Minimum Price Regulations and Equilibrium Market qed.econ. Price Regulations and Equilibrium Market

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  • Minimum Price Regulations and Equilibrium

    Market Structure

    Understanding the Quebec Gasoline Retailing Industry

    Jean-Francois Houde

    May 6, 2004

    0-0

  • Motivation

    Since 1997, the Quebec government has created a regulatoryboard (Regie de lEnergie du Quebec) to monitor and controlgasoline prices.

    The stated motivation of this regulation is to protect a categoryof retailers (i.e. independents) against predatory pricingbehavior from the majors (i.e. vertically integrated retailers).

    Similar regulations in the United States and in Canada havecontributed to raise the average prices (Anderson and Johnson,RIO, 1999).

    1

  • Over the 90s, the North-American Industry has undergone alarge reorganization:

    Reduction in the number of stations

    Change in the mix of products offered

    Entry of large capacity stations

    Recent evidences in Quebec suggest that this reorganizationhas been delayed or less pronounced.

    What is the role of the regulation on this late reorganization?

    2

  • Main Question

    What is the impact of the price regulation in

    Quebec on the recent evolution of the gasoline

    industry ?

    3

  • Specific Questions

    Does the regulation reduce the incentive for inefficient retailersto exit the market, and for the more efficient ones to enter?

    Can we quantify the rents given to the independent retailers?

    How does the regulation affects the equilibrium structure of themarket (i.e. number, size and characteristics of stations), andthe outcomes (prices and profits) ?

    4

  • Road map of the presentation

    Organization of the industry

    Historical background and general tendencies in the market

    Description of the regulation

    Data available

    Description of the markets: Geographical distribution of stations and brands

    Price and markup distributions

    5

  • 1 Organization of the industry

    6

  • 2 Historical background and trends

    2.1 Increase of the concentration in the retailing

    sector:

    Between 1989 1995 the number of gasoline stations inCanada has decreased by 25%.

    In Quebec, the adjustment process has been slower and lesspronounced.

    Table 1: Changes in the number of stations in Quebec

    1989/1995 1995/1998 1998/2001 2001/2003

    % stations 8.45 10.38 9.10 7.41

    7

  • 2.2 Changes in the type of station:

    Over the 80s the independent retailers have increased theirmarket share by offering unbranded gasoline at lower prices,through a network of self-service stations.

    The number of gasoline stations offering full services (includingcar repair) has declined relative to self-service stations withconvenient store.

    8

  • .65

    .7.7

    5.8

    .85

    5000

    5500

    6000

    6500

    7000

    Num

    ber o

    f sta

    tions

    in Q

    uebe

    c

    1985 1990 1995year...

    Number of stations in Quebec Market share of major retailersPercentage of fullservice

    Figure 1: Trends in the province of Quebec between 1985 1997

    9

  • 2.3 Increase in the average sales per station:

    Over the 90s the major companies attempted to increase thevolume of their station by opening larger capacity station.

    In the late 90s, a new category of stations entered mostnorth-american markets: the hyper-marts. These stationsare typically independent retailers associated with otherhyper-mart retailers like Costco or Wal-Mart.

    They have a volume 8 to 10 larger than regular stations. In2002, 5.4% of the US sales were made by these hyper-martsretailers.

    In Ontario, Wal-Mart, Costco, Loblaws and Safeway havealready entered. In Quebec, only Costco is present in themarket, with one station.

    10

  • Table 2: Average annual sales volume per station in Quebec andOntario

    Years Quebec Ontario Difference

    Independent Majors Total

    ML/Y ML/Y ML/Y ML/Y ML/Y

    1992 1, 58

    1995 2, 0 3, 5 1.5

    1998 1, 338 2, 837 2, 34 4, 22 1, 88

    2002 1, 455 3, 259 2, 64 4, 78 2, 14

    Source: CAA and Option Consommateur report (2002)

    11

  • 3 Description of the regulation

    The Quebec government chose to regulate the gasoline industryafter the occurrence a major price war during the summer of1996, and over the year 1997.

    The law on petroleum products was created in the summer of1997. It is administrated by the Regie de lenergie du Quebec.

    The mandate of the board is threefold:1. Monitor the gasoline industry, and gather information of

    prices

    2. Determine a weekly floor price or Minimum Estimated Price(MEP)

    3. Prevent the occurrence price wars by imposing a minimummargin regulation in a designed geographic market.

    12

  • 3.1 Determination and role of the MEP

    MEP formula:

    MEPmt = wt + tcmt + Tmt

    Where wt is the minimum rack price at the terminal, tcmt is anestimation of the transportation cost to deliver gasoline fromthe refinery to market m, and Tmt is the sum of federal andprovincial taxes.

    The role of the MEP is to set a floor price under which a firmcan sue its competitor(s) to get financially compensated on thebasis of excessive and unreasonable commercial practice.

    This feature of the law facilitate suing procedures betweencompetitors in the market, in a similar fashion as anti-dumpinglaws.

    13

  • 3.2 Description of the minimum margin

    regulation

    The third mandate of the board has been added in August1999.

    It consists of investigating evidences of predatory behavior orpricing anomalies, and deciding wether to add or not aminimum margin of $0.03 in the calculation of the MEP.

    The determination of the $0.03 margin followed from acalculation of the average operating cost of a typical self-servicestation operating a convenient store.

    14

  • 3.3 Example of imposition

    Since 1999 this minimum margin regulation has been imposedthree times in two markets, St-Jerome and Quebec city.

    In St-Jerome (north of Montreal), it was added to the MEPfrom 23/04/2002 to 25/02/2003, and again from the 9/12/2003to the 6/06/2005. The imposition of this price floor followedfrom the entry of Costco in St-Jerome, in 2000.

    In Quebec city, it was added to the MEP from 3/07/2001 to3/10/2001. Its imposition followed from a severe price war inthe Quebec city metropolitan area, over the fall of 2000.

    15

  • Price floor regulationSaintJerome

    5060

    7080

    90

    01jan2001 01jul2001 01jan2002 01jul2002 01jan2003 01jul2003date

    Minimum price (cents/litre) MEP (cents/litre)

    Figure 2: Minimum price in St-Jerome before and after the first pricefloor regulation

    16

  • Price floor regulationQuebec

    5060

    7080

    90

    01jan2000 01jan2001 01jan2002 01jan2003date

    Minimum price (cents/litre) MEP (cents/litre)

    Figure 3: Minimum price in Quebec city before and after the pricefloor regulation

    17

  • 4 Description of the data available

    1. Price information:

    From 1997 to 2004, the regulatory board gives free access toits weekly survey of gasoline prices. The survey includeprice information for two grades of gasoline (regular andsuper) for a panel of stations (between 200 and 250).

    From 1987 to 1997 the average prices for Quebec city andMontreal are available from Natural Resources Canada.

    2. Localization information:

    The Quebec Ministry of Natural Resources and Energycompiled since 1992 the list of gasoline station permits. Itcontains information on the address, the owner, the brand,and partial information of the size of tanks.

    18

  • 3. Station characteristics and sales information:

    For the period 1991 2001, Kent Marketing provided its surveyof gasoline stations in five urban markets: Quebec,Chicoutimi-Jonquiere, Drummondville, Trois-Rivieres,Sherbrooke, Drummondville.

    The data include information on station characteristics(localization, amenities, brand) and sales by gasoline grade, formost active stations.

    For all markets except Quebec, the information is availableevery fourth quarter of each year (10 periods)

    For the stations in Quebec city, the survey is bimonthly for theyear 1995 2001 (42 periods), and annually for the years1991 1994.

    19

  • 5 Geographical distribution of stations

    in the five markets

    5.1 Distribution of stations/brands in each cities

    Does competition is localized or differentiated spatially?

    Do firms are distributed evenly across the cities?

    Do more populated areas have more stations?

    Is there evidence of brand proliferation or agglomeration?

    20

  • Independents

    ESSO

    IRVING

    PETROCANA

    SHELL

    ULTRAMAR

    Municipalities

    Distribution of Stations in Quebec city in 2001

    0 2 4 6 81Kilometers

    21

  • D r u m m o n d v i l l eD r u m m o n d v i l l e

    S a i n t - C y r i l l e - d e - W e n d o v e rS a i n t - C y r i l l e - d e - W e n d o v e r

    S a i n t - C h a r l e s - d e - D r u m m o n dS a i n t - C h a r l e s - d e - D r u m m o n d

    S a i n t - M a j o r i q u e - d e - G r a n t h a mS a i n t - M a j o r i q u e - d e - G r a n t h a m

    S a i n t - N i c p h o r eS a i n t - N i c p h o r e

    20

    55

    3E

    5E

    _

    Lemire

    Saint-Joseph

    Des Pins

    Lalem

    ant

    Saint

    -Geo

    rges

    Jean

    -de-

    Brb

    euf

    _

    5E

    20

    0 1 2 3 40.5Kilometers

    Municipalities

    Indendents

    ESSO

    PETROCANADA