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Fuel investment not risk-free in flat market - BP

Wednesday 25th September 2019

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Building new petrol stations in a flat market requires BP to target new population areas and is not without risk, the Commerce Commission heard yesterday.

The sites the firm builds are “very expensive and very big” but remain at risk from changes in roading patterns, the pace of housing developments and competitor action, managing director Debi Boffa said.

In a new area, adding a median barrier to a main road a new station is on could halve traffic, she said. Even when a new “A-plus” site is successful, it will change spending patterns at the firm’s other outlets in the area and that risk has to be managed.

“There’s a whole bunch of things that can go on that have risk attached to them from our perspective,” she told the commission’s public hearing into fuel competition.

“The whole network is under threat continuously. Things are changing all the time.”

About 30 executives from the fuel industry and associated organisations are being quizzed by the commission as part of its study of competition in the sector.

In a draft report in August, the commission said the sector appeared to be making excess returns and that the high hurdle rates the firms applied to their new investments suggested they expected those high returns to continue.

Material provided confidentially by firms showed some required rates that were twice the 6.9-8.6 percent the commission estimated as the sector’s cost of capital. One was more than 20 percent.

But all fuel retailers, regardless of size, have pushed back on the commission’s analysis of the sector’s profitability.

Associate commissioner John Small challenged firms to otherwise explain the number of new petrol stations being built around the country, particularly given the “sunset” nature of the industry.

Nor was he convinced that investments really were irreversible. He noted Gull’s evidence that it was happy to “have a crack” breaking into the South Island as it could simply sell any stations it establishes there if things don’t work out.

Smaller players like Gull, Waitomo, Allied and NPD are driving the growth in new outlets. Z Energy, the country’s biggest fuel retailer, is not building new outlets.

Boffa said she had no idea whether the investments by the smaller operators were meeting their return targets.

“I build very expensive, and very big sites. I’m not building a low-cost operation.”

And BP’s spending on petrol stations is less than half the firm’s typical annual capital expenditure of $50-70 million. Most goes on maintenance, pipelines and terminals, she noted.

And the returns on projects have to be good to gain funding within the global group.

“We compete for capital. There is not an endless supply.”

Fuel companies are unhappy with the commission’s reliance on rising fuel importer margins as an indicator of rising profitability. While margins have risen since 2008, they were unsustainably low then, with many outlets shutting at the time and Shell selling out in 2010.

Firms noted that margins don’t reflect the fact that costs have also been rising and that returns are declining in a market where volumes are flat and smaller players are expanding.

Small questioned companies yesterday to try and explain why discounts appeared to have increased along with margins and then plateaued with them in recent years.

Z Energy chief financial officer Lindis Jones suggested that, earlier in the period, as margins increased, so did competition and that was expressed as discounts.

But in the past 18-24 months, he suspected the decrease in margins was more driven by lower headline prices rather than an increase in discounts.

Scott Fitchett, managing director of AA Smartfuel, noted that when that scheme started in 2011 the discount was priced at 4 cents a litre, simply to match the prevailing supermarket docket schemes.

“There was no other science behind it,” he said.

One of the scheme's two fuel retailers then moved their discount to 6 cents, which has now become the norm, with 10-cent discounts available at other times, he said.

“That was in a lower margin world, but it was more those two fighting for share of the customer and off the back of the supermarket docket scheme,” Fitchett said.

Jones said it was good for the commission to understand the history of the industry and why margins had moved over time. But he urged them not to get too hung-up trying to pick when a particular business cycle began, and focus more on the changes already underway in the industry.

“I would just encourage the commission to look at the other end i.e. what’s happening now,” he said.

“It’s really important to understand what’s happening now at this end of the business cycle and how does that inform an assessment of competition.”



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