Policy Issue Paper 14-02
An analysis on price responses of oil products to the entry of thrifty gas
station
J. H. Jung
Ⅰ. Research Background / 1
Ⅱ. Research Results / 4
Ⅲ. Policy Implications / 12
Ⅵ. Expected Achievements / 17
<References> / 19 Contents
Ⅰ. Research Background
1. Research Background
□ In 2011, the Korean government introduced thrifty gas stations to stabilize the retail prices of oil products by promoting competition in the distribution markets. To support this system, the government executed competition promoting policies including the creation of electronic commerce market for oil products.
○ The government executed various competition promoting policies to reduce retail prices by activating the competition in the oil product distribution, and to promote the competition among oil refinery companies in wholesale markets.
○ Since the introduction of thrifty gas station in December 2011, as of late 2014, over a thousand gas stations have opened in the market. In 2015, the number of thrifty gas station is expected to reach 1,300 or more, which will share 10% of gas stations in total.
○ Electronic commerce markets for oil products which opened in early 2012 is responsible for over 10% of total trading supplies. This system has shown positive effects in the sense that it provides the standard price of oil products.
□ It is necessary to conduct research to estimate the results of current policies. From the findings, we can suggest how to improve
competition promoting policies in the future. These efforts are expected to contribute to the establishment of reasonable and transparent oil product distribution market.
2. The Necessities and Purposes of Research
□ To discuss how to improve the current policies, we need to analyze the economic effects of price discount by the dissemination policy of thrifty gas station, and explore the participants' perception in the oil product distribution markets.
○ It needs to estimate the effects of thrifty gas station policy by conducting econometric study on how the entrance of a thrifty gas station influences on other neighboring franchise gas station operated by oil refinery companies.
○ In retail markets, the participants' perception and assessments on thrifty gas station policy need to be analyzed to understand the strengths and weaknesses of thrifty gas station in the field, and to make necessary improvement plans.
□ This study aims to estimate the effects of indirect price discount by the introduction of thrifty gas station, and to draw improvement plans of policies based on the results of survey on thrifty gas station policies.
○ Prior studies on this subject tend to focus on the effect analysis on the direct price discount of thrifty gas stations. This study estimates the
effects of indirect price discount from competitive gas stations nearby to comprehensively review the effects of price discount of this policy.
○ By collecting assessment and opinions on improvement plans from gas station owners who are stakeholders of thrifty gas station policy, this study aims to make practical suggestions on the policy.
Ⅱ. Research Results
□ Analysis on the price response of competitive gas stations to the entrance of thrifty gas stations
○ Before the entrance of thrifty gas stations, the sales prices of competitive gas stations located within 2 kilometers from a thrifty gas station did not show changes.
- Even if it is expected that a thrifty gas station will open soon, the pricing method does not change as competitive gas station perceive they do not need to discount prices because the thrifty gas station is not open yet.
- Potential competitors do not tend to preemptively discount prices because discounting oil product prices directly influences on the profitability of gas stations.
○ After thrifty gas stations start business, competitive gas stations nearby tends to discount prices.
- The prices of gasoline and diesel sold at competitive gas stations continuously decrease for 1 to 2 months after thrifty gas stations start business. The average gasoline price sold at competitive gas stations decreases by up to 0.23%, while the average diesel price is discounted up to 0.2%.
- The period when competitive gas stations show the biggest response by discounting gasoline and diesel prices is between 1 and 2 weeks after
thrifty gas stations start business. During this period, competitive gas stations discount their prices by 60 to 70%, which clearly represents the price competition tendency of competitive gas stations against the entrance of thrifty gas stations.
- Supposing that the retail prices of gasoline and diesel are 2,000 won and 1,800 won per liter respectively, competitive gas stations reduce the prices by 3.5 to 3.7 won in average.
- After two months since the entrance of thrifty gas stations, the response of competitive gas stations related to price discount gradually wanes.
From this phenomenon, it is possible to interpret that, in response to the entrance of thrifty gas stations, competitive gas stations focus on price competition in the short term, but, over time, run with non-price competition methods as well.
Classification Gasoline Diesel
Before a thrifty gas station starts
business
1 month 0.019 -0.005
2 weeks -0.007 -0.010
1 week -0.017 -0.023
After a thrifty station
starts business
1 week -0.101 a -0.093 a
2 weeks -0.135 a -0.154 a
1 month -0.175 a -0.206 a
2 months -0.176 a -0.174 a
3 months -0.127 a -0.149 a
<Table 6-1> Changes in the Cumulative Average Abnormal Prices of Competitive Gas Stations
(Unit: %)
Note: a, b, and c represent that the changes in the cumulative average abnormal prices are
statistically significant in the level of 1%, 5%, and 10% respectively.
○ Competitive gas stations located near thrifty gas stations may show different sizes in price response to the entrance of thrifty gas stations depending on various factors including the distance from a new thrifty gas station, ownership type, and the features of location.
- Competitive gas stations located within 1 kilometer from a thrifty gas station show a bigger price response thant other competitive gas stations located within between 1 and 2 kilometers.
- The difference in price response is the biggest after one month since the entrance of thrifty gas station, showing 0.179%p for gasoline and 0.255%p for diesel. These differences are caused by the fact that competitive gas station located within 1 kilometer cut own their prices 3.6 to 4.6 won per liter more than other stations located farther.
- This difference depending on the distance between a thrifty gas station and competitive gas stations increases for one month, and tends to be reduced after then. It is estimated that competitive gas stations nearer to a new thrifty gas station use short-term strategies focusing on price discount to prevent the reduction of sales.
Classification
Distance from a thrifty gas station (within 1 km vs.
farther than 1km)
Ownership (independent vs.
franchised)
Location (city vs. non-city)
Gasoline
1 week 0.129 a -0.094 c -0.036
2 weeks 0.137 a -0.102 -0.009
1 month 0.179 a -0.101 0.069
2 months 0.155 b -0.167 c 0.090
3 months 0.118 c -0.062 0.117 c
Diesel
1 week 0.153 a -0.064 -0.023
2 weeks 0.200 a -0.165 b -0.049
1 month 0.255 a -0.169 c 0.056
2 months 0.208 a -0.052 0.064
3 months 0.178 b 0.177 -0.008
<Table 6-2> Changes in the Cumulative Average Abnormal Prices by Features of Competitive Gas Stations
(Unit: %)
Note: a, b, and c represent that the changes in the cumulative average abnormal prices are statistically significant in the level of 1%, 5%, and 10% respectively.
- The differences in the price changes among competitive gas stations by ownership type show negative values during most periods. It means that independent gas stations usually cut down prices more than franchised gas stations do.
- The reason why franchised gas stations show a smaller discount is estimated that their business strategies are differentiated from those of independent gas stations. In fact, the sales prices of franchised gas stations tend to be maintained high compared to independent gas
stations nearby.
- The price changes of gasoline and diesel by the location of competitive gas station do not show a significant difference during most periods.
This phenomenon proves that the response of competitive gas stations by reducing their prices to the entrance of thrifty gas stations is not influence by the size of operation costs (including rent and labor costs) of gas station.
□ Results of survey for gas station owners on the thrifty gas station policy
○ According to the results of survey, the thrifty gas station policy is considered to have significant influences on the oil product market in terms of the promotion of price competition.
- 56% of competitive gas stations located within 2 kilometers from a thrifty gas station consider it as their competitor. 70% of competitive gas stations perceive that the strength of thrifty gas stations is 'price.' In addition, 73% of competitive gas stations respond that they maintain higher sales prices than thrifty gas stations.
- 86% of competitive gas stations nearby a thrifty gas station answer that they monitor the prices of thrifty gas station more than once a week, while 32% of competitive gas stations answer that they do more than once a day. These results represent that the owners of competitive gas stations concentrate their attention on the sales prices of thrifty gas stations.
- Only 2% of competitive gas stations respond that their sales have increased after the entrance of thrifty gas stations. Most of existing gas stations have experienced the reduction of sales. This situation implies that the sales competition among local gas stations have getting more severe due to the entrance of thrifty gas stations.
- As a respond to thrifty gas stations, 60% of competitive gas stations select 'to ask their oil refinery company to cut down buyer's unit price,' and 'to reduce sales prices.' These replies imply that more than a half of gas stations have practiced the reduction of buyer's unit price or sales prices to compete with thrifty gas stations in terms of prices.
- Other countermeasures except for pricing strategies may include the introduction of non-oil business, conversion to self- or thrifty gas station, the diversification of oil product providers. However, existing gas station owners cannot easily try these alternatives because they require additional costs.
○ Thrifty gas station owners also perceive that they have competitiveness in 'low prices.' Thrifty gas stations are assessed to enter the market effectively as they show the increase of sales after conversion.
- Only 40% of thrifty gas stations perceives that 'price' is the strength of competitive gas stations. This result implies that thrifty gas station owners also consider their low prices as their competitiveness.
- Thrifty gas stations count S-Oil (26%), SK (24%), GS Caltex (17%), and Hyundai Oilbank (17%) as their competitors. S-Oil gas stations are
considered as the biggest competitor while it has a relatively low share of market. This result implies that the sales prices provided by S-Oil gas stations is lower than other franchised gas stations.
- The average supply price (wholesale price) of S-Oil gas stations is 10 to 20won lower than GS Caltex and Hyundai Oilbank. This situation allows S-Oil gas station ownders to provide consumers with a bigger discount compared to other franchised gas stations.
- About 50% of thrifty gas stations answer that their sales have increased after conversion, while 70% of competitive gas stations reply their sales have decreased.
○ Thrifty gas station owners and competitive gas station owners make a different assessment on the thrifty gas station policy
- Competitive gas stations make a very negative assessment on the thrifty gas station policy. In particular, they show pessimistic opinions on the government policies including financial support, expansion of new thrifty gas stations, and supplies at a low price.
- This negative assessment from competitive gas stations implies that they perceive that their worsening profitability is caused by price competition after the entrance of thrifty gas stations.
- Meanwhile, thrifty gas stations assess that the current government support is not sufficient. More than 40% of thrifty gas stations reply that they are not satisfied with financial support and oil product supplies at a low price.
- As for the major problems to be resolved, thrifty gas station owners expect the government to improve policies to expand discount cards, increase support fund for facilities, and increase loan support.
Ⅲ. Policy Implications
□ The thrifty gas station policy needs to be consistently pursued as the means of increasing consumer's utility.
○ The results of empirical analysis and survey prove that the thrifty gas station policy is effective to cut down prices.
- This policy shows both direct effects, reduced sales prices at thrifty gas stations, and indirect effects, reduced sales prices at competitive gas stations nearby a new thrifty gas station.
- Considering that one of important goals pursued by the governments' oil market policies is to stabilize the prices of domestic oil products, the thrifty gas station policy with a high policy effectiveness needs to be consistently pursued.
- The domestic oil product markets are dominated by 4 major oil refinery companies, forming a vertical structure in the oil product distribution markets. While the dominating power of these companies are influencing on retail sectors as well, the introduction of thrifty gas stations is considered as a useful policy to contribute to reduce market prices.
- In the case that international oil prices skyrocket, the Korean government does not have effective policy means to alleviate the fluctuating prices of domestic oil products except for thrifty gas stations.
In this sense, if the government abandons this policy, it will have negative effects on the national economy in general.
○ To meet the two goals, including the price stabilization of domestic oil products and the minimization of government intervention in the market, the operation methods of Korea National Oil Corporation (KNOC) need to be improved.
- If the thrifty gas station policy, executed by KNOC, is abandoned, the national economy can be faced with negative consequences. It is because the Korean government does not have effective alternatives to stabilize the prices of domestic oil products except for thrifty gas stations. Hence, abandoning the thrifty gas station policy implies the loss of a useful and effective policy means to lead to the price stabilization in the market.
- If the operation of thrifty gas stations is transferred to the private sector, operation costs will increase so that consequently damages the policy effectiveness by weakening the price competitiveness of thrifty gas stations. This problem can lower consumers' credibility on the brand of thrifty gas station.
- To minimize government intervention in the oil product market, and to maintain the effectiveness of thrifty gas station policy, the operation methods of thrifty gas stations can be differentiated depending on the price level of oil products.
- When international oil prices increase above an normal level, the current operation method will be maintained to stabilize the price of domestic oil prices. However, when international oil prices decrease, reducing the demand of price stabilization, it is necessary to review plans to maintain
the supply prices in the similar level with other general gas stations.
- The accounting separation of KNOC related to the thrifty gas station business needs to be considered so that the profits occurred during time when oil prices decrease can be used to cut down supply prices when oil prices increase.
□ The improvement plans of thrifty gas station policy needs to be discussed based on participants' opinions in gas station markets.
○ The owners of thrifty gas stations consider the feasibility of supply prices and the sustainability of this business as the most important goals to be pursued. To reach these goals, KNOC, an agency in the public sector, is supposed to be an appropriate subject to continue to operate this project.
○ The operation of thrifty gas stations receive positive assessments in the sense that they provide consumers, who are sensitive to prices, with a wider range of choice for gas stations. To secure consumers' choice, the strategic approaches need to be developed for regions with a low distribution rate of thrifty gas stations.
- As for regions with a low distribution rate of thrifty gas stations, it is necessary to expand the financial support to convert existing gas stations to thrifty gas stations until these regions have a certain distribution rate of thrifty gas stations.
- To prevent thrifty gas stations from concentrating at certain regions, it needs to consider the establishment of new regulations to limit a
distance between thrifty gas stations.
○ Policies supporting thrifty gas stations for the areas where they have a poor competitiveness compared to franchised gas stations need to determine the appropriate level of service considering costs.
- Compared to franchised gas stations, thrifty gas stations are assessed to have a poor competitiveness in employee services, discount cards, facility support, and loan support.
- The improvement of services in these areas may require costs, and these additional costs can damage their price competitiveness, which is one of the most important strength of thrifty gas stations.
- Therefore, the thrifty gas station project needs policies to improve their competitiveness in these areas in a reasonable level, while retaining their price competitiveness.
□ It needs to prepare long term streamlining plans for gas station industries in response to the introduction of thrifty gas stations and the deepening competition in oil product retail markets.
○ As the thrifty gas station policy has promoted the price competition in the retail markets, existing gas stations have experienced the reduction of sales and profitability.
- Most of gas station owners have pessimistic overview on the gas station market in the future, assuming that the worsening profitability will lead to the decrease of gas stations.
- The decreasing number of gas stations can lead to oil product consumers' inconvenience. To minimize this problem, it is necessary to discuss how to maintain the appropriate number of gas stations in the level of policy.
○ In the long term, closed gas stations can be utilized as other types of energy supplying facilities (for example, recharging stations for electric cars or natural gas). This plan needs to be discussed and supported by developing relevant policies.
- In the case of converting closed gas stations to other types of energy supplying facilities, the government needs to provide financial support for a part of costs requiring in the demolition and environmental cleanup.
Ⅳ. Expected Achievements
□ The improvement of thrifty gas station focusing on the enhancement of price competitiveness will lead to price competition with the franchised gas stations operated by oil refinery companies.
○ When relevant institutions are consistently improved to enable thrifty gas station to stably provide oil products at low prices, thrifty gas stations can be grown to a strategic gas station to promote price competition among local gas stations, contributing to the stabilization of the retail prices of oil products.
○ The enhancement of supervision on the sales prices and quality provided at thrifty gas stations will raise consumers' credibility on thrifty gas stations.
□ The oil product distribution market will be able to diversify transaction channels and improve price transparency.
○ The introduction thrifty gas stations is expected to diversify the transaction channel in the domestic distribution markets, which currently shows a vertical structure with the involvement of oil refinery companies.
○ The diversification of transaction channel in the distribution markets will promote international oil transaction companies to enter into domestic markets. The entrance of foreign companies into the markets in Korea has been faced with difficulties due to lack of supportive policies. This
diversified channels will contribute to the stabilization of the prices of domestic oil products and the transparency of pricing process.
○ The sales prices provided by thrifty gas stations can be accepted as standard prices of oil products, and also weaken oil product providers' pricing power.
□ The failure of oil product markets caused by dominating structure can be prevented.
○ The expansion of thrifty gas stations can contribute to the correction of failure factors in oil product markets dominated by some providers, and the increase of social benefits in general.
< References >
1. References Published in Korea
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3. Others
지식경제부, www.mke.go.kr
지식경제부, 2012년 에너지산업 주요통계
한국석유공사, www.knoc.co.kr www.petronet.co.kr 한국에너지신문, www.koenergy.co.kr
석유가스신문, gnetimes.co.kr 한국주유소협회, www.ikosa.or.kr
Policy Issue Paper 14-02
An analysis on price responses of oil products to the entry of thrifty gas station
Printed on May 15, 2015 Issued on May 15, 2015
Author：Jun-Hwan Jung Publisher：Joo-Heon Park
Published by Korea Energy Economics Institute,
(Address) 405-11, Jongga-ro, Jung-gu, Ulsan, 44543, Korea, (Phone) +82-52-714-2114, (Fax) +82-52-714-2028 Registered on December 7, 1992
ⓒKorea Energy Economics Institute, 2015
