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Article Excerpt
I. INTRODUCTION
For many years, there have been competition concerns regarding how retail gasoline prices are set in the United States and Canada. In several U.S. states, including Delaware, Maryland, Nevada, and Virginia, such concerns gave rise to divorcement legislation, under which refiners are not permitted to own or operate gas stations. (1) Concerns have also been raised in the United States regarding zone pricing. A company that owns and operates gasoline stations might define price zones where prices for all its stations in the zone are the same. It has been suggested that zone pricing is a form of price discrimination and thus is an indicator of market power. It has also been argued that zone pricing can be used in an anticompetitive fashion to coordinate pricing and to deter entry through localized price cutting. (2)
In Canada, consumers have complained about the perceived uniformity of retail gas prices in some markets and the perception that retailers raise their prices at the same time. Consumers have also been troubled by the observation that retail gasoline prices in some markets rise faster than they fall. (3) Concerns have also been voiced regarding interjurisdictional differences in retail prices that do not appear to be cost based, indicating to consumers that retail gasoline markets are not competitive. (4)
Possibly in response to public concerns, Canada's gasoline industry has advanced a competitive theory of gasoline pricing to explain certain perceived features of gas pricing that lead to allegations of collusion or anticompetitive behavior. Under this theory, it is assumed that gas is a homogeneous good, consumers are willing to drive long distances to save small amounts of money on gas, and prices are perfectly observable by consumers and nearby competitors. Based on these assumptions, it is argued that intramarket prices tend to uniformity, individual stations quickly match price changes by certain competitors, and price changes pass through an entire market almost immediately, in a domino fashion. (5)
While many complaints have been made regarding how retail gas prices are set and the gasoline industry has offered explanations, there are almost no publicly available studies of how prices actually change in urban retail gasoline markets, using complete station-specific data on intraday price changes over a long period of time. Such data are simply not available for most urban markets and can only be collected through personal observation of prices, or possibly via subpoena of retailers' pricing records in the course of a formal investigation. Even here, price data may not be complete. Yet, without such data, there exists no formal evidence that the stylized facts that the competitive theory attempts to explain are indeed facts and that pricing behavior is consistent with a theory of anti-or procompetitive conduct. The purpose of this article was to use gasoline station price data collected eight times per day for 103 d, for 27 gas stations in Guelph, Ontario, to evaluate the accuracy of the received wisdom regarding gas prices and the implications advanced by the informal theory of competitive gas pricing.
While the informal competitive theory seems to have been accepted by governments in many instances, some jurisdictions remain unconvinced. For example, the sense that consumers' concerns regarding gasoline pricing were not being addressed led the House of Legislative Assembly of Nova Scotia to establish an all-party committee to investigate gasoline pricing in that province. In its report, the Committee made a number of strong recommendations, such as retail divorcement (or price regulation if divorcement is rejected), a prohibition of petroleum product sales below acquisition cost, and that refiners must charge the same rack price to all customers. (6) These recommendations are clearly motivated by anxieties regarding possible anti-competitive conduct, which may or may not be supported by a detailed analysis of retail gasoline pricing data.
The competitive market model of retail gas pricing in Canada has been the focus of some of our earlier research. However, Eckert and West (2005) investigate the price uniformity prediction, and not the price response dynamics that are also proposed in the model. Other published studies of retail gas price movements use weekly or monthly prices averaged across stations or prices for a small number of stations and cannot study how stations respond to each other's prices (see, e.g., Borenstein, Cameron, and Gilbert 1997; Borenstein and Shepard 1996; Noel 2007; Sen 2003). (7) Some studies try to explain station-level pricing using station characteristics, location, and local competition, but do not study responses to price changes (e.g., Barron, Taylor, and Umbeck 2000; Hastings 2004; Plummer, Haining, and Sheppard 1998). Some studies use station-specific prices, but the data are cross-sectional (e.g., Shepard 1991), prices are surveyed no more than once per week (e.g., Barton, Taylor, and Umbeck 2000; Haining 1983; Plummer, Haining, and Sheppard 1998), or prices are for a jurisdiction (Western Australia) that regulates the timing of gasoline price changes (Wang 2006).
To anticipate results, to our knowledge, this article offers the first convincing evidence that for at least one Canadian market, to a large extent, stations do set prices to match (or set a small differential with) a small number of other stations. However, these stations are not necessarily the closest stations. In addition, we document that while stations frequently match price changes within 2 h, many take considerably longer to respond than claimed in industry and government documents and predicted by the competitive theory. Finally, while price decreases do ripple across the city like falling dominos, increases appear to propagate across the city based more on geographic location and source of price control than on proximity to the leaders of these increases. Overall, this study provides evidence that commonly accepted stylized facts regarding gasoline pricing in Canada, which have given rise to a competitive theory to explain them, are true to a certain extent. However, they are in many ways oversimplifications which hide details that can guide the development of theory, which might provide a better understanding of conduct in these markets.
In Section II, the informal theory of competitive retail gasoline pricing in Canadian markets is presented, as well as some reasons to believe that it will not be entirely supported by the data. Section III describes the data. Section IV presents the identities of principal price matches for each gasoline station in Guelph and contains results related to station responses to price changes. Section V examines the so-called domino effect that is alleged to be present in retail gasoline markets. Section VI discusses station price responses during price cycle restorations. Section VII provides a summary and some concluding remarks.
II. THE INFORMAL THEORY OF COMPETITIVE RETAIL GASOLINE PRICING IN CANADA
In Canada, there have been frequent allegations of anticompetitive conduct among gasoline retailers and multiple investigations of pricing in the retail gasoline industry. (8) There have also been mergers over the past 25 yr, affecting vertically integrated oil companies that were among the largest gasoline retailers. This has led to the development of an informal competitive theory of retail gasoline pricing that has been advanced by the petroleum industry to defend observed pricing behavior. The origins of the theory cannot be determined, and it has not been formalized. However, the elements of the theory are clear, and certain "stylized facts" are then supposed to be outcomes of competitive rather than anticompetitive forces.
As it appears in industry documents and studies, and some government documents, the informal competitive theory makes the following four assumptions:
(1) Retail gasoline is a homogeneous product, so consumers are unwilling to pay higher prices for a station s brand of gasoline. (9) Price differentials between stations might be tolerated for full-serve versus self-serve gasoline, or if a station offers some product or service that is superior to that of its rivals. (10)
(2) Consumers are extremely price sensitive when it comes to purchasing gasoline. They will travel large distances (e.g., a mile) to save two-tenths of a cent on a liter of gas, or 10 cents for a fill-up. (11) There are apparently no capacity constraints that might prevent consumers from taking advantage of price differentials.
(3) Retail gasoline prices are clearly posted on large signs, allowing consumers to compare prices. This also allows gasoline retailers to easily monitor their nearby rivals' prices. (12)
(4) Implicit in the theory is the assumption that individual gasoline retailers set prices noncooperatively. There is some recognition that price zones exist (Conference Board of Canada 2001, 27), but their sizes vary according to competitive conditions.
These four assumptions are taken by proponents to yield the following implications:
(1) Retail gas prices tend to uniformity (with perhaps very small differentials for service quality differences) in a market, as large positive deviations from the mode price are unsustainable. Stations charging prices higher than the mode price will experience a substantial loss in business and market share over a short period of time. (13)
(2) Retail gasoline price changes move rapidly and pervasively through the market. (14) There is some variation in the interpretation of the word "rapidly." The most extreme view is advanced by the Canadian Centre for Energy Information: "Of course, there can only be one lowest price, so everyone who wants to sell gasoline has to match the lowest price in the region within minutes--hours at most--or face a dramatic drop in sales." (15) One can find reference to responses to price changes that are "immediate," (16) "quick," (17) "extremely quick," (18) or "almost immediate." (19)
(3) Gas stations respond to prices set by a small number of other stations or "key competitors." There is some question regarding how to interpret the term "key competitor." The Conference Board of Canada (2001, 25-26) notes the following:
Most of the majors and regional refiner-marketers employ a set of tactics to ensure that each of their retail outlets remains competitive within their local markets. The following steps are generally taken before initiating a price change: Each outlet identifies the key competitors within a particular market (usually two or three) and then price relationships are established with respect to these key competitors. The relationship depends on the characteristics of the key competitors.
According to the Standing Committee on Industry, Science, and Technology (2003, 21-22), it is the view of industry officials that retailers must "keep an eye on their immediate rivals' prices." It is unclear whether distance is the primary determinant of a station's key competitors or immediate rivals, but it is likely an important determining factor.
(4) Price reductions will radiate outward from the initial source, like a falling sequence of dominos. This view is captured in the characterization of rival stations' responses to a price reduction, as advanced by an expert in the Imperial Oil/Texaco merger case:
While industry data suggest that up to 70% of consumers tend to buy most of their gasoline within two miles of their homes, the structure of this market ensures that price changes move both rapidly and pervasively through most large metropolitan areas. This is because each consumer's two mile radius overlaps with the next consumer's such that a net of interlocking submarkets spans the city. Any price decrease in one area of the city is transmitted by a...
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