Volatile issue is currently too hard to call

THE row over local petrol prices had been simmering until it erupted again in December's Budget debate, when several deputies accused the industry of profiteering at the expense of the motorist. Since then, representatives of the GMTA have met Treasury and Resources minister Lyndon Trott to justify their pricing policy and another deputy has claimed his research proves that either wholesalers or retailers of petrol, or both, are exploiting islanders.

It seems that an element of politicking is happening here, but the charges are serious, slanderous and unproven. There is too little public information available to evaluate Guernsey's petrol industry and what is available is so opaque and patchy that it leaves more questions than answers. It is clear than an investigation of the industry is necessary to judge properly whether it is profiteering by overcharging for petrol.

We do know that, after the deduction of duty and sales taxes, net petrol prices in Guernsey are the highest in Europe and 20p per litre more than the UK.

This may give the superficial impression that prices are excessive in the island, but in isolation it does not necessarily mean that the industry is overcharging because we must relate prices to various other issues including cost structures, the local business environment, risk factors and invested capital.

If the industry is profiteering, as some politicians claim, they are suggesting that it is making a supernormal profit. That is defined as that level of profit in excess of normal profit, which in turn is essentially the return on a risk-less asset (usually a government bond) plus a return for risk-taking in a particular industry.

This is therefore a vast subject that requires detailed analysis. Do we know the return petrol retailers and wholesalers should be allowed to make in their industry? Do we know and understand their pricing policy, cost structures and profit margins? Do we know their invested capital? Do we know the risks of the industry? There is simply not enough information to form an opinion, so we can draw only general conclusions.

For example, there are only three wholesalers of petrol in Guernsey, which suggests they may represent an oligopoly with significant economic power and the ability to collude, which may damage consumers and competition. Retailers in Guernsey have stated that their margins are lower than or the same as their counterparts in Jersey, but the net price of fuel is higher in Guernsey than there, which suggests that wholesalers' margins are higher here.

This information is meaningless on its own and is speculative, however. Perhaps the local market is too small to support more than three wholesalers and they do not collude. Total transport costs to Guernsey may be higher, as may be the costs of complying with safety standards and of storing the product. If Guernsey wholesalers face higher costs or need to spend more on investment and they face lower volumes and economies of scale, they can justify their higher margins.

The petrol retail market is dominated by the supermarkets, which own 60% of the pumps. This suggests they may have some buying power with the wholesalers to bring down prices, but they may be able to exercise some selling power over motorists to raise them.

Independent garages must constitute the majority of the remaining 40% and they tend not to compete on price, but on convenience, service and choice.

In the UK, the entry of the supermarkets into petrol retailing has brought down prices as they exploit their economic power, while many smaller outlets have collapsed because the fall in prices combined with their lower volumes stops them covering their costs and returning normal profits. The average annual volume of petrol sold per outlet in the UK is five million litres, while it amounts to 900,000 in Guernsey.

A Jersey report in 2004 revealed that petrol retailers were making an average gross margin of over 26%, while their UK peers were making just over five.

These facts and figures are somewhat desultory and we need further information, but they are useful in providing a basic understanding of the Guernsey petrol retail market. Sales volumes are so low and operating costs, particularly property and labour, are so high that retailers need to charge a higher price and achieve a greater margin than in the UK. Whether they are making supernormal profits is another matter, but on the basis that the average retailer sells 900,000 litres at a net price of around 50p, he turns over £450,000 a year. If he makes a gross margin of say 25%, that leaves just over £110,000 to pay rent and staff and provide a return for the owner.

The chairman of the GMTA said some retailers make a net margin of about five per cent, which on a turnover of £450,000 means a net profit of just over £20,000. Of course we need further analysis and verification and to look at the profitability of the other, smaller and larger operators, but how do we know if this is a reasonable profit or not?

To judge whether the local petrol industry is profiteering, we need to conduct a thorough investigation into its operation if we think the benefits of such an investigation outweigh the costs. The study would need to consider a myriad of issues, including prices, costs, profits, risks, regulations, competition, demand, the market, other markets, investment and the local business environment. It must consider questions such as the barriers to entry and exit in the industry including scale and planning restrictions, which may limit competition. It would need to consider whether the retailers are too fragmented, the social and economic need for independent garages and whether there are too few or too many wholesalers. We simply cannot assess the industry without this analysis.

* Comments to rich@hemans.net. Richard Hemans is a chartered accountant who works on a freelance basis.