Mr. Chair, members of Parliament, and Canadians who have access to this hearing, on behalf of the members of the Canadian Petroleum Products Institute, thank you for inviting me to better understand your preoccupations with our industry.
I'll keep my comments brief so as to answer as many questions as possible.
As some of you may know, the CPPI is a national association of major Canadian companies involved in the refining, distribution, and/or marketing of petroleum products for transportation, home energy, and industrial uses. Collectively we operate 16 refineries, representing over 80% of the refining capacity in Canada, and we supply over 7,000 branded retail outlets with transportation fuels across Canada. Our members include Chevron, Husky, Imperial Oil, North Atlantic Refining, Shell Canada, Suncor Energy Products, Ultramar, NOVA Chemicals, and Bitumar Inc. Our members operate refineries in British Columbia, Alberta, Ontario, Quebec, Nova Scotia, and Newfoundland and Labrador. Arco Products Corp. and the Parkland Income Fund are marketers in western Canada.
We recognize that our industry is under the spotlight. For most Canadians we are the indispensable enabler of the drive to work and school, the transportation of paramedic and fire services, home heating fuel, and right now, even the Sunday or Saturday cutting of grass. We provide quality products, proven performance, and our complex facilities operate safely and reliably. We make our products affordable by keeping our costs down. We are also the ones, I will say, who face the consumer reaction head-on, with price signs larger than I am tall.
Affordability of our products is one of the key questions that face consumers, consumer advocates, social activists, environmentalists, scientists, engineers, and economists as well as people like you, the public policy decision-makers. We understand your interest in gas prices and refinery margins, and I hope to provide you with a reasonably straightforward answer today.
The first chart in the presentation that has been provided to you sets out the movements in gas prices in four major urban centres compared to the New York harbour wholesale price for gasoline. This says fairly straightforwardly that we operate in a commodity-based market where we are, in effect, the price taker, not the price maker.
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I'll turn to the first graph, which marks 2007 wholesale gasoline prices. In this particular case, we've tracked the price movements, from January through to June, at New York harbour, Montreal, Toronto, Calgary, and Vancouver. What you can see, or at least what this graph attempts to underscore, is that we operate in a North American market for gasoline products. We are very much the price taker, not the price maker, in this situation.
There's an additional phenomenon associated with speculation that I'd like to comment on a bit. To quote Natural Resources Canada:
News of the recent declines in stock levels, combined with the earlier than usual up-tick in gasoline demand, has market analysts speculating about possible gasoline shortages this summer. This has sent speculators and traders scurrying to the market to secure contracts for summer delivery. This trader activity has driven up wholesale prices of gasoline across North America and, subsequently, prices at the pump. Prices are likely to remain high until inventory levels begin to build or analysts are comfortable that there will be enough gasoline to meet summer demand.
That comes from Natural Resources Canada's 2007 “Petroleum Product Market Outlook”, available on their website.
This isn't something we do; rather, this is the reality of commodity trading.
In terms of refinery margins, the second chart presents the movement in margins. It is volatile, there's no question about that. And there is no question that the margins are averaging upward.
In public policy terms, this Parliament and previous Parliaments have mandated fuel policies whose financial impact in terms of fiscal expenditures has been about the magnitude of a high-speed rail corridor between Montreal and Toronto and in a much shorter period of time. Just as an example, in mandating a low-sulphur fuel requirement for gasoline and diesel, CPPI members have invested approximately $5 billion in expenditures to reconfigure this manufacturing process.
We worked in collaboration with government officials to achieve this policy, and we managed to achieve this goal while protecting Canada's competitive advantage in the production and distribution of fuels for Canadians. I'll emphasize this, because it's a lot of money: the investment is $5 billion of private sector money in a private sector-operated and competition-driven modern infrastructure. We will continue to make similar investments as a full partner with you as we take on new challenges with climate change and clean air.
For a few moments, consider the business environment in which the institute's members operate. Our principal input is crude oil, a commodity determined by a global pricing system, sourced from multiple areas in the world. There are taxes from something as complicated—and expensive, I might add—as the CRA definition of the amount of gasoline used to denature ethanol to the GST collected on the final tally. In the former, our members independently bear the cost of administering a public policy decision, and it's not that easy.
The third component is our refinery margins, which is the differential between crude input costs and the price at which fuel is sold, essentially a commodity market on top of a commodity market, which is the crude oil market, based on thousands of transactions all over the world, by the hour, involving futures and derivatives and so on. It is a margin, which is not to be confused with profit. For at least one CPPI company, it ranged from zero in December of 2006 to 10.7¢ when I wrote this brief.
Finally, there is the marketing, those services for which consumers are attracted beyond price—groceries, motor services, the location, etc.
Nevertheless, the fact remains that over the last 10 years, after-tax profits have averaged approximately 1.5¢ per litre. That is reflected in the chart entitled “Downstream Petroleum Financial Performance”.
The Canadian fuel infrastructure is alive and best serves consumers in a fully competitive marketplace. Nevertheless, a confusing policy environment is not conducive to investment decision-making. Removing the tax exemption on renewable fuel mixes should be revisited. It increases the cost of fuel vis-à-vis the United States.
With respect to clean air, the underlying assumption in the latest data provided by Environment Canada suggests that we will need to supplant future consumption with imports. With fixed caps on these criteria air contaminants, it is not going to be possible to grow to meet demand, even though our members possess the technologies that are available right now to produce the cleanest fuel possible. We are being asked to exceed performance requirements of our principal competitors in the U.S.
In respect of GHGs, the uncertainties over the pricing of carbon dioxide credits beyond the short term continue to be a challenge. What we know is that an 18% reduction target by 2010 for all large industrial emission sources, along with a 2% per year escalation thereafter will create a large domestic demand for these credits. This, coupled with the diminishing access to compliance options over time, will impose large costs on our sector, which will not have to be borne by the United States.
In implementing the renewable fuel policies—and I stress policies because we have more than one in this country—major costs have already been incurred to respond to each jurisdiction.
As for price fluctuations, I'll be honest: who doesn't hate them? They're hard to follow, and they're hard to understand, but as frustrating as they can be, they are evidence of the biggest savings over time for consumers. In fact—and other witnesses have referred to this—studies in Nova Scotia suggest that while price regulation causes few movements in price, consumers in Nova Scotia end up paying more than their counterparts in the rest of the country do.
I will plead with you to not ask us to do what we can't. This is a global commodity market where the rule of supply and demand prevails. Successive studies by, among others, the Competition Bureau and the Conference Board of Canada have concluded that Canadians benefit economically even though it can be a frustrating retail experience at any given point in time.
Historically, Canadians have had the second lowest gas prices in the western world. Whether that is good or bad in public policy terms is for you to decide, but our business is to provide Canadians with the lowest-cost fuel at the highest quality and safety, and our industry has an excellent track record of doing exactly that.
There is heightened interest in what we do and how we do it, and the CPPI welcomes that, because though our product may be a commodity, its safety, cleanliness, and low cost are functions of the incredible minds and integrity of the people who work for our members. As is the case with using different light bulbs and energy-efficient furnaces, there are more things that can be done to make consumption more efficient. To that end, CPPI has endorsed the driving tips of the Canadian Automobile Association, and just as an example, yes, tire pressures actually do matter.
On that note, I'm open to questions.
Thank you.
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Mr. Baily, Mr. Macerollo, it's good to see you here. It's good to see that some of us have changed hats and some of us haven't.
Two out of three ain't bad, Dane.
Mr. Macerollo, thank you for the presentation. I was interested in what the chair asked for with respect to the graph, because, of course, he knew I was going to ask questions on the differentials between the New York harbour cargo rate and the price. I'm going to find out in about 35 minutes what we'll be paying tomorrow. My sense is that it has always gone anywhere from 2¢ to 7¢ a litre, depending on the circumstance.
Given that we don't have similar gasoline to Buffalo's and Toronto's, and the gasoline sold in Plattsburgh, New York, which is another comparative model that you use, is not the same as the gasoline produced in Montreal, how do you justify, on almost any given day, a wholesale price for gasoline charged to your own members by your refiners, whom you represent, that is higher than wholesale prices at the refinery gate, generally in the United States?
Mr. Macerollo or Mr. Baily.
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First of all, there are a couple of pennies in transportation costs. The short-term reality is that the product doesn't flow instantaneously across the border, but if there is a long-term differential, because the products are essentially the same, and if there's an opportunity for a U.S. refiner or a U.S. wholesaler to move product in the Canadian market and make a couple of pennies more, they will do that, at the debit of the U.S. market.
So the product can move across the border. It doesn't move day to day, and that's why, when you take single days or points in time, it can be really misleading. I can pick numbers to say that—you know, I remember one day, I think in 2005, when the gasoline price was lower than crude oil. If our industry had the control that is often ascribed to us, why would we give this stuff away? The markets fundamentally set the price, and we go with that.
When you look in detail, you sometimes ask what happened to Vancouver pricing and how come it distanced—Well, the Vancouver market is a little bit distinct from New York. They tend to follow, but there are special conditions. You can see special conditions happen out west. When the western refining circuit out of Edmonton, which supplies basically Victoria to Thunder Bay, gets very tight, you'll see the wholesale prices rise in that market, and they do that to attract imports. As the wholesale price goes up, what you do is set up a condition to attract imports. If you're short on supply, that's exactly what you want to do. That's how the market balances those situations.
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Welcome, gentlemen, and thank you for being here today.
In your presentation, you correctly indicate that prices fluctuate. What consumers find really difficult is that prices jump in time for the Christmas and summer holidays. We are trying to understand what is behind that.
I believe that you represent the major oil companies in Canada. Imperial Oil, Petro-Canada, Husky Oil, EnCana, Suncor and Shell, who are the people that you represent, I imagine, racked up record profits of some $12 billion in 2006. That was an increase of 25% over 2005 and 70% over 2004.
My first question is a simple one. How can you tell us in your presentation that your companies are in a really difficult situation when you have been making record profits?
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I don't want to give you the impression that our companies are facing tough times. I do want to impress upon you that a number of public policy decisions are placing strains on the refining sector in this country. And let's make a distinction between upstream and downstream. We represent the downstream. That's when the oil arrives at the refinery, to the point where it goes to the retail station.
That has not been a profitable business for a very long time. If you look at historical data, it was the losing end of the business for quite a while. So I come back to you that at one point, a profit of 5¢ a litre.... Admittedly, that's a lot of litres, but $5 million is also a lot of money to do desulphurization, which doesn't get you either an extra cent or an extra litre of gasoline. They're both good purposes. The pollution requirement to lower sulphur is an excellent public policy decision, and we implemented it, but it does cost money.
As for the price fluctuations, Madame, there's no question that in the summer months there is an increase in demand for motor gasoline. There are only so many refineries in Canada and the United States. There is only so much product that can come in from Europe to increase the supply that is available. In the absence of more supply flexibility, you're going to see price movements.
This is not something we control. It's something our members do a pretty good job at, which pays off in dividends to the shareholders. But the refining sector—and I do underline in particular refining as opposed to the entire spectrum of activities—has not been a particularly profitable industry. It's only been that in the last couple of years.
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Thank you very much, Mr. Chair.
I want to thank both of the witnesses today, because I think you have clarified refining margin versus profit.
Some of the other witnesses we had, as Madame Brunelle was saying, said a 4¢ to 6¢ refining margin should be appropriate, and we're seeing those margins increase. I'm curious about your opinion on the trend. We see in Canada that all parties, all governments, are saying we need cleaner emissions, that we need to blend different biofuels and come up with newer technologies. And because this is a North American market, with differences between Canada and the States, we had another issue about new refineries in Canada.
How would you say the regulatory framework in Canada versus the United States plays into effect where companies make decisions on where to put refineries? Is there a big difference?
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Under ordinary circumstances I would suggest actually that the Canadian marketplace is a more stable, friendly marketplace, from a pro-competition point of view, but there have been some bizarre things happening.
There has not been a refinery built in North America—period—for many, many years. It's not just a Canadian phenomenon that it's difficult to attract capital to invest in these kinds of things. Even with the existence of refinery subsidies—those in the United States to build refineries—people are not taking up those offers.
One of your questions the other day was on tax policy. There are, in fact, incentives south of the border. We're not asking for that. As has been shown south of the border, they don't necessarily work.
In the example of renewable fuels, the federal government alone provides a 51¢ per gallon subsidy on ethanol-blended gasoline. In the last budget, the government announced that it is eliminating the equivalent of our blend or subsidy as of April 1 of next year and replacing that with a subsidy that goes directly to the producer, further widening the competitive disparity between those in Canada and our U.S. counterparts.
Those are just some of the examples. Provincial governments have done the same thing as well. There's a lot of tax policy that circles around our product, but on balance, when you look at it worldwide, the North American marketplace is, generally speaking, the lowest-tax fuel environment.
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Because the refining operation is—
There are a number of factors here. First of all, we are a very regulated industry. When governments, in both Canada and the United States, make pronouncements about conservation and energy efficiency—i.e., that we have to cut down on our consumption—they're sending messages into the marketplace that this is not a lucrative area to invest in. Government policy is trying to actually bring demand down.
Even though that hasn't worked, if I may be blunt—because it hasn't worked. Demand, very robust demand, continues in the Canadian marketplace. That coupled with environmental regulations, coupled with the whole series of planning involved to put together a refinery over a ten-year period, does not jibe with, as I mentioned in my brief, an inconclusive policy environment. We depend very much on government policy, and predictable government policy, to make those decisions.
You talk about profit here. I'm looking at the part above this chart in your presentation where you say, “Nevertheless, the fact remains, that over the last ten years, after tax profits have averaged about 1.5¢ per litre.” You also talk about going from zero in December up to 10.7¢ as of late. So there's great variation in what has happened.
When I look below the chart, I see the earnings per litre, which I'm taking to be the profit. It's almost on a vertical climb, whereas the ROCE price is staying around 17%, 17.5%, 16.9%, and then it was 14.3%.
Can you help explain that to me? How many litres are we talking about in terms of the profit?
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The major closure was Petro-Canada in Oakville. It's no secret that that refinery was not an attractive investment to put in the expenses required to desulphurize the gasoline. It was a smaller refinery and it just wasn't worthwhile.
There are three big refinery projects right now that are being talked about. Shell has one in southwestern Ontario; we're talking about 300,000 barrels a day. The total Canadian capacity is two million, so this is a huge chunk. Irving has another one, and Irving is primarily an export refinery. They supply all their local demands, but they export quality products to California—very specific gasoline blends required for California. It is a very sophisticated refiner, and that would double their capacity, another 300,000 barrels a day. Then there is another refining complex being discussed in Newfoundland. Those are huge investments.
You really have to put it into the context of the risks refiners are facing. One of the risks, certainly, is the demand, as Tony mentioned. If in the transportation segment Canada were to hit its Kyoto targets, the demand would have to drop by 30%. So it takes a fair bit of intestinal fortitude to spend $4 billion or $5 billion with the chance that your demand might go down by 30%. Those are the planning decisions that these major corporations have to look at before investing in that segment.
When you look at the upstream, over 80% of the profits of the integrated companies last year came from the upstream business. On average it's about 75%; last year it was 80%, and it's driven by the crude price.
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You have told us that a refinery would cost $5 billion, but from what I understand, it is not a question of money. ExxonMobil recorded an impressive net profit of $9.3 billion in the first quarter of this year. So that is not where a lack of money will be felt. But we understand that its sales went down by 2% because of the price of oil. Last year, oil was $73 a barrel, compared with $61 this year.
Even so, profit margins have been much higher. They made $39 billion last year and will make much more this year. But where is this profit coming from? According to the magazine Les Affaires, these people are making much more money because of the refining margins. Crude oil prices have declined, but the companies have increased the refining price.
The situation is even clearer in Canada. As my colleague mentioned, Petro-Canada recorded a net profit of $590 million in the first quarter, compared with $206 million last year in the same period. Not only did first-quarter profits double, but oil companies investing in the development of the oil sands can deduct 100% of their investment beginning in the first year.
Moreover, in a recent study that it prepared, the Canadian Association of Petroleum Producers provided estimates for the next three years on the impact that the tax breaks would have on oil companies. They amount to $5.1 billion in 2005; $4.5 billion in 2006; $3.2 billion in 2007 and $2.3 billion in 2008.
With that in mind, I do not think that building a refinery for $5 billion is a question of money. That is not a problem for the oil companies. Since the beginning, you have said that you own 16 refineries and refine 80% of the products on the Canadian market. If there are too few refineries, a new one should be built. In any case, the government will help you and give you tax breaks. Who will benefit?
Mr. Baily, I have a question for you.
The crack spread today between crude and refined gasoline in the United States is 17.5¢ a litre, as of about 3 o'clock our time. I'm going with $226.43 for U.S. gas and I'm going with $69.09 for crude. I think it's WTI, but there's probably a blend of Brent and others in that, which we are using out here.
The wholesale price established by your members—$423—would give me, nine minutes ago, 68.8¢ for Ottawa, which is down two-tenths of a cent from Friday and, the same thing, down two-tenths of a cent in Toronto, 68.7¢. Montreal remains unchanged at 67.9¢.
I'm wondering how much competition is required for your member industries to come to the identical wholesale price posted for tomorrow morning's gasoline, which will mean here in Ottawa gasoline will sell for $1.053 cents per litre and in Toronto for $1.043. How do you do that in one hour? How do you come to the identical wholesale price, which will be posted tomorrow at your stations? Unless, of course, given the fact that I say this, you'll do it to spite me, and they won't be.
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But tomorrow morning—I will wager that on any other day you don't appear here, I can predict the price pretty much in eastern Canada to one-tenth of a cent per litre.
Mr. Taylor from the Competition Bureau thought he'd be cute and say he knows the discount prices, but that doesn't stop Canadian Tire or Esso from posting the price that is exactly what it's going to be. The three factors that you quite rightly pointed out will be your wholesale price, your taxes, and your retail margins—5¢ in Toronto and 6¢ up here. Thankfully, they have a margin.
My question is this. If you are making a 17.5¢ crack spread, I know that no refinery in this country, regardless of the kind of oil they're putting in, is going to make more than 5¢. That would be a handsome return. So you're making at least 12¢ a litre on the crack spread alone, and you're now making another 4.7¢ a litre tomorrow morning, assuming 40 billion litres are sold every year and you can keep this up for a couple of years. That's a couple of billion bucks out of the bottom line for consumers, which I don't have a problem with as long as you're reinvesting it.
How do you do that? How do you manage to get an identical wholesale price by every city right across this country, and why doesn't the Competition Bureau rule that offside? Perhaps it's a rhetorical question.
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No, that is not how it's done. And I'm going to impute that you're referring to the study done by the Canadian Centre for Policy Alternatives, who talked about a psychological barrier. We reject that study. We reject the methodology outright. It is, to be perfectly blunt, an extremely left-leaning excuse for price regulation and for which there is no justification whatsoever.
The reality of the matter is that Canadians are some of the most price-sensitive consumers of gasoline in the world. They'll make a U-turn on 0.1¢ a litre. It is in the interest of suppliers to keep their costs down, because they cannot control the wholesale price.
So there is no psychological barrier, sir. This is not, for us at least, a manipulation of psychological activities. At the end of the day, though, I remind you that these products are sold, for all intents and purposes, worldwide, and used by motorists worldwide. As long as demand is going up at a pace that is in excess of the rate of increase in supply—in this case, the North American market—you're going to see the price go up.
I wish it were more complicated, because then I might have a different job and make more money on it, but it's just not as complicated as you're implying.
I don't have any other members on my list.
I did want to ask a few questions of the witnesses. First of all, thank you for coming in today.
When Natural Resources Canada were here they gave us the Canada average pump price components, and I think it's important to keep coming back to this. The 2006 average retail price was 97.7¢ per litre, crude oil was 45.8¢, the federal and provincial taxes portion was 32.7¢, refining margin 14.1¢, and marketing 5.1¢.
Their explanation on crude oil is that Canada produces 3% of the crude oil and we are therefore a price taker and we therefore cannot influence that portion of the final price of gasoline. Federal and provincial governments can choose to increase or decrease taxes, according to how they best see fit. The marketing margin, we are told, is 5.1¢ per litre, so it's fairly small. It's a very competitive market, especially at the local level.
So the hearings have really focused on the refining margin, which according to the 2006 average is 14.1¢. A big question there is of the margin, what is cost and what is profit? I thought I heard you say here today, Mr. Macerollo, that the profit was 1.5¢ per litre. I don't know if that was for 2006, but that's saying that the cost of refining is 12.6¢.
Am I correct in separating the cost and the profit within the refining margin?
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I have two pieces of advice.
Certainly, as one who for many years took calls on the subject on behalf of a member of Parliament, I told them to call the Canadian Petroleum Products Institute.
In the absence of that, if you want to get into a detailed explanation, the crude oil market is a commodity market and the gasoline market is a commodity market on top of a commodity market. Operating at 100%, there's a maximum amount you can make. You may have all the crude oil in the world, but if you don't have—The facilities can only produce so much in a given day. If at any given point in time demand is outstripping the ability of the refineries to produce that kind of supply in the marketplace, you're going to see upward pricing pressures.
It's a North American market. Canadian consumers are competing with American consumers for the same product, and American consumers will pay more, quite frankly.