Subcommittee on Oil and Gas and Other Energy Prices Committee on Aug. 27th, 2008

[Erica Pereira, Procedural Clerk]

Honourable members of the committee, I see a quorum. We can now proceed to the election of the chair. I am ready to receive motions to that effect.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Madam Clerk, thank you very much for this. I'm honoured to nominate Mr. James Rajotte, who I understand will get an increase in pay if we nominate him today as subcommittee chair—and of course we'll extend to this committee free lunches.

[Erica Pereira]

Mr. Dan McTeague moves that Mr. James Rajotte do take the chair of the subcommittee. Are there any other motions?

Is it the pleasure of the committee to adopt the motion?

[Some hon. members]

Agreed.

[Erica Pereira]

I declare the motion carried and James Rajotte the duly elected chair of the subcommittee.

[Some hon. members]

Hear, hear!

[Erica Pereira]

Before inviting Monsieur Rajotte to take the chair, if the committee wishes, we will now proceed to the election of vice-chairs.

I am now ready to receive motions for the position of First Vice-Chair.

[Bruce Stanton, Conservative, Simcoe North, ON]

I propose Dan McTeague as first vice-chair.

[Erica Pereira]

It has been moved by Bruce Stanton that Dan McTeague be elected as first vice-chair of the subcommittee. Are there any further motions?

Is it the pleasure of the committee to adopt the motion?

[Some hon. members]

Agreed.

[Erica Pereira]

I declare the motion adopted and that Mr. Dan McTeague is duly elected First Vice-Chair of the subcommittee.

I am now prepared to receive motions for the second vice-chair.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I have the great honour to move that Mr. Robert Vincent be elected Second Vice-Chair of the subcommittee.

[Erica Pereira]

It has been moved by Dan McTeague that Robert Vincent be elected as second vice-chair of the committee. Are there any further motions?

Is it the pleasure of the committee to adopt the motion?

[Some hon. members]

Agreed.

[Erica Pereira]

I declare the motion carried and Robert Vincent duly elected as the second vice-chair of the committee.

I now invite Mr. James Rajotte to take the chair.

[The Chair, Conservative, James Rajotte]

Well, good morning, ladies and gentlemen. Welcome back to Parliament.

The media can now stop writing about the election because it's happened.

I thought we'd all be in much better humour this morning. I'm sorry, that was a bad joke.

Welcome back, and congratulations to Mr. McTeague; and monsieur Vincent, félicitations.

We do have two motions before we start with the witnesses. The first deals with routine motions. Everyone should have a copy. These are the motions that the industry, science and technology committee operates under. There are three pages. These are the same motions as we adopted for the industry committee. You'll note on page three that the rounds of questions are the same rounds of questions we operate with in the normal industry, science and technology committee.

Mr. McTeague.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I propose that all motions be allowed to stand and that they be adopted by this committee.

[The Chair, Conservative, James Rajotte]

Thank you.

(Motions agreed to)

We are going to suspend for two minutes, because this committee is televised. So we will suspend and allow the committee to be televised. We'll also ask the witnesses for the first two-hour session to come to the table.

[The Chair, Conservative, James Rajotte]

Would members please take their seats, please? I remind members and witnesses that we are being televised for both the two-hour session this morning and the two-hour session this afternoon.

I want to read, for the benefit of members and witnesses and for the general public, the motion that was adopted:

That the Standing Committee on Industry, Science and Technology strike a subcommittee whose membership be composed of all 12 members of the standing committee to hold approximately three meetings during the late summer or early fall to hear from representatives of the oil and gas industry, pension fund managers, institutional investors involved with global electronic exchanges, and relevant witnesses to explain the reason for the increases in the price of oil and gas.

That is the formal motion that was adopted. That's the reason for this subcommittee, and we have two sessions here today.

From 10 a.m. until noon, we have three witnesses. First of all, from the Canadian Petroleum Products Institute, we have Mr. Peter Boag, president. Welcome.

Secondly, we have Mr. Warren MacLean as an individual. Welcome.

Thirdly, from the Canadian Independent Petroleum Marketers Association, we have Ms. Jane Savage, president and CEO. Welcome.

We will start with Mr. Boag and work our way down. You have up to five minutes for an opening presentation and then we will go to questions from members.

Mr. Boag.

[Peter Boag, President, Canadian Petroleum Products Institute]

Good morning.

Thank you, Mr. Chair. I very much appreciate the opportunity to be here today to contribute to your deliberations on a very topical and important issue for Canadian consumers.

Far too often, when we contemplate the workings of the marketplace, there's a tendency to discount the role information plays in ensuring that consumers are well armed to make choices about how to allocate their hard-earned dollars. So your work and that of CPPI is important in ensuring that Canadians can make the best choices for themselves and their families.

As many of you know, the members of the Canadian Petroleum Products Institute are the major refiners and marketers of petroleum products in Canada. Collectively, they operate 16 refineries and supply the bulk of transportation fuel choices across Canada. Their presence, products, and services are a daily necessity for Canadians. At the very root of their existence, my members are intensely competitive companies that strive to provide high-quality, affordable products. No other industry interfaces with the consuming public with a street-level, transparent display of product prices and signs as large as you and I are.

Three markets influence the cost of fuels at these stations--markets that are driven by the economic fundamentals of supply and demand. The first two are international commodity and financial markets.

First is the global market for crude oil. Thousands of daily transactions are executed by traders around the world. I believe it's well recognized today that increasing global demand, especially from Asia and the Middle East, is fundamentally driving increases in crude prices. Just look at how many people are coming out of poverty in Asia, in particular, and upward pressure on crude prices should be no surprise.

Second is the North American market for wholesale fuels. There is no unique Canadian fuels market. Wholesale prices in Canada are driven by product supply and demand balances across North America.

The third market is the local retail market--the decisions of individual retailers in any given community at any given time. As of December 31, 2006--the most recent retail survey of Canada--there were 13,772 retail gasoline stations operating in Canada. With only about 30% of those retail outlets under the ownership of major refiners, there are more than 9,500 decision-makers involved in setting the posted price of fuel at gas stations across Canada.

In the Atlantic provinces and Quebec there is also an overlay of provincial legislation and regulation that limits competition. In the Atlantic provinces, they set a maximum pump price either weekly or twice a month. In Quebec, the Régie de l'énergie sets a weekly floor price.

All three of these markets—global, North American, and local—have shown considerable volatility in the last year, with Canadian pump prices reaching all-time highs in July.

Crude oil is by far the single largest component of the pump price. Data prepared by Natural Resources Canada shows that at the current average Canadian pump price for regular unleaded gasoline—as of earlier in August, that was $1.30 a litre—crude accounts for roughly 82¢ of that cost, or just under 65% of the pump price.

Pump price changes in Canada over the past months closely track changes in crude prices set in the global market. There are a couple of charts in my presentation that show how the price components break out across Canada and how the crude oil and gasoline prices correlate over the past number of months.

This same data shows that taxes are the second largest component of pump prices--on average 34¢ per litre across Canada, or about 26% of that average $1.30 a litre pump price. Finally, the data shows that refining and marketing operations account for the smallest component of pump prices. In early August it was about 14.5¢ a litre, or about 11% of the pump price.

Refining margins are substantially lower today than they were one year ago. I stress that margins do not equal profits. Refining margin is the difference between the price of crude entering the refinery and the wholesale price of fuel leaving the refinery. Profits, if any, exist only after all costs are paid. Refining margins in early August were hovering under 8¢ per litre, at about the same level as the national average marketing margin--the difference between the wholesale price exiting the refinery and the pump price consumers pay.

Refiners have been squeezed by the significant increase in crude prices over the past few months. According to data from NRCan: “For the four week period ending August 12th, refiner margins were below 8 cents per litre at the national level and trailed last year’s levels by more than 9 cents.”

Weakening U.S. demand has exerted downward pressure on North American wholesale gasoline prices. The most recent data available from NRCan—this is in early August—shows that on a national level wholesale prices in the United States and Canada were within 1¢ of each other.

While it may be of little consolation to Canadians, the volatility we have recently witnessed is not unique to Canada. What is unique to Canada is that, notwithstanding this turbulence, Canadians pay the second lowest price in the western world for petroleum fuels. This is a function of a competitive marketplace with a very efficient refining sector.

We acknowledge the important role that the federal government plays in ensuring our competitive marketplace, and in particular we congratulate this committee for the important work it has done over the years with its review of the Competition Act. In conjunction with a very professional and knowledgeable Competition Bureau, Canadians can have confidence in a marketplace framework that truly defends the rights of consumers. As the federal government looks to further improvements in the Competition Act, CPPI will be a responsible partner with government in keeping marketplace laws modern.

For the moment, I would like to bring to your attention and that of Canadians some of the factors that affect the cost of fuel produced and sold in Canada, factors that are unrelated to increasing the amount of fuel produced. Some of these considerations are justified by environmental considerations, but they are costs nonetheless. The decision to desulphurize fuel resulted in environmental expenditures of about $5 billion by the Canadian refining sector. In April of this year, the government eliminated the federal excise tax exemption on the blending of renewable fuels.

In conclusion, we understand Canadians' concerns and frustrations with fuel price volatility. At the same time, this is the best evidence of a marketplace delivering a choice of quality products at the lowest cost possible. Global supply and demand factors are the principal drivers of fuel prices, and while CPPI does not study all international dimensions, it is clear that the demand for fuel products is likely to rise in regions like Asia, where people are buying their first cars.

Taxes are the second largest component of pump prices, and while it is not the role of CPPI to evaluate taxation levels, this component is the single largest discretionary element in the cost Canadians pay. There are other government policies that are driving costs, some supported by sound scientific reasons for environmental improvement.

Our industry is committed to providing Canadians with quality fuels at the lowest possible cost, from safe and reliable facilities. We can also provide you with conservation tips to stretch your hard-earned dollar. At the end of the day, Canadians are best served by a competitive marketplace. Today they pay the second-lowest prices in the western world.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Boag.

Mr. MacLean.

[Warren MacLean, As an Individual]

I thought I'd start out by giving you a brief CV of my background. I graduated from McMaster University with a Bachelor of Chemical Engineering degree and a Master of Business Administration. I have worked in the petroleum industry for 32 years, 10 with Gulf Canada and 22 with Suncor. I've worked in both the upstream and downstream segments of the industry, including refining, supply, trading, wholesale marketing, crude marketing and logistics, strategic planning, and mergers and acquisition-type activities. I recently retired, on June 30, 2008, and the last position I held was vice-president, supply, distribution, and biofuels.

As for the purpose of the committee today, there have been significant concerns and questions recently that the run-up in price of crude and the associate products, gasoline and diesel, has been the result of speculation and not due to market fundamentals. I cannot answer the question around how much of the price rise is due to speculation and how much is due to fundamentals of supply and demand. I can try to help you understand various markets, price discovery and price-setting processes, and how they interact. My own personal belief is that it would be extremely difficult for speculators to drive the price against market fundamentals due to the size of the market, market liquidity, number of market players, and the complexity of the market, including such things as multiple locations, quality factors, refining configurations, and substitution effects.

So what I was planning to do is just walk through each of those sections, beginning with markets.

Crude oil is traded on a worldwide basis, whereas petroleum products tend to be traded more regionally. Major refining centres tend to be price-setting markets. Those include northwest Europe, the U.S. gulf coast, and the Far East, the Far East being represented usually by Singapore but may be switching to India as refining capacity in India grows. Prices for products tend to trade at the marginal cost of the high-cost refiner. Crude oil easily arbitrages between the three markets, whereas products usually are limited to trade in the Atlantic basin and the Pacific basin, logistics being the primary driver for the market segmentation.

In terms of price discovery, generally there are three means of price discovery: the futures markets in New York and London, what's termed the swap markets, and then the physical or cash markets.

Futures markets provide the highest level of price transparency limited to single highly liquid commodities with standard terms and conditions. Buyers and sellers put up margin and are protected by the exchange against default by counterparties. Markets are regulated.

Swaps are similar to futures but are not regulated and are usually between large highly sophisticated players. Risk of default is managed through the creditworthiness of the counterparties.

In physical markets, or cash markets, price discovery is limited somewhat to the major refining centres, such as the gulf coast. Buyers and sellers complete transactions on a daily basis and report these transactions to various industry publications such as Platts, Reuters, Opus, etc. These media then publish a list of crude and product prices for a range of qualities and different market locations. Contractual arrangements often use these publications to set transaction prices on a daily basis.

In terms of price setting, the price in any market is a function of the local supply and demand structure and the transportation cost to the major refining centre. In a supply-short market, price will be set at a transportation-plus basis. In other words, you take the price in the major refining centre and add the cost of transportation. In a supply-long market, price will be set on a transportation-minus basis, which is the reverse of the short market.

Added complexities include interactions between regional markets; regulatory requirements affecting quality; something I think you've probably heard, termed “boutique fuels”; structural product movements, where a company may own a pipeline to a particular market and will include the sunk cost of that pipeline in the pricing of their products—I would call that a structural product movement—and logistics barriers, such as the St. Lawrence Seaway being closed in the winter. All of these inhibit truck price transparency. Any of these factors make the price less transparent in that particular market.

To conclude, again I'll say that market size, complexity, and diversity all contribute to the unlikelihood of speculators driving prices contrary to fundamentals.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. MacLean.

We'll go to Ms. Savage.

[Jane Savage, President and Chief Executive Officer, Canadian Independent Petroleum Marketers Association]

Thank you for enabling CIPMA, the Canadian Independent Petroleum Marketers Association, to address this committee on the subject of oil, gas, and other energy pricing.

CIPMA represents the larger independent fuel marketers in Canada. What defines “independent” in the downstream sector, which is the refining and marketing sector of the oil industry, is companies that buy rather than refine the petroleum products they sell. Independents' profitability on gasoline is therefore tied closely to the retail margin, which is the difference between the price you and I pay at the pump and the cost at the wholesale level.

Of the 13,800 gas stations in Canada, as Mr. Boag mentioned earlier, about 70% are owned by independents, with the balance being owned by refiners. CIPMA has 15 member companies that own or have some level of control of about 15% of the retail sites in Canada; the balance are not represented by a trade association.

The subject of today’s committee meeting is to understand more about the rising price of petroleum. Specifically, there are two aspects I would like to address: who is benefiting from this rising price of gasoline, and the speculative component of the crude oil markets.

We would like to contribute as best we can to that understanding, first by discussing the broad sectors within the Canadian oil industry, and specifically the relative profitability of the independent sector. We will do this in the context of gasoline. Second, we'll request that the committee take action to limit the speculative interests in the crude oil futures markets. We'll explain why this is important to the independent sector of the Canadian oil industry as well as Canadians.

Who is benefiting from the price increases at the pumps? The simple answer to that is crude oil producers. I've taken a long-term view of prices, and we see that crude oil has gone up 46¢ a litre of the total of 47¢ a litre in the past five years. There have been some cost changes. All sectors of the oil industry have seen cost increases, but we can safely say that most of the profit from higher gasoline prices is accruing to crude oil producers in this country, not to independents.

To simplify this complex industry--again, my colleagues have addressed this somewhat--there are three broad sectors in the oil industry. There are crude oil producers, which is traditionally called the upstream of the industry. And in the downstream there are two sectors: refiners and refiner marketers, and independent fuel distributors and marketers.

All three sectors work within the economic limit of a market-based margin that is given or determined by the market. As Mr. Boag pointed out, this does not necessarily reflect profit, but it reflects the available margin to each of these sectors. Refiners work with the difference between the market price of crude oil and the wholesale price of fuel products. Independent distributors and marketers work with the difference between the wholesale price of fuel products and the retail price that consumers pay.

Again, in the last five and a half years, we have seen an increase of about 47¢ a litre at the pump, and the vast majority of that has been in the sector known as crude oil production.

Contrary to what most Canadians think, almost 10,000 of the 14,000 gas stations, i.e., those owned by independent business people, have seen their available margin increase by a tiny amount, but net profit has been declining. That is simply because credit card costs increase as a percentage of the cost of fuel at the pump. Seventy percent of the gas stations in Canada actually see reduced profits as prices rise. The independent sector is in fact financially motivated for lower prices, contrary to what many Canadians believe, which is that it is the gas station making the money.

I'd like to turn now to the subject of speculation in the crude oil futures markets. Whatever the root causes driving crude oil markets higher may be, there is no debating that the volume of trading by non-oil or speculative interests in crude oil futures and indeed all energy commodity markets has increased. A recent article in the Washington Post has revealed that a full 81% of the oil contracts on the New York Mercantile Exchange, a far bigger share than had been previously stated by the Commodity Futures Trading Commission, comes about through speculative interest.

I want to define “speculative interest” because I think there's some confusion about it. Fundamentally, speculative interest on the crude oil markets are those interests that don't have any physical crude oil or crude oil-related products to buy or sell. So these are folks who are in the markets to invest and make money.

Up until recently, speculative interest in the volatile commodity oil markets has been naturally limited by the high risk associated with this volatility in commodity oil markets. But recently, reports of declining supply and rising world demand, together with ever-increasing forecasts of higher prices by investment banks, have led to the worldwide belief that crude oil markets cannot go anywhere but up. This has increasingly caused investors to ignore the traditional and increasing inherent risks of commodity oil markets. Of significant concern for this committee and for Canada is, for example, the increasing percentage of Canadians’ retirement income that is at risk in the most volatile crude oil market seen in decades.

U.S. regulators have put forward a number of possible interventions in the trading of crude oil markets. These vary from relatively inconsequential measures to eliminating the speculative component altogether, which would be a huge intervention. We respectfully call on the political leadership in Canada to acknowledge this risk and support U.S. regulators to increase market oversight, which would be a key change to the CFTC at this point. Also, stepping back for a moment, equity markets—that is where most of us have our retirement investments—are extremely well regulated. One could argue that the same level of regulation does not exist in the oil market.

I'd like to conclude by emphasizing that at least 70% of Canada's gas stations see no benefit from rising prices. Rather, profits are declining as a result of increased credit card costs. We also ask this committee to look very carefully at the speculative component of crude oil markets.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. Savage.

We'll go to questions from members.

I'll remind witnesses that members have very limited time for questions. The first round will be six minutes. Members may choose to put questions to one or all three of you. If you are not asked a question and you would like to respond, please so indicate to me, and I will try to ensure that you get some time. But there is very limited time, so we ask you to be short in your answers.

We'll start with Mr. McTeague.