Good afternoon, and thanks for your invitation for me to appear today before this committee on the subject of petroleum prices. The committee's invitation was based on our firm's reputation as an impartial expert in the field of petroleum refining and marketing. This reputation is reflected in the wide variety of clients and organizations we do business with, including federal and provincial governments. In fact, the data published on the NRCan website is collected by us in major part, but also large institutional consumers of petroleum products, academia, and of course oil companies themselves, ranging from multinationals to small regional independents.
Over the course of 30-plus years of my experience in this industry, the majority as a consultant in the sector, my firm and I have conducted numerous studies into the nature of petroleum marketing and competition relating to the sales of petroleum products, as well as ongoing monitoring and analysis of fuel prices, particularly retail gasoline prices and their constituent components.
One word that might characterize the impetus for this committee's current focus on fuel prices would be the word “transparency”. How transparent are pump prices, and what can be done to make them more so? My remarks today will address those two questions, and will provide some recommendations.
I'll apologize in advance that some of my comments might sound very similar to those of witnesses who have preceded me, but I think that does illustrate some common principles at play here.
To evaluate the transparency of the petroleum industry with respect to pump prices, one must look at the transparency of not one, but three, distinct markets: crude oil, wholesale fuels markets, and of course retail fuel markets.
Crude oil, being the raw material from which gasoline is made, is perhaps one of the most transparent of all commodities. With respect to gasoline, for what other product can a reasonably well-informed person on the street tell you its raw material cost? Many media outlets report crude oil prices on a daily basis, and the resulting transparency leads to the inevitable question, if crude oil prices dropped yesterday, why has the pump price not dropped today?
This typical observation actually illustrates one of the consequences of transparency, and this is that in an attempt to bring this transparency to a general audience, other equally available but critically important facts are often left out by the mainstream media. I think that's in an attempt to simplify things for the audience, not to mislead.
For example, when we hear that the price of crude oil today is $93 per barrel, as it was a couple of days ago, it is seldom reported that this is the price for delivery at Cushing, Oklahoma, not at a refinery in Toronto, for example. It is seldom reported that this is the price for a particular grade of crude oil, whereas other grades might be heavier and much less expensive to buy, but conversely much more expensive to process into gasoline. It also doesn't reflect differences in crude oil that might be supply and demand driven, as opposed to being based on grade differentials as well. WTI and Brent crude, which come from the U.S. and the U.K. offshore respectively, are similar in quality, but there sometimes can be upwards of a $10 per barrel difference in pricing as a result of supply and demand factors that play upon them. Most importantly, it's seldom reported that the price quoted is based on futures market trading, and not what refiners might be paying today or tomorrow, as Mr. Boag had mentioned as well.
These are the kinds of facts that are needed to better understand the relationship between crude oil prices and those at the pump, and even then they would not fully explain that relationship. The reason for this is there is a far more important benchmark to consider than the price of crude oil if one truly wants to understand the nature of gasoline prices, and that benchmark is the wholesale price of gasoline. Because petroleum marketers and dealers buy wholesale gasoline and not crude oil, it is the wholesale gasoline price that most directly influences the price at the pump, not the crude oil price.
Wholesale rack prices for gasoline do not simply follow the crude price. Although over the long term we see a relationship on a day-to-day basis, there are differences, and sometimes significant ones, because gasoline is subject to supply and demand variables of its own, causing its wholesale price to rise in times of tight gasoline supply, even if prevailing crude prices might be falling, or vice versa.
Wholesale fuel prices are also transparent. Many petroleum refiners post their rack prices on the Internet for all to see, and other organizations, such as ours, MJ Ervin and Associates and The Kent Group, collect and make available consolidated reports of these rack prices.
Unfortunately, the mainstream media do not routinely report rack prices, leaving many to continue to use crude prices as the basis for trying to understand yesterday's change in the pump price, which is, put simply, a very poor if not useless predictor of gasoline's day-to-day price movements.
This brings me to the matter of pump price transparency. Gasoline is fairly unique in its ability to be comparison-shopped for at sixty kilometres an hour. Increasingly, consumers are also able to comparison-shop for gasoline prices before leaving home, using the Internet or a smart phone. I would therefore suggest that retail gasoline is one of the most price-transparent consumer products in Canada by virtue of its price transparency at the levels of crude oil, wholesale rack, and retail markets.
Even if one agrees that fuel prices are transparent, that stills beg the question, yes, but are they fair? To properly answer that question, one must look at the four components of the pump price individually. Those four are the crude cost, the markup by the refiner from crude to wholesale price, the markup by the marketer from wholesale to retail price, and of course taxes.
One might suggest that crude oil prices are too high, driven by speculators or by oil cartels. For whatever reasons, Canadian producers sell crude oil at world market prices, and Canadian refiners buy that crude at those same market prices. Simply put, the price of crude oil is beyond the control of the Canadian oil industry.
Similarly, the amount of markup by the refiner, referred to in the industry as the crack spread, is something that cannot be arbitrarily set by Canadian refiners. Wholesale gasoline prices must be competitive with those in the United States. If they are too high, Canadian marketers will flock south of the border for their supplies. If they are too low, U.S. marketers would deplete Canadian fuel inventories, leaving consumers with low pump prices but no gasoline to sell at those low prices.
Is the retail markup fair? Fairness is a very subjective term, of course, but there are some objective data that would suggest an answer to that question. The fact that the number of retail outlets has declined from over 20,000 to under 13,000 in the last 15 years would suggest that this is not an easy business from which to profit. The fact that some traditional players in the retail gasoline business have in part or in full divested themselves of the day-to-day ownership or operation of their branded networks would also suggest that retailing of gasoline has not traditionally made a strong contribution to the corporate earnings of integrated oil companies. Finally, the fact that for the past 20 years the gross retail markup on gasoline in Canada has remained virtually stagnant in nominal terms and has declined in inflation-adjusted terms speaks to the fairness of the retail price.
I therefore suggest that a number of market mechanisms at the levels of crude oil, wholesale, and retail markets each provide for the fairness of pricing of petroleum products, although a fair price may not necessarily be a low price by the standards of the consumer. If, however, fuel prices are fair, then why is there such doubt about the fairness of pump prices?
Firstly, I think it's useful to understand that gasoline is a fairly unique commodity product among consumer products. It is what marketing academics would refer to as a low-involvement purchase. Unlike most other goods we buy, we don't care about gasoline's colour, smell, taste, or sense of security or well-being. As a result, the focus tends to be on the price itself.
Secondly, the visibility and volatility of pump prices, the very things that are indicative of its competitiveness, actually create the opposite impression in the minds of many consumers. This is a huge paradox: the significant transparency of the petroleum industry is the very reason why it has been strongly competitive for decades, yet the same transparency in many ways creates the opposite impression in the minds of the media, the public, and often regulators, who take their direction from elected officials.
I will conclude by making one recommendation, and that is to improve what is already a very transparent industry to be much more so by providing more comprehensive data on fuel prices across Canada. Right now our company, for instance, surveys pump prices on a weekly basis. With today's availability of electronic transfer of data, there's no reason why the coverage of fuel prices across the country cannot be done on a 24/7 basis for virtually every site in Canada. This would create a wealth of information and a wealth of transparency, which only requires some assurances from industry, and particularly the Competition Bureau, that the provision to a collector such as ours would not be seen as being in contravention of the Competition Act.
Again, these recommendations would make the industry even more transparent, but of course in an industry such as this there will always be regular scrutiny, such as now in times of increasing prices.