NOTAS AL PRÓLOGO

Table 18 shows the calculated effective gross margin by fuel type for each year taking account of discounts. On average gross margins appeared stable over time

43 _{The price series from the Comparative Heating Schedule for kerosene collected by the Office and}

gasoil retail prices were used as submitted by the companies. The actual price paid by consumers reflects:

 the range of discounts made available to customers by the suppliers;

 supplier choice – unlike road fuels, non-price elements such as quality of service are an important driver in the choice of supplier and therefore influence overall prices;

 timing of collection—the prices are collated on the first day of each month for most of the period and since mid 2008 twice monthly.

Table 18 – Average heating fuel effective gross margins, ppl

Kerosene Gasoil Weighted

average44

2005 _{8.16 3.04 5.61}

2006 _{8.92 3.89 6.90}

2007 _{8.13 3.04 6.28}

2008 _{9.48 4.19 7.51}

Source: Total IoM, CPL, Manx Petroleums

There are four main components of the effective gross margin:

 shipping and import costs – includes actual shipping charges, harbour dues, ship discharge and other import administrative costs

 cost of storage and on-Island distribution – these include depot costs and operating the road distribution network

 costs for retail of heating fuels – includes sales and administrative costs and charges incurred for marketing and promotion

 profits of the distributor/retailer

The wholesale costs were similar to those for road fuels discussed in Section 3.4 though there was some difference in:

 the level of shipping costs by individual fuels; and

 the allocation of storage and distribution costs.45

Retail costs for heating fuels include sales and administrative costs, and marketing and promotion charges. The estimates for these costs are highlighted in Table 19 below. These have been allocated by volume rather than by customer numbers.

Using these costs the profit of the activity can be estimated, as shown in Table 19. The combined overall profit for both fuels ranges from 2 - 4 ppl.

 profit seem to have remained stable over time except for 2007

 kerosene profits appear reasonable whereas gasoil is marginally, if at all, profitable.

44 _{The averages in this table and for the rest of Section 4 are on an annual weighted volume basis.} 45 _{Cost allocation is done by volume and not customers, which means that we have potentially over-}

Table 19 – Estimated wholesale and retail costs and profits, in ppl46

2005 2006 2007 2008

Kerosene Gross margin _{8.16 8.92 8.13 9.48}

Shipping and import 1.01-1.16 1.06-1.54 1.00-1.06 0.92-1.88 Storage and distribution 2.03-2.06 1.75-2.26 2.36-2.51 2.21-2.64 Marketing and promotion 0.06-0.27 0.09-0.46 0.07-0.43 0.11-0.22

Estimated profit 4.71-5.03 4.67-6.02 4.01-4.13 4.74-5.60

Gasoil Gross margin 3.04 3.89 3.04 4.19

Shipping and import 1.01-1.52 1.06-1.58 0.97-1.00 0.92 Storage and distribution 2.03-2.06 1.75-2.26 2.36-2.51 2.21-2.64 Marketing and promotion 0.06-0.27 0.09-0.46 0.07-0.43 0.11-0.22

Estimated profit -0.09- _-0.77 -0.40-0.99 -0.38- _-0.87 0.41-0.94 Average profit 1.98-2.48 2.63-4.00 2.23-2.49 3.13-3.86

Source: Total IoM, Manx Petroleums

The 2006 OFT study estimated that market participants were making a profit in the range of 4.2 – 4.6 ppl for kerosene and -2.4 - -3 ppl for gas oil for the period from 2001- 2005 compared to corresponding margins in the UK of 2.8 ppl and 0.2 ppl respectively for kerosene and gasoil.

The estimated profit for both products appears to have increased, and while the implied profit for gas oil is still relatively low, that of heating oil raises some cause for concern. Some of the extreme levels observed may be a consequence of the assumptions on the attribution of sales, admin and marketing costs between the two products. It is to be expected that the gas oil market would have lower market and overhead costs than the domestic kerosene market due to the smaller number of customers being served. The above costs reflect the direct costs of importation and distribution. There are other general expenses the suppliers have incurred to support their businesses that have been excluded based on an estimation of direct relevancy. These other costs would also need to be recovered through the gross retail margin. It is estimated that these costs

represent around an additional 0.6 ppl to 1.4 ppl.

Consequently, a rebalancing of the costs between gas oil and kerosene and inclusion of these excluded sundry costs may lower the profit estimate for kerosene, though it is unlikely to return to the levels of the previous study.

4.5

Comparative price assessment

As with road fuels there is a premium on heating fuel prices in the Isle of Man when compared to the UK. Table 20 below provides annual average price differentials during 2005-2008 for gasoil and kerosene. On average, the differential for kerosene was 6.58 -

46 _{The average profit is calculated as the maximum and minimum profit of both companies, weighted by}

8.88 ppl compared to 2.56 - 6.19 ppl for gasoil – the latter declined annually for the period under review.

Table 20 – Annual average UK – Isle of Man heating fuels price differentials, ppl Kerosene Gasoil 2005 7.26 6.19 2006 7.40 5.28 2007 6.58 2.56 2008 8.88 2.56

Source: IoM OFT Comparative Heating Schedule (kerosene); Total IoM, CPL, Manx Petroleums (gasoil), UK BERR Digest of UK Statistics

4.5.1.1 Historic retail price differentials between the Isle of Man and the UK

average

The kerosene differential has increased over time while gasoil has declined as

highlighted in Figure 27. This may imply that suppliers are able to place more cost on the kerosene market to make up for declining sales elsewhere.

Figure 27 – Average UK – Isle of Man heating fuel price differentials, ppl

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 2005 2006 2007 2008 Penc e per lit re

Kerosene Gasoil Average kerosene Avereage gasoil

Source: Total IoM, CPL, Manx Petroleums, UK BERR Digest of UK Statistics

Figure 20 charts the monthly price differentials highlighting the volatility. This is largely due to differences in fuel delivery cycles which are more frequent in the UK market

compared to the Isle of Man. In 2008, the price differentials narrowed, followed by a significant increase in the last quarter as indicated in Figure 28.

Figure 28 – UK – Isle of Man heating fuels price differentials, ppl

-4 -2 0 2 4 6 8 10 12 14 16 18 Jan-05Mar -05 May -05 Jul-05Sep-05Nov-05Jan-06Mar -06 May -06 Jul-06Sep-06Nov-06Jan-07Mar -07 May -07 Jul-07Sep-07Nov-07Jan-08Mar -08 May -08 Jul-08Sep-08Nov-08 Penc e per lit re

Kerosene Gas oil

Source: Total IoM, CPL, Manx Petroleums, Catalyst

4.5.2 Can the observed differential be explained?

The annual differential for the period under consideration was 6.58 – 8.88 ppl for

kerosene and 2.56 – 6.19 for gasoil.47 _{The average for the period was estimated at 7.23} ppl (kerosene) and 4.18 ppl (gasoil). Some of this difference can be explained by higher costs of operating in the Isle of Man as outlined in Table 21 below:

47 _{The monthly differential between the Isle of Man prices (as quoted in the IoM OFT Comparative}

Heating Schedule) and the UK is even more volatile – ranging between 2.3 – 13.9 ppl for kerosene and -2.7 – 9.4 for gasoil.

Table 21 – Explaining the heating fuel price differentials, ppl

Average differential with the UK 4.2 – 7.2

Readily quantifiable cost differences 5.7 – 6.3 (kerosene); _{3.0 – 3.6 (gasoil)}

 cost of importation and shipping to the Island 0.9 – 1.5

 level of discounting in the market 2.1(g) – 4.8(k)

Potential cost differences

 lack of wholesale product competition (uplift comparison relative to benchmark cost and uplift charges for other markets)

Qualitative cost differences

 low profitability of UK distribution (and/or higher on- Island distribution costs)

 higher fixed cost of operation (cost of operating two storage terminals and piers)

 diseconomies of scale from lack of support services and specialist contractors

As summarised in Table 21, some of the differential can be accounted for by the analysis of wholesale and retail costs and margins, in particular:

 the higher cost of importation and shipping to the Island is approximately 0.92 - 1.52 ppl for the combined fuels;

 the level of discounting is significant in the market and has increased over time. In 2008, the average discount for kerosene is estimated at 4.84 ppl, compared to 2.11 ppl for gasoil.

Up to 6.36 ppl of the price differential can therefore be explained for kerosene and 3.63 ppl for gasoil – leaving 0.9 ppl and 0.6 ppl in kerosene and gasoil differentials

respectively unaccounted for.48 _{As explained in Section 3, there are several potential} explanations for this and these are repeated below for completeness:

 limited competition compared to the UK - fewer market participants across any part of the supply chain means that competition at any level of the supply chain is less compared to the UK – in addition, competition with natural gas is relatively new compared to the UK and may yet take effect.

 there are further incremental costs on distribution related to shipping that are not all accounted for in the comparison to date;

 additional Island-specific costs such as the cost of operating two storage terminals and piers, which contribute to increase the cost of doing business in the Island;

 the delivery cycles and inventory holding means that on average the wholesale cost of purchase is inflated above the expected efficient cost of purchase – it also means that there is a margin to the differential which is purely a factor of the difference in cost of product from the differences in cycles;

 higher costs from lack of support services and specialist contractors forcing local market actors to invest in developing capabilities that are infrequently used or would be more cheaply sourced in a larger market (for example lack of part time road tanker drivers) or importing services and personnel from the UK; and

 the wholesale business in the UK is not very profitable - the OFT study in 2000 indicated that it earned no profit – a conclusion supported by the 2008 Highlands and Islands report which estimates that the average profit is 0.4 ppl. Thus, some additional return would be necessary to sustain the current distribution network in the UK. The higher margins would need to be reflected in higher overall returns than those necessary to sustain a stand alone business.

4.6

Summary

Having reviewed the costs and margins in the heating fuels market, the following observations can be made:

 the gross retail margins have risen over the period of this study and the implied profit was substantially greater than that at the time of the last study;

 this position is especially true in the domestic kerosene market where gross margins in the order of 8 ppl were being observed;

 with three competitors and transparent pricing behaviour, the high margins may just be indicative of the efficient allocation of fixed costs to the most insensitive group of customers; the domestic market.