Dear Tynwald Members, Road Fuel Report published in 2014

Dear Tynwald Members,

As promised by the OFT Chairman in this week’s Tynwald session, attached are copies of the2010 Liquid Fuel Price Investigation, including the Summary Report as well as the latestRoad Fuel Report published in 2014.

All documents can also be downloaded at our website, which also contains otherpublications such as the road fuel publication which collects prices on a weekly basis.https://www.gov.im/oft/info/Fuel/

There was a supplementary question regarding deliveries of domestic fuel shipments fromthe refinery.The shipments of fuel are brought to the Isle of Man at the most cost effective method. Theships will be carrying fuel generally direct from Stanlow refinery to the Isle of Man fordischarge at the fuel company’s depot. Afterwards, the ship will leave the Isle of Man andthe ship will then be used for the next job whether this is in the UK or Ireland. Thereforethe ship may not go back to Stanlow refinery. This will be a decision made by the shippingcompany.

If you have any questions on any of these topics please contact me.

Regards[Details supplied]

isle of Man Government

Reiitys Ellen Vannin

GD 0015/10

AN INVESTIGATION INTO LIQUID FUEL PRICES IN THE ISLE OF MAN

A REPORT BY THE COUNCIL OF MINISTERS

APRIL 2010

APRIL 2010 £9.20

To: The Hon N. Q. Cringle, President of Tynwald, and the Honourable Council and Keys in Tynwald assembled.

Background

In October 2008 the Council of Ministers was advised by the Isle of Man Office of Fair Trading (OFT) that it would undertake an investigation under Section 19 of the 1996 Fair Trading Act as amended into the prices being charged for liquid fuels in the Island.

The period of the investigation was set from 2005 to 2008.

The relevant part of Section 19 of the Fair Trading Act states that:-

"(.3) On completion of an investigation under this section the Board shall make a report on the investigation to the Council of Ministers:- (a) stating its findings of fact which are material to the information which it provides; and (b) containing such additional observations (if any) as it considers should be brought to the attention of the Council of Ministers as a result of the investigation."

Progress to date

Due to the extensive nature and complexity of the investigation it was necessary to engage assistance from Poyry Energy Consulting Limited. This has been a thorough and detailed examination of the Island's liquid fuels market. Due to the amount of information gained, the Board of OFT considered that it would aid understanding of the report if, in addition to the detailed analysis contained in the report, a layman's guide' was produced summarising the main findings and recommendations of the investigation.

The report concluded that whilst the prices charged for liquid fuels in the Island were higher than those charged for example in the United Kingdom, there were various factors such as the difference in the scale and scope of the United Kingdom and Isle of Man liquid fuel markets together with the additional costs and overheads incurred in supplying bulk fuel to an Island community that contributed to the price differential. In addition the investigation examined in detail the profitability of the fuel wholesalers and retailers on the Island and concluded that the level of profits made by the companies did not appear to be excessive and had declined since the last study.

The investigation report and the 'layman's guide' were considered by the Council of Ministers and approval was given for the report to be laid before Tynwald. It is intended that the layman's guide' will be published at that time.

Hon 3A Brown MHK

Chief Minister

[Signature redacted]

TABLE OF CONTENTS

1. INTRODUCTION 1

1.1 Background 1

1.2 Aim of the specialist investigation 6

1.3 Approach to the investigation 6

1.4 Structure of the report 6

2. MARKET STRUCTURE 8

2.1 The fuel supply chain 8

2.2 Supply chain in the Isle of Man 8

2.3 Consumer demand 13

3. ROAD FUELS 16

3.1 Changes in road fuel prices 16

3.2 Cost components of price 16

3.3 Explaining price changes 19

3.4 Changes in gross margins and cost to serve 25

3.5 Comparative price assessment 31

3.6 Summary 37

4. HEATING FUELS 38

4.1 Changes in heating fuel prices 38

4.2 Cost components of prices 40

4.3 Changes in wholesale prices 41

4.4 Changes in gross margins and cost to serve 42

4.5 Comparative price assessment 45

4.6 Summary 49

5. COMPETITIVE MARKET DYNAMICS 50

5.1 Wholesale costs and schedule prices 51

5.2 Road fuel retail market competition 52

5.3 Heating fuel retail competition 54

5.4 Summary 56

6. PROFITABILITY ANALYSIS 57

6.2 Company profitability 58

6.3 Summary 59

7. ENSURING APPROPRIATE MARGINS 60

7.1 Ex-ante price controls 60

7.2 Exerting external competitive pressures 62

7.3 Summary 64

8. VIEWS OF THE PUBLIC 66

8.1 Introduction 66

8.2 Views Raised 66

9. CONCLUSIONS AND RECOMMENDATIONS 77

9.1 Road fuels market 77

9.2 Heating fuels market 80

ANNEX A FUEL PRICE REGULATION 82

A.2 Road fuel price regulation in Nova Scotia, Canada 82

A.3 Road fuel price regulation in South Africa 86

A.4 Applying ex-ante price regulation in the Isle of Man 87

ANNEX B PUBLIC SUBMISSIONS 89

1

1. INTRODUCTION

1.1 Background

The Board of the Isle of Man Office of Fair Trading (OFT) determined in October 2008 that the prices charged for liquid fuels on the Isle of Man were of major public concern. It therefore decided that an investigation into those prices under the terms of Section 19 of the Fair Trading Act 1996 as amended (the Act) was required. Section 19 of the Act states ―…The Board may carry out an investigation into any price, with a view to providing the Council of Ministers with information relating to that price, if it is satisfied that the price in question is one of major public concern.‖

Pöyry Energy Consulting (Pöyry) was commissioned by the OFT to undertake an investigation into the operation of, and pricing in, the liquid fuels market in the Isle of Man over the period January 2005 to December 2008. The OFT had previously reviewed liquid fuel prices1 charged on the Island, reporting on the prices charged between January 2002 and December 2005 in October 2006 (2006 OFT study).

This report is based on the findings of that specialist investigation and has been prepared for publication by the OFT. It has been edited to take account of commercial confidentialities. This document represents the OFT‘s report to the Council of Ministers in accordance with Section 19(3) of the Act.

The liquid fuels market comprises the importation, distribution and supply of a range of refined oil products. The investigation focussed on the two main liquid fuel market segments in the Island:

road fuels – the supply of unleaded, premium unleaded, diesel and red diesel2; and

heating fuels – the supply of kerosene and gas oil for heating to domestic and non-domestic customers respectively.

Together, these fuels account for the majority of total liquid fuel sales in the Island.3 Consumption of these fuels remained relatively stable over the period of investigation at around 120 million litres, though the mix of fuels has changed. The share of road fuels increased from 40% in 2005 to 44% in 2008, but the major shift has been in the heating fuels market where increasing volumes of kerosene have replaced a declining gas oil market, as shown in Figure 1.

1 Investigation into Energy Prices, February 2007 GR 008/07.

2 Red diesel is specially dyed diesel used for specific agricultural uses that is taxed at a lower

rate. Where data is available and/or relevant this is considered as a separate product. 3 Aviation fuels were excluded from this investigation.

•

•

•

2

Figure 1 – Shares of individual fuels in the Isle of Man liquid fuels market

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008

Gasoil

Kerosene

Premium petrol

Red diesel

Diesel

Unleaded petrol

Source: Total IoM, Shell, Manx Petroleums

Though consumption has not varied significantly, the same cannot be said of the fuel prices. Prices of road and heating fuels have been subject to large changes since January 2005 as shown in Figure 2 and Figure 3 respectively. All products have experienced year-on-year price increases (in both real and nominal terms), but this has taken place in a market that has exhibited a high level of price volatility.4

For example, though unleaded pump prices were above £1 per litre for most of the period from September 2005 to December 2008, within this period they increased by 22p, or 22% in the 12 months to July 2008 and fell even more precipitously, by 28p in the following five months, to end 2008 at the same (nominal) pump price as at July 2005.

4 Real values are adjusted for inflation to be representative of the equivalent price in a particular year,

while nominal values are not. As a result, nominal values will usually appear higher.

da d° d° d° d° O\ O\ O\ O\ sy coo

t .0.„( lac o

sie

s

y

co

o

4,0,651, .sas

„„;sy co

o

,1/4..\0

4,

o

sie

s

y

co

o

,1/4..\04,

3

Figure 2 – Isle of Man monthly average road fuel prices in pence per litre (ppl), cash price, including tax and duty

80

85

90

95

100

105

110

115

120

125

130

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre

Petrol

Premium

Diesel

Source: Total IoM, Shell

Similar patterns of price movements were observed for the other road fuels, with increases in the heating fuels market (shown in Figure 3) being more pronounced than in the road fuels market. For example, a 900 litre delivery of kerosene to a domestic customer in September 2007 would have cost £376; 12 months later this would have cost the same customer £596.

ci° cI) clo 0 0 do 0 do do 0 ci‘ p'‘ Sao 441r 441,A. 5m%+04 Sao vac 0\ 1 454' g 44 I ;\ 5m%+04 g 1 1 +64'

4

Figure 3 – Isle of Man monthly average heating fuel prices, ppl, cash prices, including tax and duty

30

35

40

45

50

55

60

65

70

75

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Kerosene

Gas oil

Source: IoM OFT Comparative heating schedule, Total IoM, CPL, Manx Petroleums

This pricing behaviour has not been unique to the Isle of Man. Upward trends in wholesale product prices globally, driven mainly by the large variations that have been observed in the crude oil market5, have been passed through to customers in many countries.

However, the speed and extent of the passing on of increased costs by suppliers may differ across markets, leading over time to wider differentials between retail prices in different regions. One of the main concerns in the Island has been that the volatility in crude oil and wholesale refined product markets has led to a widening of the differential between prices in the Island and the UK. As Figure 4 shows for road fuels, this differential itself has been variable, but, in the latter period of this study has remained above 5ppl, at a time when nominal pump prices have been falling. 5ppl was the threshold suggested in the 2006 OFT study6 as a trigger for a Section 19 investigation under the terms of the Fair Trading Act.

Again, similar observations can be made about the price differentials in the heating oil market, with domestic kerosene in particular showing a substantial widening of the reported differential with UK prices.

5 These changes have been exacerbated in the UK by adverse exchange rate fluctuations. 6 Investigation into Energy Prices, February 2007 GR 008/07.

0 40 0 ,0 0 0' ci‘ si‘ ci‘ Ob Ob Ob Sao lac 41, coo9 IP 441 4, e lac Sao col2 + \o> cool °, lac 1;\ +04'

1 3 0 0 d° 0 0 0 0 0 ci‘ ci‘ ci‘ ci‘ ci‘ 00 00 coe9 6%.

Sao V §' < C‹ AP oP 4% coo +0 1) 4% 4?) coo +o 4?) 4,,ez> coe,

5

Figure 4 – Isle of Man–UK road fuels price differentials, ppl, cash prices

-2

-1

0

1

2

3

4

5

6

7

8

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Unleaded Premium Diesel

Source: Total IoM, Shell, Catalyst

Figure 5 – Isle of Man–UK heating fuels price differentials, ppl, cash prices

-4

-2

0

2

4

6

8

10

12

14

16

18

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Kerosene Gas oil

Source: Total IoM, CPL, Manx Petroleums, IoM OFT Comparative heating schedule, UK BERR Digest of UK Statistics

6

1.2 Aim of the specialist investigation

Against this background, the aim of this investigation was to examine the liquid fuel supply chain in the Island in more detail to establish the extent to which:

observed movements in prices could be explained by changes in the cost of supplying the Isle of Man; and

price differentials with relevant comparators could be justified by differences in the underlying cost and market structures.

The findings of these two complementary analyses were to be used to establish whether prices of liquid fuels in the Island are reasonable and what the appropriate form and level of regulatory oversight should be given the performance and structure of the market.

1.3 Approach to the investigation

Given the aim of the investigation, the approach has incorporated the following stages:

develop a clear picture of the physical and contractual structures underpinning the liquid fuel supply chain in the Island;

define the main costs recovered through the retail prices charged to customers and identify how these costs have changed relative to price movements;

compare the prices in the Isle of Man with those in other markets and determine the appropriateness of the observed differential;

review the reported profitability of the main participants in the Isle of Man liquid fuels market;

review methods of regulating or monitoring liquid fuel prices in other jurisdictions; and

on the basis of the preceding analysis, assess the reasonableness of prices and the appropriate level of future regulatory oversight required.

The core analysis was based on information provided in comprehensive data requests to the market participants and subsequent meetings or phone conferences.

1.4 Structure of the report

The remainder of the report is structured as follows:

Chapter 2 reviews the main aspects of the underlying structure of the fuel supply chain in the Island;

Chapter 3 describes the price movements that have been observed in the three main road fuels (diesel, gasoline and premium petrol), examining the drivers of change and whether the prices can be considered reasonable;

Chapter 4 provides a similar pricing analysis for heating fuels (kerosene and gasoil);

Chapter 5 investigates the competitive dynamics resulting from the structure of on-Island market arrangements;

Chapter 6 reports the results of a profitability analysis undertaken for the companies involved in the market;

7

Chapter 7 considers potential regulatory solutions that may be appropriate to apply in the Isle of Man; and

Chapter 8 presents conclusions and recommendations.

8

2. MARKET STRUCTURE

2.1 The fuel supply chain

There are several stages in the transformation of crude oil to its eventual distribution and sale as a road or heating fuel. The main elements are:

production of crude oil – the search for potential underground or underwater oil fields, the drilling of exploratory wells, and subsequently operating the wells that recover and bring the crude oil to the surface;

refining of crude oil – crude oil is broken down into different products such as gasoline, diesel fuel, heating oil, jet fuel, liquefied petroleum gases, and residual fuel oil, through a distillation or cracking procedure. The precise mix of product derived from a barrel of crude depends on the configuration of the refining process;

distribution and storage – the means through which refined product is moved from the refinery to the retailer or final customer. Distribution networks include bespoke product pipelines, barge/freighter or rail transportation and road tanker distribution depending on the volume being transported; and

retailing – the marketing and sale of the product to individual customers.

Some of the early, higher cost, elements of this supply chain – production and refining of crude oil – occur outside of the Isle of Man, but have an important influence on the product prices faced by Isle of Man businesses and hence on consumers. This chapter focuses in detail on the structure and relationships in the Isle of Man supply chain.

2.2 Supply chain in the Isle of Man

The supply chain of the liquid fuels industry in the Isle of Man involves the transportation (import), storage, distribution and retail operations. The structure of the market at each point in this chain (i.e. the number and market share of competitors), together with the form of vertical linkages across the supply chain (whether ownership or contractual) can affect the form and effectiveness of competition in the market, and hence influence the level and cost-reflectivity of prices and the profitability of the market participants.

The relevant supply chains for road fuels and heating fuels are as shown in Figure 6 and Figure 7 respectively. Two important aspects of the market are highlighted in these figures. Two companies are involved in the distribution of both road and heating fuels: Total Isle of Man Limited (Total(IoM)) and Manx Petroleums Limited (Manx Petroleums). Total (IoM) is active in all stages of the supply chain in the Isle of Man. The implications of these factors are expanded upon in the subsequent sections.

°lira 0 IRS

9

Figure 6 – Isle of Man road fuels supply chain

Import

Storage

Distribution

Retail

Total UK LtdTotal UK Ltd

Total IoM LtdTotal IoM Ltd


Total IoM Ltd /

Total branded

Independent dealers

Total IoM Ltd /

Total branded

Independent dealers

Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd

Manx Petroluems LtdManx Petroluems Ltd

Manx Petroleums LtdManx Petroleums Ltd

Shell branded

Independent retailers

Shell branded


Import

Storage

Distribution

Retail




Total IoM Ltd /

Total branded

Independent dealers

Total IoM Ltd /

Total branded

Independent dealers

Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd



Shell branded


Shell branded


Source: Pöyry Energy Consulting

Figure 7 – Isle of Man heating fuels supply chain

Import

Storage

Distribution

and Retail




Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd

Shell UK /

Manx Petroluems Ltd

Shell UK /

Manx Petroluems Ltd

Manx

Petroleums

Manx

PetroleumsGB Oils t/a

CPL

GB Oils t/a

CPL

Import

Storage

Distribution

and Retail




Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd

Shell UK /

Manx Petroluems Ltd

Shell UK /

Manx Petroluems Ltd

Manx

Petroleums

Manx


CPL

GB Oils t/a

CPL

Note: For the period under investigation, Shell (UK) owned the facilities for storing heating fuels, though Shell (UK)‘s direct retail involvement was in the road fuels market. .

10


2.2.1 Shipping and importation of fuels

There are no refining facilities in the Island, so fuel is imported by ship from refineries in the UK by Shell (UK) and Total (UK). Total (UK) sources fuel products on behalf of Total (IoM) from the Milford Haven refinery while Shell (UK) sources its supply, to meet its own commitments in the road fuels market and for Manx Petroleums‘ heating fuel requirements, from the Stanlow and Pembroke refineries.

The cargoes are delivered to one of two harbours on the Island; Battery Pier in Douglas and Peel Harbour. There they are unloaded and transferred to storage tanks.7 The cargoes usually carry a mixture of road and heating fuels, depending on the supply commitments, prices of fuel, physical storage capacity available and current stocks.

2.2.2 On-Island storage

At the harbours, fuel is transferred to storage facilities operated by Total (IoM) and Manx Petroleums. At Peel, Total (IoM) is the sole owner of its storage facility and loading racks, […text redacted….].8

2.2.3 Distribution

There are three wholesale fuel distributors operating in the Isle of Man market:

Manx Petroleums – an independent distributor, contracted with Shell (UK) for the delivery of road fuels to Shell-branded filling stations. Separately, Manx Petroleums distributes heating fuels directly to customers under a branding agreement with Shell that supports Manx Petroleum‘s sales into this sector;

Total (IoM) – a subsidiary of Total UK Ltd distributing road fuels to its company-owned and branded filling stations and also heating fuels;

CPL Petroleum – a member of the GB Oils group whose parent, DCC Plc, acquired CPL Petroleum in July 20079 distributing heating fuels and limited diesel volumes.

Each distributor has its own fleet of road tankers for transporting liquid fuels and its own staff. As it does not have its own storage depot, CPL Petroleum contracts with Manx Petroleums for purchase of fuel drawn from Battery Pier Terminal.

Manx Petroleums and Total (IoM) deliver petrol and diesel to the filling stations in accordance with their contracts with the fuel supplier; Shell or Total. They also sell heating oil directly to the domestic and non-domestic market. Manx Petroleums is an authorised distributor of heating fuels for Shell (UK) and pays a brand fee to Shell. CPL Petroleum distributes both heating fuels and road diesel10

7 There are restrictions on the size of ships that can dock at either harbour – the largest ships carry

around 3,600 tonnes of product. These are relatively small ships and the market for these coastal tankers is limited.

8 Footnote redacted. 9 Irish Times, DCC to buy CPL Petroleum for €74m, July 07, 2007. 10 CPL Petroleum supplied road fuels until June 2006.

11

In addition, both Total (IoM) and Manx Petroleums provide maintenance service for oil fired heating installations to both commercial and domestic customers.

2.2.4 Fuel retailing

There are 21 commercial filling stations in the Island supplying road fuel products. Of these, seven are Shell branded stations, thirteen Total branded stations and one is an independent non-branded station.

Though 20 of the stations are company branded, they exist under three different operating models:

company owned/company operated – where the fuel supply company owns the site and has control over the operation;

company owned/dealer operated – where the company owns the site but leases it to an independent manager; and

dealer owned/dealer operated – where the individual dealer owns the site and operates it himself.

The Shell branded stations are all dealer owned/dealer operated, though one is owned by Retail Services Ltd, an associated company of Manx Petroleums. Five Total branded stations are company owned and operated, seven are dealer owned and operated, while one station is company owned, but dealer operated.

Whereas company-owned sites have internal contractual arrangements with their parent fuel supply company, the independent, dealer-owned/dealer-operated stations secure long-term fuel supply contracts (or solus agreements) with one or other of the fuel suppliers. These agreements are time limited (typically lasting for five years) and restrict the retailer from buying petrol and diesel from distributors other than the contracting party. The nature of the arrangements vary between companies and between dealers according to the timing of the contract renegotiation, the strategic importance of the dealer to the distributor (in terms of location or throughput) and the precise terms and conditions.

Most existing agreements specify a retail margin in pence per litre (ppl) that the retailer can expect to achieve, but may include other special support mechanisms (including additional rebates in ppl), or capital grants for refurbishment or re-branding of the station (though these are often repaid through deductions from the agreed margin when fuel delivery charges are calculated). During the period of this investigation, Shell has moved away from suggesting a margin that retailers may add to its stated Schedule Price (the delivery price that retailers pay for the fuel) allowing complete independent pricing by its stations. However, the understanding is [……..text redacted……..].

The periodic renegotiation of these solus arrangements provides some semblance of competitive pressure between the two main fuel suppliers. However, only one site has changed company affiliation over the period of this investigation. While this may suggest that potential competition is encouraging the incumbent fuel supplier to offer competitive terms to retailers, it may also indicate that further competition for sites is less attractive now that the two companies have geographically dispersed filling station sites. Interestingly, while there has been little change in the number of stations supplied by each fuel supplier, the market share by volume has shown some material change over the period.

12

Figure 8 – Road fuels market share11

[Figure redacted] Source: Total IoM, Shell, GB Oils, Manx Petroleums

Since 2005 no site has closed and no new sites have been developed (Fairy Cottage station in Laxey closed in 2006 amid supply problems but has since reopened as a diesel and biofuel supplier). Consequently, with continued overall growth in fuel demand the average annual throughput of stations in the Island has increased by over 10% from 2.1 million litres in 2005 to 2.35 million litres in 2008, as shown in Table 1. However, Table 1 also shows that average throughput is significantly lower than in the UK, though this is largely a function of the presence of supermarket filling stations in the UK12. Average throughput is above that of the average dealer-owned site in the UK.

While this is encouraging, it should be noted that the average figure masks a wide variation in throughput of individual filling stations. For example, throughput in the Island ranges from around 200,000 litres per annum to 7 million litres per annum. If prices support the average site, this may raise questions regarding the financial viability of smaller stations.

Table 1 – Average filling station throughput, (1,000 litres)

Isle of Man UK

average company owned

dealer owned

supermarket

2005 2,101 3,345 4,374 1,854 9,656

2006 2,279 3,529 4,706 1,925 9,791

2007 2,348 3,652 4,795 2,129 9,817

2008 2,351 3,836 4,836 2,178 10,622

Source: Total IoM, Shell, Forecourt Trader Magazine

However, consideration of other benchmarks of market structure such as filling stations per capita, suggests that the Isle of Man does not appear to be over-supplied. Figure 9 shows that the Isle of Man, with approximately 1 outlet per 3,800 inhabitants, compares well to Ireland (1 outlet per 2,020 inhabitants), Northern Ireland (1 outlet per 3,100 inhabitants) and the EU average (1 outlet per 3,440 inhabitants).

11 Diesel combines conventional diesel and red diesel. 12 As of 2008, supermarkets comprised about 13% of total number of outlets and 36% of total volume.

A volume weighted average throughput of company and dealer-owned sites in the UK would be in the order of 2.6 million litres.

4- 4, c-\ 6 e ,e. ,z,z, ecc, , c("49 Soe6,

cleeekee cly ‘i'` 03"° e & eA cq r6 eA

9 c‘ Q oce , cc• e or e 0 . 0 1-e '* 0 9 0e c° 1? \e •c• N

tier •., G

13

Figure 9 – Number of petrol stations per 1,000 inhabitants

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Gre

ece

Gue

rnse

y

Luxe

mbo

urg

Ireland

Jers

eyIta

ly

Den

mar

k

Swed

en

Belgium

Finland

Isle o

f Man

Net

herla

nds

Por

tuga

l

Franc

e

Spa

in

Ger

man

yUK

Cze

ch R

epub

lic

Hun

gary

Polan

d

Sta

tio

ns p

er

1,0

00

in

ha

bita

nts

Stations per 1000 inhabitants

EU average

Source: Catalyst

2.3 Consumer demand

2.3.1 Road fuels

The road fuels market in the Island was approximately 54 million litres in 2008, up by just under 10% since 2005, as reported in Table 2. This growth has been concentrated in diesel, a trend that is being observed increasingly in road fuel markets. Figure 6 highlights the monthly breakdown of the road fuel market between 2005 and 2008.

Table 2 – Isle of Man road fuel sales, million litres

Total demand

Unleaded petrol

Diesel Red diesel Premium petrol

2005 49.1

2006 51.3

2007 53.9

2008 53.5

[Figures in Table redacted] Source: Total IoM, Shell

The Total brand covers 62% of filling station sites, […text redacted…]

c4o sjo clo cjo jck ,c

ck Jck .6k _pcb pcb 00 jjb d .V C‹ 1>

lac „" coo +o4 4,9) 4,41>

coe +04 IF e

coe9 rt,c% 44§ t cip

14

Figure 10 – Isle of Man road fuel volumes, million litres

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Mill

ion

litre

s

Source: Total IoM, Shell, Forecourt Trader Magazine

2.3.2 Heating fuels

The market for heating fuels is, by its nature, seasonal. As such, it is to be expected that there will be variations in annual consumption across time related to, for example, temperature changes. This pattern is evident in Figure 11. Table 3 shows the annual demand patterns for heating fuels.

The main change in the Island was a fundamental shift in gas oil consumption between 2005 and 2006, around one-third of on-Island consumption being lost.13 This reduction has partially been offset through the expansion in kerosene volumes over the remaining period.

Table 3 – Isle of Man heating fuel sales, in million litres

Total demand Kerosene Gasoil

2005 73.2

2006 61.7

2007 64.6

2008 68.4

[Figures redacted in Table redacted] Source: Total IoM, CPL, Manx Petroleums

13 This may be related to lower gas oil requirements from the MEA for power generation as a

consequence of the operation of the gas-fired power station at Pulrose.

0 .33 0 .33 .33 0 0 3° 0 3° 3° 0 .6‘ 6 .0 6 6 .6‘ Ob Ob 0 Ob cP Ob Sao lac 4%"° ' - \ •."50 04 0 ‘k. ,S\ 0 4% (t 4% co0 64 qr.\ 4% 4% ,tr , co0 64z;\ + 4% 4% yes' + 64 + " +

15

There are three main suppliers of heating fuels in the Island. […text redacted…]

The heating fuels market has seen an improvement in market concentration as measured by the Herfindahl-Hirschman Index (HHI). This indicator declined from 4,736 in 2005 to 4,216 in 2008.14

Figure 11 – Isle of Man heating fuel demand, million litres

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Mill

ion

litre

s

Source: Total IoM, CPL, Manx Petroleums

14 HHI is a commonly accepted measure of market concentration. It is calculated by squaring the

market share of each firm competing in a market, and then summing the resulting numbers. HHI ranges between close to 0 and 10,000. According to the U.S. Department of Justice a market with an HHI of less than 1,000 is considered a competitive marketplace; a result of 1,000-1,800 is a moderately concentrated marketplace; and a result of 1,800 or greater is considered a highly concentrated marketplace.

0 0 , c.$3 , \ 03 90 , , 44z.,OHO .3 ,v. ,c§. .0. .0. 0 0 0 .6‘ 0 0 Ob Ob Ob Ob Ob 00 Sao 4z. coo +o ,z, 44z> coe9 454 ez,C% , 44z,-\ coesr +o-r ,zg 44-ty 44z,-V coeo' +04'

16

3. ROAD FUELS

3.1 Changes in road fuel prices

The prices of the main road fuels – unleaded, diesel and premium – changed substantially over the period studied as Figure 12 illustrates. The price of unleaded petrol was 88 ppl, and for the next two years fluctuated between 90 ppl and 100 ppl. However, from May 2007 to November 2008 the price remained above 100 ppl, reaching a high of 122 ppl in July 2008. Similar, but more pronounced, patterns were observed for diesel and premium.

Figure 12 – Isle of Man average road fuel prices, ppl, cash prices

80

85

90

95

100

105

110

115

120

125

130

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Petrol

Premium

Diesel


3.2 Cost components of price

In a competitive market, these price movements should be explained by changes in the underlying cost of supplying the product. In order to analyse this, the market price has to be broken down into its constituent cost components. The price of fuel at the pump reflects the activities through the supply chain. These have been placed into the following four categories:

the cost of the product (the commodity price);

government fuel taxes and duties;

the costs and profit of the fuel distributor (the wholesale margin); and

the costs and profit of the fuel retailer (the retail margin).

17

The commodity price is derived from a liquid, transparent wholesale trading market for oil products within North West Europe, centred on the refinery and port complexes of Amsterdam-Rotterdam-Antwerp (ARA). Both Shell (UK) and Total (UK) index the contracted product price to this recognised reference market price. Though there will be adjustments made in relation to the form of indexation, or any uplift applied for access to specific terminal or depot facilities, the reported ARA wholesale price can be used as a benchmark for the cost of product in the market.

Wholesale ARA prices vary on a daily basis. The relevant price for any contracted delivery may be defined relative to the date of shipping, unloading or final delivery. This investigation used a time weighted monthly average of daily ARA prices reported as North West Europe FOB has been used.15

Tax and duty are outside of the control of the participants in the liquid fuel market and though they impact on the overall change in prices facing consumers, they are not major drivers of volatility in the market. Changes in tax levels – for example, the rise in customs duty by 5.25 ppl – tend to be infrequent, although the existence of ad valorem (or proportionate) taxes, such as VAT, serve to amplify any changes in underlying product cost. Consequently, the focus of analysis was changes in the non-tax elements of the price – namely the commodity price and the wholesale and retail margin.

The retail margin is the difference between the price paid by a fuel retailer for the delivery of fuel to the filling station (also referred to as the Schedule Price) and the pump price charged. The margin has to cover the costs of operating and maintaining the filling station, administrative overheads, staff costs and provide a profit or return to the station owner. There may be a difference between the stated and effective Schedule Price faced by the retailer if there are explicit discounts or rebates (perhaps providing special price support) or premia (such as repayments determined on a ppl basis on capital loans made by the wholesaler to the retailer) that have been agreed within the terms of the solus agreement.

The wholesale margin is the difference between the commodity price paid and the Schedule Price charged to the fuel retailer. It must cover the operational and administrative overhead costs associated with importation, storage and distribution of the fuel, in addition to providing a return or profit to the distributor (noting that this is a relatively capital intensive activity).

In some cases it is not possible to differentiate between the wholesale and retail margins. In these cases a gross retail margin is reported, being the difference between the commodity price and the retail price (i.e. it is the sum of the wholesale and retail margins defined above).

Figure 13 to Figure 15 highlight the breakdown of the three product pump prices between the benchmark commodity price (ARA), duties and taxes, and the gross retail margin. These figures show that by far the largest component of road fuel prices is the taxes and duties that are applied. On average, taxes comprise 62% of the retail price, commodity purchase costs account for a further 25-30% of the price, leaving an average of 8-13% of the price to cover the wholesale and retail margins.

15 Free on Board (FOB) specifies which party (buyer or seller) pays for which shipment and loading

costs, and/or where responsibility for the goods is transferred. The transfer of title is particularly important for determining liability for goods lost in transit from the seller to the buyer.

43 4) .33 3. 3. OHO d. 3. C3° .6‘ si‘ .6‘ .0 Ob 04' §. A .V 9 4. c< Sao co coo o 41> r, .) • co0 4 0

\I' coe ‘4° \141' 'a• o, + 04. c< lac A ‘V 9 4. C‹ 4 9— -

•

vdo

\sjo sjo s§c) cco c§o s§o c§o cjk cjk ‘b 4) 4)

zt ?) \et coe9 +0 etc` 1 ,z7X 9 4. c< .V CP 0 04' \t` coe ) 4?) 4%0 -fa c54 ,k A 9 4.

+ 4• 4?) co0

18

Figure 13 – Constituents of Isle of Man petrol prices, ppl, cash prices

0

20

40

60

80

100

120

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

ARA Duty & VAT Gross Margin

Source: Total IoM, Shell, Platts

Figure 14 – Constituents of Isle of Man diesel prices, ppl, cash prices

0

20

40

60

80

100

120

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re



04:

et

0434e,

Cli° 043_. .9

04 6403 ect SP /S PC° (0‘ 0‘ ..,\S S 4 4 c:P c:P c:P

Sao -v ‘4, co0 +0 441, 1 1 4\ 9 4. 4% Coe

19

Figure 15 – Constituents of Isle of Man premium petrol prices, ppl, cash prices

0

20

40

60

80

100

120

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re



3.3 Explaining price changes

Table 4 shows monthly average retail prices for road fuels in the Isle of Man and estimated levels of the cost components in January of each year. It reinforces the point that taxes are a major component of actual prices and that volatility in commodity prices is very significant.

Figure 16 shows how year-on-year changes in retail price can be explained by changes in the individual components of price between each year. It illustrates some important conclusions:

commodity price is by far the largest driver of changes in retail prices;

the change in retail price is often less than the change in the commodity price;

gross margin often moves counter to the changes in the wholesale and retail price movements; and

gross retail margin varies more for unleaded than for other products.

Taking the price of unleaded as an example, between January 2005 and January 2006 the ARA or wholesale price increased by 8.6 ppl, whereas retail prices increased by 6.4 ppl – less than the increase in the underlying product. The difference was accounted for by a decline in the gross retail margin by 3.1 ppl. In contrast, between January 2006 and January 2007 ARA prices declined by 5.8 ppl but retail prices declined by 1.8 ppl –

20

the gross retail margin being 2.9 ppl higher.16 Figures 13 to 15 show the extremes of this trend in early summer 2008. The prices were highest; the gross margins earned fell significantly.

While such snapshots are useful illustrative devices, observation of Figure 13 to Figure 15 shows that there is significant volatility in both the gross margins and the commodity price month-on-month over the period of the investigation. On average, ARA prices account for approximately 80% of the volatility. Consequently, the drivers of changes in these underlying costs have been reviewed in more detail.

Table 4 – Retail prices and cost components as of January each year

Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009

Unleaded Retail Price 88.47 94.89 93.07 106.90 93.06

ARA 15.85 24.42 18.70 30.20 19.56

Duty & VAT 60.28 61.23 62.21 66.27 66.21

Gross Margin 12.34 9.24 12.16 10.44 7.30

Premium Retail Price 91.32 96.89 96.31 111.68 98.23

ARA 15.85 24.42 18.70 30.20 19.56

Duty & VAT 60.70 61.53 62.69 66.98 65.16

Gross Margin 14.77 10.94 14.91 14.50 13.51

Diesel Retail Price 89.12 97.99 96.07 113.38 104.38

ARA 19.73 27.32 22.39 35.87 28.04

Duty & VAT 60.37 61.69 62.66 67.24 65.96

Gross Margin 9.02 8.97 11.02 10.27 10.37 Source: Total IoM, Shell, Platts

16 Customs duty has increased by 5.25 ppl over the period in three increments, therefore given the

annual January snapshots, taxes seem to increase even where prices have decreased – despite this, taxes have had little impact on monthly volatility.

• • • i • i I •

I • 1

1 i ■

-

21

Figure 16 – Changes in retail prices and cost components as of January each year, ppl, nominal prices

-20

-15

-10

-5

0

5

10

15

20

2005-

2006

2006-

2007

2007-

2008

2008-

2009

2005-

2006

2006-

2007

2007-

2008

2008-

2009

2005-

2006

2006-

2007

2007-

2008

2008-

2009


Pe

nce

pe

r lit

re



3.3.1 Changes in ARA refinery wholesale prices

The ARA price comprises the largest component of pre-tax prices. On average, between 2005 and 2008, product wholesale prices accounted for 68-75% of the net of tax retail price of unleaded, 64-69% of the net of tax retail price of premium and 75-88% of the net of tax retail price of diesel. Not only is the wholesale price the largest component, but it is also the most volatile – average monthly volatility in ARA prices for all products and for the period is estimated at 2 - 2.3 ppl per month.17 The fundamental driver of this change in cost is the cost of the raw material (crude oil).

3.3.1.1 Correlation between crude prices and wholesale prices

Figure 17 below highlights changes in ARA prices compared to changes in underlying Brent crude prices. While it is common for the volatility in product price to be attributed to movements in the crude oil price, it is important to note that while oil product prices at ARA are correlated with movements in crude prices the relationship is not necessarily linear or proportionate. The extent of the correlation with the crude price differs by product and across time. This reflects the fact that there are other drivers affecting price formation for individual products in the wholesale market notably the supply-demand balance for individual products.

17 This is the absolute month-to-month variation in ARA commodity prices.

I I I I I I I I I I I I I I I I I I I I I I I

_0,0 0,0 0 .0 0 0 0 0 0 0 ci‘ ci‘ si‘ ci‘ si‘ Ob Ob 00 00 Sao lac (3\ 54" lac 4. ek. A ‘V 9 4. c< lac A ,V

Nr 4% Co + 4% 4% coo +0 1> 4. 441> co0 +0 4z, coe

22

Figure 17 – ARA gasoline and gasoil prices and Brent crude prices, ppl

0

5

10

15

20

25

30

35

40

45

50

55

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

ARA gasoline ARA gasoil Brent crude

Source: Platts

As Figure 17 highlights, there is a relatively constant margin between the cost of diesel and crude oil, however the margin for gasoline is highly volatile signifying that there is a dissimilar cost pass-through on both products – in some cases, notably the end of 2008, refined petrol appears to have been cheaper than crude.

These inter-product differentials can be explained through different supply-demand dynamics for each product.

The refinery process breaks down the raw material into different products such as gasoline, diesel fuel, heating oil, jet fuel, liquefied petroleum gases, residual fuel oil and other products. The average 159 litres barrel of crude yields 167-170 litres of refined products - the additional volume results from processing gains. Depending on the configuration of the refinery the mix of products produced can vary significantly. Simple refineries produce relatively high volumes of gasoline compared to middle distillates (gasoil, diesel and kerosene), whereas complex refineries produce more of the middle distillates.

Once the refinery is designed and built, there is little flexibility in the product mix without further investments in plant upgrade. Currently the situation in the EU is that:

demand for diesel is growing whilst that for gasoline is static;

refinery capacity has much greater capability to produce gasoline than diesel.

Consequently, prices of diesel are rising relative to those of gasoline as shown in Figure 18.

cp cp cp cp cp cp cp cco c@ cco cco CDAA CS 9' 4' 5) p cjb pcb

‘„X.- comb 4?) ie comb 4 ~a~ lac 446-$ coeN +04 cdb44 +04"

23

Figure 18 – Estimated ARA gasoline-diesel spread, in ppl

0

2

4

6

8

10

12

14

16

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre

Source: Platts

Thus not only is it the case that product and crude oil prices do not move in tandem, but prices of individual products may move in different directions in response to the same underlying crude price changes.

3.3.2 Changes in gross margins

Gross margins appear to have changed considerably over the period as highlighted in Figure 19 below. There are three possible explanations for changes in margins and for the volatility observed, including:

inconsistencies in the cost data used to calculate gross margins;

changes in the underlying cost of operations (cost to serve); and

changes in profit earned.

O3 .33 .33 .33 4) cf. 3° 3° 3° cf. .6‘ 0 .6‘ cP 00 00 lac (3\ 64' 4. (3\ 1 el 04. lac (3\ lac A %\)••

4% Ci ‘4% 4% CO + 4% 4% COe ‘4° 4% 4%e Coe 4)

24

Figure 19 – Changes in combined wholesale and retail margins, in ppl

0

2

4

6

8

10

12

14

16

18

20

22

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Petrol

Premium

Diesel


The volatility in gross margins may be exaggerated by the use of ARA monthly average spot prices in the calculations if the actual cost of product is higher or lower due to contracting or pricing strategies. […text redacted…]This would affect the proportion of change attributed to the gross retail margin.18 Whilst it is unclear whether the volatility of the cost of product is higher, there is evidence that the actual cost of product for fuel suppliers can be higher than the benchmark cost.

The analysis of the data suggests that this is potentially substantial – for unleaded, the actual cost may be between 0.54 ppl and 1.01 ppl higher than the benchmark, and for diesel the actual cost is between 2.39 ppl and 2.81 ppl higher than the ARA benchmark.

An uplift on the regional wholesale price is to be expected. The extent of any uplift is not always related to direct cost – it depends on underlying market conditions, the alternative value of the product and the position of the individual fuel supplier‘s supply portfolio.19

18 Footnote text redacted.

19 The cost of product is also dependent on the terms of contracting - when the supplier takes title and who bears the risk for other miscellaneous risks such as exchange rates and physical loss of product. In particular (a) who bears losses due to exchange price movements and whether island consumers pay for it. ARA prices are priced in US dollars and in general this have been stable except for volatility in 2008; and (b) who bears physical losses and whether they remain on-island – one supplier notes that it buys product on a standard litre basis (volumes corrected to 15 degrees Celsius) and sells on-island on an ambient litres basis (13-14 degrees Celsius) which results in a loss of approximately £50,000 per annum or approximately 0.09 ppl.

25

Most of the costs associated with operations across the supply chain are fixed or vary little over the period (e.g. wage costs). It is unlikely that changes here are responsible for extent of the variability observed.

The implication is that there is significant variation in profits earned, meaning that suppliers are accepting exposure in the market so that retail prices change less frequently. The advantage of this ability to smooth out fluctuations is that it shields customers and retailers from taking on the risk of fluctuations in cost of product and shifts it to suppliers who have the size and are better able to bear it. However, the fuel suppliers taking on this risk would also expect to be rewarded for taking on this risk through their margin.

3.4 Changes in gross margins and cost to serve

Table 5 below highlights the average annual gross margin in the Island by fuel type for each year. In general:

margins have remained relatively stable across the period on a year-on-year basis, showing little variation between 2005 and 2007, though rising noticeably in 2008;

diesel has earned slightly higher margins than unleaded.

Table 5 – Average road fuel wholesale and retail margins combined, ppl

Petrol Diesel Weighted average20

2005 10.19 10.74 10.42

2006 10.12 10.57 10.31

2007 9.87 10.78 10.28

2008 10.87 12.22 11.49 Source: Total IoM, Shell

It was mentioned previously that the gross margins are composed of two key elements – wholesale margins and retail margins. The type and extent of the margin can be identified if the schedule price – the price paid by the retailer to the fuel supplier - is derived. Using the data provided by the fuel suppliers effective schedule price for each product can be calculated by comparing actual revenue with volume delivered, netting off any reported rebates paid. This allows them to split the gross margin to be split into its wholesale and retail components.

3.4.1 Wholesale margins

On the basis of the effective Schedule Price, wholesale margins for road fuels have been between 6.42 ppl and 7.78 ppl (on a volume-weighted average of the two fuels) during the study period. As in the gross margins, the values were relatively stable through to 2007, but rose noticeably in 2008, as shown in Table 6.

20 The road fuel average margin in this table and for the rest of the analysis on costs on margins refers

to the volume weighted average of the two fuels.

26

Table 6 – Average wholesale margins, in ppl

Petrol Diesel Weighted average

2005 6.49 8.19 7.20

2006 6.16 7.57 6.77

2007 5.50 7.52 6.42


The main costs covered in the wholesale margins are discussed in detail below and include:

shipping and import costs – these include actual shipping charges, harbour dues, ship discharge and other import administrative costs;

storage and on-Island distribution costs – these include depot costs and operating road distribution network; and

an estimated wholesale profit.

3.4.1.1 Shipping and import costs

Shipping and import costs are incurred in transporting road fuels from the refinery gate in the UK to storage terminals in the Island. They include actual shipping costs, harbour dues and other administrative charges incurred to bring fuel to the Island. Table 7 below reports our estimates of the cost of shipping commodities to the Isle of Man. These are based on the charges made by Shell (UK) and Total (UK) to their respective distributors in the Island, covering the shipping cost and the associated administrative costs of importation.

Once the underlying market is considered there is limited scope for improved cost savings in the shipping. There is currently only one independent provider of coastal freight services, James Fisher Everard Ltd, and thus there is limited scope for competitive pressure to lower costs (though large companies such as Total and Shell will have some bargaining power in this regard).

27

Table 7 – Estimated shipping and import costs, in ppl21

2005 2006 2007 2008

Unleaded Shipping costs 0.76-0.85 0.77-1.06 0.54-0.70 0.31-0.60

Harbour dues 0.21 0.21 0.22 0.22

Ships discharge labour 0.00-0.03 0.03-0.04 0.03-0.05 0.03-0.06

Total shipping and import 0.97-1.10 1.02-1.31 0.78-0.96 0.56-0.88

Diesel Shipping costs 0.88-0.98 0.89-1.38 0.81-1.20 0.70-1.06

Harbour dues 0.21 0.21 0.22 0.22

Ships discharge labour 0.00-0.03 0.03-0.04 0.03-0.05 0.03-0.06

Total shipping and import 1.09-1.22 1.14-1.63 1.07-1.44 0.98-1.31

Average cost 1.02-1.15 1.07-1.45 0.91-1.18 0.76-1.08 Source: Total IoM, Shell

Shipping costs have remained relatively stable over the last five years. The cost as highlighted in the 2006 OFT report was approximately 0.97-1.15 for unleaded and 1.33-1.83 for diesel, broadly similar to the costs highlighted in this report.22 The cost of shipping is normally quoted on a per tonne shipment basis, thus converting to a cost per litre basis implies that the assumed cost of shipping may differ across products.

Harbour dues have marginally increased since 2006. In 2008, the Isle of Man harbour dues were set at £2.83 per tonne for each vessel carrying liquid petroleum products for most of 2008. The fee has marginally increased since 2006 when it was set at £2.61 per tonne.23 24 Other costs incurred and highlighted in Table 7 include ship discharge labour (port security attendance during unloading).

3.4.1.2 Cost of storage and on-Island distribution

The costs of storage and on-Island distribution are incurred following importation of fuels. These include the cost of storing and transporting fuels to retail forecourts and the costs of maintaining distribution vehicles and terminals together with related administrative charges. 25

21 Costs are based on reported figures from the relevant companies – total costs are calculated for each

company and are not the combined or average for the Island. 22 The cost of shipping for each supplier as calculated from data submitted by the respective companies

are broadly similar on an annual basis, however there are significant differences between how they charge for each fuel type, especially on a monthly basis, which leads to divergence in costs within a year.

23 Isle of Man Harbour Dues (Merchant Vessels) Regulations 2008, Statutory Document No.30/08; OFT Liquid Fuel Investigation Report, October 2006;

24 In comparison, 2006 Port Dues levied in Jersey were £7.48 per tonne, and £1.15 per tonne at Immingham in the UK - Energy Market Investigation, States of Guernsey, May 2007

25 Distribution and storage is the most capital intensive constituent of the supply chain due to the need to maintain and replace storage tanks, tankers etc.

28

Table 8 below presents an estimate of the cost of storage and distribution sourced from the various distribution costs charged by Total (IoM) and Manx Petroleums.

Table 8 – Estimated cost of storage and on-Island distribution, in pence per litre

2005 2006 2007 2008

Depot costs 0.29-0.61 0.29-0.40 0.30-0.48 0.30-0.63

Distribution charges 0.85-1.60 0.82-1.60 0.79-1.60 0.96-1.60

Maintenance and depreciation 0.20-0.33 0.06-0.13 0.08-0.11 0.09-0.13

Total storage and distribution 1.80-2.09 1.35-1.96 1.38-1.98 1.73-1.99 Source: Total IoM, Shell

3.4.1.3 Estimated wholesale profit

Table 9 shows the wholesale margin, the identified costs and the implied profit from the distribution activity in the road fuels market (the implied profit being the difference between the wholesale margin and the wholesale costs). As can be seen, the profit level appears relatively high, being over half of the reported wholesale margin. Whereas the average profit was estimated at between 3.5 ppl and 4 ppl for 2005 to 2007, this rose to between 4.5 ppl and 5 ppl in 2008.

Table 9 – Estimated wholesale profits, in ppl26

2005 2006 2007 2008

Unleaded Wholesale margin 6.49 6.16 5.50 6.57

Shipping and import 0.97-1.10 1.02-1.31 0.78-0.96 0.56-0.88

Storage and distribution 1.80-2.09 1.35-1.96 1.38-1.98 1.73-1.99

Implied profit 3.43-3.59 3.18-3.50 2.56-3.35 3.70-4.28

Diesel Wholesale margin 8.19 7.57 7.52 9.20



Implied profit 5.01-5.17 4.48-4.59 4.46-4.70 6.17-6.23

Average profit27 4.22-4.38 3.70-3.94 3.25-3.84 4.62-5.01


26 Please note that the lower and upper range of the implied profit are not the difference between the

wholesale margin and the upper and lower end of wholesale costs respectively, but are calculated for each company separately.

27 Average profit is the range between weighted of lower end and upper end of both fuels – highest for unleaded and highest for diesel for each year and lowest for both fuels separately

29

However, the wholesale margin has been calculated using an ARA benchmark price and analysis in Section 3.3.2 has shown that the actual cost of product for the Island is higher for both unleaded and diesel. The difference is substantial. This increased cost lowers the diesel wholesale profit by 2.54 ppl and that of unleaded by 0.77 ppl. The impact on the average wholesale profit is to lower it by 1.57 ppl, putting it in the range of 3 ppl to 3.5 ppl in 2008. This is broadly comparable with the findings of the previous OFT study, where wholesale margins were in the region of 2.5 ppl to 4.2 ppl. However, it is interesting to note that a higher proportion of the wholesale profit is now derived from the diesel sales.

The costs above reflect the direct costs of importation and distribution. The fuel suppliers also undertake other activities on behalf of their retailers, such as credit card transactions support, pump maintenance, etc. These other costs will also need to be recovered through the wholesale margin. It is estimated that these costs represent around an additional 0.5 ppl to 1 ppl.

However, even allowing for this further adjustment, the implied profit of 2ppl to 3ppl is higher than those reported in a recent 2008 study of the fuel market in the Highlands and Islands of Scotland, which estimated implied wholesale profits there at 0.4 ppl.28 The same report suggested those levels were insufficient to sustain a viable industry so the appropriateness of these margins will have to be considered alongside evidence of cross-country comparisons and the analysis of corporate profitability undertaken in Chapter 6.

3.4.2 Retail margins

Retail margins comprise the costs of operating filling stations and the profit retailers earn from selling fuel. On the basis of the estimated wholesale margin, the implied average retail margin in the Island is around 3.6 ppl and has broadly remained the same over time as shown in Table 10 below. By comparison, the average retail margin in the UK has broadly averaged 3 pence during the period.29

Table 10 – Estimated retail margins, in ppl

Petrol Diesel Weighted average

2005 3.70 2.56 3.22

2006 3.96 3.00 3.55

2007 4.36 3.26 3.86


The retail margins established in the previous report for the period 2002–05 were approximately 2.8 ppl for unleaded petrol and 3.3 ppl for diesel and are less than the estimated margins presented above. The 2008 Highlands and Islands of Scotland study

28 Defined as Oil company marketing margin – See Highlands and Islands Enterprise, HITRANS, The

Highland Council, Road Fuel Supply in the Highlands and Islands – Current Situation, November 2008 Study.

29 Forecourt Trader Magazine.

30

estimated retail margins at 5.7 – 6.5 ppl for unleaded and petrol respectively.30 These margins need to cover the operator‘s costs.

Table 11 gives an illustrative example of the financials of a typical retailer. The average Isle of Man filling station with a throughput of 2.4 million litres a year and a margin of 3.7 ppl has annual revenues of £88,800. These revenues have to cover wages, lease or mortgage payments for site rental, utilities, business rates and other expenses.

Table 11 – Estimated financials of an average service station

2008 (£) 2008 (ppl)

Gross margin 88,800 3.7

Salaries and wages 29,000 1.2

Leases or interest payments/depreciation for site 14,600 0.6

Utilities and rates 7,250 0.3

Sales and marketing 6,800 0.3

Total overheads 57,650 2.4

Profit

31,150 1.3


These expenses are often substantial – a typical fuel station opening for 16 hours per day (requiring an approximate minimum staffing of 1.5 full time equivalent employees) had an average wage bill of £29,000.31 The annual cost of a site either acquired (depreciation, interest payments) or leased (rental payments) was conservatively estimated at £14,600.32 Combined with other expenses, the average station is making an estimated profit of £30,000 or 1.23 ppl, leaving very little room for any exceptional overheads or for a meaningful return for the site proprietor.33

The relatively low margins resulting from increased supermarket penetration in the UK were responsible for rapid consolidation in filling station numbers with approximately 9,000 stations going out of business between 1992 and 2008. The majority of remaining filling stations have responded to this competitive pressure by diversifying

30 Highlands and Islands Enterprise, HITRANS, The Highland Council, Road Fuel Supply in the

Highlands and Islands – Current Situation, November 2008 Study. 31 Comparisons with the wage bill of several stations in the Island provides a wide variance in costs due

to differences in allocating the costs to non-fuel businesses such as car washes and convenience store on site. The stated cost estimate is conservative given that the average Isle of Man weekly gross wage of £ 568.76 implies an annual wage bill of approximately £45,000 for 1.5 FTE - see Isle of Man Treasury, Prices & Earnings 2008.

32 The cost of renting or owning the site also varies; we have selected a conservative estimate based on selected depreciation expenses of several filling stations. However, for comparisons on the upper limit, we have reviewed a local station with an average throughput which estimates its value at £900,000 as of 31 December 2007; AMC Petrol Consultants estimates that the cost of developing a new station, as of 2003 was approximately £600,000 - £900,000. Even assuming a 5% interest rate as interest payments/ straight line depreciation on £600,000 gives an estimate of £30,000. We therefore believe the figure provided is conservative.

33 Non-regular but significant costs include the cost of replacing pumps.

31

sources of revenue through convenience store sales and other activities such as car washes.34 It is estimated that the average gross margin on shop sales is approximately 20% compared to 4-5% on fuel sales.35

3.5 Comparative price assessment

Road fuels in the Isle of Man have historically been sold at a premium to prices in the UK. For consumers, comparisons of prices in the Isle of Man and in the UK are the most accessible means of judging whether prices are reasonable. Table 12 below highlights the average annual price differential for road fuels with the UK average36:

the average annual differential with the UK national average has broadly declined across all fuel products since 2005;

with the exception of unleaded in 2005, the annual average differential has remained within the 5 ppl differential suggested as a trigger for further Section 19 investigation in the 2006 OFT fuel price study;

the differentials are lower for premium unleaded and highest for unleaded; and

there is significant volatility in the differentials (see Figure 20);

Table 12 – Average UK and Isle of Man road fuel price differentials, ppl

Petrol Premium Diesel

2005 5.28 2.52 4.31

2006 4.80 1.22 3.43

2007 4.42 1.74 4.12

2008 3.77 1.86 3.96 Source: Total IoM, Shell, Catalyst

The average annual differential with the UK national average for the last five years was approximately 4.33 ppl for unleaded petrol and a 3.80 ppl diesel. .37 With the exception of 2005, the differentials have remained broadly below 5 ppl.

As Figure 20 illustrates, the monthly price differentials have exhibited much volatility and a pronounced worsening in the second half of 2008. This volatility may have arisen for several reasons:

34 All company owned forecourts in the UK have a convenience store - as of 2008, over 80% of all

dealer owned sites had an attached shop. Similarly, 60% of all company owned and supermarket sites in the UK have a car wash on site, as do half of all dealer sites. In part this reflects the low profitability of the fuel sector, and the comparative higher margins available for fuel retailers in the sale of non-food items and services.

35 Forecourt Trader Magazine 36 The UK average is defined as the average for all sites in the UK and is sourced from data collected by

Catalyst. The UK Department for Energy and Climate Change (DECC) produces Quarterly Energy Prices and Energy Trends which provide annual UK average prices, however we have chosen Catalyst for this analysis because it provides similar data by region and dealer type. For monitoring price differentials, the DECC average is equally suitable.

37 Calculated from OFT 2006 report (2001-2004); and data submissions from Total IoM, Shell (2005-2008) with UK average prices from Catalyst.

, c03 AO , 0 13 d° OD do 4, 04, 4 cik Os A A A cs cs cs cs 1, 4:1> 441, coe9 +0 Sao 1 r,V 1 4. c< V .V \P OA OA 00 Ob Ob

\t` coe +c) 1̀> ‘.‘41' 4:1> e ci c` ,§ A ,V < 4. CO + l'' 4• 441 co0 +0

32

differences in the frequency of data collection – monthly figures are often collected on a specified day in the month. If these are not aligned then prices may not be comparable because of changes in the underlying cost of product between times. Differentials may thus arise precisely because markets are competitive and prices are cost reflective.

differences in frequency of fuel deliveries – the Isle of Man receives deliveries on a regular basis, but no more than once a fortnight on average. Thus at any point in time, there are stocks of product purchased at prices between two weeks and a month old. This inventory cost is not as pronounced in the UK, where there is a more integrated distribution network.

competitive pressure is less – the large number of stations and the greater frequency of deliveries means that UK forecourt prices reflect changes more quickly in wholesale product cost. Since retailers respond when one competitor changes price, the speed of cost changes is quicker.

Figure 20 – UK – Isle of Man road fuels price differentials, ppl

-2

-1

0

1

2

3

4

5

6

7

8

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re



3.5.1 What benchmark price is appropriate?

The use of a UK average masks significant diversity within the industry along two lines:

geography; and

dealer type and associated business model.

33

3.5.1.1 Geographical diversity of UK retail prices

Regional fuel prices are influenced by locational drivers such as distribution network and proximity to refineries, local demand and competitive dynamics and the cost of labour.

As Table 13 highlights, regional prices can diverge significantly both above and below the average UK prices. Depending on the region chosen, the Isle of Man prices could have looked between 0.8 ppl worse or 0.6 ppl better than the average.

Table 13 – Comparing UK average retail prices for road fuels with regional prices, annual prices in ppl

UK average North West Northern Ireland

Scotland Wales

Petrol 2005 87.92 87.37 88.50 87.55 88.33

2006 91.96 91.38 92.29 91.76 92.49

2007 94.98 94.42 95.47 94.56 95.47

2008 107.53 106.71 108.12 107.08 107.75

Diesel 2005 91.86 91.41 92.73 92.06 92.49

2006 95.65 95.06 96.41 95.91 96.16

2007 97.44 96.72 97.94 97.59 97.98

2008 118.12 117.33 118.78 118.43 118.61 Source: Catalyst Note: prices highlighted in red are above the UK average, whereas prices in blue are below the average

3.5.1.2 Dealer-type diversity of UK retail prices

One of the most important trends in the UK market has been the emergence of supermarkets as the dominant channel for retailing fuel; as of 2008, they comprise 13% of outlets and 36% of volume sold. The diversity of forecourt types (supermarket owned stations, dealer-owned independent stations and company-owned and operated stations) reflected the differences in business models and strategies.

Table 14 – Comparing UK average retail prices for road fuels with dealer-type prices, annual prices in ppl

UK average UK supermarket

UK dealer UK company

Petrol 2006 91.96 90.57 93.61 91.65

2007 94.98 93.40 96.64 95.24

2008 107.53 105.95 107.91 106.48

Diesel 2006 95.65 94.22 96.78 95.61

2007 97.44 95.59 98.81 98.05

2008 118.12 116.08 118.18 117.27 Source: Catalyst

34

Note: prices highlighted in red are above the UK average, whereas prices in blue are below the average.38

UK dealer prices were around 0.38-1.66 ppl below the average illustrating the strength of the impact of supermarket competition. Supermarket sites, working on a different business model, tended to have prices around 1.5 – 2 ppl lower than the national average, recovering cost through higher volume throughput and linked revenues from increased retail sales in the associated shops.

The comparisons above highlight the fact that the reported differential for the Isle of Man will vary with:

the region chosen; and

the type of market comparator used.

3.5.1.3 Retail price differentials between the Isle of Man and other islands

As an island, the Isle of Man shares similar characteristics and market structure with other island jurisdictions such as Jersey and Guernsey and even the Republic of Ireland. Table 15 below highlights the price differential between the Isle of Man and the selected islands net of taxes.

Table 15 – Road fuel price differentials of Isle of Man net of tax prices with Jersey, Guernsey, and the Republic of Ireland, ppl

Jersey Guernsey Republic of

Ireland

Petrol 2005 -15.3 -21.4 3.0

2006 -11.8 -16.6 2.5

2007 -12.5 -20.8 2.6

2008 -14.2 -14.0 -0.5

Diesel 2005 -17.3 -14.1 1.2

2006 -15.4 -13.2 0.7

2007 -15.5 -8.0 1.4

2008 -16.2 -14.4 -1.5 Source: Isle of Man (Total IoM, Shell); Guernsey Policy and Research Unit, Jersey Statistics Unit, EU Oil Bulletin

38 The UK average cited in Table 13 and Table 14 and the accompanying regional and dealer-type

pricing data are sourced from Catalyst. The UK average in both tables and the regional UK prices are based on mid-monthly average prices, whereas the dealer-type prices are calculated from end month prices across all suppliers. Both tables also highlight the difficulty of finding appropriate comparators and the importance of looking beyond short term deviations in the differentials. Comparing the Catalyst prices with the UK averages issued in the EU Oil Bulletin and those produced by DECC in the Quarterly Energy Prices and Energy Trends, reinforces this message – as all three rarely provide a similar UK average on a monthly basis. Short-term comparisons may give a slightly skewed view of the actual relativities as they are often spot observations on a particular day in a month and the differences may reflect some transient differentials linked to the speed of cost pass-through into price changes.

35

Retail prices in the Isle of Man were consistently and significantly lower – on average 12-15 ppl lower for petrol compared to Jersey, and 14-21 ppl lower compared to Guernsey. The Isle of Man price was 15-17 ppl lower than on Jersey in the diesel market, and 8-14 ppl lower than Guernsey. While the differentials were larger than would be expected, they provide evidence that the market in the Island is pricing more competitively compared to similar markets. Price differentials with the Republic of Ireland suggest a difference of 2.5-3.0 ppl on average for unleaded and 0.7-1.4 ppl for diesel in favour of Ireland (with 2008 differentials as a possible outlier).

Despite sharing similarities with Jersey and Guernsey, the prices in the Isle of Man were significantly lower than in either Jersey or Guernsey, net of taxes, in the study period. It is likely that the absence of duties allows Channel Island suppliers to obtain a significant mark up. This may be because their consumers‘ reference point is the difference between their domestic retail prices and those in the UK or Europe and not the pre-tax differential, and especially because the final prices are still cheaper than UK prices.

3.5.2 Which comparators are useful or relevant?

In order to assess whether the differentials observed are reasonable, it is important to identify an appropriate comparator, whether the UK average, a specified region or type of fuel station. It is also important to identify an appropriate timeframe, for comparison and an appropriate or reasonable price difference between the two jurisdictions:-

an appropriate comparator; the most relevant of the comparators assessed in this section are UK independent dealer-owned filling stations. Most filling stations in the Island share the same business model (dealer owned-dealer operated) and have a comparable throughput. Dealer owned and operated average prices in the UK as reported by Catalyst are the most appropriate comparator. The UK average while a more straightforward comparator is heavily influenced by the share of supermarkets which comprise 36% of the total volume of road fuel sold

an appropriate time frame; monthly and annual averages have been used for ease of comparison, however a rolling eight week period would be appropriate for monitoring differentials as it provides a reasonable period to remove the impact of transient changes in differentials due to inventory holding or fuel contracting strategies.

3.5.3 Can the observed differential be explained?

The annual retail price differentials with independent UK dealers were estimated at 2.76–3.90 ppl for unleaded and 2.3–3.9 ppl for diesel. The average differential for both fuels was estimated at 2.98 ppl (diesel) – 3.27 ppl (unleaded).39 Some of this difference can be explained by higher costs of operating in the Isle of Man as outlined in Table 16:

39 The monthly differential with UK dealer average is significantly volatile – ranging between -2.4 – 12.4

ppl for unleaded and -3.2 – 11.1 ppl for diesel.

36

Table 16 – Explaining the road fuel price differentials, ppl

Average differential with UK dealer owned sites 3.0 – 3.3

Readily quantifiable cost differences 1.0 – 2.3

cost of importation and shipping to the Island 0.8 – 1.5

smaller scale of operation (smaller tanker sizes) 0.3 – 0.8

Potential cost differences 0.5 – 1.0

lack of wholesale product competition (higher uplift relative to the benchmark cost and uplift charges for other sub-markets in the UK)

limited competition compared to the UK (lack of a ‗supermarket effect‘)

0.5 – 1.0

Qualitative cost differences

low profitability of UK distribution (and/or higher on-Island distribution costs)

higher fixed cost of operation (cost of operating two storage terminals and piers)

diseconomies of scale from lack of support services and specialist contractors

The costs summarised in Table 16, are outlined in detail below and include:

the cost of importation and shipping to the Island adds 0.76 - 1.45 ppl to the cost;

limited competition compared to the UK – though the throughput implications have been accounted for by comparing with a dealer-owned site, the additional impact on all market participants in the UK of the nature of retail market competition with the inclusion of the supermarkets has not been accounted for. Without the prospect of this pressure, average margins may be higher. It is hard to quantify this difference robustly. Indicative calculations suggest that, without supermarket competition, average margins in the UK might be in the order of 0.5 ppl to 1 ppl higher;

lack of wholesale product competition – the extent of the uplift on ARA prices applied to Isle of Man imports may be higher than that in the UK. The current uplifts are 0.73 ppl for unleaded and 2.54 ppl for diesel. Though it is not expected that all of this is an additional Island cost, a proportion may be;

smaller scale of operation – the average road tanker size in the UK is 36,000 litres, whereas the largest used for Isle of Man deliveries is 23,000 litres. Even in the Island, there are small load premia for lower volume deliveries, so there is expected to be a differential with average UK delivery costs.

37

higher unit fixed costs specific to the Island - costs such as the cost of operating two storage terminals and piers and the costs for inventory holdings due to delivery cycle contribute to the increased costs of supplying road fuels in the Island;

higher costs due to lack of support services and specialist contractors forcing local market actors to invest in developing capabilities that are infrequently used or would be more cheaply sourced in a larger market or importing services and personnel from the UK (such as, for example, lack of part time road tanker drivers);

the wholesale business in the UK is not very profitable - the UK OFT study in 2000 indicated that it earned no profit – a conclusion supported by the 2008 Highlands and Islands report which estimates that the average profit is 0.4 ppl. Thus, some additional return would be necessary to sustain the current distribution network in the UK. The higher margins would need to be reflected in higher overall returns than those necessary to sustain a stand alone business. The combined cost of small scale operation (described above) and higher distribution costs on-Island is estimated to account for a combined total of 0.26-0.8 ppl of the differential. 40

Thus, between 1.5 ppl and 3.3 ppl of the average differential can be explained by direct cost and market size differences. However, this still leaves up to 1.8 ppl without a readily quantifiable explanation.41 Whilst several drivers of the elements of higher costs have been noted above, it has not been possible to determine whether or not they account for the remaining difference, although it is expected, however they will account for at least a proportion of the remaining differentials.

3.6 Summary

Having reviewed the costs and margins in the road fuels market the main conclusions are as follows:

wholesale margins remained relatively stable for unleaded but were high for diesel, however adjusting for the higher cost of product for diesel implies constant margins for the period relative to 2006 findings;

retail margins were relatively stable, but do not appear to be unreasonable given the size of the market and the fixed costs associated with operating a filling station;

the differential with UK average prices has decreased in recent times, however, in general the level of the differential has been of the order of 5 ppl against UK average prices and 2 – 4 ppl relative to UK dealer - owned sites;

Up to 1.8 ppl of the differential with the UK is unexplained by direct cost, market structure or competition issues, however other unquantified cost drivers were highlighted that may partly explain the residual differential.

40 The estimates are based on views relating to the impact of economies of scale across distribution

activities in the UK. 41 The unexplained differential ranges between -0.3 – 1.5 ppl (diesel) and 0.0 –1.8 ppl for (unleaded)

4) d) cl° 4) 0 d) 0 0 0 0 0 0 cc\ cc\ sik cc\ Ok 4 Ob Ob Ob Ob Ob Ob q>c< ‘k. qr.V 64. c< rtr A' .V C‹ rtr •\)! 4. c< ‘V ".1.

4% 4% CO9 ° + 4% \`‘%q CO°9 ‘4°4. 4% \14ZA Co°/ 4) \14?V 44?̀V Co°1 4)

38

4. HEATING FUELS

4.1 Changes in heating fuel prices

The nominal price of heating fuels has increased substantially since the last OFT report as highlighted in Figure 21. Between January 2007 and July 2008 the price of kerosene rose by more than 29p – an increase of 31% while the price of gasoil rose by 33p (a 35% increase). Since then, prices declined by 14p and 17p for kerosene and gasoil respectively, but at the end of the study period they were still over 50% above the levels at the start of 2005.

Figure 21 – Isle of Man heating fuel prices, ppl, cash prices

30

35

40

45

50

55

60

65

70

75

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Kerosene Gas oil

Source: IoM OFT Comparative Heating Schedule (kerosene); Total IoM, CPL, Manx Petroleums (gasoil)

4.1.1 Which components of prices have changed?

The price can be differentiated into the same three components as for road fuels, namely:

commodity price (which includes the price of crude and refining costs);

custom duties and VAT;

gross margin (the combined expenses incurred in importing, storing, distributing and selling fuel and the profits at each stage).

Figure 22 and Figure 23 below highlight the price constituents for the period under review. Relative to road fuels tax/duty is a much smaller component accounting for approximately 21% of the gasoil price and 5% of the kerosene price.

0 0 .33 0 0 .33 0 0 3° 0 0 3° .6‘ .6‘ .6‘ 111 fk. re,V ‘V 4. c< • P P

c 0- +d ,j• b9 +0 et> 41> 44) B< 41!' 44& coe9 +c)

•

_40 ..y43 4,d) ,.<03 _4,HO 03 OD .1d° c)‘ ci‘ ,,c§5 .:§5 pcs vocs c§5 pcs y. 6,9 +o- 4,,o4reo co09. +0= 11 4r. y 630+0= lac coe<

39

Figure 22 – Constituent of Isle of Man gasoil prices, pence per litre

0

10

20

30

40

50

60

70

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re



Figure 23 – Constituent of Isle of Man kerosene prices, pence per litre

0

10

20

30

40

50

60

70

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

ARA Gross Margin VAT


40

4.2 Cost components of prices

Table 17 below highlights average retail prices for heating fuels in the Isle of Man and estimated levels of the cost components in January of each year. The change in ARA is significantly the largest contributor to changes in retail prices, accounting for around 80% of the price change observed.

Table 17 – Average monthly retail prices and price constituents

Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009

Kerosene Retail Price 31.93 39.64 39.97 49.56 41.27

ARA 18.58 27.22 22.89 35.38 26.22

Duty & VAT 1.52 1.89 1.9 2.36 1.97

Gross Margin 11.83 10.53 15.17 11.82 13.08

Gasoil Retail Price 31.43 40.79 39.88 52.48 44.39

ARA 17.76 25.76 20.98 34.21 26.62

Duty & VAT 6.72 8.38 9.59 12.19 12.18

Gross Margin 6.95 6.65 9.31 6.08 5.59

Source: Total IoM, Manx Petroleums, CPL, Platts

What is most interesting again is that the gross retail margin appears to move counter to the changes in the ARA price.

Figure 25 highlights the changes from one year to the next as of January each year. Taking the price of kerosene as an example - between January 2005 and January 2006 retail prices increased by 7.7 pence, whilst in comparison, ARA or wholesale cost increased by 8.6 pence. Thus the gross margin declined by 1.3 pence, signifying that price increases were not fully passed on. Over the next year, retail prices increased by 0.3 pence, while ARA price declined by 4.3 pence and thus the gross margin increased by 4.6 pence. Similarly between January 2007 and January 2008 retail prices increased by 9.6 pence whilst ARA prices increased by 12.5 pence. In the final twelve months, retail prices declined by 8.3 pence in light of a decline of 9.2 pence in ARA prices. It appears that suppliers are reducing the gross margin earned when wholesale costs increase but increasing it when costs fall.

•

_

_

41

Figure 24 – Annual changes in heating fuel retail prices and price constituents as of January each year, ppl, nominal prices

-15

-10

-5

0

5

10

15

20

2005-2006 2006-2007 2007-2008 2008-2009 2005-2006 2006-2007 2007-2008 2008-2009

Kerosene Gasoil

Pe

nce

pe

r lit

re


Source: Total IoM, Manx Petroleums, CPL, Platts

4.3 Changes in wholesale prices

Not only was the commodity price the largest component of prices, net of taxes, its contribution to price volatility was also the largest.

As noted in Section 3, ARA prices are determined by the price of crude, the costs of refining and the supply and demand balance in the regional wholesale market that affects the margin earned on individual products. Figure 25 below highlights changes in kerosene and gasoil ARA prices compared to changes in underlying Brent crude prices. The correlation here is more pronounced than was noted for gasoline in Section 3.3.1.

oh da d° d° d° O\ O\ O\ O\ 00 00 00 4.0, sy coo

t.0

.„( or",

s

y

co

o

4,0,651, .sas

„„;sy coo

t

o

sie

s

y

coo 4,0,

651,

42

Figure 25 – ARA kerosene and gasoil prices and Brent crude prices

0

5

10

15

20

25

30

35

40

45

50

55

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre

Brent

ARA Gasoil price

ARA Kerosene price

Source: : Total IoM, CPL, Manx Petroleums

4.4 Changes in gross margins and cost to serve

Since heating fuels are distributed directly to consumers without a separate retailing channel, the investigation focussed on the gross margin rather than the individual wholesale and retail margins.

Heating fuel gross margins have changed considerably over time and on a monthly basis as highlighted in Figure 26 below.42 As highlighted in the road fuels analysis (Section 3.3.2), there are three possible explanations for why the gross margin has changed over time and for the volatility observed:

inconsistencies with the cost data used – the volatility observed may be partly due to ARA monthly average spot prices which differ from the actual cost of product due to contracting strategies;

changes in the underlying cost to serve - wages, utilities, maintenance and repairs and other costs are generally fixed in the short to medium term, and therefore do not explain the volatility observed; and/or

changes in profit earned - if the reported costs are correct then the monthly volatility reflects changes in profits earned in the sector. This may highlight fact that companies smooth out volatility in their profitability, taking risks or exposure in the market so that retail prices change less frequently.

42 Effective gross margin - the effective gross margin as described above excludes discounting.

0 0 cI) 4) 4) cI) c§. c§. 4. c§. c§. 4. ci‘ ci‘ 6 ci‘ ci‘ 6 Ob Ob Ob Ob Ob Ob 1,c, lac 441-,v # +04' 1 lac 441-,V 1 # +04' 1 lac 441-,V 1 # +04' 1 lac 40 1 cp. +04'

43

Figure 26 – Changes in combined wholesale and retail margins, ppl

-6

-2

2

6

10

14

18

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Kerosene

Gasoil

Source: IoM OFT Comparative Heating Schedule, Catalyst

The heating fuels market is characterised by significant discounting. Based on a review of reported prices, the investigation has estimated that the final kerosene price for example was approximately 8% lower than the corresponding average prices cited in the comparative heating schedule for the period.43

As a result in establishing the level of profitability, we have taken into account the influence of discounts to calculate the effective gross margin - the gross margin net of discounts.

4.4.1 Explanation of the gross margin

Table 18 shows the calculated effective gross margin by fuel type for each year taking account of discounts. On average gross margins appeared stable over time

43 The price series from the Comparative Heating Schedule for kerosene collected by the Office and

gasoil retail prices were used as submitted by the companies. The actual price paid by consumers reflects:

the range of discounts made available to customers by the suppliers;

supplier choice – unlike road fuels, non-price elements such as quality of service are an important driver in the choice of supplier and therefore influence overall prices;

timing of collection—the prices are collated on the first day of each month for most of the period and since mid 2008 twice monthly.

44

Table 18 – Average heating fuel effective gross margins, ppl

Kerosene Gasoil Weighted

average44

2005 8.16 3.04 5.61

2006 8.92 3.89 6.90

2007 8.13 3.04 6.28

2008 9.48 4.19 7.51 Source: Total IoM, CPL, Manx Petroleums

There are four main components of the effective gross margin:

shipping and import costs – includes actual shipping charges, harbour dues, ship discharge and other import administrative costs

cost of storage and on-Island distribution – these include depot costs and operating the road distribution network

costs for retail of heating fuels – includes sales and administrative costs and charges incurred for marketing and promotion

profits of the distributor/retailer

The wholesale costs were similar to those for road fuels discussed in Section 3.4 though there was some difference in:

the level of shipping costs by individual fuels; and

the allocation of storage and distribution costs.45

Retail costs for heating fuels include sales and administrative costs, and marketing and promotion charges. The estimates for these costs are highlighted in Table 19 below. These have been allocated by volume rather than by customer numbers.

Using these costs the profit of the activity can be estimated, as shown in Table 19. The combined overall profit for both fuels ranges from 2 - 4 ppl.

profit seem to have remained stable over time except for 2007

kerosene profits appear reasonable whereas gasoil is marginally, if at all, profitable.

44 The averages in this table and for the rest of Section 4 are on an annual weighted volume basis. 45 Cost allocation is done by volume and not customers, which means that we have potentially over-

allocated overheads to gasoil

45

Table 19 – Estimated wholesale and retail costs and profits, in ppl46

2005 2006 2007 2008

Kerosene Gross margin 8.16 8.92 8.13 9.48



Marketing and promotion 0.06-0.27 0.09-0.46 0.07-0.43 0.11-0.22

Estimated profit 4.71-5.03 4.67-6.02 4.01-4.13 4.74-5.60

Gasoil Gross margin 3.04 3.89 3.04 4.19

Shipping and import 1.01-1.52 1.06-1.58 0.97-1.00 0.92


Marketing and promotion 0.06-0.27 0.09-0.46 0.07-0.43 0.11-0.22

Estimated profit -0.09- -0.77

-0.40-0.99 -0.38- -0.87

0.41-0.94

Average profit 1.98-2.48 2.63-4.00 2.23-2.49 3.13-3.86

Source: Total IoM, Manx Petroleums

The 2006 OFT study estimated that market participants were making a profit in the range of 4.2 – 4.6 ppl for kerosene and -2.4 - -3 ppl for gas oil for the period from 2001-2005 compared to corresponding margins in the UK of 2.8 ppl and 0.2 ppl respectively for kerosene and gasoil.

The estimated profit for both products appears to have increased, and while the implied profit for gas oil is still relatively low, that of heating oil raises some cause for concern. Some of the extreme levels observed may be a consequence of the assumptions on the attribution of sales, admin and marketing costs between the two products. It is to be expected that the gas oil market would have lower market and overhead costs than the domestic kerosene market due to the smaller number of customers being served.

The above costs reflect the direct costs of importation and distribution. There are other general expenses the suppliers have incurred to support their businesses that have been excluded based on an estimation of direct relevancy. These other costs would also need to be recovered through the gross retail margin. It is estimated that these costs represent around an additional 0.6 ppl to 1.4 ppl.

Consequently, a rebalancing of the costs between gas oil and kerosene and inclusion of these excluded sundry costs may lower the profit estimate for kerosene, though it is unlikely to return to the levels of the previous study.

4.5 Comparative price assessment

As with road fuels there is a premium on heating fuel prices in the Isle of Man when compared to the UK. Table 20 below provides annual average price differentials during 2005-2008 for gasoil and kerosene. On average, the differential for kerosene was 6.58 -

46 The average profit is calculated as the maximum and minimum profit of both companies, weighted by

the proportion of Island kerosene and gasoil shares.

46

8.88 ppl compared to 2.56 - 6.19 ppl for gasoil – the latter declined annually for the period under review.

Table 20 – Annual average UK – Isle of Man heating fuels price differentials, ppl

Kerosene Gasoil

2005 7.26 6.19

2006 7.40 5.28

2007 6.58 2.56

2008 8.88 2.56 Source: IoM OFT Comparative Heating Schedule (kerosene); Total IoM, CPL, Manx Petroleums (gasoil), UK BERR Digest of UK Statistics

4.5.1.1 Historic retail price differentials between the Isle of Man and the UK average

The kerosene differential has increased over time while gasoil has declined as highlighted in Figure 27. This may imply that suppliers are able to place more cost on the kerosene market to make up for declining sales elsewhere.

Figure 27 – Average UK – Isle of Man heating fuel price differentials, ppl

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

2005 2006 2007 2008

Pe

nce

pe

r lit

re

Kerosene Gasoil Average kerosene Avereage gasoil

Source: Total IoM, CPL, Manx Petroleums, UK BERR Digest of UK Statistics

Figure 20 charts the monthly price differentials highlighting the volatility. This is largely due to differences in fuel delivery cycles which are more frequent in the UK market

4) Sao

13 _tO) , pc. oc° ci‘ ci‘ ci‘ ci‘ ci‘ s§5 5§5 .3§5 00 00 v- _69 cr. qr 06:1 .c.( ty < c A

co + 4. 3 coo + o't> 44Z, coo +o 4,4t> coe +0

47

compared to the Isle of Man. In 2008, the price differentials narrowed, followed by a significant increase in the last quarter as indicated in Figure 28.

Figure 28 – UK – Isle of Man heating fuels price differentials, ppl

-4

-2

0

2

4

6

8

10

12

14

16

18

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pe

nce

pe

r lit

re

Kerosene Gas oil

Source: Total IoM, CPL, Manx Petroleums, Catalyst

4.5.2 Can the observed differential be explained?

The annual differential for the period under consideration was 6.58 – 8.88 ppl for kerosene and 2.56 – 6.19 for gasoil.47 The average for the period was estimated at 7.23 ppl (kerosene) and 4.18 ppl (gasoil). Some of this difference can be explained by higher costs of operating in the Isle of Man as outlined in Table 21 below:

47 The monthly differential between the Isle of Man prices (as quoted in the IoM OFT Comparative

Heating Schedule) and the UK is even more volatile – ranging between 2.3 – 13.9 ppl for kerosene and -2.7 – 9.4 for gasoil.

48

Table 21 – Explaining the heating fuel price differentials, ppl

Average differential with the UK 4.2 – 7.2

Readily quantifiable cost differences 5.7 – 6.3 (kerosene);

3.0 – 3.6 (gasoil)

cost of importation and shipping to the Island 0.9 – 1.5

level of discounting in the market 2.1(g) – 4.8(k)

Potential cost differences

lack of wholesale product competition (uplift comparison relative to benchmark cost and uplift charges for other markets)

Qualitative cost differences

low profitability of UK distribution (and/or higher on-Island distribution costs)

higher fixed cost of operation (cost of operating two storage terminals and piers)

diseconomies of scale from lack of support services and specialist contractors

As summarised in Table 21, some of the differential can be accounted for by the analysis of wholesale and retail costs and margins, in particular:

the higher cost of importation and shipping to the Island is approximately 0.92 - 1.52 ppl for the combined fuels;

the level of discounting is significant in the market and has increased over time. In 2008, the average discount for kerosene is estimated at 4.84 ppl, compared to 2.11 ppl for gasoil.

Up to 6.36 ppl of the price differential can therefore be explained for kerosene and 3.63 ppl for gasoil – leaving 0.9 ppl and 0.6 ppl in kerosene and gasoil differentials respectively unaccounted for.48 As explained in Section 3, there are several potential explanations for this and these are repeated below for completeness:

limited competition compared to the UK - fewer market participants across any part of the supply chain means that competition at any level of the supply chain is less compared to the UK – in addition, competition with natural gas is relatively new compared to the UK and may yet take effect.

there are further incremental costs on distribution related to shipping that are not all accounted for in the comparison to date;

48 0.9 – 1.5 ppl (kerosene) and 0.6 –1.2 ppl (gasoil)

49

additional Island-specific costs such as the cost of operating two storage terminals and piers, which contribute to increase the cost of doing business in the Island;

the delivery cycles and inventory holding means that on average the wholesale cost of purchase is inflated above the expected efficient cost of purchase – it also means that there is a margin to the differential which is purely a factor of the difference in cost of product from the differences in cycles;

higher costs from lack of support services and specialist contractors forcing local market actors to invest in developing capabilities that are infrequently used or would be more cheaply sourced in a larger market (for example lack of part time road tanker drivers) or importing services and personnel from the UK; and

the wholesale business in the UK is not very profitable - the OFT study in 2000 indicated that it earned no profit – a conclusion supported by the 2008 Highlands and Islands report which estimates that the average profit is 0.4 ppl. Thus, some additional return would be necessary to sustain the current distribution network in the UK. The higher margins would need to be reflected in higher overall returns than those necessary to sustain a stand alone business.

4.6 Summary

Having reviewed the costs and margins in the heating fuels market, the following observations can be made:

the gross retail margins have risen over the period of this study and the implied profit was substantially greater than that at the time of the last study;

this position is especially true in the domestic kerosene market where gross margins in the order of 8 ppl were being observed;

with three competitors and transparent pricing behaviour, the high margins may just be indicative of the efficient allocation of fixed costs to the most insensitive group of customers; the domestic market.

50

5. COMPETITIVE MARKET DYNAMICS

Further insight into the form and extent of competition in the Island can be gained from analysing the pattern of how costs are passed through to consumers and the pricing decisions of retailers in the markets. While fuel suppliers cannot fully control the wholesale product costs, in competitive markets the speed and extent of pass-through to consumers is influenced by the structure of on-Island market arrangements.

A stylised representation of the set of interactions between wholesale product prices and retail pump prices in the road fuel market is provided below (see Figure 29). This highlights the transmission mechanisms that lead to wholesale cost changes being reflected in retail price changes. Essentially, there are three main stages:

wholesale price changes alter the costs of fuel suppliers;

fuel suppliers pass some or all of these changes onto retailers through alterations in their schedule price; and

retailers determine what proportion of their cost changes to pass on to customers taking account of the likely behaviour of consumers and the reaction of competing filling stations.

A final interaction exists between the pump price and the schedule price in that it is possible that fuel suppliers alter their schedule price in response to observed changes in the pump prices offered by their filling stations or other brands, a process that enables them to contain the margin being earned by the retailer.

Figure 29 – Competitive dynamics in the market

Fuel supplier

Wholesale price

changes

Retailer

Pump price

Schedule price

Impact of retail

competitionObserved pump

prices


51

The following sections investigate these two main interactions:

wholesale price and schedule price movements; and

retail price movements between suppliers.

5.1 Wholesale costs and schedule prices

In general, it would be expected that changes in wholesale cost would be reflected in changes in the schedule price quoted by the fuel suppliers. Figure 30 and Figure 31 show these relationships for Shell (UK) and Total (IoM) respectively. The cost of product is not the ARA benchmark, but the reported cost from each company. There are two interesting points to note here:

the cost of product for Shell (UK) is much more volatile than that of Total (IoM) , which may reflect differences in the contractual terms on which Shell purchases product;

the relationship between cost of product and schedule price is much more variable for Shell (UK).

Shell‘s schedule price changed less frequently than its underlying cost of product, suggesting the supplier was not fully passing on the cost changes. This may imply that Shell (UK) was acting to mitigate the impact of volatile prices on customers.

However, it could also imply that Shell‘s schedule price was being influenced by that of Total – the Shell schedule price having to alter to ensure relative comparability for its filling stations with those of Total. Variations would then be related to the inability of Shell to pass on higher costs, or lack of incentive to pass on benefits of lower costs, to its retailers, because of divergences between its cost of product and that of Total.

As Figure 31 shows, the relationship for Total (IoM) is much more stable. This suggests two things. First, the contracting structure for fuel purchase of Total (IOM) exposes the fuel supplier to less risk. Second, that it is possible that Total is able to act as a price leader with its stations providing the benchmark against which Shell-branded stations set prices. In relation to the stylised diagram, the retail price changes act as a larger influence on Shell‘s schedule price setting than it does on Total‘s. To the extent that Total is pricing reasonably, this pricing behaviour does not necessarily adversely affect the market.

Figure 30 – Relationship between Shell’s cost of product and schedule price net of tax for unleaded, in ppl

[Figure redacted] Source: Shell

Figure 31 – Relationship between Total’s cost of product and schedule price net of tax for unleaded, in ppl

[Figure redacted] Source: Total

52

5.2 Road fuel retail market competition

Two characteristics of road fuels are important for understanding the nature of retail competition. First, road fuels are homogeneous products – despite some differences at the margin on additives and branding perception, petrol is petrol and diesel is diesel. Thus major differences between prices in the market would not be expected. Secondly, however, consumers do not respond significantly to small changes in the price of product. This explains the stability in overall consumption patterns but also implies that there should be scope for some differentiation in prices between stations without an adverse impact on volume of sales (as evidenced in the general 1 ppl differential between Shell and Total branded sites).

In order to understand the dynamics of price setting in the Isle of Man market, prices were collected from ten Island petrol stations over a period of 12 weeks between February and April. The OFT wrote to all filling station operators in February asking for them to advise the timing and size of any fuel price change in order to assist the investigation. It is regrettable that only ten garages complied with the Office‘s request for information to understand the mechanisms of the marketplace to a greater degree. Figure 32 and Figure 33 below highlight the unleaded petrol and diesel prices at a sample of the stations (colour coded by brand) during the period and the date of change in price.

Figure 32 – Changes in unleaded prices at selected filling stations, February 14 – April 21, 2009, in ppl

Airport garage

(Total)

Brown bobby

(Shell)

Bray hill

(Total)

Empire

garage

(Shell)

Ray motors

(Shell)

Darnills

(Shell)

Market

garage

(Shell)

17-Feb-2009 95.9 95.9

18-Feb-2009 96.9 96.9

19-Feb-2009 96.9 95.9 96.9

25-Feb-2009 96.9

26-Feb-2009 96.9

27-Feb-2009 96.9 97.9

28-Feb-2009 97.9 97.9

3-Mar-2009 97.9

19-Mar-2009 97.9 97.9 97.9

25-Mar-2009 98.9

26-Mar-2009 98.9 98.9 98.9

1-Apr-2009 100.9 100.9 100.9 100.9

2-Apr-2009 100.9 100.9 100.9

3-Apr-2009 101.9 101.9

4-Apr-2009 101.9

18-Apr-2009 102.9 Source: Isle of Man Office of Fair Trading - data collected from stations

53

Figure 33 – Changes in diesel prices at selected filling stations, February 14 – April 21, 2009, in ppl

Airport garage

(Total)

Bray hill

(Total)

Brown bobby

(Shell)

Empire

garage

(Shell)

Ray motors

(Shell)

Darnills

(Shell)

Market

garage

(Shell)

17-Feb-09 106.9

19-Feb-09 108.9

25-Feb-09 105.9

26-Feb-09 105.9

27-Feb-09 105.9 106.9

28-Feb-09 106.9 106.9

3-Mar-09 106.9

5-Mar-09 103.9

7-Mar-09 104.9 104.9 104.9

10-Mar-09 104.9

26-Mar-09 104.9

30-Mar-09 104.9

31-Mar-09 104.9

1-Apr-09 106.9 106.9 107.9 107.9

2-Apr-09 106.9 106.9 107.9

3-Apr-09 101.9

4-Apr-09

18-Apr-09 107.9 Source: Isle of Man Office of Fair Trading - data collected from stations

Despite the small sample of data, the analysis provided several pointers about the market structure and price formation in the market:

the difference between stations was in most cases 1-2 pence – highlighting clustering of prices at the retail level.

price changes seem clustered together over a day or two indicating that filling stations monitor and respond to each other‘s price;

the analysis does not provide strong evidence of an obvious price leader in the market – while Total stations appear to change unleaded prices first, the picture for diesel is mixed.

There is limited price differentiation between filling stations due to the homogenous nature of the product – diesel or unleaded from a Total station is similar to the same product from a Shell station. As a result, any filing station faces the risk of losing its customers if it were to charge higher prices than its competitors. Conversely, customers are also driven by factors other than price in their purchasing decision, factors such as quality of service, presence of a shop or car wash, inertia or loyalty to a particular station. Therefore, they are willing to pay higher prices and are relatively unresponsive. Up to a certain point, customers are not likely to alter their volume of consumption or switching to an alternative station – to a certain point. These two factors in part explain why there is often a 1-2 pence difference in prices, and the degree of retail competition.

These competitive dynamics in retailing influences changes in Schedule Price. Suppliers will change the Schedule Price in response to:

changes in underlying cost of product; high cost shipments may often trigger a change in the Schedule Price; or

54

changes in retail prices; there is a circularity in how retail prices change. Retailers will typically respond to changes in competing brand stations by notifying the supplier, however this notification allows the supplier to change the Schedule Price and so prevent filling stations from earning higher margins.

As noted above, there was some anecdotal evidence that Total is a price leader in the market. Total owns several stations in the Island which gives it a good understanding of the cost to serve in the Island at any point in time. By having company sites it can also signal this cost to the market. This arrangement allows it to effectively signal its pricing policy to the rest of the market and to set prices for two thirds of the market.

Given the retail dynamics explained above, Shell retailers can respond by changing their own prices (if they wish) and/or notifying Shell which can in turn respond by changing its Schedule Price as a net-back on the Total station pump prices.49 As explained, Figure 30 and Figure 31 above highlight the fact that Total‘s changes seem to have mirrored changes in its underlying costs, whereas until 2008, Shell‘s price changes seemed to have changed less frequently, even in light of new product.

5.3 Heating fuel retail competition

The heating fuels market in the Island has three main suppliers. There is existing reporting of kerosene price offers through the Comparative Heating Schedule published by the Office. Some indicators suggested an improvement in the level of competition in this market over the period, including:

reductions in the concentration of the market as measured by the HHI;

increased competition from natural gas;

convergence in retail prices;

increased levels of discounting;

increased activity reported in the ring-around market

There are three suppliers in the market. As of 2008 the market shares […text redacted…] . The collective HHI in the heating fuels sector is estimated at 4,216 – a slight decline from 4,736 in 2005.50 While highly concentrated, it is more competitive than the road fuels market with a HHI of 4,933.

Figure 34 below highlights changes in Comparative Heating Schedule prices collected by the Office. Prices for the two largest suppliers, Manx Petroleums and Total, seemed to converge over time. This suggests that the transparency of price instituted as part of the last investigation and monitored informally by the Office may have aided competition. However these headline prices are becoming less representative of the available prices.51

49 Net back pricing simply defined in this case is calculating the wholesale price as a function of retail

prices. 50 According to the U.S. Department of Justice a market with a result of less than 1,000 is considered a

competitive marketplace; a result of 1,000-1,800 is a moderately concentrated marketplace; and a result of 1,800 or greater is considered a highly concentrated marketplace.

51 Competition in the heating sector also includes natural gas. In 2002, natural gas became available to approximately two-thirds of the mains gas-metered customers on the Island (those connected in the ex-Douglas Gas areas). With ongoing plans to extend the network to the rest of the Island, gas will become a long term competitor to heating fuels. The availability of gas provides an implicit

O' (P (P .:0 (P (P (P dP dP dPbdPbAAAAAA% 4 4 A\ 4 4 4 ,‘ 4 0 Ob Ob Ob da cp N <0 <0 A rh 4 '1 4 \

4 \ 4C 4C I 4C 4C 4 \ \' \ 43 NN NN C' \ 0 0 0 0 0 0 0 0 0 Ci' 0 Ci'

55

Figure 34 – Evaluating convergence in kerosene prices in the Isle of Man, in ppl

30

35

40

45

50

55

60

65

70

75

01/1

1/04

01/0

1/05

01/0

3/05

01/0

5/05

01/0

7/05

01/0

9/05

01/1

1/05

01/0

1/06

01/0

3/06

01/0

5/06

01/0

7/06

01/0

9/06

01/1

1/06

01/0

1/07

01/0

3/07

01/0

5/07

01/0

7/07

01/0

9/07

01/1

1/07

01/0

1/08

01/0

3/08

01/0

5/08

01/0

7/08

01/0

9/08

01/1

1/08

01/0

1/09

Pe

nce

pe

r lit

re

Manx Petroleums

CPL Petroleums

Total

Source: Isle of Man Office of Fair Trading, Comparative Heating Schedule

The level of discounting in the heating fuel sector was high as highlighted in Table 22 below. […text redacted…].52 This could suggest that competition at the retail level is working and is forcing companies to discount more heavily to attract customers.

Table 22 – Estimated average discount offered for kerosene sales, %

Total Manx Petroleums

2005

2006

2007

2008

[Figures redacted] Source: Total IoM, Manx Petroleums

ceiling on the profitability of suppliers, at a minimum set at the transaction cost of shifting to gas and the price differentials between the two fuels.

52 It could also suggest any of the following (a) inflation in comparative heating schedule prices, given consumer expectation of a discount or (b) data inconsistencies resulting from comparing a monthly average of price points to a snapshot price estimate, collected until recently once a month.

56

Finally, service quality is an important point of differentiation in addition to price and there is anecdotal evidence that the suppliers compete on service quality and that customers respond to quality differences in addition to price differences.

5.4 Summary

This section found that:

there was a lagged cost pass-through between wholesale and retail prices. Between 2005 and 2007, suppliers tended to smooth out fluctuations in retail prices, however in 2008, the speed and extent has increased;

the retail segment of road fuels was price responsive – the price dynamics was driven in part due to transparency of pricing. The difference between stations was in most cases 1 - 2 pence – highlighting clustering in prices at the retail level. Price changes also seemed to be clustered together over a day or two indicating that filling stations monitor and follow each other‘s prices;

although gross retail margins and implied profits in the retail heating fuel market rose over the period of this study and were now substantially greater than that at the time of the last study, there was evidence of the sector becoming more competitive – prices quoted had converged reflecting in part the transparency caused by the monitoring scheme imposed by the OFT. In addition, high levels of discounting highlighted competitive pressure on company margins. The presences of multiple suppliers and of competition from natural gas help to put a ceiling on price increases.

57

6. PROFITABILITY ANALYSIS

The previous sections focussed on explanations of the ppl margins earned in supplying the different fuels. However, as noted, the distribution assets are used jointly in the provision of road and heating fuels. Consequently, it is informative to consider the overall level of profitability achieved by the liquid fuel supply companies in the Isle of Man.

6.1.1 Profitability indicators

This analysis used three broad indicators of profitability for the different fuel supply companies in the Isle of Man for the period of 2005 to 2008:

Gross margin – defined as turnover net of duty, VAT and the cost of good sold. The gross margin is calculated by dividing gross profits by revenue (net of duty and VAT).

Return on sales (ROS) – defined as the operating returns on the business. The ROS is calculated by deducting operating expenses from gross profits (to produce earnings before interest and tax, or EBIT) and dividing this by revenue (net of duty and VAT).

Return on capital employed (ROCE) – defined as the return to investors (debt holders and equity) against the capital employed; calculated by dividing the Earnings Before Interest and Tax (EBIT) by the sum of debt and equity.

Total (IoM) and Manx Petroleums submitted statutory and management accounts for their operations, while GB Oils and Shell UK submitted management accounts.53 The information provided by GB Oils (CPL) is insufficient for a complete assessment and was therefore excluded from the analysis.54 The profitability analysis used the information submitted and several assumptions55 to estimate the relevant accounting measures of profitability.

53 Shell did not provide statutory reports as the Isle of Man business does not exist as an independent

business but is part of Shell UK Oil Products Ltd (SUKOP) its subsidiary responsible for the refining and marketing of fuels and lubricants within the UK. Similarly GB Oils in the Isle of Man does not exist as an independent business. Statutory accounts are only relevant for registered companies.

54 The UK parent company for CPL Petroleum was acquired by DCC Plc, the holding company for GB Oils in July 2007. The trading data prior to the acquisition forms part of CPL Industries Ltd records for which GB Oils was unable to access, as it is held by CPL. As a result, the finacials received are largely for a few months. In addition, GB Oils is a relatively small player in the market [...text redacted...] and therefore its exclusion is unlikely to significantly affect the conclusions reached using other company data.

55 The assumptions include:

Manx Petroleums - the turnover figures for Manx Petroleum include payments to Manx from Shell for distribution services and that the payments to Manx Petroleum from Shell in the calendar years 2005, 2006, 2007, and 2008 are the same as the actual payments during the period December 2007 to November 2008. The distribution of Manx Petroleum‘s administrative expense between its retail and distribution services is based on volumes splits.

Total (IoM) - the distribution of Total‘s administrative expense between its road fuel and heating fuel retail services is based on the volume splits. The distribution of Total‘s turnover and Cost of Goods Sold between its road fuel and heating fuel retail services is based on the respective split between the total revenues.

58

6.2 Company profitability

Table 23 below highlights the results of the analysis of the profitability ratios for 2005-2008. It also highlights the profitability ratios calculated as part of the 2006 OFT fuel study for comparison.

Table 23 – Estimated company profitability ratios, 2001-2008

Gross margins 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total 24.5 25.7 25.2 24.7 24.5 19.9 18.6 20.6 15.5

Manx Petroleums 17.4 19.2 17.6 17.5 17.4 13.3 12.3 13.4 9.6

Shell 18.1 15.6 14.0 13.5

Return on sales

Total 6.1 7.7 6.2 9.0 6.1 6.8 6.5 8.8 6.6

Manx Petroleums 4.4 7.5 4.8 5.6 4.4 4.1 4.4 3.2 2.6

Shell 2.5 3.2 0.2 3.5

Return on capital employed

Total 15.8 16.8 12.1 18.0 15.8 16.3 13.8 16.3 14.2

Manx Petroleums 19.1 29.5 17.4 14.4 19.1 16.1 16.6 9.8 10.7

Source: 2001-2004 from Isle of Man OFT Fuel Study, October 2006; 2005-2008, Pöyry estimates from data submissions (Shell UK, Total IoM, Manx Petroleum).

6.2.1 Gross margins

The gross margin during the period varied across companies and time. Total reported the highest gross margins at 16.6 - 20.6%, though its additional assets and costs may explain this. Manx Petroleums had the lowest gross margins at 6.6 -13.4% while Shell UK margins ranged between 13.5 - 18.1%.

The current review period shows a significant decline in profitability for all suppliers when compared to 2001-2005. For instance, Total‘s gross margin averaged 25% for 2001-2004, compared to 18.7% for 2005-2008. Manx Petroleums‘ gross margin has also declined from an average of 17.9% to 12.1%.

Changes in the levels of gross margin highlight the extent to which changes in the price of the underlying fuel have been passed through to final consumers - declining gross margins suggest that suppliers are unable to pass on costs to consumers. In order to maintain the same level of gross margin during period of price increases, a supplier would need to increase its revenues by more than the cost. In times of higher prices, a lower ratio of cost to revenue suggests fixed pence per litre targets.

6.2.2 Return on sales

The return on sales metric is a more useful measure for low capital intensity activities. Though all firms have capital investments, the ROS is reported for completeness.

The ROS for the period range between of 0.2 - 9%. Total reported the highest ROS ranging from 6.5 - 8.8% while Shell UK had the lowest at 0.2 - 3.5%. Manx Petroleums

59

ROS was estimated at 2.6 - 4.4%. There was no discernable pattern on how ROS has changed during the period, however 2007 seemed to be an anomaly with high ROS for Total and low ROS for Shell and Manx Petroleums.

Returns on sales were stable for Total but declined for Manx Petroleums. Manx Petroleum‘s low ROS profitability is due in part to lower revenues on fuel deliveries for Shell compared to Total‘s earnings on wholesale and retail sale of road fuels (despite similar overheads on the wholesale side). The distribution charges that Manx Petroleums received from Shell have not been increased in almost ten years and have declined in real terms even as its overheads have increased.

6.2.3 Return on capital employed

The return on capital employed averaged 10 - 17% as highlighted in Table 23 above. ROCE for Total averaged 13.8 - 16.3% and 9.8 - 16.6% for Manx Petroleums. Manx Petroleums seemed to have experienced a significant decline in ROCE over the last two years.

Compared to 2001-2005 levels, ROCE similarly shows a decline - Total‘s ROCE declined from 15.7% (2001-2004) to 15.2% (2005-2008), while Manx Petroleum‘s ROCE declined from 20.1% to 13.3%.

ROCE is a measure of the returns achieved against investments in a business. It is affected by the capital intensity of a business, which differs across the companies in the sector depending on their niche in the supply chain or business model. For instance, Total (IoM) is vertically integrated, and is involved in several segments of the supply chain that are capital intensive, such as distribution and operation of filling stations.

ROCE comparisons should therefore be viewed with these complexities in mind.

6.3 Summary

The profitability analysis presented in this section suggests that the companies in the sector are not making excessive profits:

There are no good comparator benchmarks for operations of this scale and therefore it is hard to confirm whether these returns are reasonable. However, the most pertinent observation is that these returns, on whichever basis, are lower than that during the period of the previous study. Consequently, it does not appear that the situation in the Isle of Man worsened over the period

profitability ratios broadly declined compared to the extent established in the last OFT report for 2001-2005 – gross margins have experienced the biggest declines suggesting that suppliers may look for a fixed return.

Total (IoM) is the most profitable company on all measures – suggesting that its vertically integrated structure allows it to recoup some of its overheads across the supply chain. In contrast, Manx Petroleums displayed a declining and low rate of return due in part to lower revenues on fuel deliveries compared to Total‘s earnings on wholesale and retail sale of road fuels (despite similar overheads on the wholesale side).

60

7. ENSURING APPROPRIATE MARGINS

Given the size of the overall market, the scope for significant changes to the competitive structure is very limited. As such it may be relevant to consider some proxy for the competitive pressure that exists in other markets. There are two broad options for achieving this:

ex-ante retail price controls; and

ex-post, or real time, monitoring of Isle of Man prices against an appropriate benchmark comparator or cost index.

These are discussed in more detail below.

7.1 Ex-ante price controls

Ex-ante price control is the formal regulation of allowable levels of fuel prices. South Africa and the Canadian province of Nova Scotia provide two examples of jurisdictions that have adopted formal price regulation for road fuels. In both jurisdictions, the price is based on the cost of product established from an international benchmark, and a defined wholesale and retail margin. This margin is related to allowed costs of operation and a fixed margin of profitability. Detailed case studies of their experiences are covered in Annex A.

While formal price regulation is effective in controlling prices, it is:

costly to institute and manage; and

may stifle innovation in retail models or wholesale contracting.

To determine how material an impact this may have, an ex-post hypothetical analysis of how prices may have evolved in the Isle of Man within a South African or Canadian price regulation framework was conducted. Figure 35 below highlights petrol prices under a Canadian and South African approach, while Figure 36 highlights diesel prices under the Canadian price regulation.56

56 Monthly ARA refinery prices have been used as cost of product - South Africa product price is

determined monthly, whereas Canadian product price is determined weekly. Pöyry have also used the regulated margins (transportation, shipping, storage) across all years as a percentage of net of tax prices.

sg3 c13 c13 c13 d° d° d° 6 6 5§ 6 6 It'k gt`b z`b Zcb 1#1 1,41,A 1#04' 1,41,A #1 "41,c41,A 4SP 04'

‘4.

d.) d.) do do do do do do 6 6 6 A A ,z7,\ ' c< 9, c< „P

cjb< 04

‘-‘• cDe ‘49 c"

A 93 93 43 43 43 43 A A e `§%

\A04 09 ‘-‘ •

61

Figure 35 – Comparison of outturn Isle of Man unleaded prices, with prices under a hypothetical South African or Canadian price regulation, in ppl

80

85

90

95

100

105

110

115

120

125

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence

per

litre

IoM avg (unregulated)

Pump price (Canadian style regulation)

Pump price (SA style regulation)

Source: Shell, Total, Pöyry analysis

Figure 36 – Comparison of outturn Isle of Man diesel prices, with prices under a hypothetical Canadian price regulation, in ppl

80

90

100

110

120

130

140

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre

Pump price (Canadian style regulation)

IoM avg

Source: Shell, Total, Pöyry analysis

62

Analysing the above figures plotting by unregulated and hypothetically regulated Isle of Man prices, it can be seen that the general level of the product at the pump would be very similar in regulated or unregulated environments.

In the regulated scenario, oil companies are unable to smooth out fluctuations in retail prices and as a result the regulated price drops faster in line with a falling refined product prices but in addition prices may go higher more quickly.

Much depends on the level of cost chosen at various stages. This analysis selected the retail and wholesale prices as a percentage of net of tax prices over the period as comparable cost metrics. Tighter allowable margins would lower price, but also risk the unintended consequences of causing a supplier to leave the market.

Table 24 presents the annual differential between the outturn prices under the current market structure and what they would be under a hypothetical South African and Nova Scotia regulation methodology.

Table 24 – Road fuel differentials between current market system and a South African and Canadian style regulatory approach, ppl

Unleaded Diesel

Nova Scotia regulation

methodology South African

regulation methodology Nova Scotia regulation

methodology

2005 1.73 -0.58 -4.62

2006 1.64 -0.69 -3.37

2007 1.43 -0.90 -3.91

2008 2.87 0.50 -8.76

Source: Pöyry Energy Consulting analysis

The hypothetical Nova Scotia style regulation would have yielded consistently lower unleaded prices but consistently higher diesel prices. The South African approach on the other hand would have yielded marginally higher unleaded prices. These results are highly indicative and are not presented as definitive evidence for or against regulation, but are highlighted to illustrate the range of options that other non-market approaches may provide in pricing.

7.2 Exerting external competitive pressures

An alternative to ex-ante price controls is to provide an external competitive pressure by linking Island prices to changes in a benchmark index. There are two ways of doing so:

applying and enforcing a specific margin (pence per litre) differential trigger assessed over a defined time frame; or

applying a trigger based on an international cost of product benchmark that is accessible and transparent such as a time weighted average of ARA spot prices assessed over a defined time-period.

63

7.2.1.1 Applying and enforcing a specific margin (pence per litre) trigger

A specific margin differential trigger is similar to the recommendations provided in the 2006 OFT report. That report recommended that a differential of 3 ppl between the Isle of Man average retail price and the average for all UK dealer owned sites be accepted as justified and around 4 ppl on average be allowed for some short-term discrepancies and time-lags. A differential of 5 ppl or more was to trigger further detailed examination and could lead to a Section 19 report to the Council of Ministers.

The limited success of the 2006 trigger justified reconsideration of this mechanism works and whether or not the monitoring or threshold was appropriate. Whilst it appears that the threshold was appropriate; however the time period was left undefined.

The advantage of applying and enforcing a specific margin is that it is less costly to implement than price regulation and if accompanied by price transparency would comparatively improve the competitiveness in the market.

7.2.1.2 Applying and enforcing a cost-based benchmark

A cost based benchmark links changes in prices to cost as would be expected in a competitive market. This may appear simple and transparent given the transparency of wholesale markets, but has some disadvantages:

the relationship between different cost components change over time; the benchmark therefore needs to be able to adjust to fixed cost changes

it imposes a contracting strategy

Consequently a price-based differential comparator would be easier to monitor and more transparent to the general public.

7.2.2 An enhanced monitoring regime

There are two steps to developing and enforcing a suitable monitoring regime, namely:

defining an appropriate benchmark – comparator, level of cost difference and time period for monitoring breach; and

defining an early warning system and a series of enforcement measures in case of breach.

The most relevant short term benchmark for road fuels are dealer owned filling stations in the UK. Dealer owned stations reflect the characteristics of the Isle of Man market which is predominantly dealer owned and dealer operated. The throughput at the retail level is also similar. The UK average on the other hand is heavily influenced by the share of supermarkets which comprise 36% of the total volume of road fuel sold. Given the competitiveness of supermarkets, prices in this benchmark are likely to be lower and the appropriate differential higher. It is accepted that the availability of appropriate time series of data may require the continuation of review against a UK average reported price such as from the Department of Energy and Climate Change (DECC) rather than a dealer average price from data providers such as Catalyst.

The second component of the benchmark is the identification of an appropriate differential. Given the lack of complete information on the cost differences between the Isle of Man and the UK, the original differential of 3 ppl recommended in the 2006 OFT

64

study remain an appropriate trigger – as noted in Section 3.5.3 1.5 ppl and 3.3 ppl of the differential can be accounted for.57

The third and final constituent is the definition of an appropriate time frame. It is proposed that a consistent divergence from these differentials for eight rolling weeks is a reasonable time frame. While this is an arbitrary cut-off, it balances transient changes in differentials due to inventory holding, fuel contracting strategies versus longer term cost changes or increases in profitability.

7.2.2.1 How to ensure compliance

Compliance requires incentives. It is suggested that the industry should be made aware of the benchmark and the various triggers suggested and that data should be reported. To improve compliance, industry stakeholders should report weekly on their retail prices providing information on changes in their underlying cost structure such as changes in cost of product. Since the price monitoring is on retail prices it is likely that retail forecourt operators will be primarily responsible for data submission to the OFT.

The data submitted should be compared against an 8-week rolling average, with results published on a monthly basis alongside the comparative heating schedule. This would require some additional reporting of prices by the fuel suppliers and/or retailers in addition to the reporting that is currently provided on the heating fuel side. It is accepted that this imposes an administrative burden on retailers that may need to be ensured through regulatory provision.

The eventual design of the monitoring program will depend on the timing and availability of comparator data. The frequency and timing of submissions should reflect comparator data, thus if the comparator data is only available on a monthly basis, it may make sense to institute a monthly submission to the OFT rather than weekly or fortnightly submissions.

It is also accepted that in the event of a breach the OFT currently has only those options provided by Section 19 of the Fair Trading Act as amended. However, the transparency in pricing that could result from suppliers submitting regular pricing updates means that it will be easier to establish whether a breach is in fact a change in cost to serve rather than increasing profits. In the absence of pricing information as in the current status quo, a breach that could have been explained instead, triggers a formal inquiry.

7.3 Summary

The limited competition in the Island suggests the need for a closer monitoring of market participants than is currently being undertaken. This may be in the form of ex-ante control or exertion of external competitive pressures.

Ex-ante price controls or formal price regulation, if implemented correctly, lead to faster and fuller cost pass-through and greater transparency in retail prices and price constituents. However the analysis of its application in the Island context suggests that it likely to be too costly to justify.

The exerting of external competitive pressure by linking Island prices to the UK is recommended – in particular defining an appropriate benchmark, monitoring the price

57 The unexplained differential ranges between -0.3 – 1.5 ppl (diesel) and 0.0 –1.8 ppl for (unleaded)

65

differential with the UK through timely data series and ensuring that fuel suppliers submit regular prices and price differentials to the OFT as described.

66

8. VIEWS OF THE PUBLIC

8.1 Introduction

In order to gather the views of consumers and other interested parties on the price charged for liquid fuels in the Island, a public notice was issued by the Office along with an accompanying press release detailing the process for the submission of views. The public notice was printed in full in the Isle of Man Examiner on 2nd March 2009 and the Isle of Man Courier on 5th March 2009. The deadline for the submission of views was 3rd April 2009.

In addition, the Chairman of the Office, Mr R W Henderson MHK, contacted all Members of Tynwald to advise of the invitation for public views and welcoming views either from themselves or on behalf of their constituents.

The Office issued two press releases to the local media to draw the public‘s attention to the opportunity to make their views known regarding the price of liquid fuels and these releases generated significant media coverage. The topic was covered on two separate occasions by Isle of Man Newspapers and carried on all of the Island‘s radio stations by both their news bulletins and website. Coverage was also given on the following websites; www.isleofman.com and www.bbc.co.uk/isleofman. In addition, the invitation for public submissions was promoted extensively both on the Office‘s own website (www.gov.im/oft) and on the main Isle of Man Government website (www.gov.im)

The OFT received a total of 42 responses from members of the public, associations and Members of Tynwald. A full listing of those persons or bodies making a submission has been included as Appendix B. The Office would like to take this opportunity to give its sincere thanks to all those parties who took the time to make a submission detailing their views on the prices charged for liquid fuels in the Isle of Man.

8.2 Views Raised

As would be expected, many of the respondents raised similar issues in their submissions relating to the price of liquid fuels. For the purpose of presentation, these submissions have been grouped into broad categories. The main views raised by the public can be summarised into the following headings, which are in descending order of popularity:

67

Excessive price differential when Isle of Man prices are compared to UK.

Relationship between retail liquid fuel prices and crude oil prices

Cost of transporting the product to the Isle of Man

Alleged collusion between companies

Current price is acceptable

Lack of competition

Increased transparency

Level of ‗acceptable differential‘ with UK prices

Miscellaneous

8.2.1 Excessive price differential when Isle of Man prices are compared to UK

This was the most popular opinion expressed by those persons making a submission to the investigation. 17 people voiced the opinion that the difference in prices between the Isle of Man and the UK is too much. Views were not restricted to one product group; members of the public felt that both road fuels and heating fuels are priced too high. A selection of excerpts from the responses received are given below:

Vince Lamont ―I‘m just fed up by the rip off that we have to put up with here in

the Island by the Oil Company‘s. All these figures that I am quoting are true, and its all based on 900 lts of household heating fuel. End of Sep 2008 – IOM Total £545 North Antrim Fuels £385 (a difference of £160) price of oil per barrel 61 dollars. Middle of Nov 2008 – IOM Total £436 North Antrim Fuels £355 (a difference of £81) price of oil per barrel 54.7 dollars. Middle of Dec 2008 – IOM Shell £426.20 IOM Total £408.24 N. Antrim £315 (a difference of £93 if you get it from Total, a difference of £111 from Shell) price of oil 47 dollars per barrel. The 47 dollars per barrel is the lowest its been since 2005. Yet 8thMarch 2005 I paid £296.12 for 900 lts. Also 25th Oct 2005 I paid £348.55 for 900 lts.‖

Matt Tee ―Fuels prices in the UK vary regionally based primarily on local competition. But typically in the regions I mainly travel in (North-West/Midlands) fuels prices are 9-10p/ltr less than the Isle of Man. I'm lead to believe that it costs somewhere in the region of 2.5p/ltr to transport the fuel from the depot in the UK to the island, so it begs the question, what is the other 7.5p/ltr for if not blatant profiteering?‖

Brian Goodspeed ―When I came to live here 40 years ago petrol and diesel were cheaper than in UK. I believe there was a small govt. subsidy at that time to encourage tourism. Diesel also cost less than petrol both here and in UK. When the IOM subsidy ended the price dropped to the same as UK. There were also fewer vehicles and more filling stations here then. I regularly buy fuel at forecourts

68

in UK at 10 per litre less than here and that's not at supermarkets! It's time the OFT were given some real power to stop the rank profiteering which has been going on for far too long.‖

Mr McGiveron ―Just a small note. Recently I needed a fill for domestic oil. I telephoned a number from Manx yellow pages and was given a quote for 1000 litres. When asked for my delivery address I gave my IOM address. I was then told that I had the wrong telephone number i.e. I had called the oil company's Heysham depot and that I would have to phone to Douglas. The new quote from the same company based in Douglas was 28% more than quoted on the mainland. I of course had no choice but to order at this inflated price because what was the

alternative......I didn't have one.‖

Steve Hamer ―Petrol/Derv;Garage forecourts are the places where we regularly see the price differences with the UK. Anyone coming back from the UK immediately notices the difference between the going rate here and supermarket petrol stations 'across'. The difference has increased over the past few years - often 10p/litre, instead of about 6p. This makes an additional cost of a 'fill-up' of about £5-6, which is significant. This increasingly large margin needs justifying. Heating Oil; This is significantly dearer than the UK, but normally by a smaller margin than petrol. Currently the ave IoM cost is at least 36p/litre while it is available in the UK up to 8p/litre cheaper.‖

Simon Clucas ―Can it also be explained where the extra 8 pence odd over the price at the pumps in Heysham comes from – exactly? Can the profit per litre in the NW UK be compared to the profit per litre on the IOM for Total say and be published-they should really be the same. Rumour has it that the IOM is used as a cash cow in the NW.‖

R. Couch ―As a motorist with a full licence for almost 55 years with driving experience in America, Australia and Germany where I lived and worked for four years I am more than well acquainted with fuel pricing and its vagaries. But on relocating from the UK to the I.o.M. in 1985 I was simply astonished by the elevated prices of petrol here compared to the averages in the UK. The difference was simply staggering. So why is it so different? One response I heard to this question was that (you‘ll laugh at this) the turnover at the garage forecourts would not be sufficient to sustain the service. The next thing we saw was permission being granted to Total to build two more petrol filling stations. In more recent years we have indeed seen a number cease trading: the area around the airport was at virtual saturation so that's no surprise! Today 20 odd years on the price differential, i.e. the status quo, is still being maintained.‖

Juan Watterson MHK ―There are arguments that suggest that the UK price of road fuel against which the OFT has been comparing Manx prices is an artificially higher priced basket. Whilst I accept that sales below market price by some supermarkets must be removed from the basket to prevent distortion, so too must more remote Filling Stations such as those in the Highlands and Islands, and remote parts of Scotland. In reality, our prices should be comparable to the Merseyside area, as this is as far the fuel has to travel before it is shipped to the Island. …I have looked at the pump price statistics on the website of the UK Department of Business, Enterprise and Regulatory Reform (BERR). Whilst the 2006 Report mentions the DTI‘s (as it was known) figures, these do not correlate

69

to the BERR figures mentioned above. The 2006 Report also mentions ―Forecourt Trader‖. It is unclear which prices were quoted to me by OFT in our correspondence‖.

David Doran ―I am very concerned at the almost daily hike in forecourt fuel prices over the past 3 weeks. I cannot see any justification in the meteoric rise of unleaded fuel from 91.9 to 96.9 (last night 1 p increase from 95.9) since the mainland pump prices have fallen‖.

This issue is explored extensively in the report in Section 3.5.

8.2.2 Relationship between retail liquid fuel prices and crude oil prices

Another popular topic raised by 12 of the respondents is the relationship between prices charged by retailers for liquid fuels and the price on the international markets for crude oil. The views expressed noted that retail prices were very quick to rise when crude oil prices are rising, but prices do not seem to fall to a corresponding degree when crude prices fall. As crude oil is an internationally traded product, many respondents were able to take published crude prices and correlate them to retail prices, to query the asymmetry in the relationship. A random selection of these views is given below:

Michael Cain ―We had oil fired central heating installed in April 2007. We had to order 900 litres of central heating oil. In April 2007 it cost £347-76. In February 2008 it rose to over £450. In July 2008 it was about £627. I believe it is now £667. The price of oil has fallen dramatically, yet these very high prices are still in force. In about 19 months it has risen by around 90%...―.

Paul Kerruish Kelly ―The current price per barrel is $38.56 or at todays

exchange rates £26.63. The average price in November 2008 was $49.29 or, at the 24 November 2008 exchange rate £33.43. So in £ terms the price of a barrel of oil in November 2008 was 27% dearer than it is now. This means on that measure that fuel prices should be significantly cheaper today. So if that is not the reason, is it due to the higher cost of oil futures? In November 2008 oil futures were approximately $11 per barrel dearer than they are now. At those levels they were significantly lower than they had been earlier in the year. Since then the trend has been downwards not upwards. So based on oil futures costs we should be seeing a continuing reduction in fuel prices not an increase.‖

Matt Tee ―When fuel prices go up globally it's a matter of a few hours before the prices at the pump on the island have shot up accordingly. However when the fuel prices go down globally it takes days, and in some cases weeks to see this reflected in the prices at the pump. Simple "back of a napkin" maths says that this is blatant profiteering.‖

Anonymous ―The price of world oil has fallen 55% since the peak of summer 2008. The price of unleaded petrol at present is about $45 to $46 a barrel at present. A very small variation yet the price of unleaded has risen sharply from about 91p litre. This seems to be completely incongruous to me. A small variation in world price of oil & local fuel leaps out of all proportion but that does not fall in tune with world prices to anywhere near the same percentage.‖

70

Jim Dowling ―What brought the price of fuel down? Brent crude was at a high of $145.59 back in July 4. 08. It has now dropped to a low of between $42,& $45 per barrel. I note that the price of petrol is now up to 96.9 from a low of 91.9, just why is there a rise of 5p? What are the filling stations basing this incising cost on? , it would appear as if they can charge just what they wish ,strange as it seams all the filling stations are very close in cost I wonder how? The only reason the cost came down in England was because of the supper markets filling stations who started to drop the cost from a high of close to 120.9 down to 86.9 or there about , not the main oil companies who try there best to keep it as high as they can, there was talk of bringing in some form of legislation . Question? When is there going to be a change in the legislation on the ISLE OF MAN which will give ―joe public‖ some hope of some control of the cost at the pumps in relation to the changes in Brent crude, not just what the forecourt owners want to charge, its very strange how there very little in the difference from each one.―.

Jim Wallace ―…I actually work in the oil industry travelling to many countries throughout the world and it has always astounded me at the prices we have to pay at the pumps not only in the UK but also in the IOM, the past year has seen huge increases in the price of oil resulting in petrol prices going up with immediate effect, yet when the price of oil tumbles as it had done, the price of petrol never comes down with immediate effect, in fact it is often some time after such oil price fall and when they hear the public voicing their concerns that they decide to lower the cost at the pumps‖.

Chris Ismay ―Back in July/August last year, the oil price rocketed to $150 per barrel, in line with this our litre of petrol jumped to 120p, that barrel of oil is and has been for months fluctuating between $40 and $52, and yet we are still at 100p per litre, surely a more realistic price should be 60p? If we look to the US, their current average price per gallon is $2.045, which is 45 cents per litre, convert to sterling at 1.47 and we get 30p per litre. A recent argument was the prediction that demand would increase, however this has proved false and demand has declined globally. The U.S. Energy Information Administration said Wednesday that stockpiles rose 2.8 million barrels in the week and remain at more than the upper limit for of the average range for this time of year.‖

The relationship between crude oil and refined products is examined in Section 3.3.1 for road fuels and 4.3 for heating fuels. In summary, heating fuel prices share a closer correlation to crude prices than road fuels. Figures shown for road fuels in Section 3.3.1 shows that the relationship between road fuel prices and crude oil is frequently volatile and is not linear and proportionate as commonly believed.

8.2.3 Cost of transporting the product to the Isle of Man

Many respondents felt that one of the reasons often cited as contributing to the higher cost of liquid fuels in the Isle of Man is questionable. Nearly 25% of respondents (10) felt that this reasoning was open to question. A selection of the views received is given below:

71

William Vannin ―…we know we are an Island and things have to be imported but the cost of that is not massive….fuel in the highlands of Scotland is far cheaper than here and that is being transport 100s of miles by road to petrol stations from the oil depots‖

Richard Hardy ―It is pointless to say that transport plays a great part in making fuel more expensive here because fuel must be also transport from the refinery/storage sites on the mainland by road, rail or boat and prices there are always cheaper then here. The OFT should take that matter up by with the fuel suppliers with a view to bringing prices down.‖

Aidan ―How can the prices be 5% more here than in the UK? The price of transporting a litre of any liquid by sea from the UK, no matter how combustible, does not justify the price hike. It is profiteering and nothing else. For instance bunkering ships travel the length and breadth of the UK from refinery to refinery yet the price of fuel across the UK remains consistent. How does this differ in any way to the journey they need to make here? It is about time that the island makes a stand against the exploitation from excessive charges.‖

Anonymous ―Costs of tanker sailing to the IOM from Milford Haven, yes we know, but a tank holds a tremendous amount of fuel in my opinion does not justify the huge difference in price compared with UK at the pumps.‖ ‖

Colin Johnson ―It has to be accepted that there will always be a price differential between petrol sold off and on the Island. Over the last few years it has been noticeable that the number of coastal tankers visiting the Island has decreased. The volume of oil brought into the Island has probably gone up during the same period; however, the tonnage of the tankers has increased hence where before there would be (say) 5 visiting vessels a month that is now 3. Obviously by common sense the cost of transport is, technically, cheaper.‖

The costs involved in transporting liquid fuels to the Island is quantified in a pence per litre basis in Section 3.4.1 for road fuels and 4.4.1 for heating fuels. The figures differ between products as the volumes imported differ but full figures across the investigation period are given for shipping and import costs which include; actual shipping costs, harbour dues and ships discharge labour.

8.2.4 Alleged collusion between companies

Four respondents query whether some sort of collusion has occurred between the companies participating in the liquid fuels market in the Isle of Man.

James Crook ―It is also interesting to review why the prices are so consistently similar between Shell and Total – is there an agreement between them on pricing?‖

John Hammersley ―…take firm action against what amounts to a cartel on the island with 2 operators effectively colluding to price fix within 1p of each other.‖

72

Richard Hardy ―It is also worth asking why the price of Total fuel is always below that of Shell. I would love to have an answer to that!‖

Simon Clucas ―Worst, it appears to me as though there is really a cartel operating in the IOM for petrol prices-look at Total, Shell etc, and they rarely charge different prices or at the manx 1 pence different. In the UK where our relatives live prices vary between filling stations by up to 5 pence – no cartel. Why is it tolerated here as it completely anti-competitive. Lastly WHY doesn‘t Tesco open a petrol pump-un the UK their petrol is often well over 10 pence cheaper than in the IOM-do they want to open one? Have they been obstructed? If they did open one at UK prices Total and the other cartel members would be finished off in my opinion. Why not approach Tesco to introduce a service.‖

The Office has the powers and sanctions, as detailed in the Fair Trading Act 1996 as amended, to investigate instances of anti-competitive practice. During the course of the investigation the Office found no course to believe that any collusive activity was occurring between any of the companies involved in the industry in the Isle of Man.

8.2.5 Current price is acceptable

The current price of fuel in the Isle of Man was felt to be acceptable by three of the respondents.

Joanne McGlynn ―I feel that the price of fuel on the island is over priced but due to having it shipped over here I feel it is a good price.‖

Kriston Renshaw ―Fuel prices are at a reasonable level. I think the price should be high enough for us to look more favourably towards greener forms of transport.‖

Name withheld ―Please add my name to the list of those who believe the price of petrol to be too low. Living near two schools means I daily see a veritable armada of cars, mornings and evenings, making unnecessary journeys transporting perfectly healthy children short distances. Public transport, walking and cycling are better options. Even the pupils now have their own cars and petrol prices seem to be no problem…..It strikes me as unfair the way our politicians execrate the petrol stations. The garages provide an excellent service being open early till late, enabling the public to buy food and drink. If that puts a few pence on petrol – so be it.‖

8.2.6 Lack of competition

Two respondents advised that they felt that prices on the Isle of Man would be lower if there were more companies competing in the liquid fuels sector. Perryn Callister ―It seems that most people who live on the Isle of Man, either

through birth or choice, are being unfairly penalised not only in terms of pricing, but also for only having a choice of two liquid fuels suppliers – Total and Shell. Perhaps when looking into the pricing issue, now is the time to consider allowing a few more fuel retailers to trade in the Island. This would give more choice for the

73

consumer and healthy competition for the retailers. The current ―duopoly‖ can‘t be a good thing, surely!?‖

Steve Somers ―I would like to see the doors opened to competition. I think it is staggeringly unfair that we should be penalised for living under monopolies that use the ‗keeping it Manx‘ mantra to guilt-trip us into not complaining. It‘s time that ended. Monopolies are scrutinised and strictly regulated almost everywhere else in the Western world. Why not here?‖

The OFT is not aware of any restriction placed on the number of oil suppliers that can operate in the Isle of Man. As with most other sectors in the Manx economy it is left for the free market to decide how many businesses should operate in a given sector. Put simply, there is nothing to stop any business entering the market here should they wish. When businesses earn large levels of profits, in free market economics this acts as a signal to other business to join the marketplace.

8.2.7 Increased Transparency

One of the respondents and Mr J Watterson MHK advised that they wished to see increased transparency in the operation of the liquid fuels market on the Island.

Matt Tee “The typical member of the public is not going to spend many hours researching very detailed facts and figures behind the fuel prices. The fuel companies undoubtedly already do this and it is their job to communicate this information to the public and in turn build confidence and trust. As they are clearly failing to do this, it falls on the Government, specifically the OFT to correct this. If the fuel prices are justified then we, the public, need to see the justification for it backed up with basic figures that everybody can understand.‖

Mr J Watterson MHK ―I also appreciate that the OFT has been collecting and monitoring road fuel prices, however this information has not been displayed on the website so that people can independently verify it. If figures of the cheapest price (e.g. discount supermarket retailers) were published alongside the existing data and crude oil prices (time-lag adjusted), it would give people greater information as to how price and market conditions, not just crude oil prices have dictated road fuel prices over time‖.

8.2.8 Level of ‘acceptable differential’ with UK prices

The 2006 OFT report identified a level of acceptable differential between Isle of Man and UK independent dealer prices which was to be monitored with a trigger point of 5 ppl or higher to be used to launch a further price investigation under the Fair Trading Act. One of the respondents and Mr Juan Watterson MHK gave their views on this level of differential and how the Office had monitored it.

John Hammersley ―About a year ago the OFT released a statement saying that it would not investigate petrol retailers on the Island as long as the average price charged on the Island was no more that 5p per litre dearer than the average petrol price in the UK. However, I believe that this left a subtle yet huge loophole

74

for the Island retailers to exploit…the average UK petrol price is not what the average UK person pays. This is because the average person is within easy reach of filling station in a urban location….The UK figures are skewed because there are as many filling stations in remote locates who charge far more through lack of competition and transport costs. The IOM by contrast is a small geographic area with a fixed overhead of importing petrol and only a minimum on island additional cost for distribution, due to the close proximity, in comparison to the UK, of all locations to Douglas.‖

Mr J Watterson MHK ―I have used as my starting point the initial investigation of 30th October 2006 (―the 2006 Report‖) as a starting point and subsequent changes in assumptions and communications from constituents since that date… Recommendation 7 supported the view that a 3ppl differential could be justified in the Isle of Man Market, with a 5ppl differential leading to an OFT inquiry under s. 19 of the Fair Trading Act. The figures I received….on 2nd March 2009 seem to show significant trends above this level, with a cumulative differential of 4.8ppl for unleaded, and 33.9ppl for diesel. This cumulative differential should remove any arguments for time lags and represent a pure contribution to profit. This cumulative contribution has been consistently high since September 2008 for diesel. For unleaded petrol it has been more inconsistent, but has been consistently positive since October 2008. For these reasons, based on the same assumptions as set out in the 2006 Report, the price of road fuel has been higher than can be justified on the Island.‖

The Board of the OFT shared these concerns regarding the level of price differentials between the UK and Isle of Man when they determined in October 2008 to carry out this investigation. The breaching of the figure set as an acceptable level of price differential between UK and Isle of Man prices also was a factor.

8.2.9 Taxation issues

Three respondents raised issues in relation to the size and nature of duty and taxation levied on road fuels and company taxation.

Gareth Colquitt ―The main problem is of course with the ludicrous tax as this accounts for some 70% of the cost. This needs to be reduced immediately as we already pay enough road tax to use manx country lanes.‖

Mark Clarke ―The U.K. fuel price has always been higher than Europe due to excessive taxation. Is it not time this situation is corrected? reduced transport costs help everybody.‖

Colin Johnson ―There is however, one major consideration that the OFT have to

take into account in this investigation and that is the tax status of the oil distribution companies. Under Island legislation Island companies do not pay Income Tax on their profits. It is my understanding that that is not the case in the United Kingdom where companies have to pay 21% if profits are less than £1.5million and 28% if over. Hence the UK oil companies will, I understand, be subject to that income tax tariff. The Island companies are not. Consequently

75

would it not be prudent of the Island oil distributors to pass to Island consumers the benefit of the tax anomaly that appears to exist between off and on Island.‖

The Isle of Man is committed to charging the same level of tax and duty on road fuel as is charged in the UK. The Customs and Excise Agreement, which is backed by both UK and Manx legislation, means that for VAT, customs and most (but not all) excise duty purposes the two territories are treated as if one. The impact of company taxation on the companies involved in the investigation was a factor considered and taken into account in the production of Chapter 6 which details a full profitability analysis of the companies.

8.2.10 Miscellaneous

The remaining comments made by respondents do not strictly fit under any of the broad categories above. Hon P Gawne MHK ―I have no specific evidence of artificially high liquid fuel

prices on the Isle of Man, though there is a collective opinion of many of my constituents that this is the case.‖

Jason Callister ―I think £400 a month on fuel is self explanatory. When I‘m paid

£1300 a month, after tax.‖

Joanne McGlynn ―The main thing I am concerned of is if the fuel is contaminated. I have had problems when I have filled my car with fuel from certain filling stations and had major problems as there has been water missed in with it‖

If anybody has concerns about contaminated liquid fuels then they should advise the OFT as soon as possible. The OFT will test for the same and take appropriate action and advise accordingly.

8.2.11 Views of Island Road Transport Association

In response to the request for submissions from the public regarding the price of liquid fuels in the Island, a meeting was requested by representatives of the Island Road Transport Association (IRTA). Chairman of the OFT, Mr R W Henderson MHK and officers met with Mr Jonathan Bennett, Chairman of IRTA in May 2009. The main points raised on behalf of the member companies of the IRTA by Mr Bennett during the meeting are summarised below:

Mr Bennett indicated that during the previous summer when fuel prices were rising dramatically there was a difference of 16 pence per litre on the Island compared to UK. This was based on the pole sign at the Milestone Garage compared to the price that he was receiving on his fuel card which was an average of the UK scheduled price.

Mr Bennett estimated 75% of businesses use or have used fuel cards. He explained before Shell withdrew their offer to reward the scheduled UK price those who used this card would pay that price, rather than the price at the

76

pump. In September 2007 companies received a letter from Shell UK Oil Products Limited advising that they would be withdrawing the card. He did indicate that the IRTA had approached Manx Petroleums to ask about the withdrawal of the card. However Manx Petroleum advised that they were not part of Shell, merely their authorised distributor and therefore could not comment on their commercial decision.

Mr Bennett explained that since this has happened he uses the Total fuel card issued via UK Fuel Cards but doesn‘t get the same level of reduced prices.

Mr Bennett raised the issue of the proportion of the IOM-UK price differential that could be proportioned to shipping costs.

77

9. CONCLUSIONS AND RECOMMENDATIONS

The analysis presented in this report has addressed whether the prices that are being charged for road and heating fuels in the Isle of Man can be considered reasonable or whether there are aspects of the market that may be cause for concern. The main findings and subsequent recommendations are summarised below.

9.1 Road fuels market

9.1.1 Price levels and cost changes

Over the period of the investigation, the main driver of price changes for road fuels has been movement in the underlying wholesale commodity price. The pattern of wholesale price developments – the large increases in the period to July 2008, the subsequent steep fall and the volatility around this broad trend – is, itself derived from changes in the crude oil price. Crude oil is the base input into the refining process delivering the products under investigation.

However, while there is a strong relationship between movements in the price of crude oil and the refined products, it is not a straightforward one. The price of a particular product also depends on the underlying supply-demand balance in the regional or global wholesale market. Structural imbalances between refining capability in the EU and liquid fuel demand patterns led to rising differentials between diesel and gasoline over the period, reflecting the higher value of diesel in the market58.

Though the majority of the variation in road fuel prices can be attributed to commodity price movements, the analysis has also shown that the pump price does not tend to fully reflect the changes in the price of the commodity, whether up or down. Some of these underlying cost changes are absorbed by, or retained by, the retailer or distributor. This is evidenced by the observed volatility in the gross margin (the difference between the commodity price and the price paid by the consumer).

This characteristic of the gross margin does not appear to derive from differences between the actual cost of product and the benchmark ARA price, nor do there appear to be substantial changes in the ongoing costs of wholesale or retail activities in the Island even having taken into account timing of delivery and the contractual terms for payment of imported product. More plausible explanations are that exposure to daily price volatility is smoothed by the fuel suppliers and that the timing of price changes by either fuel supplier will be influenced by the actions (and contractual costs) of their competitor.

This latter point is reinforced by review of actual price levels and changes at a sub-set of filling stations – price levels show little variation (though Shell-branded sites are generally 1 ppl more expensive than Total sites) and changes in pump prices are clustered. This price pattern would be expected in a competitive market, but it would also be consistent with some form of price leadership. Whilst there is no robust evidence of this, the conditions for such price leadership do exist.

58 See Section 3.3.1 (Changes in ARA refinery wholesale prices)

78

The gross margin – the margin to cover the costs of importation, storage, distribution and retail activities in the Island (together with providing a return to the company involved) – is in the order of 9.9 – 10.9 ppl over the period for unleaded and 10.6 - 12.2 ppl for diesel. Estimating the effective Schedule Price charged to retailers by a fuel supplier (net of rebates contained in the solus agreement) suggests that 5.5 – 6.6 ppl of this is accruing to the wholesale activity (for unleaded) and 7.5 – 9.2 ppl (for diesel). The retail activity seems to earn an average of 3.6 ppl.

Given the scale of the retail business, this retail margin does not appear to be excessive. Indeed, the trend in retailing is to expand into non-fuel activities, such as convenience stores, to provide higher margins to sustain the business.

The wholesale margin is reasonable given the underlying costs that have been identified, providing a potential wholesale profit in the order of 2.6 – 4.3 ppl for unleaded and 4.5 – 6.2 ppl for diesel (with the higher range of profits being earned in 2008).

This range of profit appears high compared to the distribution profit margins being earned in other jurisdictions – for example, in the Highlands and Islands, recent studies have suggested wholesale profit margins of around 0.4 ppl. Adjusting for an off-Island cost of service (the difference between ARA prices and the reported cost of product) reduces the implied profit for diesel by 2.54 ppl and the 1.57 ppl for the combined margin making it broadly comparable to the profits identified in the last report. In addition, there are three main issues to consider:

the low or non-existent profit level in the UK example cited above have been considered to be unsustainably low and likely to lead to exit from the market;

the profit is comparable with, or lower than, that identified in the previous OFT study; and

the identified profit may not accrue to the distributor, but may be passed back to the fuel supplier through the form of contractual agreement that exists between the supplier and distributor. In this case, the distributor is not earning any material profit from the activity.

9.1.2 Price differentials

Price differentials with the UK are to be anticipated, given the smaller market size, the more costly importation and distribution routes and the lack of competition from supermarkets, whose business model is built on lower fuel margins but high synergies with other activities, these have been of concern over the last year, rising above the 5 ppl threshold identified in the 2006 report in the latter half of 2008.

Short-term comparisons may give a slightly skewed view of the actual relativities as they are often spot observations on a particular day in a month. The differences may reflect some transient differentials linked to the speed of cost pass-through into price changes.

Looking over a longer five year time frame, the observed differential was estimated at 4.3 ppl for petrol and 3.8 ppl for diesel and has broadly annually since the last study. This differential is based on a comparison with the UK average reported price that is biased by the pricing behaviour of the supermarkets. Due to their larger scale (the average throughput for a UK supermarket is five times that of an Island retailer) and business model, the margins of supermarkets are, on average, 2 – 3 ppl lower than

79

share of independent retailers in the UK. Since this model cannot feasibly be replicated in the Island a larger differential should be expected.59

Comparing with the UK average for dealer owned site, on an annual basis, the average differential for both fuels during the period was around 3.0 - 3.3 ppl. Higher costs of importation and distribution in the Island can account for around 1 – 2.3 ppl and less effective retail competition due to the lack of supermarkets and lower average throughput could account for a further 0.5 – 1ppl. This still leaves up to 1.8 ppl without a readily quantifiable explanation though this may in part be explained by the unsustainably low margins achieved by wholesalers in the UK market.60

9.1.3 Company profitability

It is not obvious that the missing differential has accrued to suppliers – the profitability of companies in the Island as measured by the return on sales or capital employed does not appear excessive and has declined since the last study.

9.1.4 Recommendations

The analysis does not suggest that the prices faced by consumers are, in general, unreasonable. While, at certain times, the level of differential with the UK in particular may be high, these extremes are generally transitory and can be explained by the slower speed of cost pass-through in a market where competition is less intense and the average cost to serve is higher due to the lack of integration with a larger distribution network.

Some jurisdictions have introduced formal price regulation. Two key reasons suggest that such an approach might not be justified in the Isle of Man.

The pattern of prices studied was not materially different than that which would have emerged under such a regime and therefore the additional cost would have yielded little benefit;

restrictions in the road fuel prices may have unintended consequences on the heating fuels market, requiring suppliers to recover a higher proportion of cost, thereby further increasing heating fuel costs.

Nevertheless, given the limited nature of competition in a small Island environment, some form of monitoring and reporting of reasonable cost movements may be beneficial. It is important is to identify an appropriate comparator and timescale.

The Office therefore recommends as follows:

i. a comparator based on retail price differentials with the UK should continue to be used as there is no additional benefit from using a wholesale price index tracker;

59 In the UK, the entry of supermarkets has led to a downward pressure on dealer margins and levels

of profitability. 60 1.5–3.3 ppl can be readily quantified by direct cost and market size differences. However, this still

leaves an unexplained differential of between -0.3 – 1.5 ppl (diesel) and 0.0 –1.8 ppl for (unleaded). Possible explanations for the very low margins in the UK wholesale sector includes the level of competition in the market – both the distribution and refining sector in the UK have experienced very low margins.

80

ii. the most appropriate comparator would be the average of dealer owned sites in the UK, though the availability of appropriate time series of data may require the continuation of review against a UK average reported price;

iii. that it engages in further dialogue with those parties involved in sourcing road fuels from the refineries for use on the Island to ascertain whether the uplift applied on ARA prices, to the extent that it accounts for the unexplained differential, is not unnecessarily onerous to the Island when compared to their other areas of operation in the UK;

iv. the differential should be in the order of 3 ppl if compared against dealer-owned sites, but 5 ppl if a UK average comparator is used;61

v. the assessment should be undertaken weekly, against an 8-week rolling average, with results published on a monthly basis alongside the comparative heating schedule;

vi. some additional reporting of prices by the fuel suppliers and/or retailers in addition to the reporting that is currently provided on the heating fuel side would be required;

vii. a trigger and mechanism to re-evaluate the comparator (either based on a defined period) or on ad-hoc basis should be established to ensure that the system accommodates future local operating fluctuations.

9.2 Heating fuels market

9.2.1 Price levels and changes

As with road fuels, the heating fuel market saw substantial changes in the underlying price, a large proportion of which could be attributed to movements in the wholesale commodity price. However, the gross retail margins for both gasoil and kerosene rose over the period studied, most strikingly for kerosene during 2008.

The effective gross retail margin (accounting for discounts) averaged 8.1 – 9.5 ppl for kerosene and 3 – 4.2 ppl for gasoil between 2005 and 2008. Unlike road fuels, the distribution and retail activities are integrated operations of the same supplier. The estimated profit from the combined activity varied over the period between 2 - 4 ppl.

These margins are higher than those observed in the 2006 OFT study, which ranged between 0.55 – 1.12 ppl though the relativities (i.e. the higher margins in the kerosene market) are similar. This latter characteristic is linked to the nature of these markets. Kerosene is sold mainly to households, which tend to have inelastic demand and have a higher cost to serve. Gasoil in comparison is a high-volume, low margin business catering to the commercial sector, which is considerably more price conscious. Furthermore, higher margins for gasoil may, in part, be due to lower overall volumes requiring the fixed cost of operation to be recovered from a smaller volume base.

Though margins in the Island for kerosene are high, there is a high level of transparency in pricing and awareness of competition amongst customers. This is evidenced both by the existence of the comparative heating schedule and discussions with suppliers who

61 Sections 3.5.2 (Which comparators are useful or relevant?) and Section 7.2.2 (An enhanced

monitoring regime) for the justifications for the 3 ppl and 5 ppl differentials

81

identify an increase in the ring-around market, illustrating that customers are willing and able to switch supplier.

9.2.2 Price Differentials

The annual differential between prices in the Isle of Man and in the UK ranged between 6.58 – 8.88 ppl for kerosene and 2.56 –6.19 ppl for gasoil (or an average of 7.2 and 4.2 ppl respectively) for the period, with particularly low gasoil differentials in 2007 and 2008. Up to 6.3 ppl of the differential for kerosene and 3.6 ppl for gasoil are able to be accounted for due to the higher cost of importation and shipping to the Island and the mismatch between quoted and final prices due to discounting. The remaining differential of 0.9 ppl (kerosene) and 0.6 ppl (gasoil) is unexplained.62

9.2.3 Recommendations

The biggest anomaly identified in the heating fuel market was the high profit identified as accruing to distributors from the domestic kerosene market. However, the situation in the heating fuel market is impacted by the integrated nature of the road fuel and heating fuel distribution infrastructure; changes to the pricing behaviour in one part of the market may have unintended consequences on prices or cost in the other market, impacting price or viability of the existing businesses.

It is not necessarily inefficient for common costs of operation to be borne by the customer group that is least responsive to price movements63, and this appears to be the situation in the Island.

The Office would therefore recommend as follows:

i. that the Office continues with its current policy of publicising heating fuel prices through the Comparative Heating Schedules published and encouraging search amongst consumers;

ii. a similar cross-jurisdiction comparator to that used in the road fuel market is unlikely to be as effective or practical and should not be developed in the near-term.

62 The unexplained differential ranges between 0.9 – 1.5 ppl (kerosene) and 0.6 –1.2 ppl (gasoil). The

explanations for the unaccounted for differences and possible explanations are cited in Section 4.5.2 63 This is known as Ramsey pricing, where the markup of each commodity is inversely proportional to

the elasticities of demand or consumer response to price changes. This implies that mark-up is greatest on the part of the market where consumers are least responsive to price changes.

82

ANNEX A FUEL PRICE REGULATION

A.1.1 The case for and against fuel price regulation

The case for fuel price regulation is largely based on its ability to introduce a measure of stability and predictability into an otherwise volatile market for petroleum products. Given the demand for fuel, most consumers see stable and predictable fuel prices as a benefit. Fuel price regulation also benefits retailers by providing them an opportunity to operate with higher margins than they may have realised prior to regulation. This could be seen as a benefit particularly if it allows retailers with low profitability for example in remote rural areas to stay in business and continue to serve these kinds of markets.

In the economy as a whole, consumers and other sectors of the economy base their economic decisions on their expectations of fuel prices. If they are exposed to the kind of volatility that would be implied by full market exposure, they may be unlikely to make those investments or decisions or may at least attempt to find alternative means to hedge that risk, resulting in economic inefficiency. In addition, in cases where they have made decisions predicated on an expected price of fuel (sunken costs), the volatility in oil prices introduces a hold-up problem. The argument is that regulation would correct for this by smoothing out the effects of price volatility.

The case against fuel price regulation is primarily the challenge of getting it right or doing better than a competitive market would. Consumers generally want stable but moderate prices, and are therefore unwilling to pay for the stability through higher prices. Retailers and dealers on the other hand would prefer higher, stable and predictable margins to improve the viability of their businesses. At the same time suppliers would like a transparent charging methodology that allows them to maintain predictable and stable margins to meet their cost of capital and expected returns for the business. However, the goals of the different groups are often contradictory and where one part of the value chain gains, it is likely that another part will lose – too much stability for one group results in too much unpredictability and/or cost for another. Moreover, regulations affecting price signals in any part of the chain risk having unwanted consequences in other parts of the chain, as market actors will react to artificial signals which may not reflect the underlying market conditions. Therefore the reasonably successful fuel price regulations attempt to mimic the market by allowing margins for the retail and wholesale segments that are broadly comparable to what they would have achieved under market conditions. For a market where the market actors is already smoothing prices over time, such as in the Isle of Man, it is hard to see what additional gains price regulation would bring, especially given the cost of opting out of a market based system.

A.2 Road fuel price regulation in Nova Scotia, Canada

A.2.1 Rationale behind road fuel price regulation in Canada

The Canadian province of Nova Scotia introduced petroleum and diesel price regulation in 2006. The main reasons behind the decision were to:

stabilise prices - reduce the frequency and seeming arbitrariness of price changes, as well to create more uniform pricing across the province. Before regulation was introduced, customers were complaining about some dealers changing prices many

83

times a week, and in some cases even as often as 2-3 times a day. Controlling the frequency of price changes was one of the main reasons for regulating prices;

maintain industry infrastructure - slow or halt the decline in the dealer network, particularly in rural areas, by improving viability through regulated margins. The number of outlets declined by about 50% between 1990 and 2005, with many of these disappearing in rural communities. Competitive pressure on margins and rising costs explain why many of these dealers were unable to continue in the business. Improving the viability of gasoline outlets through controlled prices and better margins represents a second objective of regulation;

minimise cost to consumers – to make sure that consumers are not forced to pay unfair margins for a vital commodity;

minimise cost variation within province - while some price variation across the province is understandable; often the differences would exceed what could be explained by transportation costs alone. The government had difficulty explaining why market forces would allow prices to vary by 3-4 (Canadian dollar) cents per litre (cpl), when all the gasoline came from practically the same source, sold by the same suppliers, and through similar outlets under the same brand names. Reducing price variation across the province became an important regulatory aim.

At the onset of price regulation, independent dealers were given the option of opting out of the regulation – a decision taken by approximately 60%. Many opted out because opting in would have resulted in fundamental changes in their operating arrangements, while others opted out because their margins compared favourably with the regulated margin.

A.2.1.1 Methodology and mechanics of regulation

Fuel prices are set by the Nova Scotia Utility and Review Board and revised weekly using the methodology described below:

Pump price = Platt's Daily Spot Price (New York Harbour) + Fixed Wholesale Margin (FWM) + Retail Margin (RM) + Taxes

The Fixed Wholesale Margin is defined as wholesaler costs including a zone differential for transportation within the province and a profit margin. It is currently set at 6 cpl plus the zone differential ranging from 0.3 – 2 cpl

RM is set as a band between 4pl - 5.5 cpl

Regulated Price Build-Up, Nova Scotia Example (March 2009)

Table 25 below provides a worked example of the components of pump price for regular self-serve gasoline (excluding taxes).

84

Table 25 – Sample of components of the Nova Scotia Petrol Price

NYH spot cpl (US$) Exchange rate NYH spot cpl (C$)

Previous benchmark

Thursday 63.08 0.85 74.21

Friday 66.07 0.83 79.61

Saturday

Sunday

Monday 64.22 0.82 78.32

Tuesday 62.12 0.81 76.69

Wednesday 60.77 0.80 75.96

Adjusted benchmark 79.96

Add maximum wholesale margin 6.00

Maximum wholesale price 83.00

Add maximum retail margin 5.50

Maximum retail price 88.50

Add actual transportation 1.50

Maximum total price pre-tax 90.00

Source: Service Nova Scotia and Municipal Relations

The Regulator tracks the NYH daily spot price, taking the average for the previous 7-day period and adjusting the previous benchmark to the new average. In the example, the benchmark drops from 82.12 to 76.96 cpl, following the drop in the NYH spot price. The maximum wholesale price is derived by adding the wholesale margin (6.0 cpl) to the benchmark. Adding the retail margin (5.5 cpl) brings the maximum retail price (excluding taxes) to 88.5 cpl. Adding the actual cost of fuel delivery to the station adds (in this example) 1.5 cpl bringing the maximum total price (pretax) to 90.0 cpl.

A.2.2 Review of price regulation in Nova Scotia

At the end of 2008, the provincial government commissioned an evaluation of the fuel price regulation to review the performance of the regime over the first two years of petroleum and diesel price regulation. The results are summarised in the table below.

85

Table 26 – Review of Pricing regulation in Nova Scotia

Policy objectives Findings

Price stability Regulation results in increased predictability in the timing and reduced frequency in the number of gasoline and diesel price changes.

Regulation results in fewer price changes compared with unregulated markets in eastern North America.

Regulation removes much of the price variation within Nova Scotia.

Differences are attributable to transportation and the extent to which competition drives prices below the maximum allowed under regulation.

Industry infrastructure

Half the independent retail dealers (surveyed as part of the two year review) indicate they are better off with regulation. The dealers better off are

located mainly in rural areas. About one-quarter indicate they are worse off,

while another one-quarter indicate no change.

The rate of decline in the number of closures has slowed since the inception

of regulation, and several stations have entered the industry. Regulation, specifically the minimum retail price, has played a role in stabilizing retail and

wholesale infrastructure, particularly in rural areas.

Higher costs are eroding margins. In particular, current labour and credit

card costs are not reflected in the historic basis used to set margins when

regulation was introduced.

Promotions, including discounts, coupons and loyalty schemes undermine the

viability of independent dealers.

The larger wholesalers indicate that, due to a slightly higher marketing

margin, they are either better off or at least no worse off financially than

they were at the outset of regulation.

Conditions facing resellers have improved with the shift from two-week to

one-week adjustments and by removal of the full-serve cap. As a result of adjustments they have made in their arrangements with the dealers they

supply, most resellers indicate they are better off or at least no worse off as a result of regulation.

The proportion of independent dealers deciding to opt out of regulation (just

over 60%) does not represent a reliable indictor of the merits of the regulatory program from a dealer‘s perspective. Many opted out because

opting in would have resulted in fundamental changes in their operating arrangements, while others opted out because their margins compared

favourably with the regulated margin.

Minimizing cost The average marketing margin across Nova Scotia has risen by an estimated 0.51 cpl in the two years since regulation was introduced. The increase is

due to higher minimum retail prices under regulation.

Prices in most major centres in Canada have risen relative to those in Halifax

since July 2006. The relative increase is attributable to differences in competitive conditions, including the ability to pass on higher operating costs

through higher margins. Regulation in Nova Scotia has fixed margins, serving

to constrain the ability to pass on the rising costs industry faces.

Pricing

mechanism The Regulator should continue to use the NYH spot price as the benchmark

for adjusting fuel prices. The NYH spot price serves as the best benchmark for adjusting regulated prices in Nova Scotia because it is competitively

determined (can‘t easily be manipulated), transparent and highly visible.

Rack prices provide a weak alternative because they are not set transparently

86

and do not represent the actual price at which the commodity is traded, but

rather they serve merely as a guide to trading prices.

The Regulator should conduct periodic reviews of margins in light of rising

costs facing the industry. This review should provide guidance on a method for making routine margin adjustments in response to changes in key cost

factors such as minimum wage and credit card fees.

The Regulator should develop a benchmark price for winter blend diesel fuel based on actual costs as reported by industry. For example, the price could

be derived from the weighted average daily NYH spot price of kerosene and diesel fuels, with the weighting factor tied to the proportions of each fuel in

the blend. Alternatively, depending on industry practice, the price could be based on diesel plus the cost of additives.

Source: Evaluation of petroleum products pricing regulation in Nova Scotia

A.3 Road fuel price regulation in South Africa

Road fuel price regulation in South Africa dates back to 1977, at a time when South Africa faced an international oil embargo. Considered by many as a hangover from the past, the opinion is divided for and against continued regulation of road fuel prices in South Africa. Besides the historical roots, regulation has endured as a means of ensuring international market prices for locally produced oil. South Africa produces roughly 30% of the oil it uses from domestic coal resources.

A.3.1.1 Methodology and mechanics of regulation

The South African fuel price is set by the Central Energy Fund on behalf of the Department of Minerals and Energy and is revised on the first Wednesday of each month. The current methodology is highlighted below:

Pump price = Basic Fuel Price (BFP) + Domestic cost component

Basic fuel price

Basic Fuel Price =Fuel Spot prices + Cost of Freight + Insurance Cost + Ocean loss allowance +cargo dues + coastal storage

International petroleum market spot prices for physical importation is set as follows:

Petrol = 50% (Mediterranean spot for premium unleaded FOB) + 50% (Singapore spot for 95 Octane unleaded FOB)

Diesel = 50% (Mediterranean spot for Gas oil FOB) + 50% (Arab Gulf spot for Gas oil FOB)

Cost of freight – from Augusta; Singapore and Mina-al-Ahmadi, plus demurrage, adjusted with Average Freight Rate Assessment of the London Tanker Brokers Panel + premium for transportation

Insurance cost = 0.15% of product FOB and freight costs, plus premium for miscellaneous (broker fees, letters of credit etc)

Ocean loss allowance = 0.3% normal leakage allowance

Cargo dues = National Ports Authority of South Africa contract tariffs for petroleum products

Coastal storage = realistic cost for handling and coastal terminal storage

87

Domestic cost component

Domestic cost component = Transport cost + Delivery Cost + Wholesale Margin + Retail Margin + Miscellaneous Charges

Transport costs (zonal differential)

Delivery costs (depot related costs, storage and handling) – historical costs averaged on a national basis

Wholesale (marketing margin) – aimed at a 15% return on depreciated book value of assets, before tax and interest

Retail margin – fixed by the Department of Minerals and Energy on basis of actual cost of distributing petrol based on rental, labour overheads and profit

Miscellaneous charges include:

equalization fund levy – to smooth fluctuations in prices, provide synfuel tariff protection

fuel taxes – VAT

customs and excise levy

road accident levy – third party victim compensation fund

slate levy – recovery to oil companies due to time delay in adjustment of pump prices

A.3.2 Review of price regulation in South Africa

There are mixed reviews on the performance of fuel regulation in South Africa or not. A 2008 study by the Fuel Retailers Association concluded that deregulation would not bring down the petrol price, but would instead increase prices. The study compared the partly deregulated diesel prices with regulated petrol prices, and found that higher margins were being paid on diesel. The benefit of regulation is that nit has reduced the regional diversity of fuel prices especially for remote areas of the country. The down side is that the sector may suffer from inefficiency due to a lack of competition.

Given that the regulated petrol price allows for covering costs and a fair retail margin, it appears as if the petrol price in South Africa could potentially be higher if it was deregulated. However, this is purely speculative. As in Canada, it is likely that rural areas with a small throughput are the regions that benefit the most from price regulation, whereas large urban areas may suffer. This is due to the downward pressure on prices due to competition in urban areas being neutralised by regulation.

A.4 Applying ex-ante price regulation in the Isle of Man

We have conducted an ex-post hypothetical analysis of how prices may have evolved within a South African or Canadian price regulation framework. This is detailed in Section 7 and is briefly summarised here:

A.4.1.1 Petrol

Regulated petrol prices are directly tied to the underlying product price. In the case of the Isle of Man, ARA refinery price plus shipping and terminal costs have been used as product price

88

Hypothetical regulated prices on Isle of Man react quicker to the underlying product price. For instance, when product price falls the regulated pump price falls immediately, while the unregulated price shows a lag

The overall level of the regulated and unregulated prices are about the same

A.4.1.2 Diesel prices

The hypothetically regulated diesel prices tend to be significantly higher than average Isle of Man pump prices. The reason behind this are that the higher margins allowed in the regulated scenario compared to actual Isle of Man margins

The average regulated margin (wholesale + retail) looking at Canadian style regulation in 2008 would have been 6.40 pence per litre, whereas the real margins obtained in Isle of Man were only roughly 1.20 pence per litre

A possible reason for the low (calculated) realised margins in Isle of Man in 2008 is that the oil companies active on Isle of Man were not purchasing their product at prevailing high ARA prices during summer and fall, but maybe depleted storages during these times.

89

ANNEX B PUBLIC SUBMISSIONS

Members of the public

1. Peter Dawson 2. Peter Quirk 3. Chris Ismay 4. Ivor Knight 5. R. Couch 6. Simon Clucas 7. Nigel Clucas 8. Stephen Somers 9. Glyn Harper 10. Jason Callister 11. Jim Wallace 12. Jim Dowling 13. Colin Johnson 14. Brian Lynn 15. Kriston Renshaw 16. Mark Clarke 17. Steve Hamer 18. Adrian Cooper 19. Gareth Colquitt 20. Joanne McGlynn 21. Aidan 22. David Doran 23. Richard Hardy 24. John Hammersley 25. William Vannin 26. Mr McGiveron 27. Brian Goodspeed 28. James Crook 29. Barry Jackson 30. Matt Tee 31. Chris Ward 32. Paul Kerruish-Kelly 33. Michael Cain 34. Perryn Callister 35. Vincent Lamont 36. J Keith Sutton 37. Confidential 38. Confidential 39. Anonymous

Members of the Legislature

40. Mr Juan Watterson BA (Hons) ACA MHK 41. Hon Phil Gawne MHK

Associations

42. Island Road Transport Association

90

GD 024/10

Summary of the Main Findings taken from the

2010 Liquid Fuel Price Investigation Report

(GD 0015/10)

April 2010 APRIL 2010 £2.00

1

Introduction

The Board of the Isle of Man Office of Fair Trading (OFT) determined in October 2008 that the prices charged for liquid fuels in the Isle of Man were of major public concern. The Board also saw that the level of price difference between the Isle of Man and UK average dealer prices had exceeded the level where the previous OFT Fuel Report had indicated a further investigation should commence. The Board therefore decided that an investigation into liquid fuel prices under Section 19 of the Fair Trading Act 1996 should be carried out. This guide is an overview to give an idea of the main findings of the investigation which was carried out and to present some of its key findings. It also sets out to try and answer some of the public concerns, questions and possible public misconceptions in a less technical way than the main report. The guide is not intended to be the authoritative statement on the full investigation findings; these should be sourced from the full report. The Board of the OFT appreciated that although by necessity any report carried out under Section 19 of the Fair Trading Act is an historic document, the factors which cause prices for liquid fuel in the Isle of Man are current and so remain valid today. Set out below are some of the perceptions and questions commonly voiced to the OFT by members of the public and a summary of the findings in relation to them.

Common Perceptions and Questions: Fact or Fiction? 1. “It‟s all just a rip off; they are all coining it in on the backs of the public.” The Investigation‟s Findings: The Office of Fair Trading completed an extensive investigation into all the factors

contributing to the price of road (petrol, diesel) and heating (kerosene) fuels on the Island. The findings are summarised over the following pages. As the investigation was carried out under the Fair Trading Act 1996 all the companies involved bringing liquid fuel were obliged to supply the documents and accounting information requested or face legal sanction.

The pie charts below give a breakdown of the average price over the month at the pumps for

petrol and diesel in January 2009. The charts show that the largest part of the pump price is made up of the duty and VAT paid by the consumer, which account for nearly two thirds of the pump price. The next largest part of the price is the cost of the fuel paid by the wholesaler to obtain the fuel. The smallest component of the pump price is what is known as the “gross margin”.

The gross margin covers the margin made by the wholesaler in bringing the fuel to the Isle of Man and the margin made by the filling station operator. The gross margin is the amount added to the wholesale fuel price, following tax and duty, which covers the costs and profits of the fuel wholesaler and fuel distributor. The gross margin can be split into the retail margin (costs and profits charged by the filling station operator) and the wholesale margin (costs and profits of the fuel wholesaler/importer). Further breakdowns of the wholesale and retail margins are given later on in this guide.

2

Isle of Man -petrol price breakdown (Jan 2009; average price over month 93.07 pence per litre)

Gross Margin 7.3

Duty & VAT 66.21

Product 19.56

Isle of Man -diesel price breakdown (Jan 2009; average price over month 104.4 pence per litre)

Gross Margin

10.37

Product 28.04

Duty & VAT 65.96

The gross margin can be split as follows:-

retail margin (costs and profits charged by the filling station operator)

wholesale margin (costs and profits of the fuel wholesaler /importer).

Further breakdowns of the retail and wholesale margins are given in questions 2 & 3 below

3

To compare, the chart below shows an estimation of the breakdown of the petrol pump price in the Scottish Highlands, Guernsey and Jersey:

Scottish Highlands petrol price breakdown March 2009, pump price = 112.ppl

Gross margin 10.6

Duty & Vat 72

Product 28.6

Source: Experian Catalist

Guernsey petrol price breakdown November 2006, pump price = 52.3 ppl

Gross Margin 24.08

Product 21.42

Tax & duty 6.8

Source: States of Guernsey, Energy Market Investigation, May 2007

4

Jersey petrol price breakdown November 2006, pump price = 71.9 ppl

Product 25.37

Gross Margin 16.51

Tax & duty 38.02

Source: States of Guernsey, Energy Market Investigation, May 2007

Note: Since 2006, pump prices in both Guernsey and Jersey have risen, which will have affected the three components ( i.e. product price , tax & duty and gross margin) shown in the pie chart, however as there have been no further Energy Market Investigations undertaken in the Channel Islands since 2007, there is no 2009 data available to compare directly with 2009 petrol price breakdown shown for the Isle of Man.

The gross margin is the only part of the fuel price that the companies have any control over. The gross margin charged on road fuels has fluctuated considerably over the investigation period, as shown in the chart below:

0

2

4

6

8

10

12

14

16

18

20

22

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre

Petrol

Premium

Diesel


5

2. “The filling stations make loads of money on petrol, that‟s why the price stays so high!”

The Investigation‟s Findings:

The retail margin (total earnings by the filling station operator to cover operating costs plus profit) was on average 3.7 pence per litre (ppl). This does not appear to be unreasonable. The annual average profit per year for Island filling stations is £88,800. From this figure operating costs such as pump machinery and site maintenance costs, property overheads such as heating, lighting, staff wages and owners drawings have to be taken. It is clear then that if only road fuel was sold most stations would not be economically viable and this supports the trend of most stations to move into non-fuel activities, i.e. convenience stores, which provide higher margins.

A breakdown of the average retail margin charged by filling station operators of 3.7 ppl in 2008 is shown below. Road fuel prices fluctuated significantly throughout 2008, average pump prices for unleaded were around 111 ppl and diesel 124 ppl. In this context the amount of actual profit accruing to the filling station owner is a very small component of the pump price.

Breakdown of average retail margin 2008 in pence per litre

utilities; water, electricity

etc and rates 0.30

sales and marketing 0.30

profit for filling station

owner 1.30

leases, interest

payments/depreciation for

filling station site 0.60

staff costs 1.20

3. “It‟s not just the filling stations; the wholesalers are ripping us off too.” The Investigation‟s Findings:

Over the investigation period the average wholesale margin (i.e. the price „mark up‟ to cover costs of importation, storage, distribution and profit) achieved by the Island‟s road fuel suppliers was: 6.2 ppl for unleaded and 8.1 ppl for diesel. Comparing with other comparable UK distributors showed the Isle of Man margin to be higher but not excessively higher. Research also found that some studies suggest that the level of margin achieved by

6

some UK distributors is unsustainable and will have to rise. Overall the level of wholesale margins achieved by our local distributors was considered a reasonable but not excessive return on their investment.

The chart below shows a simplified breakdown of the average parts of wholesale margins charged over the investigation period in pence per litre

Unleaded

Shipping & Import Costs

0.95

Storage & Distribution

Costs 1.75

Profit 3.48

Diesel

Shipping & Import Costs

1.24

Storage & Distribution

Costs 1.79

Profit 5.09

4. “Which companies are involved in bringing fuel to the Isle of Man and how does

the supply chain operate?”

The Investigation‟s Findings: The following diagrams show the companies that were involved at each stage of the supply

chain in bringing road fuels (petrol and diesel) and heating fuels (kerosene and gas oil) to the Island during the investigation period.

7

Road Fuel

Import

Storage

Distribution

Retail




Total IoM Ltd /

Total branded

Independent dealers

Total IoM Ltd /

Total branded

Independent dealers

Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd



Shell branded


Shell branded


Import

Storage

Distribution

Retail




Total IoM Ltd /

Total branded

Independent dealers

Total IoM Ltd /

Total branded

Independent dealers

Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd



Shell branded


Shell branded


Heating Fuel

Import

Storage

Distribution

and Retail




Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd

Shell UK /

Manx Petroluems Ltd

Shell UK /

Manx Petroluems Ltd

Manx

Petroleums

Manx


CPL

GB Oils t/a

CPL

Import

Storage

Distribution

and Retail




Shell UK

Oil Products Ltd

Shell UK

Oil Products Ltd

Shell UK /

Manx Petroluems Ltd

Shell UK /

Manx Petroluems Ltd

Manx

Petroleums

Manx


CPL

GB Oils t/a

CPL

5. “The filling stations are quick enough to put the prices up, but they never seem to drop their prices that quick.”


The main factor that causes prices to change so quickly and frequently at the pumps is changes in the wholesale price of fuel.

8

Both crude oil and refined products such as petrol and diesel are traded on international commodity markets and changes in the price of the products in the market ultimately are translated into changes in the prices at the pumps. Unfortunately the commodity market for fuels is a particularly volatile one with prices changing on a daily basis.

What this means for wholesalers of fuel and for filling stations is that it is extremely difficult for them to know how much the fuel is going to cost when they next have a shipment to the Island or delivery to the filling station.

The investigation found that some of the impact of changes in wholesale price (both up and down) are absorbed by or retained by, the filling station or the distributor in an effort to „smooth out‟ the price and avoid having to make large fluctuations in the pump price. The amount retained/absorbed by the filling station or distributor constantly changes as the fuel price fluctuates. This is also reflected in the chart above which shows how volatile the gross margins are for fuel.

The investigation found that by adopting this fuel pricing mechanism some of the increase in prices is being borne by the Island‟s distributors or filling stations and similarly some of the decreases are retained.

The change in pump prices is often less than the change in the wholesale price.

The gross margin often moves opposite to the changes in wholesale and pump prices. This is contrary to what the public believe, members of the public frequently phone the Office to complain about companies “profiteering” when fuel prices are rising.

From the examination of the information submitted by the companies, no evidence was found that the Island‟s retailers or wholesalers manipulate price changes to increase their profit margins.

Filling stations in the UK sell more fuel than the average Isle of Man filling station. The higher volume throughput of fuel means that these filling stations have less “stock holding” issues to consider when changing their prices and are more likely to receive more frequent deliveries of fuel. These factors may explain how prices change, both up and down, more quickly in UK filling stations. The chart below compares the amount of fuel sold in the average Isle of Man filling station with the differing type of UK filling stations:

1,000

3,000

5,000

7,000

9,000

11,000

13,000

2005 2006 2007 2008

Annual

Ave

rage

Thro

ughput

(1,0

00 litre

s)

IOM UK average

UK Company Owned UK Dealer Owned

UK Supermarket

9

The charts below show how Isle of Man pump prices compare with those for the average UK independent dealer:

Unleaded

85.0

90.0

95.0

100.0

105.0

110.0

115.0

120.0

125.0

Nov-

07

Dec-

07

Jan-

08

Feb-

08

Mar-

08

Apr-

08

May-

08

Jun-

08

Jul-

08

Aug-

08

Sep-

08

Oct-

08

Nov-

08

Dec-

08

Jan-

09

Feb-

09

Mar-

09

Apr-

09

May-

09

Jun-

09

Jul-

09

Aug-

09

Sep-

09

Oct-

09

Pence

per

litre

UK IOM

Diesel

95.0

100.0

105.0

110.0

115.0

120.0

125.0

130.0

135.0

140.0

Nov-

07

Dec-

07

Jan-

08

Feb-

08

Mar-

08

Apr-

08

May-

08

Jun-

08

Jul-

08

Aug-

08

Sep-

08

Oct-

08

Nov-

08

Dec-

08

Jan-

09

Feb-

09

Mar-

09

Apr-

09

May-

09

Jun-

09

Jul-

09

Aug-

09

Sep-

09

Oct-

09

Pence

per

litre

UK

IOM

6. “When the product price goes up, the wholesaler‟s storage tanks may already be full of fuel they bought at a cheaper price, surely they must be making more profit when this happens, so why don‟t they keep the price the same until the storage tanks are empty?”

10


Refined road fuels are a traded commodity and just like any product traded on a stock market the price of fuel changes virtually daily. If, as suggested, when the price of wholesale fuel went up, the wholesaler did not pass the increase on until their tanks were empty, then consumers would pay less in the very short term but when the tanks were refilled at a higher price, the retail price would have to increase dramatically.

The investigation found that rather than have prices change by significant amounts (both up

and down) the wholesalers monitor changes in the wholesale market price and adjust their prices on a more gradual basis. This approach tends to smooth out retail prices in what is an extremely volatile market. If this monitoring was not undertaken prices would alter more frequently and would be subject to more extreme increases or decreases.

With regard to increases in prices caused by changes to the Excise Duty and/or VAT rate both of the Island‟s road fuel suppliers store their fuel, duty and VAT free and therefore pay duty & VAT only when fuel is removed from a storage tank and placed in a road tanker for delivery. They therefore cannot pay in advance and must pay whatever the rate of duty is on the day of removal. A tax rise therefore cannot increase the wholesaler‟s profits.

7. “I bet the wholesalers make more profit every year.” The Investigation‟s Findings:

The last fuel price investigation was completed in 2006, looking at prices from 2001-2005. A comparison to the profits achieved via a return on the capital employed and gross margin published in the previous report showed a downward trend. Although there may be many explanations for this downward trend, one reason could be that the wholesalers are absorbing some of the increased fuel costs rather than passing them on in full to the consumers. The table below shows the profits earned by the companies involved, using a number of different ratios. All of the companies below submitted all of the statutory and management accounts requested to the investigation along with a large volume of other material.

Gross margins 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total 24.5 25.7 25.2 24.7 24.5 19.9 18.6 20.6 15.5

Manx Petroleums 17.4 19.2 17.6 17.5 17.4 13.3 12.3 13.4 9.6

Shell 18.1 15.6 14.0 13.5

Return on sales

Total 6.1 7.7 6.2 9.0 6.1 6.8 6.5 8.8 6.6

Manx Petroleums 4.4 7.5 4.8 5.6 4.4 4.1 4.4 3.2 2.6

Shell 2.5 3.2 0.2 3.5

Return on capital

employed

Total 15.8 16.8 12.1 18.0 15.8 16.3 13.8 16.3 14.2

Manx Petroleums 19.1 29.5 17.4 14.4 19.1 16.1 16.6 9.8 10.7

11

8. “What about the price we pay to get fuel to the Island; I‟ve heard that the ships either come in half full or only unload half as they are on their way to Northern Ireland and we‟re paying for it?” The Investigation‟s Findings:

The investigation found no evidence to support the perception that the Island is subsidising the cost of transporting fuel to Northern Ireland nor did it find that the fuel suppliers were bringing in „half full vessels‟. However the following points were established:

a. Both fuel distributors have to use the same company to transport fuel to the Island as

they are the only company providing coastal freight services. b. The shipping company will charge the fuel distributors for any unused space in their

tankers when making deliveries, so it is in their interests to ensure that full shipments are received.

9. “Typical „official investigation report‟ No wonder they never find anything wrong, I bet the fuel companies only give the OFT half „the books‟ and keep the important stuff back.” The Investigation‟s Findings:

As the investigation is carried out under the Fair Trading Act, the Office had the power to request that the companies involved in the investigation submitted all relevant information. The Office issued formal notices under the Act requesting the submission of named information and all companies complied with these notices.

The notice requested the submission of a great deal of information in relation to the businesses operation. The information requested differed between the businesses depending on their involvement in the marketplace but typically the information supplied included details of: corporate structure, shareholders, statutory and management accounts, details of assets and infrastructure owned volumes of products supplied and prices charged, purchase prices for fuel, details of shipping costs, storage/distribution costs, customer numbers, fuel procurement strategy and details of capital expenditure and current capital expenditure commitments.

In summary, every document that was requested from the companies involved was provided and full co-operation with the investigation was given. There was no evidence that any important documents were retained by them and not submitted. All of the documentation provided was analysed in depth by the expert analysts who provided support to the Office during the investigation. The information was examined by the highly qualified and experienced economists and financial analysts at Poyry Energy Consulting.

10. “Why does the OFT take so long to do these investigations?” The Investigation‟s Findings:

Price investigations under Section 19 of the Fair Trading Act are not undertaken lightly and there must be considerable public concern regarding a price before the Board will instigate an investigation. Once the investigation is commenced it is imperative that it is a thorough examination of how the company prices its products and the factors that influence the setting of its prices. To do this effectively a large volume of data and information is normally required from the company or organisation and then it frequently needs specialist analysis and comparison against similar products or services supplied in the UK or other comparable jurisdictions before a report is produced. Once the report is approved by the Board it is

12

submitted to the Council of Ministers (who will consider whether any further actions should be taken) and then the report is laid before Tynwald when it becomes public. Perhaps therefore understandably, the whole procedure will normally take up to 12 months.

With regard to this liquid fuels investigation, following notification that the 5 pence per litre „trigger‟ level of price differential had been breached in the summer of 2008 and conscious of the major public concern, at their October 2008 Board meeting the OFT Board directed that the OFT commence a price investigation under Section 19 of the Fair Trading Act. In accordance with Government Financial Regulations, a detailed specification for the investigation was drawn up of necessary specialist support and the tendering process followed with the specialist consultants Poyry Energy Consulting being appointed in January 2009. Notices to produce the required information were served on the various companies in late January 2009. Over the following months an extensive analysis was carried out by Poyry of all the submitted information. Following consideration and review of the work a draft report was completed in July 2009. This report was considered by the Board of the OFT at their next meeting in late August 2009. Considering the complexity of the issues and the volumes of data collected, a period of nine months to complete the investigation is believed to be reasonable. However, the danger with a 100 page, very technical report is that people would find this difficult to digest; with this in mind the Board of the OFT directed that the difficult task of producing a „layman‟s guide‟ be undertaken. As this document had to be drafted, approved by the Board and sent to the Council of Ministers before publication this has taken further time.

11. “One thing I can never understand is if I see on the news that the price of crude oil is coming down, how come the price of petrol and heating oil doesn‟t come down at the same rate?” The Investigation‟s Findings:

The investigation noted that there are separate international traded commodity markets for crude oil and refined road fuels and heating oils and that these, whilst the refined markets are affected by the crude prices, also operate completely independently of each other, subject to their own demand and supply pressures. Quite surprisingly at one point during the period of investigation, the price of crude oil was higher than that of petrol. When one considers that the crude oil has to be extracted from the ground or seabed, transported to a refinery and converted to road fuel, then perhaps sent half way around the word to a distributor and then supplied to retailers, to have that price be lower than crude oil seems impossible, but it does clearly illustrate that the markets for crude and refined fuel products work independently.

Whilst differences in wholesale market prices are still primarily driven by movements in the price of crude oil because of the independence of the refined commodity markets on occasion it is possible for the price of crude oil to be dropping but the price of road or heating oil to be going up (or vice versa). Therefore although the prices of crude and refined fuels normally follow the same trend e.g. either up or down, the rate of price change can be substantially different.

12. “All I know is that every time I get off the boat at Heysham or Liverpool, petrol is at least 6p per litre cheaper; why can‟t it be the same price in the Isle of Man?” The Investigation‟s Findings:

The average difference between UK and Isle of Man average pump prices over the investigation period was 4.3 ppl for petrol and 3.8 ppl for diesel. This is based on a UK national average which includes supermarket prices. Supermarket filling stations are

13

approximately five times larger than the average Isle of Man retailer. In addition to their economies of scale their business model is totally different in that they may make a lower margin on road fuel because the consumer may have bought many of the other products they sell which attract higher margins. They may also sell their fuel as almost a loss leader to attract custom. The scale of the UK supermarket share of the road fuel market is so large that they can use these types of cross subsidisation pricing policies. The difficulty for independent dealer owned sites in the UK is that they be geographically close to a supermarket filling station and are therefore forced to keep their price close to the supermarket price in order to compete for business. The chart below shows how the size of the price difference between the average UK and Isle of Man prices fluctuates considerably:

-2

-1

0

1

2

3

4

5

6

7

8

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep

-05

Nov

-05

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep

-06

Nov

-06

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Pence p

er

litre


The investigation found that comparing with the average UK dealer owned site, the annual average differential for both fuels was around 3.0 – 3.3 ppl over the investigation period.

Another reason why the Isle of Man prices for road fuel are unlikely to be able to compete

with those in the UK is because of increased costs. These cost which can be measured are:

Importation and shipping costs 0.8 – 1.5 ppl Smaller scale of operation (smaller tanker sizes) 0.3 – 0.8 ppl Lack of wholesale product competition & 0.5 – 1.0 ppl limited retail competition compare to UK („supermarket effect‟) Total 1.5 – 3.3 ppl

However there are other factors which cannot be measured but will undoubtedly cause the price of road fuel on the Island to be higher than in the UK:-

UK wholesale business is not very profitable, backed up by recent UK studies (and/or higher on-Island distribution costs)

Higher costs of operating in the Island (two storage depots and terminals exist on the Island, when the volume could be served by one)

Diseconomies of scale from the lack of support services and specialist contractors Higher number of filling stations per head on the Isle of Man

14

The „bottom line‟ is that because of the economies of scale, increased transportation and storage costs, larger overheads and reduced competition, the local suppliers are unlikely to be able, either now or in the future, to charge the same prices as in the UK.

13. “What about heating your house? My bill for a tank full seems to go up every winter.”


As you would expect the investigation found that similar to road fuels, most of the changes in the price of heating oil were caused by the change in the wholesale product prices.

Margins for both gas oil and especially kerosene rose over the period of the investigation. The effective gross margin averaged 8.1 – 9.5 ppl for kerosene and 3 – 4.2 ppl for gas oil. Margins have increased since the previous OFT investigation.

Margins are higher for kerosene as it is sold mainly to domestic households, which tend to be less responsive to price changes and they cost more to serve. Gas oil is high volume, low margin business catering to the commercial sector which is more price conscious.

Though the profit margins identified for kerosene are high, there is a high level of transparency in pricing. This is in part due to the fact the Office of Fair Trading conducts regular price comparisons for the local suppliers and publishes the information obtained in the Comparative Heating Schedule. Because refilling a home heating tank is a high outlay expense consumers tend to “ring round” the suppliers and consumers are also willing and able to switch between fuel suppliers based on price. This encourages local competition and the level of discounts the suppliers are prepared to make.

The investigation compared the annual difference in prices between the UK and the Isle of

Man and these ranged between 6.6 – 8.9 ppl for kerosene and 2.6 – 6.2 ppl for gas oil respectively. Although on face value these seem high, the investigation found that up to 6.3 ppl for kerosene and 3.6 ppl for gas oil can be accounted for by „Isle of Man‟ factors e.g. higher cost of transportation and storage, higher overheads of the fuel suppliers, the necessity to use smaller road tankers than in the UK, less competition. Taking these factors into account, although a reasonable return is being made by our local suppliers, it is not excessively higher than that made by suppliers in the UK.

15

Conclusions and Next Steps

As mentioned above in answering the „perceptions and questions‟ the investigation found that the main cause of price changes at the pumps is changes in the cost of the wholesale fuel. There was no evidence to support the perception that price increases were driven by the Island‟s wholesalers or filling stations seeking solely to increase their profit margins. The investigation does not suggest that prices faced by the consumers are unreasonable. The profitability analysis conducted suggests that the companies in this sector are not making excessive profits and the gross profit margin made shows a downward trend between 2005 – 2008 and a significant decline in the profit margin achieved compared to 2001 – 2004. Averaging the gross profit margin achieved by both companies for each 4 year period shows that for 2001-2004 the gross profit margins achieved were: Total 25.02% & Manx Petroleums 17.92% but the average percentages achieved for 2005-2008 had reduced to: Total 18.65% & Manx Petroleums 12.15%. Similarly, profitability ratios (such as the return on sales or the return on capital employed) have broadly declined compared to the previous OFT investigation. Whilst at times, the level of the differential with the UK may be high, taking into account the higher overheads and operating costs that are inevitable in supplying liquid fuels in an Island location and the lower intensity of competition compared to jurisdictions like the UK where supermarket chains hold a large market share, these differences can largely be explained. The investigation also found that in comparison to perhaps more similar markets such as Eire and the Channel Islands the price of fuel on the Island (adjusted for indirect taxation) was either comparable or in fact lower. In terms of the „next steps‟ the investigation has highlighted the necessity to review prices on the Island over a long period and that initiating price investigations in an extremely volatile market has to be carefully judged. It is intended therefore that the OFT will continue to monitor the differential between local prices and those charged in the UK on a weekly basis against an eight week rolling average with the results published monthly. The OFT will also look at when and how it may be necessary to re-evaluate the benchmark comparator for price differentials to ensure the system takes into account future local operating conditions. Full details of the Conclusions and Recommendations are contained in Section 9 of the full report.

16

Isle of Man Office of Fair Trading

ROAD FUELS MARKET MONITORING REPORT 2014

VERSION 1.0

MARCH 2014

Page 2 of 32 Version 1.0


FOREWORD BY THE CHAIRMAN

In April 2010 the Council of Ministers published on behalf of the Office

of Fair Trading a Report entitled “An Investigation into Liquid Fuel Prices

in the Isle of Man”. This concluded, based upon the work of specialist

external consultants, that the differences between Manx and United

Kingdom fuel prices were justified by the additional costs associated

with supply to an Island market and the lack of economies of scale. The

2010 Report also concluded that both the importers and retailers were

making reasonable levels of profit.

Following publication of the 2010 Report the Office of Fair Trading introduced a regime of market

monitoring in order to ensure that prices remained within reasonable bounds. I am very pleased to

advise that the two importers have co-operated with this monitoring process and have provided the

Office with commercially confidential data which makes that task a lot easier and more rigorous.

In Tynwald in December 2012 I promised that the Office would have a careful look at the road fuels

market. Rather than launch another expensive formal investigation the first step was to critically

examine the data which we held and determine whether there was any real likelihood that a new

investigation would reach a different conclusion. This Report represents the outcome of that work.

It concludes that whilst there have been structural changes within the market, with Manx Petroleum

becoming an importer in their own right rather than a Shell agent, and the business of Total (IOM)

being sold to Ellan Vannin Fuels, the underlying business models are fundamentally the same. It

also concludes that the changes in the differential between local prices and U.K. benchmarks are

explained by increased costs and that neither the importers nor retailers have increased profitability

since 2009.

The Office understands that local consumers would like fuel to be the same price as that sold by

the major UK supermarkets but as the 2010 Report concluded that is an unrealistic aspiration. Not

only do the local importers lack the massive buying power of the supermarkets, but they face

additional costs for shipping and providing small scale depot and storage networks.

The Office of Fair Trading understands the importance of road fuel prices and will continue to

monitor the road fuels market in the Island and make comparisons with the relevant U.K

benchmarks.

David Quirk MHK Chairman


CONTENTS

1. INTRODUCTION 5

2. MARKET STRUCTURE 7

3. UNITED KINGDOM INVESTIGATION 11

4. ISLE OF MAN TRENDS AND STATISTICS 13

5. CHANGE FACTORS – 2010 TO 2013 25

6. CONCLUSIONS 29

Click on page number to move to the section


1. INTRODUCTION

1.1 In April 2010 the Council of Ministers published a Report by the Office of Fair Trading

relating to an investigation undertaken pursuant to section 19 of the Fair Trading Act 1996

(as amended) into liquid fuel prices in the Isle of Man over the period 2005 to 20081.

Although the Report was commissioned by the OFT, due to the extensive and complex

nature of the investigation specialist external consultants (Pőyry Energy Consulting Ltd.)

were engaged to assist.

1.2 The report concluded that whilst the prices charged for liquid fuels on the Island were

higher than those charged in the United Kingdom for example, there were various

contributing factors accounting for this. The differences in the scale and scope of the Isle of

Man and United Kingdom markets and the increased costs in supplying the Isle of Man

being the main factors.

1.3 In addition the investigation examined in detail the profitability of the fuel wholesalers and

retailers on the Island and concluded that the level of profits made by the companies did

not appear excessive.

1.4 One recommendation contained in the 2010 Report was that the OFT should carry out

some form of monitoring and reporting of road fuel cost movements, using a comparator

based on retail price differentials with the United Kingdom; and that the most appropriate

comparator would be the average price of dealer owned sites. These assessments are

undertaken weekly using data gathered locally by the OFT and comparing it to UK industry

data supplied by Experian Catalyst Limited. Since 2010 this data has been published

monthly.

1.5 In addition to gathering data and comparators the OFT has also developed a relationship

with the two importers Manx Petroleums Ltd. and Ellan Vannin Fuels Ltd. and both

regularly submit commercially confidential information which enables the OFT to have a

better understanding of the market. In addition both companies voluntarily provided copies

of their audited accounts.

1.6 Although there have been changes to the market participants since the 2010 Report; which

are discussed further in section 2, these do not appear to have had a significant impact

upon the way in which the market itself functions.

1.7 The OFT is acutely aware that road fuel prices continue to be a matter of concern within

the local community; and that alone might justify the commissioning of a further detailed

price investigation under section 19. This is, however, a market which has, already, been

investigated twice and neither investigation has revealed any cause for intervention in the

market. Formal investigations are expensive and the OFT would not wish to embark upon a

1 An Investigation into Liquid Fuel Prices in the Isle of Man – A Report by the Council of Ministers

http://www.gov.im/lib/docs/oft/finalreporttobepublished.pdf


further investigation unless there is reason to at least suspect that there is likely to be a

different outcome.

1.8 This Report analyses the data and information gathered by the OFT since the 2010 Report

and seeks to provide answers to three key questions:-

1. Can any changes in differentials between Manx prices and the selected UK

benchmark since the last investigation be explained?

2. Have there been any material changes to the profitability of the fuel

importers since the last investigation?

3. Have there been any material changes to the profitability of the forecourt

retailers since the last investigation?

It uses both the published data and information provided by the two importers under

commercial confidentiality. In the latter case great care is taken to ensure that the

underlying data is not disclosed; and, in particular, that the two companies (each of which

holds their own data) cannot decouple the data to discover that of their competitor.

1.9 The answers to these three question then inform a decision by the OFT as to whether a

further investigation into road fuel prices pursuant to section 19 of the Fair Trading Act

1996 (as amended) would represent value for money for the taxpayer.

1.10 The Report covers the period 1st April 2009 to 31st March 2013, although in some cases the

available data may be limited. In the body of the Report - Manx Petroleums Ltd. is referred

to as Manx Petroleum or MP and Ellan Vannin Fuels Ltd. is referred to as Ellan Vannin Fuels

or EVF.


2. MARKET STRUCTURE

2.1 There are four key stages involved in the processing of crude oil to its transporting and

sale as a road fuels by the retailer. This process is set out as follows:-

Figure 1 – Road Fuel Market Structure

This Report is simply about Stages 3 and 4 in that process. As the 2010 Report explained in

considerable detail the two importers of road fuel into the Isle of Man are, in the overall

Stage 1 Extraction of crude oil - the extraction of crude oil from underground or underwater oil fields and its transportation to the location where it is refined or processed.

Stage 2

Refining of crude oil - the refining of crude oil into

different products such as petrol diesel, heating oil, jet

fuel and liquid petroleum gases and residual fuel oil.

Stage 3

Distribution and storage - involving the transportation

of the refined product from the refinery to the retailer

or final consumer. Distribution networks include

bespoke product pipelines, barge/freighter or rail

transportation and road tanker distribution depending

on the volume being transported.

Stage 4

Retailing - the sale and transportation of road fuel to

the forecourt and its sale by the retailer to the

consumer.


scheme of things, price takers. They are small customers of huge refinery businesses and

they have no choice but to accept the price determined.

2.2 The 2010 Report summarised the supply chain for Isle of Man road fuels as follows.

Figure 2 – Supply Chain for Road Fuels 2010

It should be noted that road fuels are not a standalone market and there is a close

relationship and interdependence with heating oil and commercial fuels which share the

shipping, storage and delivery elements of the supply chain.

2.3 Since the 2010 Report there have been a number of changes within the local market.

These changes are outlined in the following paragraphs and whilst, at first sight, they may

sound significant they do not fundamentally impact upon the way the market functions.

2.4 As will be seen in the above diagram during the period covered by the 2010 Report Manx

Petroleum Ltd. was operating as a Shell U.K. Oil Products Ltd. distributor. In July 2010 Shell

exited the Isle of Man market and Manx Petroleum became an importer and distributor in

its own right. This change involved significant investment by Manx Petroleum including

complete rebranding of the depot, fleet and retail outlets from Shell to Manx Petroleum

which was completed over the ensuing period.

2.5 In 2011 the Shell UK Oil Products Ltd. refinery on the River Mersey, which had supplied

Manx Petroleum as a Shell distributor and then as an independent, was sold by Shell to

Essar Oil UK Ltd2. The supply contract to Manx Petroleum transferred to Essar Oil UK Ltd. at

that stage.

2 http://www.essar.com/article.aspx?cont_id=9ySRaet7p5s


2.6 During the period covered by the 2010 Report the importation and distribution of Total

fuels was undertaken by Total IOM Ltd. a subsidiary of Total UK Ltd. With effect from

November 2011 the Total IOM Ltd. business was sold to DCC PLC3. It is operated as a

subsidiary of DCC PLC company GB Oils now Certas Energy4 The business was rebranded

as Ellan Vannin Fuels.

2.7 Initially under the terms of the sale the business continued under the Total banner but a

rebranding programme involving the depot, fleet and retail outlets from Total to EVF was

under way during the period covered by this Report; and will be completed by the time this

Report is published.

2.8 Since coming to the Island in 1989 the fuel for Total IOM Ltd. had been supplied from the

refinery in Milford Haven by its UK parent. This continued following sale of the business

until November 2012 when Ellan Vannin Fuels moved its contract to the Essar Oil UK Ltd.

refinery at Stanlow on the River Mersey.

2.9 As a result of these changes the Isle of Man supply chain for road fuel is:-

Figure 3 – Supply Chain for Road Fuels 2013

3 http://www.dcc.ie/

4 http://www.certasenergy.co.uk/gb-oils-rebrands-as-certas-energy/

Essar Oil UK Ltd. Stanlow Refinery

Manx Petroleum

Ellan Vannin Fuels

Manx Petroleum

Ellan Vannin Fuels

MP branded

independent retailers

Ellan Vannin Fuels

& EVF branded independent retailers


2.10 Whilst these changes within the market have not been fundamental to the way in which the

market functions, there has been a significant impact on both participants in terms of

capital expenditure, on-going running costs and increased business risks as risks formerly

held by UK parents have transferred into the local companies. Whilst it is difficult to

quantify these changes in term of their retail price impact they have certainly not been

beneficial.

2.11 In broad terms the shipping arrangements have not changed and both Manx Petroleum and

Ellan Vannin Fuels continue to be constrained in terms of vessel size and choice by the size

of the harbours at Douglas and Peel respectively.

2.12 Equally there has been little shift within the petrol retail sector although some sites have

changed ownership including shifting from dealer owned to distributor owned. There are

now 20 filling stations in the Island supplying road fuel with the Glen Mona forecourt

closing in 2010. This is in stark contrast to the decline in the number of UK petrol stations

in the face of cut throat supermarket pricing.

2.13 During the period covered by the 2010 Report the road fuel market in the Island increased

by nearly 10% from 49 million litres in 2005 to 54 million litres in 2008. Since that time

consumption has been on a downward trend dropping back to 50 million litres in 2012.

2.14 There has also been a shift in terms of market share from petrol to diesel and this is

covered in more detail in section 4.4.


3. UNITED KINGDOM INVESTIGATION 3.1 In September 2012 the United Kingdom Office of Fair Trading (UKOFT) launched a call for

information (CFI) to investigate claims that the UK petrol and diesel sectors were not

working well. The aim was to identify whether there were competition problems that the

UKOFT could address to improve the way the sector functions. Given the fact that all road

fuel imported into the Island comes from the United Kingdom that market provides an

important backdrop to the local market.

3.2 When the UKOFT review was launched there were a number of specific issues which they

wished to address:-

• whether there were local areas where a lack of competition was leading to higher

prices

• whether independent dealers were able to compete fairly with supermarkets and

oil companies

• whether pump prices rise more quickly in response to increases in crude oil or

wholesale road fuel prices, than they move downwards in response to falling crude

oil or wholesale prices (this is often referred to as rocket and feather pricing)

• whether speculation or manipulation in crude oil markets or crude oil futures

markets could be leading to higher pump prices, and

• whether inaccurate oil or wholesale road fuel price reporting could be leading to

higher pump prices.

3.3 The resultant UKOFT Report5 was issued in January 2013 and based on the evidence that

was collected over the course of the investigation, it was concluded that competition in the

UK road fuels sector was working relatively effectively.

3.4 The UKOFT concluded that the UK has some of the cheapest prices in Europe before tax

and duty although after tax and duty prices are amongst the most expensive. Increases in

the pump prices of petrol and diesel over the past 10 years had been caused largely by

higher crude oil prices and increases in tax and duty. The margins being made by UK

refiners, wholesalers and retailers did not appear to have contributed as significantly to

increases in pump prices. They also concluded that according to European Commission

data, in November 2012 the price of UK petrol was around 14 pence per litre higher than

the EU average and the price of UK diesel was around 25 pence per litre higher than the

EU average (in both cases inclusive of tax and duty). UK diesel pump prices are further out

of step with EU prices than petrol prices because unlike most other EU nations, which levy

5 http://www.oft.gov.uk/OFTwork/markets-work/othermarketswork/road-fuel-CFI/#named3


higher taxes on petrol than diesel, the UK levies duty on both petrol and diesel at the same

rate.

3.5 According to the UK OFT the average price of petrol at supermarkets was 2 pence per litre

cheaper than the average oil company owned sites and 4.3 pence per litre cheaper than

the average charged by independent dealers. There is no doubt supermarkets have

exerted a lot of downward pressure on prices and have forced independent dealers and oil

companies to act accordingly. This is particularly relevant when comparisons are being

made to the Isle of Man because the Island does not have supermarket petrol retailers or

oil company sites. The Island’s importer and independent sites are also relatively small in

comparison to typical UK dealer owned petrol stations.

3.6 The UKOFT also noted that many of the rivals of the supermarkets had undoubtedly found

it difficult to compete with them. Overall, the number of UK forecourts had fallen from

10,867 in 2004 to 8,677 in 2012, although the rate of decline appeared to have slowed

since 2010. The average filling station throughput in the UK has gradually increased over

the same time period from 3.3million litres to 4.2million litres.

3.7 The “rocket and feather” effect on prices was substantially discounted by UKOFT who

concluded “Our analysis of the relationship between retail and wholesale prices at a

national, local area and site level, as well as the relationship between crude oil prices and

wholesale prices at a national level, found very limited evidence of rocket and feather

pricing. This result is consistent with evidence that we gathered from market participants,

which suggests that rocket and feather pricing is unlikely to occur.” This conclusion is

consistent with the findings in the Island in the 2010 Report.


4. ISLE OF MAN TRENDS AND STATISTICS 4.1 As previously indicated one of the outcomes from the 2010 Report was the commencement

by the OFT of a programme of monitoring of the road fuels market. The results of that

programme have been published on the OFT website on a regular basis and we know from

web statistics that the information is being accessed by consumers. The published data

provides a trigger for any concerns and a basis for an ongoing dialogue between the OFT

and both Manx Petroleum and Ellan Vannin Fuels. The published data is a snapshot of what

is happening in the market and in this section we stand back from that snapshot and

present, with analysis, the data over a three year period.

4.2 One recommendation in the 2010 Report was that the OFT would carry out some form of

monitoring and reporting of fuel cost movements. It was recommended that a comparator

based on retail price differentials with the United Kingdom (UK) should continue and that

the most appropriate comparator would be the average price of dealer owned sites. With

effect from April 2010, the Office engaged Experian Catalyst Limited to provide weekly

average road fuel (Diesel and Unleaded petrol) prices for dealer owned sites in the UK. The

Office also carries out a weekly price analysis of six local dealer owned sites to obtain an

Isle of Man weekly average road fuel price.

Figure 4 – Comparison of UK & IOM Pump Prices (Petrol)

100.00

105.00

110.00

115.00

120.00

125.00

130.00

135.00

140.00

145.00

150.00

155.00

05

/10

06

/10

07

/10

08

/10

09

/10

10

/10

11

/10

12

/10

01

/11

02

/11

03

/11

04

/11

05

/11

06

/11

07

/11

08

/11

09

/11

10

/11

11

/11

12

/11

01

/12

02

/12

03

/12

04

/12

05

/12

06

/12

07

/12

08

/12

09

/12

10

/12

11

/12

12

/12

01

/13

02

/13

Pe

nce

Pe

r Li

tre

Unleaded Petrol Prices

UK IOM


Figure 5 – UK & IOM Price Differential (Petrol)

Figure 6 - Comparison of UK & IOM Pump Prices (Diesel)

0

2

4

6

8

10

12

Pe

nce

Pe

r Li

tre

Unleaded Differential UK v IOM

100.00

105.00

110.00

115.00

120.00

125.00

130.00

135.00

140.00

145.00

150.00

155.00

05

/10

06

/10

07

/10

08

/10

09

/10

10

/10

11

/10

12

/10

01

/11

02

/11

03

/11

04

/11

05

/11

06

/11

07

/11

08

/11

09

/11

10

/11

11

/11

12

/11

01

/12

02

/12

03

/12

04

/12

05

/12

06

/12

07

/12

08

/12

09

/12

10

/12

11

/12

12

/12

01

/13

02

/13

Pe

nce

Pe

r Li

tre

Diesel Prices

UK IOM


Figure 7 – UK & IOM Price Differential (Diesel)

Figures 4 to 7 illustrate that whilst the differential between Manx and UK prices for both

petrol and diesel does fluctuate when it is viewed in the long term it is relatively constant.

Careful examination of Figures 4 and 6 does also reveal a time lag in price changes in the

Island compared to the UK market; and then manifests itself in fluctuations in Figures 5

and 7. This is an issue which is raised from time to time by consumers and the principle

reason is the longer timeline for the Manx supply chain. Manx Petroleum and Ellan Vannin

Fuels receive deliveries by sea; and whilst the time between deliveries does fluctuate

typically each will receive a delivery once a month. Both recognise the vagaries of living on

an Island, especially during winter months, and neither operates a “just in time” restocking

policy, so there will be some carry forward of stock between shipments. This means that by

the time the fuel has been delivered to the filling station and is sold to a consumer it will

typically be a few weeks since it left the refinery. In the U.K. with no sea journey or

interim holding that timescale from refinery (or pipelined depot) to point of sale will be

much shorter, in many cases perhaps as short as a few days.

4.3 The price of oil is rarely out of the news especially during periods of price instability such as

that experienced in 2011. Consumers often struggle to see how the crude oil price feeds

through to retail fuel prices and this breeds suspicion that the market as a whole is failing.

There is no doubt that when viewed in the short term the linkages are difficult to see but

looked at in the longer term the broad correlations are much clearer.

0

1

2

3

4

5

6

7

8

9

10

Pe

nce

pe

r Li

tre

Diesel Differential UK v IOM


Figure 8 – Comparison of Crude Oil and Road Fuel Prices

4.3 Another issue which consumers raise with the OFT is the gap in price between petrol and

diesel; often quoting relative prices in continental Europe. The difference in the relative

prices of petrol and diesel in the British Isles (including the Isle of Man) and other

European states is about taxation. Many EU Member States have a tax structure which

favours diesel over petrol whereas in the United Kingdom (and because of our common

indirect taxation, the Isle of Man) there is no differential taxation policy. Petrol and diesel

are two separate markets at an international level and the relative prices do change.

80

90

100

110

120

130

140

150

160

04

/10

06

/10

08

/10

10

/10

12

/10

02

/11

04

/11

06

/11

08

/11

10

/11

12

/11

02

/12

04

/12

06

/12

08

/12

10

/12

12

/12

02

/13

Ind

ex

Ap

ril 2

01

0 =

10

0

Rates of change of IOM Prices against Crude Oil

Index April 2010 = 100

IOM UL IOM Diesel Crude Oil


Figure 9 – Price difference between Petrol and Diesel

Since the previous investigation prices from the forecourts for both petrol and diesel have

been collected on a weekly basis to highlight the differentials. The information is then

expressed as an 8 week rolling average, which irons out differences resulting from the

different length of the respective supply chains. We would expect UK prices to respond

more quickly to global events than local prices because many of the UK forecourts will be

getting at least one, possibly two deliveries ex refinery per week. In the Island each of our

importers buys fuel in monthly batches in order to ship efficiently. This means that our

average delivery time from refinery to forecourt is around 6 weeks rather than a few days

in the UK.

Viewing the data since 2010, the price differential between diesel and petrol in the IOM and

the UK has been very similar. The average price differential between unleaded petrol and

diesel in the IOM over this period was 5.23p whilst in the UK this was 5.21p.

There is little evidence to indicate that the price differential between petrol and diesel in

the IOM is consistently greater than in the UK and this is illustrated in the graph above.

4.4 The issue of competitiveness within the Isle of Man road fuels market is considered more

fully in Section 6 of this Report but at this stage it is worth examining the market data.

Firstly it is a market which is declining in overall size and which is shifting from petrol to

diesel.

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.000

6/0

8/2

01

0

06

/10

/20

10

06

/12

/20

10

06

/02

/20

11

06

/04

/20

11

06

/06

/20

11

06

/08

/20

11

06

/10

/20

11

06

/12

/20

11

06

/02

/20

12

06

/04

/20

12

06

/06

/20

12

06

/08

/20

12

06

/10

/20

12

06

/12

/20

12

06

/02

/20

13

Diesel and petrol price differential

UK

IOM


Figure 10 – Isle of Man Market Size (Petrol & Diesel)

Table 1 - Total Volumes of Petrol and Diesel Sold in the Isle of Man

Financial Year Diesel Volume Petrol Volume

2007/08 22,481,486 31,519,573

2008/09 23,074,117 30,656,688

2009/10 23,181,501 30,081,485

2010/11 23,140,148 28,773,841

2011/12 23,289,136 27,867,395

2012/13 23,065,609 26,803,679

15,000,000

17,000,000

19,000,000

21,000,000

23,000,000

25,000,000

27,000,000

29,000,000

31,000,000

33,000,000

35,000,000

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13

litre

s

Total Volumes of Petrol and Diesel Sold

Diesel UL


Thus over a six year period there has been a 7.5% decline in the overall market but petrol

sales have fallen by 15% whilst diesel sales have actually risen by 2.5%. Although petrol

sales are still greater than diesel sales the market share of petrol sales has fallen from 58%

in 2007/08 to 54% in 2012/13. This change in split between petrol and diesel is broadly

consistent with the change in fuel type within the vehicles registered in the Island. In

December 2009 there were 44,860 petrol vehicles and 21,400 diesel vehicles registered in

the Island. By December 2013 there were 44,680 petrol vehicles (-0.4%) and 24,560

diesel vehicles (+14.7%).

4.5 In monitoring overall prices in the Island the OFT also identifies prices charged at both MP

and EVF branded sites within the sample

Figure 11 – Price Differentials between branded sites (Petrol)

The overall average observed differential between the two brands for unleaded petrol was

0.31 pence per litre. The differential ranged from zero to 3 pence per litre.

100.00

105.00

110.00

115.00

120.00

125.00

130.00

135.00

140.00

145.00

150.00

155.00

04

/10

06

/10

08

/10

10

/10

12

/10

02

/11

04

/11

06

/11

08

/11

10

/11

12

/11

02

/12

04

/12

06

/12

08

/12

10

/12

12

/12

02

/13

Pe

nce

pe

r Li

tre

Unleaded Petrol Prices (EVF v MP)

EVF UL Price MP UL Price


Figure 12 – Price Differentials between branded sites (Diesel)

The overall average observed differential between the two local brands for diesel is 0.16

pence per litre. The differential ranged from nil to 2 pence per litre.

4.6 Throughout the period of this Report there has been broad equilibrium between the two

importers in terms of market share. Certainly neither has obtained a real degree of market

dominance. There have, however, been changes in market share within a range of plus or

minus 10% which signify the implications of competition between the two brands in the

retail market.

100.00

105.00

110.00

115.00

120.00

125.00

130.00

135.00

140.00

145.00

150.00

155.00

160.000

4/1

0

06

/10

08

/10

10

/10

12

/10

02

/11

04

/11

06

/11

08

/11

10

/11

12

/11

02

/12

04

/12

06

/12

08

/12

10

/12

12

/12

02

/13

Pe

nce

oe

r Li

tre

Diesel Prices (EVF v MP)

EVF Diesel Price MP Diesel Price


Figure 13 – Road Fuels Market Share 2007 to 2013

4.7 There are currently 20 commercial filling stations in the Island supplying road fuel

products. Of these, eight are MP branded stations, eleven are EVF branded stations and

one is an independent non-branded station (Fairy Cottage – diesel only). Since the last

Liquid Fuel Investigation Report (published in 2010), only one filling station (Glen Mona,

Maughold) has closed on the Island.

Though 19 of the stations are company branded, they exist under three different operating

models:

• company owned/company operated – where the fuel supply company owns

the site and has control over the operation;

• company owned/dealer operated – where the company owns the site but

leases it to an independent manager; and

• dealer owned/dealer operated – where the individual dealer owns the site

and operates it himself.

Manx Petroleum do not operate any MP branded retail sites. Manx Petroleum recently

purchased the real estate of Milestone filling station on Peel Road, Douglas and the

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007/8 2008/9 2009/10 2010/11 2011/12 2012/13

Manx Petroleum Ellan Vannin Fuels


premises were immediately leased by Manx Petroleum to CI Newsagents Ltd. At the same

time CI Newsagents Ltd. purchased the ingoing of the retail business from the previous site

owner/dealer. The property at this site is company owned, but the retail business is owned

and operated by CI Newsagents Ltd.

In March 2013 six of the Ellan Vannin Fuels branded stations were company owned and

operated, whilst four were dealer owned and operated and one was company owned but

dealer operated. Subsequently, prior to the publication of this Report, this changed so that

now eight of the EVF branded stations are company owned and operated and three are

dealer owned are operated.

Whereas company owned sites have internal contractual arrangements with their parent

fuel supply company, the independent, dealer owned/dealer operated stations secure long-

term fuel supply contracts (or sole supplier agreements) with one or other of the fuel

suppliers. These agreements are time limited (typically lasting for five years) and restrict

the retailer from buying petrol and diesel from distributors other than the contracting party.

The nature of the arrangements vary between companies and between dealers according

to the timing of the contract renegotiation, the strategic importance of the dealer to the

distributor (in terms of location or throughput) and the precise terms and conditions.

It would appear to the OFT that the two importers see site branding as pivotal to the

growth of market share and as a result both are keen to expand their network and equally,

if not more, keen to defend their existing network. Only one site has changed branding in

recent years (Airport Garage from Total to Manx Petroleum) and therefore there is

currently a broad equilibrium in the retail market. Both companies have invested

significantly in their retail offering in order to make their secondary offering more

attractive. Not only are secondary retail revenue streams themselves important to petrol

retailers but the secondary retail offering appears to influence consumer choice and hence

drive petrol sales.

4.8 The retail stability in the Isle of Man is in stark contrast to the situation in the United

Kingdom6 where road fuel retailing is a highly competitive business, a trend that has

accelerated during the 1990s and into this century. With around thirteen significant players

in the UK retail fuels market, pump prices in the UK have been consistently amongst the

lowest in Europe, excluding duty and VAT.

These conditions reflect, in part, the growing presence of supermarkets, whose share of

the retail fuels market has grown from 19% in 1997 to over 40.4% in 2012. This growth

has coincided with a rapid expansion in their large out-of-town stores, with filling stations

able to sell large volumes of fuel, particularly to people doing their weekly shop at the main

store; and headline fuel prices being viewed as a significant factor in consumer decision

making.

The overall effect of this has been to force the closure of smaller and less well located

filling stations, a trend that has been compounded by the increasing costs of meeting

6 http://www.ukpia.com/industry_information/marketing.aspx


stricter environmental standards. The result is that the number of filling stations in the UK

has fallen from about 18,000 in 1992 to 8,714 in 2012.

Figure 14 – Decline in UK Petrol Stations7

Increasingly, the slim margin on fuel retailing has prompted the redevelopment of many

sites to boost volume throughput and provide a better standard of service and facilities,

with particular emphasis on larger shops or convenience stores which are a vital element in

overall site profitability.

In a highly competitive market place with high volumes and low margins, changes in

underlying factors, such as cost of refined product and exchange rates, tend to be reflected

fairly quickly in pump prices as retailers cannot afford to ignore market fluctuations for any

length of time.

4.9 Finally it is important to recognise the significance of taxation on fuel prices. There are two

types of taxation on road fuel which together account for around 60% of the final price

paid at the pump; fuel duty which is a fixed amount and VAT which is based on the selling

price at the pump. The IOM and UK have a customs union and so any changes made by

the UK Treasury to indirect taxes such as VAT and fuel duty have an impact in the Isle of

Man. Changes in taxation are shown in the following Tables.

7 Petroleum Review Retail Marketing Survey 2012/13

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total Number of Petrol Stations in the UK


Table 2 - Changes in VAT Rate

DATES VAT RATE

01 December 2008 to 31 December 2009 15.0%

01 January 2010 to 03 November 2011 17.5%

04 November 2011 to Present 20.0%

Table 3 – Changes in Fuel Duty

DATES PETROL DUTY

PER LITRE DIESEL DUTY

PER LITRE

01 December 2008 to 31 March 2009 52.35p 52.35p

01 April 2009 to 31 August 2009 54.19p 54.19p

01 September 2009 to 31 March 2010 56.19p 56.19p

01 April 2010 to 30 September 2010 57.19p 57.19p

01 October 2010 to 31 December 2010 58.19p 58.19p

01 January 2011 to 22 March 2011 58.95p 58.95p

23 March 2011 to Present 57.95p 57.95p


5. CHANGE FACTORS – 2010 TO 2013

5.1 The comprehensive investigation pursuant to section 19 of the Fair Trading Act 1996

(as amended) and the resultant 2010 Report concluded that there were valid reasons

for the price differential for road fuels between the Island and the United Kingdom. It

concluded that both the importers (at the time Manx Petroleum as a Shell agent and

Total (IOM) Ltd.) and petrol retailers were making a reasonable, but not excessive,

level of profits. Whilst the investigation was undertaken by the OFT those conclusions

were based on analysis undertaken by specialist external consultants. In this section

consideration will be given to developments over the intervening period and their

impact on the price differential.

5.2 The 2010 Report highlighted Isle of Man Factors which would always lead to a higher

road fuel prices:-

Smaller buying power

High shipping costs; and

Economies of scale.

What was not recognised at the time of the 2010 Report was that the UK market was

itself one of the most effective and efficient fuel markets in Europe. In the conclusion

of the 2013 United Kingdom Office of Fair Trading Report, UK fuel prices were

(excluding taxes) amongst the cheapest in Europe was startling.

5.3 In terms of buying power the situation has probably worsened slightly since the 2010

Report. At the time of the Report Manx Petroleum was operating as a Shell agent and

buying from a Shell Refinery. The ensuing changes mean that it is now an independent

small supplier buying from a large refinery. Equally in 2010 Total (IOM) Ltd. was a part

of Total and whilst following the changes it remains part of a large group in the

petroleum industry, if anything, its buying power has lessened. It does not appear that

this has resulted in a direct impact upon prices but it has certainly resulted in the

transfer of a degree of commercial risk in the transactions from the refinery to the local

importer. In summary the two fuel importers remain in the position of being “price

takers” from the big refineries.

5.4 The high cost of shipping road fuels to the Island was cited as significant in 2010

accounting for between 0.8 pence per litre and 1.1 pence per litre to the overall cost

differential. Certainly shipping costs have increased over the intervening period. There

are very few coastal tankers of a size (draft and length) suitable for the ports of

Douglas and Peel and thus the two importers are not in a strong negotiating position.

This has led to an increase in shipping costs of around 20% between 2009 and 2013;

partly due to simple price increases and partly due to changes in the way in which

unused space is charged.


The cost of the vessel is not the only cost faced by the importer; in addition the

Department of Infrastructure charges for both harbour dues and ship security and

these have risen by 15% and 22% respectively from 2008/09 to 2012/13.

5.5 It is clear that there have been no significant changes in relation to the absence of

economies of scale. Both Manx Petroleum and Ellan Vannin Fuels remain small scale

operations by UK standards but require the full range of infrastructure to operate a fuel

storage depot.

5.6 As part of their response to the 2010 Report the two fuel importers agreed to provide

various ongoing information to the OFT on a strictly commercially confidential basis.

Whilst the OFT has been able to use this data in the preparation of this Report and it

underpins the conclusions, clearly it is not in a position to publish the underlying data.

The OFT understands the principal reason why the two importers would not wish to see

the data published – it would be very useful to their competitor. One of the pieces of

information provided by both Manx Petroleum and Ellan Vannin Fuels are company

accounts. Those accounts relate to the whole business rather than simply the

petroleum importation business and therefore do not enable a judgement to be made

as to the source of profit. However, both indicate that the relative profitability of their

different business streams have not changed over the intervening period. Equally, given

that road fuels are such a significant proportion of the overall business, it is difficult to

see how any step change in profitability in relation to road fuels could fail to make a

discernable impact on overall profits. In both cases the net profitability has actually

declined since the period covered by the 2010 Report.

5.7 Whilst the confidential data provided by the two importers does not allow a detailed

examination of changes in net retail margins it does at least allow analysis of any

changes in gross margins. The gross retail margin has risen from around 3.7 pence per

litre in the 2010 Report to around 5 pence per litre in March 2013; which is not

unexpected given rising costs over the period. The average gross retail margin in the

2010 report represented approximately 3.8% of the sale price and by March 2013 this

had fallen to a 3.4% margin.

5.8 In the 2010 Report there was an analysis of the make-up of the price per litre of both

petrol and diesel as at January 2009. Over the period of this Report there has been a

substantial rise in the price of both petrol and diesel. Petrol has risen by over 52 pence

per litre and diesel at nearly 48 pence per litre. The main driving force behind the

increase has been the cost of the product; Diesel has risen from 28 pence to over 56

pence and petrol from under 20 pence to over 52 pence. Duty and VAT for petrol and

diesel increased from 66 pence to 82 and 83 pence respectively. Although duty is

charged at the same rate for petrol and diesel, VAT is levied as a proportion of overall

price and so the rate is different. The gross margin has fallen slightly for petrol from

7.8% to 7.7% whilst diesel has declined from 9.9% to 7.9%. It must be emphasised

that in this context and in the following Figures “Gross Margin” is not profit. Whilst it

includes profits at both wholesale and retail levels it also includes the complete costs

incurred in both the wholesale and retail operations. In 2009 duty and VAT accounted


for 71% and 63% of petrol and diesel. Both have fallen to 56% and 55% of the total

price. The product now accounts for 36% of petrol and 37% for diesel prices. In 2009

the proportions were 21% for petrol and 27% for diesel.

Figure 15 – Petrol Price Breakdown 2009 @ 93.07 pence per litre

Product

21%

Duty & VAT

71.2%

Gross

Margin

7.8%

Product

35.9%

Duty & VAT

56.4%

Gross

Margin

7.7%

Figure 16 - Petrol price breakdown 2013 @145.9 pence per litre


Product

26.9%

Duty & VAT

63.2%

Gross

Margin

9.9%

Figure 17 -Diesel price breakdown 2009 @104.4 pence per litre

Product

37.3%

Duty & VAT

54.8%

Gross

Margin

7.9%

Figure 18 -Diesel petrol price breakdown 2013 @151.9 pence per litre


6. CONCLUSIONS

6.1 The 2010 Report described a market with two participants, Manx Petroleum as a Shell

agent and Total (IOM) Ltd.as a subsidiary of Total UK. Whilst the market participants

have changed and are now Manx Petroleum in their own right and Ellan Vannin Fuels, in

both cases they have inherited the infrastructure and basic business models of their

predecessor. The overall market has shrunk in size by 7.5%.

6.2 The 2010 Report concluded that the levels of profitability enjoyed by the two petrol

importers were fair and reasonable. Evaluation of the audited accounts provided under

commercial confidentiality by both importers suggests that overall profitability has

declined slightly.

6.3 Both Manx Petroleum and Ellan Vannin Fuels have invested heavily in depot

infrastructure in order to meet evolving standards of health and safety. Both have also

had to invest in rebranding following changes of ownership and both have invested

(directly or indirectly) in the quality of their petrol stations and the associated retail

offering.

6.4 Throughout the period covered by this Report there has been limited variation in the

retail prices charged by the two brands but this is not surprising given that the operating

models of the two businesses and the associated costs are very similar.

6.5 Competition between the two brands appears to have been focussed on the secondary

retail offerings and the filling stations themselves. To a lesser extent both MP and EVF

appear to look at opportunities to gain market share through site acquisition and are

equally keen to retain existing sites. As a result site branding is fairly constant with both

brands generally in competition in most localities.

6.6 Whilst the overall market for road fuels between the two brands has remained in broad

equilibrium following the 2010 Report, the competition between MP and EVF has

resulted in measurable changes in market share.

6.7 The current market (which in economic terms is an oligopoly) offers a number of

advantages:-

Competition between MP and EVF, together with market scrutiny by the OFT

ensures a reasonable level of prices and the avoidance of excessive profits.

The fact that there are two completely independent supply infrastructures offers

the Island considerable resilience of supply.

The nature of the competition between MP and EVF has resulted in the Island

maintaining a good geographic spread of filling stations.


Those benefits do, however, come at a cost because the price paid at the pump is

inevitably supporting two small storage and supply infrastructures.

6.8 The 2010 Report concluded that the retail margins enjoyed by the petrol retailers were

fair and reasonable in the context of the scale of operations. There is no evidence that

retail margins have increased disproportionately since then. It must be recognised that

margins in the U.K. have over that period been subject to significant downward pressure

as a result of the supermarkets, leading to a decline in the number of petrol stations.

6.9 The 2010 Report concluded that whilst the prices charged for liquid fuels in the Island

were higher than those charged for in the United Kingdom there were various factors,

which contributed towards this. The difference in the scale and scope of the United

Kingdom and Isle of Man liquid fuel markets, together with the additional costs and

overheads incurred in supplying bulk fuel to an Island community, contributed to the

price differential. Nothing that the OFT has discovered through its ongoing monitoring or

in the production of this Report suggests that a full price investigation pursuant to

section 19 of the Fair Trading Act 1996 would produce a different conclusion today.

6.10 In section 1.8 of this Report we posed three key questions which would inform any

decision by the OFT Board with regard to a further section 19 investigation. We now

provide the answer to those questions:-

Question: Can any changes in differentials between Manx prices and the

selected UK benchmark since the last investigation be explained?

Answer: Yes – there have been increases in costs such as shipping which

explain the changes. Market shrinkage has not helped – overall the

market volumes are down by 7.5%.

Question: Have there been any material changes to the profitability of the fuel

importers since the last investigation?

Answer: Importer margins have reduced slightly.

Question: Have there been any material changes to the profitability of the

forecourt retailers since the last investigation?

Answer: Whilst we have not been able to look at net margins, gross margins

appear to have reduced as a percentage of the sale price but

increased in absolute terms. Overall there is no evidence that petrol

retailing has become significantly more profitable.

6.10 As a result of the above conclusions the OFT Board does not propose to initiate a further

formal investigation pursuant to section 19 of the Fair Trading Act 1996 at this time.

6.11 The OFT Board recognise that there is ongoing public concern about road fuel prices and

will continue to monitor the market. If at any stage there is any evidence of

unreasonable profit levels or other market abuses the Board will not hesitate to use its

formal investigatory powers.


SUMMARY OF FIGURES AND TABLES

Figure 1 Road Fuel Market Structure

Figure 2 Supply Chain for Road Fuels 2010

Figure 3 Supply Chain for Road Fuels 2013

Figure 4 Comparison of UK & IOM Pump Prices (Petrol)

Figure 5 UK & IOM Price Differential (Petrol)

Figure 6 Comparison of UK & IOM Pump Prices (Diesel)

Figure 7 UK & IOM Price Differential (Diesel)

Figure 8 Comparison of Crude Oil and Road Fuel Prices

Figure 9 Price difference between Petrol and Diesel

Figure 10 Isle of Man Market Size (Petrol & Diesel)

Figure 11 Price Differentials between branded sites (Petrol)

Figure 12 Price Differentials between branded sites (Diesel)

Figure 13 Road Fuels Market Share 2007 to 2013 Figure 14 Decline in UK Petrol Stations

Figure 15 Petrol Price Breakdown 2009

Figure 16 Petrol Price Breakdown 2013

Figure 17 Diesel Price Breakdown 2009

Figure 18 Diesel Price Breakdown 2013

Table 1 Total Volumes of Petrol and Diesel Sold in the Isle of Man

Table 2 Changes in VAT Rate

Table 3 Changes in Fuel Duty


Documents

Dear Tynwald Members, Road Fuel Report published in 2014