The draft report does not seek to answer these questions. The aim is to set up a framework that can operate through the new Australian Council for Competition Policy. (ACCP). The ACCP is the second element of human services reform. It will advise, facilitate and monitor reform. It can investigate overseas experience and draw together both academic and practical learning to help advise governments. And it will fill the gap left by the demise of the COAG Reform Council.

Unsurprisingly, the initial reaction to these reforms from insiders and the ‘magic pudding’ brigade have been negative. This of course mirrors the earlier Hilmer reforms. The biggest opponents of these reforms were those who had a stake in the existing structure. The bureaucrats in Telecom Australia and the SECV did not give up their power easily!

The Hilmer reforms to utility industries were not easy. It will be even harder in human services.

For example, tendering for service delivery can lead to higher quality services being provided at a lower cost. But both economics and experience highlight potential shortcomings.

Contracts with third-party providers must be clear but flexible. It has to be clear what is to be provided, when and to whom. If these are not clear then service delivery will fail as the provider and government fight over the allocation of responsibility.

Service delivery may involve a variety of measured and unmeasured features. For example, delivery of services to the homeless can involve measurable outputs of food and shelter. But just as important are the unmeasurables, such as simply having a volunteer to talk to, someone to listen to your issues. These unmeasurables are critical but can be overlooked when formal contracts are written.

The Review’s focus on human services should be welcomed. But it needs broad feedback on the draft recommendations. And it needs to work out how the ACCP will bring the various factions, including government, into the debate.

(Stephen King is a member of the National Competition Council and the Economic Regulation Authority of WA. He attended the Review conference, held in Canberra last week)

Words matter. That’s why the ACCC has got it wrong.

Words matter.

With Australia’s competition laws, the wording of our ‘abuse of market power’ laws are ahead of the rest of the world. But the Australian Competition and Consumer Commission (ACCC) wants to change the words and introduce ambiguity just as the rest of the world is starting to recognise the benefits of the Australian approach.

What is the issue?

Australia’s competition laws make it illegal for “[a] corporation that has a substantial degree of power in a market” to “take advantage of that power” for an anti-competitive purpose. The ACCC wants to make three changes:

“The ACCC considers that making this provision effective could be best achieved through the introduction of an effects test, including a substantial lessening of competition, and amendments to overcome limitations inherent in the current interpretation of the ‘take advantage’ test.”

Making it clear that the law covers any acts that have a purpose of substantially lessening competition is benign.

The real issue is the combination of the other two changes. Together they weaken the link between market power and the anti-competitive objective of a business. At a minimum this will make businesses wary about engaging in pro-competitive actions that benefit consumers but harm competitors. At worst, it will force businesses to defend pro-competitive conduct before the Courts.

For a current state-of-play in the debate and a statement of the ACCC’s views, see the letter from the Chairman of the ACCC to the current Competition Policy Review.

Are we leading the world?

Coincidently, last Friday I heard a talk by one of the world’s leading experts on competition law, Professor Louis Kaplow from Harvard University. He outlined his new research on the failure of US and EU laws to link ‘market power’ and ‘anti-competitive conduct’. These laws look a lot like what the ACCC wants. Professor Kaplow noted that this had led the Courts to segment the analysis leading to poor decisions.

In contrast, Australia’s existing law links ‘market power’ and ‘conduct’.

A firm only ‘takes advantage’ of its market power if its behaviour is inconsistent with the behaviour of a business that doesn’t have market power. Any business can have a great idea, introduce a better product, or work hard to lower its costs. These actions raise its profits and usually harm its competitors. They do not depend on market power and are clearly not illegal in Australia under our current laws.

So our ‘take advantage’ test largely does what Professor Kaplow wants for the US and EU laws. The ACCC appears to agree.

“This means that the words “taking advantage” have had to do the heavy lifting in Section 46, distinguishing what is anti-competitive from what is pro-competitive.”

But the ACCC wants these words removed.

Why? Possibly because it makes the regulator’s job harder. It has to prove the link between ‘market power’ and the ‘anti-competitive conduct’. As The ACCC Chairman notes:

“[The] courts have been distracted into deliberations about what a hypothetical firm in a counterfactual world lacking substantial market power might do (for some other purpose).”

Sorry Mr Sims. These are not distractions. These are the key bits of the analysis. You cannot know if a business is abusing its market power unless you ask if its behaviour is inconsistent with a competitive business. Of course this bit of the law does the heavy lifting. It is the key economic test that ensures our competition laws promote, not prevent, competitive behaviour.

Throwing the baby out with the bathwater!

Don’t get me wrong. I am not saying that our laws are perfect. But our current law appears to be ahead of both the equivalent US and EU laws in making sure that competition, not competitors, is the focus.

Maybe the wording could be improved. But the ACCC suggestions clearly do not do this.

The US has partially overcome the problems that the ACCC wants to introduce through legal precedent. But their law is almost 100 years old. The ACCC amendments would throw out our own legal precedent and hope the Courts will ‘get it right’.

Why?

The Courts currently have guidance through the wording of the law and our legal precedent has become much clearer over the last two decades.

As for Professor Kaplow’s talk, I couldn’t help myself. I pointed out that the ‘missing link’ between power and conduct existed in Australia’s law. I am not sure that anyone else in the talk cared - it was in Europe and I think I was the only person from the Antipodes in the room.

It would, however, be ironic, if the ACCC got its way and had our law changed just as the rest of the world starts to catch up.