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 l’Energie 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 90’s, 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 80’s 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 full−service

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

9

2.3 Increase in the average sales per station:

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

• In the late 90’s, 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 l’energie du Quebec.

• The mandate of the board is threefold:

1. Monitor the gasoline industry, and gather information ofprices

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 or“pricing 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.

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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.

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Price floor regulationSaint−Jerome

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

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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.

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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.

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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?

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

20

55

3E

5E

_

Lemire

Saint-Joseph

Des Pins

Lalemant

Saint-Georges

Jean-d

e-Bré

beuf

_

5E

20

0 1 2 3 40.5Kilometers

Municipalities

Indendents

ESSO

PETROCANADA

SHELL

ULTRAMAR

Distribution of Stations in Drummondville, 1991

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

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

20

55

3E

_

5E

Lemire

Saint-Joseph

8E

Des Pins

Chass

é

Baril

Laleman

t

108E

Saint-Georges

Jean

-de-

Brébeuf

_

20

Distribution of stations in Drummondville, 2001

22

T r o i s - R i v i è r e sT r o i s - R i v i è r e s

B é c a n c o u rB é c a n c o u rT r o i s - R i v i è r e s - O u e s tT r o i s - R i v i è r e s - O u e s t

C a p - d e - l a - M a d e l e i n eC a p - d e - l a - M a d e l e i n e

S a i n t - L o u i s - d e - F r a n c eS a i n t - L o u i s - d e - F r a n c eS a i n t e - M a r t h e - d u - C a pS a i n t e - M a r t h e - d u - C a p

P o i n t e - d u - L a cP o i n t e - d u - L a c

0300.00

0211.00

0210.00

0101.02

0100.02

0005.00

0003.00

0204.00

0100.01

0200.00

0013.03

0205.01

0013.01

0004.00

0205.02

0008.00

0013.02

0205.03

0010.00

0101.04

0012.02

0002.00

0101.03

0201.00

0011.00

0203.00

0001.00

0012.01

0007.00

0006.00

0202.00

0009.00

755

30

Des Forges

Béc

anco

ur

Thibeau

Jean

-Xxii

i

Richelieu

Transquébécoise

Royal

Patry

Notre-

Dame

Saint-Malo

Rosemont

Félix-Leclerc

Des R

écolle

ts

155

Roy

ale

Saint-Laurent

Laviolette Hart

Hamelin

Fusey

Du

Car

me

l

Rigaud

Du Parc

Saint-Mauric

e

Massicotte

40

Du Rochon

Foucher

Laflamme

Baril

16E

Cartier

Chanoine-Moreau

Thuney

Des Prairies

Courteau

Jacq

ues-Cartie

r

De Courval

Des C

yprès

Des O

rmeaux

Whitehead

De l'Université

Sainte-Marguerite

1E

Saint-Louis

Des Vétérans

Matteau

Sai

nte-

Mar

ie

Du Boisé

Des Prairies

Notre-Dame

Notre-D

ame

Rigaud

Municipalities

Independents

brand

ESSO

IRVING

PETROCANADA

SHELL

ULTRAMAR

Distribution of Stations in the Trois-Rivieres market, 2001

0 0.9 1.8 2.7 3.60.45Kilometers

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5.2 Demographics and the distribution of

gasoline stations

24

Distribution of gasoline sales and average income in Quebec cityAugust - September 2001

0 - 176937

176938 - 317639

317640 - 481514

481515 - 693652

693653 - 1545845

0.00 - 42067.00

42067.01 - 57153.00

57153.01 - 69853.00

69853.01 - 91929.00

91929.01 - 127284.00

25

0 1 2 3 40.5Kilometers

Sales in 2001

Sales Volume as % of total0.073977% - 0.675951%

0.675952% - 1.287491%

1.287492% - 2.046429%

2.046430% - 3.331411%

3.331412% - 4.680277%

Census Tracts

Population Density14.46 - 131.0131.1 - 341.5341.6 - 17551756 - 33713372 - 5265

Distribution of sales and population in the Sherbrooke market, 2001

26

5.3 Distribution of stations in local markets

−2.5 0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0 22.5 25.0 27.5 30.0

0.05

0.10

Number competing firms along a street

−1 0 1 2 3 4 5 6 7 8 9 10 11 12

0.1

0.2

0.3

Number of firms in a 1km neighbourhood along a street

Figure 4: Number of stations in local neighborhood27

0 1 2 3 4 5 6 7 8

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25 Distance from the closest firm

Figure 5: Distance with the closest neighbor

28

5.4 Evolution of the market structure

• How the product mixed changed?

• Did the localization strategy changed?

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Aug/Sept 1991 Aug/Sept 2001

Type of convenient stores in Quebec city

30

Nb Pumps2 - 5

6 - 9

10 - 17

18 - 26

27 - 36

Quebec Aug/Sept 1991 Quebec Aug/Sept 2001

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5.5 Entry and exit patterns

• Does exit is localized?

• Do entry and exit are correlated?

• What types of station are more likely to exit?

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Type of Convenient store for new and closed stations in Quebec

Legend

No C/S

Mini C/S

Medium C/S

Maxi C/S

New stations Closed stations

33

Number of pumps for new stations and closed stations

Legend

3 - 6

7 - 8

9 - 16

17 - 24

25 - 36

New stations Closed stations

34

Type of service offered for new stations and closed stations

Legend

Full

Self

Split

New stations Closed stations

35

J o n q u i è r eJ o n q u i è r eC h i c o u t i m iC h i c o u t i m i

T r e m b l a yT r e m b l a y

S h i p s h a wS h i p s h a w

L a t e r r i è r eL a t e r r i è r e

S a i n t - H o n o r éS a i n t - H o n o r é

L a c - K é n o g a m iL a c - K é n o g a m i

L a B a i eL a B a i e

70

Talbot

170

Du Royaume

Du Saguenay

Roussel

Sainte-Geneviève

Bégin

Harvey

Mat

hias

Saint-Damien

Saint-Paul

De la Réserve

Royaume, du

Drake

Mel

lon

De Vimy

Sain

t-Dom

iniq

ue

Du Roi-Georges

Del

isle

Racine

Du Pont

De l'Université

Saint-Anto

ine

Jacques-Cartier

_

Sai

nt-H

uber

t

De Saint-Léonard

Price

Sai

nt-M

artin

De Tadoussac

Mal

raux

Saint-François

Hu

dson

Vimy

De la Salle

Fabien

Garnier

Wolfe

Du Plate

au

Paré

Lorne

Des Champs

De Saint-Léonard

De Tadoussac

_

Mathias

Du Saguenay

Vimy

_

Royaume, du

Distribution of new, closed, and suvrivor stations in the Chicoutimi market

0 2.5 5 7.5 101.25Kilometers

Legend:Nb of Pumps

3

4

5 - 6

7 - 10

11 - 12

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5.6 Main conclusions from the maps

1. Stations are not uniformly distributed: competition is highlylocalized at intersections and along streets (local markets).

2. They are not highly geographically differentiated from eachother (principal of minimum differentiation holds).

3. The major four brands are present in most of the local markets(symmetric localization strategies).

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4. Most of the exit took place between 1991− 1996.

5. The exit decisions are correlated within local areas.

6. Entry occurred less frequently.

7. Stations do change the type of products they offer (number ofpumps, brand, convenient store, etc.)

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6 Pricing patterns in the five markets

6.1 Average margin across time and markets:

• Is there evidence that retail margins are higher after theregulation?

• Do we observe cross-sectional differences between markets?

39

09/1997

08/19990

510

15

1990m1 1995m1 2000m1 2005m1Month

Yearly average margin (cents/litre) Mean margin (cents/litre)

Figure 6: Margin on regular gasoline in the Quebec market

40

05

1015

05

1015

1998q1 2000q1 2002q1 2004q11998q1 2000q1 2002q1 2004q1

chicoutimi drummondville

sherbrooke trois−rivieres

Yearly average margin (cents/litre) Mean margin (cents/litre)

Quarter

Graphs by id_market

Figure 7: Margin on regular gasoline in the four regional markets

41

6.2 Price dispersion

• Does the regulation affects the distribution of prices withincities?

• Can price differences be explained by product/locationdifferentiation?

• Do price differences are temporary or permanent?

• Is there differences across markets?

42

Before August 1999

pit+1 < pmt+1 pit+1 = pmt+1 pit+1 > pmt+1

pit < pmt 43.12 41.26 15.62

pit = pmt 16.26 69.63 14.10

pit > pmt 17.98 32.63 49.40

After August 1999

pit+1 < pmt+1 pit+1 = pmt+1 pit+1 > pmt+1

pit < pmt 42.31 43.73 13.95

pit = pmt 14.15 72.61 13.24

pit > pmt 11.42 33.80 54.77

note: pmt is the median price in market m during week t.

Table 3: Transition matrix of individual prices within the weeklyprice distribution of all urban markets.

43

020

4060

80

−.2 −.1 0 .1 .2Log Deviation from the mean price (reg)

t < 08/1999 t> 08/1999

020

4060

80−.2 −.1 0 .1 .2

Log Deviation from the mean price (sup)

t < 08/1999 t> 08/1999

Figure 8: Kernel densities of the log-deviation from mean price forall urban markets in Quebec before and after 1999

44

050

100

150

050

100

150

−.1 0 .1 −.1 0 .1

chicoutimi quebec

sherbrooke trois−rivieres

Den

sity

Log Deviation from the mean price (reg)Graphs by id_market

Figure 9: Distribution of log-deviations from mean price for the re-gional markets except Drummondville

45

6.3 Main conclusions from the price information

1. There is no clear evidence that the average retail margin ishigher under the regulation.

2. There are important cross-sectional differences across themarkets:

• Stations in Chicoutimi have a significantly higher averagemargin than in the other markets.

• The margin is more volatile in Quebec.

• The amount of price dispersion is different between cities.

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3. On aggregate the price dispersion is low and less persistentthan other markets (see for e.g. Lach (2002)).

4. The regulation seems to affect the distribution of prices:

• The frequency of periods with no price dispersion increased

• There is less price dispersion after August 1999. Firms seem tobe able to better coordinate after the implementation of theregulation.

5. Higher retail margin is associated with lower price dispersion(e.g. Chicoutimi).

47