As in most other jurisdictions, security of supply and pricing of refined petroleum products ("RPP") has long been a concern in New Brunswick. This was demonstrated in public hearings held by the Select Committee on Gasoline Pricing. Their final report, issued in 1997, addressed the perceived deficiencies in the New Brunswick gasoline market. In response, the Province undertook to improve monitoring and reporting of the industry, and worked toward preventing discriminatory pricing practices, as recommended by the Select Committee.

The energy policy proceeds to the next step by developing measures which broaden the scope of recommendations to include motor fuels and heating oil, and by increasing the extent to which information is monitored and reported.

1. Background

Refined petroleum product distribution in New Brunswick is highly fragmented due, in part, to a sparse population that is dispersed across rural areas and urban centres. In addition, the numbers of people in various areas are relatively small. Not surprisingly, the scale of the oil and gasoline business at the distribution level reflects the population density. While individual businesses are small and dispersed, most are affiliated with only a handful of corporations.

At the wholesale level, the market area is regional in nature. For New Brunswick, refined products can be obtained either directly or through exchanges from refineries and terminals in Quebec, Nova Scotia, and New Brunswick. Two refineries, one in Saint John and one in Dartmouth, Nova Scotia supply the majority of product to New Brunswick. The Imperial Oil refinery in Dartmouth has a capacity of 82,200 barrels of crude per day while the capacity of the Irving Oil refinery in Saint John is 250,000 barrels per day, of which 50% is exported. The Northwest region of the Province receives supply from the Diamond Shamrock (Ultramar) refinery in St. Romuald, Quebec. Product is also transported by rail from the Shell refinery in Montreal, Quebec to the Miramichi terminal.

Despite the large scale of these refining operations relative to the local markets, it is important to understand that these suppliers are participants in global oil markets. The prices of their crude oil inputs and refined petroleum product outputs are determined, for the most part, by markets clearing in commodity exchanges such as the New York Mercantile Exchange ("NYMEX"). Regional refiners such as particularly for the parties that are not fully integrated, i.e., Irving Oil Limited and Ultramar are particularly exposed because they are not fully integrated, i.e., they do not produce crude oil. To some degree the volatility in the oil markets is exacerbated by traders who collectively move the market in response to production, demand and inventory statistics, and inferred behaviour of major Organization of Petroleum Exporting Countries ("OPEC") cartel. At a bulk wholesale level, these refiners are essentially price-takers for crude oil, gasoline, and distillate oil (home heating oil and No. 2, ddiesel fuel). Like other refiners, they likely use all the financial tools necessary to manage their price exposure and minimize their risk. Nonetheless, with no upstream production to buffer this price volatility, the prices established in this worldwide market flow through to the retail market. Even fully integrated producers can be expected to flow through these NYMEX-based prices because they represent the opportunity cost against which retail sales margins must be compared. With wholesalers and retailers attempting to drive down costs by reducing inventories, these prices are likely to flow through the value chain more quickly.

At a regional market level, wholesale prices for refined petroleum products are determined partially by commodity markets and partially by local supply and demand conditions. These local conditions include the amount and availability of bulk storage, terminal capacity, inventory levels, number of retail outlets, volume of sales per outlet, demand for refined petroleum products, and expected prices.

As discussed, distributors receive product from terminals or refiners in Nova Scotia, New Brunswick or Quebec. Product is either transported by truck, rail or barge, or exchanged between parties with offsetting inventory positions. The transportation cost from Dartmouth, Nova Scotia to most outlets in New Brunswick, including the cost of marine transport to the distribution terminals, is between 1¢ and 2¢ per litre. Transportation costs for outlets serviced by the Saint John refinery are generally less. Truck transport costs are estimated to be between 0.4¢ and 0.5¢ per litre per 100 kilometres. No outlet in New Brunswick is very far from a wholesale terminal. There are distribution terminals ("racks") in Saint John, Miramichi and Belledune. To some degree, this is symptomatic of the challenges posed by refined petroleum products market in New Brunswick. The small size of the market challenges wholesalers to aggressively control fixed costs such as storage. Product is picked up at these locations, then re-delivered to local storage, dealer outlets, or directly to customers.

At the retail level, competitive pressures in local markets and taxes determine prices for gasoline and distillate oils. These competitive pressures include prices charged by competing sellers, and costs experienced by the final distribution operations (dealer outlets and heating oil distributors). The margins are determined by the difference between the locally determined retail price, net of taxes, and the wholesale price. Other components of distribution, such as the price and availability of trucking and bulk storage capacity, add to the complexity and lack of transparency of prices. Also, dealer outlets with relatively small sales volumes often have higher average costs than a large volume outlet. Accordingly, the cost structure of different competitors may either justify a higher price, or make an outlet uncompetitive. These differing dealer cost structures also can contribute to the differences in prices between outlets.

The potential for market power along the distribution chain is an issue, given the small size of the New Brunswick market and the limited number of wholesalers. With most wholesalers also having retail operations, they are able to squeeze margins to independents by electing to take their margin at the wholesale level and increasing wholesale prices. Furthermore, there is the potential for horizontal market power given the limited number of competitors. One persistent challenge for the Province is to monitor industry pricing so that anti-competitive behaviour can be evaluated.

The volatility in local markets can be explained by the impact of independent marketers and independently owned "branded" outlets who may relinquish retail margin in an attempt to lower prices and increase market share. The result is often a price war as all competitors fight to protect their market share.

During periods of high input costs, refiners attempt to limit the amount of crude oil in storage to the minimum amount of crude oil necessary to feed their refineries. This avoids the risk of incurring inventory losses when crude costs decrease and retail prices drop. In 2000, inventories in the U.S. were at a 24-year low, resulting in volatile retail prices. After the Gulf War, prices collapsed at the retail and wholesale level and refiners were forced to absorb the costs of crude oil purchased during the war. As a result, the industry moved to "last in, first out" pricing to avoid getting caught in a future pricing squeeze. Currently, retail prices reflect international pricing events of the previous two weeks and the oil industry would like to see this delay reduced even further. This is the only industry that allows almost direct consumer participation at all levels in the market place, in that decisions made by the consumer to purchase (or not purchase) the product has an almost immediate impact on prices. However, consumers appear to want stable prices that are competitive with other jurisdictions.

In New Brunswick, refined petroleum product policy issues include prices that reflect the functioning of efficient and competitive markets, access to accurate and timely information, security of supply and economic stability.

2. Efficient and Competitive Markets
1. Motor Fuels

New Brunswick has approximately 680 retail gasoline outlets, which has fallen from approximately 1400 outlets in the 1970s. The province’s retail market is highly concentrated, with two companies sharing 62% of the retail outlets, and four companies sharing the next 21%. Further, 36% of the retail outlets are owned by the dominant wholesaler. Other dominant companies are either completely integrated or integrated to the refinery level. They can compete for business at either the retail or wholesale level.

Less than 10% of outlets are classified as independents. Independent outlets are classified as those which are not owned by an integrated oil company and do not operate under the brand name of an integrated oil company. New Brunswick has the second lowest percentage of such independent outlets in Canada. The Select Committee on Gasoline Pricing concluded that this has played a role in the degree of competition in the market and the price differences between New Brunswick and other jurisdictions, with the presence of independents having a downward impact on prices. An analysis conducted by the Select Committee on Gasoline Prices indicated that "in general, the counties with the most independents have the lowest prices and the counties that have the highest degree of domination by a single firm have the highest prices."

The average volume of sales of gasoline per outlet in New Brunswick is about 1.36 million litres annually, compared to a Canadian average of approximately 2 million litres. Given the relatively low throughputs for outlets in the province, there has been an ongoing rationalization of outlets The increased prevalence of Convenience Marts drives down retail gasoline margins as owner/operators view these margins as just one source of profit and increased gasoline sales have the potential to lead to other sales. The forced replacement or upgrading of underground storage tank systems through compliance with the Underground Storage Act caused a number of outlets to close because they could not justify the cost. The Wellfield Protection Regulation, under the Clean Water Act, will result in the closure of all outlets that are in established wellfields. Upgrading and re-routing of the TransCanada Highway will limit direct access, forcing further rationalization. These pressures, and others, will result in further reductions in the number of retail outlets.

To the degree to which consolidation occurs among independents this could have an adverse effect on competition. However, there are few policy levers available that do not require outright market intervention, or, other than monitoring industry pricing to ensure that any consolidation is attributable to market economics rather than uncompetitive behaviour.

Although consumers appear to desire stable prices and view disparities in prices across the province as evidence of uncompetitive behaviour, such price outcomes are unlikely to be achieved and in fact are more likely to indicate an uncompetitive market than a competitive market. Disparities between gasoline prices in different parts of the province are explained by differences in transportation costs, inventory levels (and hence different costs of gasoline in inventory) and local market conditions, e.g., a price war in one market versus a stable pricing relationship in another.

Diesel fuel for use in the transportation of goods is important to the New Brunswick economy given its reliance on the trucking industry for imports and exports. This market is significantly influenced by events in the home heating oil market because of the similarities between the two fuels. However, because of the large single volume diesel purchases, margins are lower than for the motor gasoline market, and there are fewer competitors. As well, the harmonized sales tax component of the price is returned to the purchaser in the form of a tax credit.

Regulation of sulphur content also has an effect on supply competitiveness and gasoline pricing. In 1999, Environment Canada mandated that the average sulphur content in gasoline be reduced to 150 parts per million ("ppm") by July 2002 and further reduced to 30 ppm by January 1, 2005. Refiners across Canada would like these measures harmonized with actions in the U.S. New Brunswick’s only refinery is already capable of producing gasoline with less than 150 ppm of sulphur, and expects to achieve 30 ppm by 2002. The U.S. Environmental Protection Agency (E.P.A.) has mandated U.S. refiners to phase in 30 ppm sulphur content between 2004 and 2007. Low sulphur gasoline is required by car manufacturers by 2004 for new vehicles which have new and improved pollution control equipment that is sensitive to high levels of sulphur. There is concern that these regulations will result in short term supply disruptions and price spikes similar to the price spikes experienced during the 2000 motoring season in the U.S. Mandated changes in fuel qualities can result in temporary shortages as the existing storage facilities prove to be inadequate for additional fuel types. Natural Resources Canada and Industry Canada have undertaken a study into potential supply disruptions as a result of the new regulations. Similar concerns were raised when low sulphur diesel was introduced in the mid-1990s and they proved groundless.

Beyond low sulphur gasoline initiatives, Environment Canada is planning to implement ultra-low sulphur diesel fuel regulations that would result in a level of 15 ppm by 2007. During the transition, these and other regulations regarding fuel quality will add further pressure on available supplies of gasoline and diesel oil and may result in price spikes.

As discussed, a host of factors influence supply and, hence, pricing of gasoline and diesel oil. In Canada, the regulation of retail prices is left to the discretion of the provinces. Prince Edward Island is the only province to implement full retail gasoline price regulation. Experience has shown that regulated prices may remain low in the short-term but they tend to be higher than unregulated prices in the longer term. Studies conducted by the American Petroleum Institute have determined that in the U.S., states with price controls tend to pay higher retail prices.

A comparison of prices in markets with price regulation and those without and the distortions that result from such regulation indicates that workably competitive RPP markets produce better price outcomes than those that result from the distortions caused by price regulation. Consequently, the Province will only intervene with price regulation in the refined petroleum product markets if there is in the evidence of market failure. However, the Province, if confronted with evidence of the abuse of market power, will bring such evidence to the attention of the Competition Bureau and encourage them to take action.

2. Heating Oil

The heating oil market is relatively concentrated with only a small number of suppliers. Of the 77 retail oil dealers in the province, 18 are affiliated with one company. Another five carry some brand identification. Most of the major oil companies as well as several independent marketers compete in the heating oil market. The major oil companies act as wholesalers supplying independently owned and operated outlets. With the exception of one company, most major oil companies do not own and operate retail dealerships.

Because of the large quantities of product purchased at any given time, retail prices for heating oil do not fluctuate as much as gasoline prices.

In New Brunswick, 25% of households rely on heating oil as the primary source of heat. Given that demand is primarily determined by weather conditions, a cold snap early in the heating season, while inventories are still building from the changeover from high gasoline runs, can result in a dramatic run-up in prices. The shutdown of a major refinery in North America during the heating season can have a similar effect on prices. Therefore, price volatility such as that experienced during the winter of 1999-2000 continues to be a significant concern. During this period, a bout of severe winter weather in the U.S. Northeast, following two relatively mild winters caught both suppliers and consumers in the region by surprise. The sudden increase in demand for heating fuels coupled with insufficient supplies and supply route disruptions pushed prices up rapidly. As a result of supply problems and the ensuing price increases experienced in the U.S. Northeast, retail prices across Eastern Canada increased accordingly. New Brunswick retail prices increased by 43% during the 1999/2000 heating season.

Given that its similarity to home heating oil and , diesel fuel are similar products, diesel fuel prices are usually also aadversely affected by these conditions. This can have an adverse impact on the New Brunswick economy industry given its reliance on the trucking industry to deliver its products to market and to import products.

The primary challenge of home heating oil pertains to price volatility and its impact on customers given the "lumpiness" of purchase decisions. One option to make home heating oil purchases more affordable to consumers is to reduce minimum purchase requirements imposed by distributors. These minimum purchase requirements stem from the economics of the home heating oil distribution business. There are significant fixed costs to delivering home heating oil, i.e., the travel time and distance from the terminal to the customer or other customers on the route, such that distributors find it more economical to deliver larger volumes, less frequently. Price volatility can be further mitigated by budget billing which can be an attractive alternative for helping customers better manage cash flow issues stemming from home heating oil purchases. The Province will encourage heating oil dealers to reduce minimum purchase requirements and to offer budget-billing arrangements.

Purchase arrangements such as reducing minimum deliveries and budget billing may not be sufficient to offset the inherent price volatility of home heating fuel, which is more directly affected by the volatility of world oil prices than other heating fuels, and consequently can have a greater negative affect on lower income households. New Brunswick currently has heating assistance programs in place to offset fuel costs. The Province will examine the effectiveness of existing heating assistance programs to make improvements where warranted.

In addition, the Province will monitor supply, demand and inventory positions for gasoline, diesel and heating oil to enable it to advise consumers of market conditions and to monitor the ongoing competitiveness of these markets. This is important to ensuring that the Government can provide consumers with information that might assist them in better managing market price volatility. Clearly, the use of this information can have a significant impact on the market and as such it must be released cautiously.

3. Access to Accurate and Timely Price Information

For a competitive market to be effective and fair, all buyers and sellers must have the information that they need to make rational economic decisions. This, in turn, depends on equal access to accurate and timely information that is relevant to a purchasing decision. New Brunswick can encourage competition by promoting price transparency and by gathering and making available refined petroleum product pricing information. Providing RPP pricing information will result in a more informed public, allowing customers to make better decisions and requiring suppliers to behave more competitively. Specifically, the Province will encourage competition by promoting price transparency through the public posting of wholesale and retail price information.

In addition to price information, the Province will provide price advisories to the public when appropriate. The objective is to better allow the New Brunswick public to anticipate, or respond more quickly to, events that are likely to result in considerable swings in prices. For example, prior to the heating season, the Government will inform the public regarding the state of heating oil inventories and current retail prices. Care will be taken to not exacerbate price swings by timing the release of information in a manner that mitigates price volatility.

4. Security of Supply and Economic Stability

Experience demonstrates that product prices spike when supply is tight and demand exceeds supply. This occurs at any number of places along the distribution chain. The result is a price increase that is absorbed by all downstream participants, primarily the consumer. Storage inventories buffer the impact of mismatches between demand and supply and hence storage is valuable in hedging against RPP price volatility. Canada does not have a strategic petroleum reserve like that of the United States, because it is a net exporter of crude oil. Instead, as a member of the International Energy Agency ("IEA"), Canada, through the Energy Supplies Allocation Board, will implement its Demand Restraint Program, if a global supply disruption occurs. The minimum trigger is a 7% shortfall in crude oil supply for any member country of the IEA. The last time a global supply disruption warranted action by the IEA was during the Persian Gulf War in 1990-91. At the provincial level any disruption in refined petroleum product supplies, such as the ice storm of 1998, is handled by the New Brunswick Emergency Measures Organization.

Market outcomes are indifferent to hardship or economic stability. As such, the Province will exercise its authority to monitor markets by collecting, maintaining and analyzing pertinent refined petroleum product market information. At the same time, we recognize that the information itself can trigger undesirable outcomes. Accordingly, individual company information on product supply, inventories, storage capacities, trucking, and deliveries will be kept strictly confidential to ensure market competitiveness is maintained.