20: Petrol Prices. Are you being taken for a ride?

Burgernomics Podcast. 2/5/22

Petrol Pricing. Are you being taken for a ride?

David Byrne. Professor Of Economics. Melbourne University

Transcript

Female Speaker: Welcome to Burgernomics, demystifying economics with Ross MacDowell.

Ross MacDowell: Hi, I'm Ross MacDowell. Welcome to Burgernomics, the podcast that demystifies economics, applying it to your everyday life. Today's topic is petrol prices. Are you being taken for a ride? Every day when driving our cars, we pass lots of petrol stations, all displaying electronic pricing boards that give the impression each petrol retailer is adjusting prices to get your business. The pricing boards give the appearance of a lively competitive marketplace for retail petrol, but is it?

When researching today's podcast on petrol, I contacted several economists, including Professor Ian Harper, who chaired the 2015 Australian Competition Policy Review, which examined, amongst other things, whether petrol was being priced legally in Australia. All the economists I contacted agreed. The gentleman sitting opposite me is the ultimate expert on petrol pricing. That gentleman is David Byrne, Professor Of Economics at Melbourne University. David, welcome to the Burgernomics Podcast.

Professor David Byrne: It's great to be here, Ross.

Ross: It would take up the whole podcast if I would list all the academic papers and media contributions you've made regarding anti-commercial competitive behaviour in Australia. The one I want to concentrate on today is a study you authored with Professor Nicholas de Roos of the University of Sydney called Learning to Coordinate: A Study in Gasoline. Your study concluded that there was some form of the interrelationship between petrol pricing as it appears at the pump. In it, you mention a company and their price leadership in petrol retailing and their experiments in pricing appear to have facilitated a mutual understanding among rivals of a new profit-enhancing focal pricing structure.

Before we talk specifically about your findings in that study and how you went about it, did you produce the study because you thought that petrol pricing in terms of what the public was paying that, well, the public was being taken for a ride?

David: A bit of background, I've worked on price-fixing cases and retail gasoline or petrol, I'm Canadian, but petrol markets, dating back 2008, 2009 was the first time I was involved. I had quite a bit of experience working with petrol data. It's very rich, like the pricing boards you talked about. I had a feel for that type of data and I got a feel for how these markets were operating having done research for more than a decade on them, up until starting to write that paper. One day, Nicholas de Roos at the University of Sydney, my colleague that's writing all these papers with me and good friend, he came to me sort of with like a dead body.

He brought a cadaver and he said, "Look, I've been looking at margins in Perth, petrol margins, and something weird's happening in 2010. Look at it before 2010, margins are--" I don't know, it was 3 or 4 or 5 cents per liter on average, relative to this terminal gate price, the wholesale cost that moves overtime for the retailers. Then, this gap grows, there's this growth between the retail prices go up but the wholesale costs aren't moving with it and it seems to stay up. That's where it came. It was around 2015. Basically, it's like here's a dead body, should we do an autopsy? If we think about margins just moving up for some reason.

The good thing about Perth from a research perspective and from being able to have nice Petri dishes and a microscope to really look into what went wrong with competition is the market generates from a government platform called Fuel Watch every single price every single station sets at every single point in time. We can see everything. From that point, we said let's look into this and to see what's happened here and why did prices all of a sudden start to jump around 2010 and have stayed up ever since relative to cost. That's where it started from.

Ross: Okay. Then, you decided that you would conduct a study.

David: Forensic investigation is one way we've often talked about it.

Ross: Okay, so you were going to be able to empirically prove your conclusions?

David: We were going to try to solve the murder mystery. That's what we were going to get into, is okay, we're looking at monthly prices, and that's the usual thing we can see when we look at margins in any market. We can look at like average price and average cost and see how those are moving over time. What we were able to do with Perth was start to look at individual station level daily high-frequency prices to really zoom in around when these prices started to take off, was anything happening between individual players in the market. We're talking British Petroleum or BP, Caltex, Coles, and Woolworths who run 60 to 70% of all the stations in that market.

Were they doing things at very high frequencies that you can't see? You can't see it in the monthly data, but if I look at the daily data, the interactions between the stations each day, could we start to see things there that look not competitive or things that would've potentially facilitated this shift to a higher price equilibrium that they were able to get to. We looked into that and yes, we found some very peculiar behaviour.

Ross: Let's talk about your definition of very peculiar behaviour.

David: Sure.

Ross: What would you call very peculiar behaviour? We'll go back to exactly what you did,-

David: Sure, sure.

Ross: -but in Australia, we have legislation that prohibits a whole range of practices that are deemed to be anti-competitive. Since 1965, we've enhanced the legislation to protect consumers against having to pay too much or [unintelligible 00:06:45]. What were the practices that you were concerned about that may have been occurring in that market?

David: One thing we had noticed was-- Let me just step back and talk about how prices behave in Perth, but also in every other price in a petrol market in Australia, the major cities especially. In the urban centers, we see these cycles in prices. They go up, then they go down, they go up and they go down. There's high price days and low price days. In Perth, prior to 2000 and 2010, when did the high price days occur in the market? They happened prior to 2009, 2010. They happened all throughout the week. Some weeks it would be Sunday was the high price day. Some days Monday would be, Wednesday, Friday. It would be mixed. The companies that would be the first to move up happened with everybody.

Every station was sometimes the higher guy and then the higher price station would go up and the rest of the market would follow. Then, it would teeter back down. Then, the prices would go up again on some other day by some other station later. We started to see around April 2009, we looked at this, all of a sudden Thursday became the magical jump day. Thursday, Thursday, Thursday, Thursday, Thursday. That was pretty interesting. It went from being mixed to every day Thursday. Why Thursday? Wholesale costs aren't doing anything differently on Thursday. There's this magical Thursday day. We call it a focal pricing equilibrium. This was one of the focal points. Thursday we all go up together.

Think about it, Ross. We're across the street from each other. Some days you go up and I go down and it's noisy. Then, all of a sudden we realize, okay, Thursday is our day, mate, when we're going to increase our prices. It becomes easier to coordinate and anticipate what we're going to do with each other if everybody's working on Thursday. When we were started to narrow that microscope with that rich data. We start to see it goes from every day of the week to Thursday becomes a magic day. We look a little further and we started to see actually, that's on average for the whole market, but BP was actually going up on Wednesdays.

BP's Wednesday, rest of the market Thursday. Wednesday, Thursday, Wednesday, Thursday. BP would set prices on Wednesdays that the whole market you'd be shocked to hear matched on Thursday. BP had established itself by repeatedly moving all its prices up for its whole station network on Wednesdays and the market would just follow. Once BP knows everybody just follows them, BP is in the driver's seat. They basically get to say, "Right, let's just go up whatever price we want on Wednesday, we know you're all going to follow.

The more we go up, the more we all make." We call that price leadership.

We saw this very stark form of regular price leadership emerge in 2009, 2010, in a way, that BP was able to cement itself as the leader. You get this leader-follower thing happening every week, and then it's part of the job at that point, it's easy for BP, increase the price on Wednesday, and whatever we set the market will determine. They could orchestrate the market. We've often talked about it was as if BP was like the conductor and the market was the orchestra. They were orchestrating where prices would go every Thursday.

That doesn't take any phone calls, that doesn't take any messages, that just we're going to increase, and if we just do this regularly every week, we can all settle into a routine of we'll watch you go up on Wednesday and everybody else will go up on Thursday. We saw that. That was one big part of it, it's just an artificial price increase. We couldn't understand on Thursdays for no cost or demand-related reasons why prices would go up.

Ross: Why do you think they chose Thursday or Wednesday?

David: Yes, they've changed it over time. They did that for 5 or 6 years, and then it went to Wednesday for some years and Tuesdays for some years. I don't know if the day of the week so much matters, it's that there is a regular day of the week. I think that's the key thing. Why do we want a regular day of the week? One thing is it's easy for all those players in the market to just know that it's Thursday. The other thing is prior to them creating the focal day, this Thursday day, their magic day that all the prices go up, the way they used to price petrol is when these jumps would irregularly happen. Everybody would cut prices in between these jumps, that cycle I was telling you about.

We'd increase price and then it's like a war would start. We'd all increase prices and we'd keep doing that until we went down to wholesale cost, then we'd go back up again. When we do this magical Wednesday thing in Perth, what was happening is we were limiting how much undercutting would occur. This was going to be the second part of the focal rule. BP not only helped implement Thursdays as the magic day to increase prices, but they also implemented a second focal rule we document in the paper, they created what we call 2 cent per liter price cuts. Every day between those jumps, you'd cut 2 cents like a stair step, 2 cent, 2 cent, 2 cent, 2 cent, 2 cent. You'd do that for six days, then we'd go back up.

If we just say there's six days and 2 cents each day, that limits price undercutting to 12 cents per liter between the jumps. What you're able to do then if your BP is say, "Right, we're going to make sure we never price down to cost, we'll just keep the undercutting under control. There's six days of it between the Thursdays, 2 cents per liter per day." The market followed that focal rule as well. "Then, we'll just increase prices on Wednesday. The market will follow our signal on the Thursday."

What we know now, this is how the two focal pricing rules work in tandem. BP then all you gotta is increase your margins on Thursday, everybody follows, and then we'll cut prices by 12 cents per liter in between, but the average price is higher. We're now no longer cutting prices down to cost. We're restraining the amount of competitive pressure in the market, the willingness to price because those firms are willing to potentially compete for customers undercutting low cost, but that wasn't the norm. That's not what the focal rules were doing. That's what we established in the market.

We also further found there was a time when Caltex wasn't agreeing to the Thursday increases, they were doing Fridays, and BP was doing Wednesday increases, and everybody would start following Caltex to the Fridays. Caltex wasn't playing nice. BP then decided, this happened, this discoordination happened for a few months in 2009, 2010, and BP, basically in the data we show said, "Right, let's all try not having price increases for a month, December 2009. We'll just stop leading the market. Let's just price low. Let's see how we all feel about that."

Ross: When you say, "Let's see how we all feel about that," they were having that conversation with themselves in their own office. They weren't having that conversation with-

David: With each other.

Ross: - their competitors.

David: No, but basically, it was clear in the market, again, using the hyper-rich data we have, we can see all this, that there was this leader-follower dynamic, and Caltex was being a bit cheeky if you will, they were delaying the following. We're not going to follow on Thursday we'll follow on Friday. Now BP's really high and Caltex is stealing business like crazy and so BP then spent a month not leading. They just said, "Right, we'll just pull the plug on this. We'll just price chaotically and we'll just see how we all go. Margins fall because there's no coordination, price-cutting starts taking off getting closer to cost. There's no big price increases. None of the other little players know what to do.

They're an orchestra without their conductor. They're just making noise. Then, in 2010, BP starts signaling, "Let's try this again." Through the lens of an economic model and what we found fascinating with that as researchers is in the field of industrial organization, which is the study of market power in economics, we call that punishment. When you have leaders that are trying to enforce in economic terms, make this distinction clear, this is not a legal discussion, strictly in terms of economic theory and economic models, if I want to price above competitive levels, a key thing I need to do to stop my competitors from undercuting me and screwing up our collusive agreement is I need to be able to threaten if you don't agree, I'll punish you.

Ross: Hang on. What you're saying here is they've set up a pattern of behaviour without direct communication that people follow to the day and it is so entrenched in terms of the petrol companies in your study about out when they increased and decreased their behaviour, that they followed that so rigidly that that put everybody other than BP the price leader in a position where they could be punished-

David: If they didn't play nice.

Ross: - if they didn't continue to price according to these cycles, BP would use their market power-

David: Their leadership role, market power, yes.

Ross: - to punish those that weren't following their price increases and decreases.

David: Yes, that they weren't following let's call them the rules. These are all tacit, silent rules, but the norms. That's perfectly consistent with theories of tacit collusion in economics. That if you don't follow by the rules, we'll punish. As researchers, as scientists, we were fascinated. We never get to see punishment in the field. We just don't see it and we saw that, said, "Oh my God, they're doing it. They're doing what the theory says they should do." The theory is very mafialike. It's like, we're going to run this neighborhood and you should play by our rules and it would be a shame if something happened to your knees if you didn't follow by the rules.

The way we think about cartels and illusion in economic theory is just out of The Sopranos. We were seeing something that was consistent with that in the field in Perth, and the reason we could see it, coming back to the cadaver and trying to figure out why things weren't working there in terms of margins and why they're taking off, is we had that hyper-rich data and we could see exactly when the other players stopped playing by the rules according to the norms and when BP took action for a month to just say, "Right, let's just blow this up and see how we all feel about this."

Ross: Okay.

David: After coming out of that, we would sometimes call that a price war, that conflict period, BP then, in 2010, started to reinitiate the cycle of we increase Wednesday, you guys follow Thursday, we'll only cut 2 cents per liter per day between the Thursdays, and we can increase margins overall. BP used experiments and signals through the prices in the market to reestablish that cyclical behaviour. Then, we found something else out. [chuckles] I'm happy to go on further about it. This is going to bring in a separate issue though. Separate from [crosstalk]--

Ross: Okay. Before you do that, let me just ask you one thing.

David: Sure.

Ross: You've talked about competitive behaviour increasing and decreasing. We exist in a market capitalist economy, market forces, this magic phrase, market forces, and the profit motive is meant to determine and govern a whole lot of activity.

David: Absolutely.

Ross: Therefore, if I was in a market such as petrol and I wanted to increase my market share, I would think about a couple of things. I would increase my advertising budget to say my petrol's better than everybody else. At the same time, I might decrease the retail cost of my petrol so then people driving around would go, "Wow, I'm not buying that petrol, it's too expensive, I'll go and buy this petrol." Therefore, they take all of their business, fill up their cars at the cheaper petrol. The person with the more expensive petrol doesn't sell as much, therefore, his profit margin drops, and that's a market efficiently working.

In this case, you've got BP that are setting the marketplace. Why didn't management sit back and go, okay, increasing advertising budget's not working, let's just continuously cut price until we take off enough business or these people it hurts them so much BP that we can maintain some of those customers and retain our profitability? Why didn't the market forces in that psychological scenario work?

David: I think there's two countervailing forces at play there. One is you have these small asymmetric competitors in the market, these independent stations, and they always have, and they do in the data, they always undercut the bigger brands, so if you're Caltex, you might think, "Let's undercut BP a bit, steal some market." The second you do that, you're going to see, first of all, BP will price match you, you haven't gained anything, and on top of that, you've spurred the little guys to cut like, "Okay. We're cutting. Let's go. Let's go. Let's keep stealing," and so if we all know when we undercut that we're all going to match and go lower, you quickly end up in a race to the bottom.

Because where do you stop? Where do you draw the line? That's when we start pricing towards marginal cost. That's exactly what we saw in a world before these focal rules took off. You can choose to go down that path and that's when the margins are half of what they were after the focal rules came in or you can decide to price according to these easily observed focal rules, increase on Thursday, cut by 2 cents per liter each day.

If we all mutually understand that that keeps in check hyper-competition which can potentially take off in this type of market when petrol stations have big visible boards and there's a subsegment of people that really shop around and the little guys are really trying to get those players, the little independent stations, that's a choice that particularly if four of the stations own 60, 70% of the market and you know the little guys just follow you and undercut, you can basically make that choice, let's follow the rules and not end up in that race to the bottom.

I think that you can choose to undercut but if you know everybody's going to undercut with you, all you've done is reduce your margin and you've stolen no market share. Given that choice, why not just follow the rules? That's one take, and again, our theories of tacit collusion in economics is really about that. We can choose to stay high or we can all fight. If we all fight, we make no money. If we know that's what happens, then we'll never get there. We'll just stay high. That's one problem.

The second is a lot of people don't pay attention to petrol prices. You be shocked to hear that in Perth in separate work I've done with Professor de Roos we estimate something like one in five people shop with their online petrol price platform Fuel Watch. It allows you to compare every price on your route everywhere, you can be the hyper-informed consumer looking around. The problem I think is people are busy and you have a commuting route. You're not as attentive as people would be to petrol prices and surveys from the ACCC suggest people fill up once a week. A lot of people have norms in shopping called fill up when empty, but that can happen all kinds of times during the day.

You might think we can undercut and steal a whole bunch of business but I think in these markets there's two segments. There's people who we might call them shoppers and then there's the fill up when emptiers. That's like my mom. Even I fill up when empty and I've been studying these things for 15 or 20 years these markets. Life's hard, it gets complicated. I can't coordinate optimal petrol price shopping when I got to pick up the kids, get the grocery, get to work, blah, blah, blah, blah, blah. Even if you undercut and think let's steal some market, there's a certain degree of ignorance in the market on the demand side, but it's rational ignorance. We're busy.

People are busy that you're not going to steal as much as you want. Put another way. If everybody was hyper-attuned to the price cycle, everybody would with that Thursday up because Thursday's the high price day, Wednesday was always the day where you could find some low price stations. Everybody in Perth should have bought on Wednesday. Yet we show in our research and the appendix and stuff they're still buying throughout the entire week. I think the thing about it is people are aware that there's a cycle. Some people are aware but not everybody, and so that underlines the gains to that competition and the undercutting you're talking about.

Ross: If I look at the data which says that on average people are using 35 liters of fuel per week in their car, their monthly cost was $140 before the price of fuel went up to nearly $300 a month is what they're using in fuel costs currently, would any of those figures change if your marketplace that you described was different? I guess what I'm trying to ask you is, you've described a certain way that a market's functioning, and you're saying that it's led by a large company and others follow and they're doing this for reasons of making a margin so that their companies are profitable but they're doing it in a somewhat different way than other markets. Let's say the milk market.

If they were to stop these practices, would they be as profitable as they are now?

David: Milk's a good example. I don't have high-frequency milk pricing data but consider a market that has what we would say is cost-plus pricing, so retail prices just move with costs and there's some markup to cover the company's costs and that thing. You've just asked a million-dollar question as I would expect. On the research side of that, that's a massive question that people are currently trying to figure out. In the absence of cyclical pricing and petrol which we see in Australia and around the world, would margins be lower? We don't have a definitive answer on that, to be honest.

You could imagine worlds where you're BP and you try to coordinate the market on cost-plus pricing as opposed to these cycles. Some of the evidence that's out there suggests those small independents if you try to do cost-plus, they would shave your plus and steal market, and eventually, you're getting really squeezed on the margins. It's true in the markets we have studied where you see cycles get manipulated with price leadership in these sorts of things. As the price leadership becomes more stark, like in our paper when the norms emerge and the leadership becomes stronger, profit margins increase by 100% relative to pre-coordinated pricing behaviour.

If we think of competition as a little less coordinated, a little more go get them aggressiveness, and then we think about what we saw in Perth as coordinated, folks in Perth are paying, according to our estimates, this is over 2010 to 2015, they're all paying just because of coordination an additional 5 cents per liter every time they go to the pump.

Ross: You're saying in a market that's not really a free market, they're paying more.

David: In a market where the firms aren't ruthlessly aggressively undercutting each other and there's a leader and follower and they have norms with pricing like we've seen here, but we've seen these in other markets. This isn't just a phenomenon in petrol. There's examples of this in wholesale electricity market, online advertising. There's many environments. The reason why we study it in petrol is because we have the data to really see it.

When we have this leader-follower dynamic and you have these dominant players that can orchestrate the rest of the market, we're seeing in our paper at least additional margins above and beyond what was being found before the leadership became very entrenched. There's this market power inflation of 5 cents per liter. Is that a lot? You're filling up a 50-liter tank, it's $2.50 every time you go to the Bowser. 2.50, but that's 52 weeks of the year, it's $100, it's more than that probably because you're going to fill up more in the holidays. They're taking a grocery bill from you and that's just one person and then you multiply this by millions of people. These are big bucks quite quickly.

These numbers are not small. These are large profit increases and they reflect companies taking advantage of their relative size, their dominance in the market to be able to orchestrate it and move pricing to something that is quite coordinated. If every petrol station in our example in Perth was owned by just one person, I had one, you had one, all of our friends had one, we tried to coordinate and we couldn't see each other, it'd be chaos.

Ross: That's okay.

David: That's competition.

Ross: That's fantastic.

David: That's what we want.

Ross: That's what we want.

David: We want somebody to go out there and try, "Oh, I'm going to undercut these guys and get a bit more market." Then, Ross is like, "Well, I'm going to give that a go too. I can get from you," and then you get what you're talking about, that competitive outcome. All we're trying to do in the market is the best we can given what people do.

Ross: Let me ask you this question.

David: Sure.

Ross: If we went to the chaos theory where every man and his dog owned a petrol station and were driving around looking at their competitor's prices and adjusting theirs accordingly to meet the market, would there be enough profit margin in the petroleum industry to support the infrastructure within the industry of exploration and refining or would that diminish? Because in Australia, we have this fantastic habit of we want to have exactly the same, how can I describe it, choice in automotive products, supermarket products, et cetera, as the rest of the world, and I guess we use the United States as being the example of that.

Yet we are a country that is a lot, lot smaller numerically in terms of population, and geographically, we're spread out everywhere, and you could never expect with those two factors for us to be able to profitably run the similar services and produce the same products as maybe United States or countries in Europe. If we were to have a fantastic free market without these anti-competitive practices, would it generate enough profit to keep the large petroleum companies invested in Australia?

David: Yes, because at the end of the day, we all need petrol to get around. There's a bigger question here about how much do we need petrol? We need it. Now the question is how much competition is there for our business between two different petrol retailers. I think if we had the insane everybody owns one station we compete like crazy and we reduce margins, in the long run, you'd probably have fewer stations, and probably it'd be more like those stations that are not on main transportation routes. We would get maybe fewer stations but more efficiently located stations or the ones that are on the densely populated commuting groups would emerge.

You would still have stations serving the market in the most dense parts of an urban area or in a city. Maybe you'd have a few less on the periphery. Much of the margin is made actually upstream when we go from looking at crude oil prices to wholesale. It's really coming from where we go from refining to wholesaling. That's where the big margins are. We don't have any data to really tell you how big those margins are. These are our major refiners, the BPs, those kind of players. That's where the big margins are. The retail margins still matter, still millions of dollars, but I think I would conjecture those are second-order to the wholesale market.

The wholesale margins reflect the simple fact that we all need petrol to drive around. We would still have a petrol industry. We might have, in a hyper-competitive retail market, a few less stations, but we'd still have all the stations say on the main routes competing away for those consumers.

Ross: Okay. Now, you did a study and it was in Perth, do you believe that basically, the same system is operating throughout the country?

David: Yes. Nick de Roos and I, we've teamed up with Matt Lewis from Clemson who's the leading petrol researcher in the United States. We're kind of a research hub on this now. We're looking at that data now for the rest of the country. I can tell you some preliminary things we see. We do see price leadership.

Ross: Price leadership [crosstalk]--

David: Meaning that the players that have large market shares of stations, the BPs, the Caltexs, the Coles, Woolworths. We do see the same sorts of dynamics play out.

Ross: Different players in different markets?

David: Same players across the country playing out in Sydney, Melbourne, Adelaide, Brisbane. We do see the same leader-follower behaviour. It's not as stark as what was in Perth. What we found in Perth was quite stark. I think that was partly because in Perth, there's a regulation there under Fuel Watch. They can only set their prices once a day and then it's fixed there for 24 hours to help people be able to shop. The rest of the country, the stations can set their prices whenever they want. It's more chaotic in that sense, it's a messier version of it, but we still see the cycles, we still see the leadership, and we still see that orchestrator-conductor interaction between the big dominant players and the smaller players.

I would add that we've also seen legal matters taken against the bigger players in the market in 2015, 2016 on a matter called informed sources. Not sure if your listeners are aware of this, prior to 2015, 2016, there was this platform, this online data hub where at least the big five, so your BP, Caltex, Woolworths, Coles, and 7-Eleven were subscribed to a platform where those companies were uploading their station's prices in real-time to allow them and each other to watch all of each other's station's prices across the country. The ACCC thought this wasn't good, we can all monitor each other like they were doing in Perth and maybe we're coordinating and things.

That matter resolved in December 2015 saying informed sources needed to stop just hoarding all the data on the supply side of the market just amongst the retailers. They had to make the data available to the consumers so they could shop. Coles had to desubscribe from the platform. Those were actions taken by the government against those players for information sharing over concerns of tacit collusion and coordination.

Ross: How did the government go? Did they win?

David: It was a settlement, so they weren't shutting down informed sources. There's nothing per se wrong with sharing information. We observe each other all the time in these markets. They might observe each other looking at each other's stations across the street from each other and you could argue we're using the internet to watch each other, what's wrong with that. They reached basically a settlement.

It didn't go trial or anything like this where they said, "Okay, we're not going to stop you from using technology to watch each other in pricing, but you got to make that information available to consumers too," so what we call search platforms, platforms that help you shop around can emerge, use that data to help people shop. That did happen as a result of that. You try to balance the scales between the retailers and consumers in terms of how informed they're.

Ross: Okay, but you've described a marketplace that's operating that I would think breaks a whole lot of laws in terms of anti-competitive behaviour, not for you to pursue that because you are an economist, but in terms of the ACCC, have they mounted actions against the petrol retailers and distributors on anti-competitive grounds?

David: There's historical examples of price-fixing cases that the ACCC have taken against players where they've known in the market they've explicitly communicated with each other. That's illegal. You can't talk to each other and just determine how to set prices. There are historical examples of that. Where we're in a tricky situation now in petrol markets and many other markets for that matter is this middle ground where I don't have any evidence of us talking to each other. There's no conspiracy. We're not in a smoke-filled room or on a golf course with wiretaps establishing Ross and Dave talked about how to set prices, but there's wink-wink going on in the market. There's mutual understanding arriving.

We now have these concerted practice act in Australia that says things to the effect of you can't act as if you talked. That's a recent reform that strengthens the ACCC's ability to come after players for this. Now, have they taken a case in petrol leveraging that relatively new piece of legislation? No, not to my knowledge.

Ross: Why not?

David: I think the optics are tough for the ACCC in these cases. They're very public. If they're going to go, they better have a strong case in to go public with prosecuting the companies, particularly petrol companies which are very sensitive to everybody because we see them every day and we pay so much money for their services. I think there's a lot of pressure that comes with that, I would say that in the first instance, and I think the second thing is when you get into court, you run into the problem of what I would call the counterfactual. The lawyers are going to say, "If you didn't do this, it's your question, "If you didn't do this, what would you do? What's the count?"

As an expert, I've been in these cases on both sides. I've been on the retailer side working for them, I've been on the government side, and you run into a challenge of the counterfactual of, well, what does competition look like? We don't know what it looks like because we've only ever seen pricing in this way and that so seeds a doubt.

Ross: Isn't that the great crux of the problem, what you and I are talking about? Is that at the beginning we have a freely operating marketplace, then we have a dominant player that comes in. He sets a methodology to ensure his and other competitors' profit margins and are healthier, he does that in maybe an anti-competitive manner, but because he's not immediately prosecuted successfully, and it goes on for such a long time, that becomes the culture of the market. Then, the culture of the market just continues to grow out into the other states, maybe even into other markets. The culture of the petrol market is this cycle of price increases.

When they go up and when they go down has been now happening for so long and hasn't been successfully stopped or prosecuted that it's really the petrol wholesalers that are in control.

David: Let me push back on that in a way that's going to irritate all the listeners. Let me be the expert on the other side of that. Ross, we shouldn't hate the players, you can hate the game. What we're seeing with these cycles, it's competition playing out in a world where people don't pay attention to prices. Consumers don't shop aggressively enough to punish high prices. They don't time their purchases to buy at the low part of the cycle and avoid the high part. If people don't pay attention and people don't time their purchases, why shouldn't the companies take advantage of them? That's just profit maximization in a world with uninformed consumers. I call that competition where I live.

That's what comes up. I can go further. Are we going to go then charge all the airlines for colluding because people book at the last second and they get exploited? That's competition. You have inelastic demand, you're not price sensitive, I'll charge a higher price and make more money off of you. There's nothing wrong with that. That's perfectly consistent with competition. If you get me in court talking about price cycles and coordination, I can come back and say this to you all day long.

Now, I'm an economist so I probably don't have much of a soul left, but when I say those things, what angers me, just not as an economist and just trying to be a decent human being, is I'm blaming everybody, all of us, the consumers, for the outcomes that we're seeing in the market. I think it's somewhere in between. We have dominant players, but we have dominant players that are exploiting people's inability to shop around. I think that's why you end up often with government policy in this area not pursuing anti-competitive practices, a lawsuit for collusion, they say, "Let's inform consumers, let's give them the data, let's make the platforms for them."

"If the disease is the margins, and the symptom is uninformed consumers, let's go after the uninformed consumers and try to help them." I'm not saying it always helps, but that's why we end up not prosecuting anti-competitive behaviour.

Ross: Can I put to you a dark theory?

David: Sure.

Ross: I'd love to hear your comment on it. Perhaps government isn't that interested in trying to aggressively pursue the petroleum but would like the optics that it was because if we have a look at what the government gets out of this industry, it's really for the government's benefit. If you look at a liter of petrol and we break down the cost of a liter of petrol at the Bowser, 50% of that the government legislates that you can afford to the cost of the actual fuel, 12% of it allows for the cost of its distribution for profit margins, and 38% of it just until the last budget was government revenue.

Before the government temporarily halved their excise on fuel, just on that 38%, they were making $50 billion over four years. They are absolutely addicted to the revenue from that industry. Secondly, in my dark theory,-

David: Yes, your dark theory.

Ross: - that I want you to comment on, after World War II, and through the '50s and the '60s, the government thought, "We're an island at the bottom of the world, we're very dependent upon Middle East fuel petrol, it's incredibly cheap. We need to become self-sufficient." All of a sudden, they started throwing money at the petroleum companies, namely BHP and Exxon or Esso, "Go out and find some fuel, go out and find some oil in Australia," which they beautifully did in the [unintelligible 00:42:40] and the West Australian areas. Then, lo and behold, by the year 2000, we were self-sufficient in petrol, let's talk about petrol, rather than oil and things.

David: Sure, sure.

Ross: That was terrific, they achieved that objective. Then, all of a sudden, people felt that they weren't making enough money [unintelligible 00:43:03] the fuel companies weren't making enough money, and now we're in a situation where we import a little more than 8 billion liters of petrol per year and that we locally refine over 7 billion liters of petrol, but the majority of that comes from imported crude oil. That allows us motorists the 15 and a half billion liters of fuel that we require every year.

Now all of a sudden, the International Energy Commission says, "Look, Australia, you're not doing a great job down there because you don't actually have enough fuel to cover your country's needs for more than a small period of time. We believe that you should have enough fuel to cover your needs if we blocked all your shipping lines for 90 days. You're not even close to that." All of a sudden, the government goes, "Okay, this is not good. In other words, we're back to 1960. Short term effect, what we'll do is these refineries, we'll give them a subsidy, if they fall short of making a reasonable profit margin, we'll give them money, we'll subsidize them."

On the one hand, the government is subsidizing exploration, subsidizing refining, and taking a massive amount of money in taxes, GST, and excise out of fuel, but on the other hand, saying, "Oh, look at this [unintelligible 00:44:36] competitive behaviour here, we're going to get the stick out and beat you over the top of the head." My dark theory that I want you to comment on is the government seems to be in a very interesting position here because they don't want to scare away the very industry that they rely upon to create self-sufficiency, yet to make themselves politically popular, we'll have the ACCC walk around with a baseball bat and give them a bit of a smack over the back of their head occasionally because it looks good, but really underneath it, we're going to pay millions and millions and millions of dollars to keep these people happy.

What do you think about my dark theory?

Interviewee: [chuckles] There's a lot to unpack in your dark theory. On the surface, it all does sound very circular. Let's just break it down into its bits and pieces. On the fuel excise, that's more of a road user charge than anything else. I think a lot of economists are favorable of fuel excise. It has good properties in the sense that it's a user charge, the more you drive, the more excise you pay, and we use that excise to buy roads and build infrastructure. It's a user charge for your use of infrastructure. I think the first-order usage of fuel excise and its goal is that, not so much just making a war chest to revenue that they're going to use for a million other things.

It's up to debate the politicians get into what it gets used for and these sorts of things, but as a first-order issue, it's really about roads and infrastructure, and we have some of the lower fuel excise taxes in the world, actually, relative to comparable countries. We could, in principle, be higher on that one, but we're not. I'd say that's where the fuel excise fits in, it's more about that than it is about anything else in terms of political economy.

On energy independence, in terms of academic circles and policy circles, it's really back in style on the backs of the war in Ukraine and all these questions about the independence, and the flip side of that, all the interdependencies that has happened across many different markets, including oil markets across the world, and especially in Australia, over this age of globalization we've come into in the '80s, '90s, and 2000s. Yes, we are now fully dependent on foreign oil, we've gotten away from domestically produced oil now that pendulum is swinging back the other way because we've lived through peaceful times where we haven't been threatened in our supply chains in oil for quite some time.

There's nothing to talk about there, everything's working fine. When we go offshore and go overseas, you can bring down the cost of oil. The exploration costs are much lower in Saudi Arabia and Russia, that's why they're so dominant, but it's also why they're so dominant and they can hold you up in geopolitical circumstances. That risk is always bubbling underneath, but as we've seen with our governments, particularly the current one, they don't tend to head off risks, they tend to react to things after it's already happened. We've had both labor and the coalition oversee this offshoring of foreign oil and our growing dependence on foreign oil over time.

We're coming now back full circle to what you're saying, are we back in the 60s? We are a little bit in terms of we've maybe over-globalized relative to how much risk we should be taking on in terms of our dependence on foreign oil supply. We're seeing that come back the other way. We purchased a ton of oil there in March 2020, April 2020, the federal government bought it and tried to boost those reserves as the oil markets crashed. In hindsight, that was a good decision. We still are still short relative to international benchmarks in terms of how much oil we have onshore to deal with emergencies. That's actually in the United States, so we'd have to wait for it to come over if we needed it.

People point to that as real concerns about shortfalls. Again, we tend to be so reactionary and not proactive with so much of public policy that at the end of the day, governments always have this incentive to say, "Look, we can push prices down offshore, offshore, offshore." It's not so fun to say, "Hey, everybody, let's pay a bit more to buy our own stuff onshore all the time, but then we don't have to worry about geopolitical risk." If that geopolitical risk is never there for people for 20 years, there's nothing to tell the voters. Russia could go to war, and it's like, "Well, they haven't for 15, 20 years, so why are we still paying this Russia goes to war premium?"

That political tension and then the private tensions boil into that of like, "Well, we can cut costs if we just offshore it. I think we see people's desire for cost savings now and underestimating the amount of risk that's out there from being fully dependent on foreign resources and oil that plays out, and now we're coming back the other way because the risk has bubbled up. Because it's biting us in the butt now, we're now backtracking and saying, "Wait a minute, maybe there is something to this energy independence."

If we go back to peaceful times, and we do set up all this domestic oil wholesale supply, and there's peaceful times coming, that pressure will eventually grow, "Well, we're postwar, let's just offshore everything, it's safe now." That'll come back up because people really pay a lot more attention to what's right in front of them than the things that could happen in the future.

Ross: Okay. Do you think because we're in that situation now, the government would be less zealous in pursuing any anti-competitive actions against petrol wholesale retailers?

David: In the time of the pandemic and particularly when the oil markets collapsed, and we just published a paper on exactly this, I wanted to call the paper The Word of Rod as in Rod Sims but my co-authors wouldn't allow me to do it, but basically, the ACCC did come out, the stick bashing, "Oil prices are falling, the economy's crashing, petrol retailers better pass through those falling wholesale costs to people because we're all suffering right now economically that we need some support." We did actually see the retailers react to the government announcement. We are seeing the government being vocal on the issue of what we call cost pass through.

Meaning when costs down, those prices better come quickly with them, not stay high and then the companies just make a bunch of profit. In terms of anti-competitive behaviour, I think at the current moment it's probably just not front of mind with the government with everything that's currently going on in various spheres, but in competition policy in particular, I think the thing that's eating up the most resources at the moment with say the ACCC is much more about digital issues, Facebook, Google, and these sorts of things.

Ross: I've got two questions to ask before we [unintelligible 00:51:36].

David: Sure.

Ross: This is a new question that I'm now going to ask every one of my experts. In terms of petrol and what we're talking about, why is economics the hero in the story about petrol prices?

David: Economics really hits it stride when you look at the world and say it's really complicated, and you can try to understand a complicated world by digging into every single detail of everything that happened. If you do that, you're probably not going to learn anything. Economics is really good at taking something complicated, petrol price cycles, they look insane when you look at a graph, there's tons of data, and it's really good at disciplining somebody to say, "What are the few things that really matter here? Out of all the possible things that are going on in the real world, what are the core issues that are driving how prices are being said in the market and how consumers are behaving in the market?"

I've heard 17,000 different things thrown at me about petrol prices. At the end of the day, economics is the hero because it's able to really through a combination of economic theory and then empirical evidence to test and test our theories in the real world to say, "Yes, there's a lot going on. There's a million things going on that affect oil markets and prices at the Bowser." When I want to think about anti-competitive behaviour, I think it really boils down to consumers' inability to shop, that people are busy, I think that's a core force driving what we see, and big players' ability to understand they're a big player.

Then if they do stuff others follow and if they all mutually understand that we just do this, then we'll set prices like this. That we'll coordinate together. I think those two real facets which come from economic theory and then I get the rich data to discipline and say like, "If I can understand those two things, I can get a lot of the story." Economics provides structure and insight in a world of chaos to help us understand where we're going and what we may or may not be able to do about it." That's why it's the hero.

Ross: My last question. The [unintelligible 00:53:50] test. We've got the simple hamburger. How can you apply your competitive pricing situation that you and Professor de Roos wrote the paper, how would you apply that to a hamburger?

David: It's takeaway food, tends to be a weekend type of food, it is for me, at least. Most people who commute, most Australians, you got to fill your tank every week, and your petrol market say because of coordinated behaviour, you're getting like 5 cents per liter higher prices than you otherwise should get. You filled up your petrol tank. It's 50 liters, 55 liters, your Toyota Camry. First of all, you've paid $2.50 cents more to fill up your burger. Now suppose you're going to my [unintelligible 00:54:40]. Now you're going to feed the family. You can buy one less burger because it's cost you more to fill up at the tank. That $2.50 you can no longer buy that burger with.

You've just lost a burger and then you show up at [unintelligible 00:54:55] and everything's 10, 20, 30 cents more expensive. Whoa, whoa, I've already lost a burger because it's more expensive because they've increased the prices on me. Why is this happening? Well, we had to ship it here. Guess what? That took petrol and we're paying those higher prices because of that as well. Okay, fine, I guess so. The meat had to come, the grains had to come, the buns had to come, so I'm going to pay for that. Is that enough? No, no, no. Suzanne who's serving you, she had to drive here too. Guess what? She paid $2.50 more for petrol too.

Her wages need to be a bit higher to compensate for that market power-driven price growth, so we got to pay her too. Now not only can you buy one less burger because you're filling up more, but the burgers you can buy are more expensive because the products that go into them and the people that serve you to them are also more expensive, so you're paying more there as well.

Ross: Fantastic. Professor David Byrne, thank you very much for explaining the dynamics of the petrol market in Australia to us. I think it's fascinating. I think there are going to be many of our listeners that will be sitting nodding their head the whole time they're listening to you. Perhaps they believe economists and other people maybe within government are all got the same view to support a system that they feel in their gut something's not working correctly. You've said through what we talked about today, well, it's certainly working in a much different way than what other markets would work and you've proved that empirically. Thank you very much.

David: Very welcome and apologize for blaming everybody for being too busy to shop when I had to be the bad cop there mid-chat, but it's tricky. With data and evidence, we can move the needle just a bit hopefully every paper by paper and interaction and interaction with government and these companies.

Ross: Thank you very much. My thanks for today's podcast to Melbourne University Professor of Economics David Byrne. If you want to read Professors Byrne and de Roos' study on Australian petrol pricing and deep dive into other reading Professor Byrne recommends relating to Australian petrol pricing, please check the deep dive section in the show notes of this podcast or visit the [unintelligible 00:57:15] website. Professor Byrne is passionate that all motorists start using apps to find the cheapest petrol near where they live. These apps are also listed. I'm also interested in your suggestions for topics you would like our experts to discuss.

Please email them to me@rossatbergonomicspodcast.com.au. My thanks also to Ology Creative who provide [unintelligible 00:57:46] with design excellence and Suzanne Tonks who heads up [unintelligible 00:57:51] PR agency Oliver & York. Don't forget to rate and subscribe to the [unintelligible 00:57:57] podcast. That way we know you like our topics. Follow us on Twitter, Instagram, LinkedIn, and TikTok.

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