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doi:10.1016/j.en

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Energy Policy 35 (2007) 3595–3605

www.elsevier.com/locate/enpol

Regulation and market power in the Spanish liquefiedpetroleum gas industry: Progress or failure?

Alejandro Bello�, Emilio Huerta

Departamento de Gestion de Empresas, Universidad Publica de Navarra, Campus de Arrosadıa, 31006 Pamplona, Navarra, Spain

Received 6 June 2006; accepted 21 December 2006

Available online 23 February 2007

Abstract

This paper presents a detailed study of the structure, market power and competition in the distribution sector for liquefied petroleum

gas (LPG), within Spain. It is a segment of energy consumption and supply that is not often given serious attention, despite the fact that

LPG is a crucial source of energy to many households, in many countries in Europe and in the rest of the world. Despite formally being

an open and liberalized sector, the Spanish LPG market is characterized by high concentration within the industry; Repsol Butano, the

dominant operator, practically controls the entire value chain. These structural characteristics probably justify state intervention in the

form of price fixing, in order to guarantee accessible prices for final consumers. Nevertheless, applying this tool has had negative effects

on the opening and liberalization process. On the one hand, it fails to encourage entry or an increase in the participation of new

operators; on the other, it has considerably deteriorated the economic and financial performance of the distribution agents that are

subjected to two strong forces. First, the dominant operator looks after its own interests and its income; and second, the Government

tries to defend the interests of final consumers by fixing prices that inadequately remunerate the activity. This shows the contradictory

regulatory actions that try to promote competition, and then establish mechanisms to regulate activity by fixing prices that act as price

limits. These government set prices discourage new competitors from entering.

r 2007 Elsevier Ltd. All rights reserved.

JEL Classification: K23; L1; L11; L95

Keywords: Market power; Price regulation; LPG industry

1. Introduction

For the last 20 years Spain has been ambitiouslyimmersed in opening and liberalizing its strategic economicsectors. These processes have been the object of frequentattention by specialized literature. Among others areArocena et al. (2002) in the gas, petroleum and electricitysectors, Resines Garcıa (2005) in the gas sector, Correlje(1990) and Contın et al. (2001a, b) in the petroleum sector,Qurios and Picazo (2001) in the telecommunications sector,and Vives (1990), and Salas and Saurina (2003) in thebanking sector. These processes have been motivated, first,by demands from the European authorities responsible for

e front matter r 2007 Elsevier Ltd. All rights reserved.

pol.2006.12.030

ing author. Tel.: +94816 6085; fax: +94 819 9368.

esses: alejandro.bello@unavarra.es (A. Bello), ehuerta@

Huerta).

liberalizing the public Spanish services, as requirement toenter the European Union (EU); and secondly, because theSpanish authorities recognized that these actions wouldimprove welfare.However, Spanish governments have traditionally

viewed these sectors as ‘‘strategic’’ to the economy, andas such should be led by advantageously positioned largeprivate Spanish companies, in order to compete withpotential foreign entrants once the markets are liberalized.In fact Spanish companies currently dominate the ‘‘utilitiessectors’’: Telefonica in fixed and mobile phones, Endesa inelectricity, Gas Natural in gas and Repsol–Ypf in petrol. Itcould be said that the Spanish opening and privatizationprocess both reflects and is marked by the conflict betweenthe advocacy of market liberalization and the protection ofnational interests; and this has stimulated the formation ofnational champions in the utilities sectors (Arocena, 2006).

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2One focal point has been the design and usage of specific vertical

control systems as instruments to improve companies’ economic profits.

We approach the issue of how vertical agreements can contribute to

bettering the organizational efficiency of the companies, and under which

circumstances this efficiency is transferred to the final consumers. See

Director and Levi (1956), Perry (1989), Riordan (1998), and Mason and

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–36053596

In this paper we analyse the current situation in Spain’sliquefied petroleum gas (LPG) sector. This sector, incommon with all the petroleum industry activities, wasformally liberalized by the 1998 Hydrocarbon Law.Despite having implemented a series of measures designedto promote the sector’s opening and liberalization, it islong away from effective and active competition. Excessiveindustrial concentration is maintained, as one dominantoperator, Repsol Butano, controls practically all theindustry’s vertical chain. It even imposes important verticalconstraints in its contracts with distributors. These restric-tions affect competition and require constant protectionand control by the State, and by the competition andregulatory authorities. Moreover, the Government hasstrictly controlled final prices since 1992. It fixes maximumprices with the theoretical aim of stopping the dominantfirm from exercising its power and fixing monopolisticprices.

LPGs is still an important source of energy in theSpanish market principally for domestic use as cookingand heating, with demand at 2.53% of total energyconsumption; and this figure is comparable with coal orrenewable sources of energy. There are currently aroundtwelve million customers nationwide, mainly concentratedin the residential segment.

The final distribution of LPG cylinders is by ‘‘distribu-tion agencies’’ that are exclusive dealers for the ‘‘wholesaleoperators’’. In recent years we have witnessed an ongoingreduction in these agencies’ numbers. Since 1998, over 300distribution agencies have disappeared, and nowadaysthere are 700 agencies. Many of these closures are linkedto Repsol Butano, and this constant and significantreduction in the number of agencies shows us that LPGactivity is ceasing to be profitable.

The aims of this paper are the following. First, to offer adescription and analysis of the Spanish LPG industry andits differences compared to the other EU countries. It issurprising that although LPGs continue to be a strongsource of energy in Europe, and worldwide, there are noeconomic papers that have studied this industry in depth.Secondly, we have analysed the Spanish retail distributionsystem, which is currently experiencing serious difficulties,and we would like to offer an explanation to this situation.

To do this, we use the structure–conduct–performancescheme in the New Industrial Economy framework, andespecially the Porter’s Five Forces approach.1 In the firstinstance the sector’s structural aspects are analysed, special

1This analytical framework of the markets systematizes the relationship

within the market structure, the behaviour of participating companies and

the agents’ results. The methodological model of Porter (1980) recognizes

the influence of environmental factors, principally the sector’s structure

and the capacity of companies to compete. This framework focuses on the

existence of different forces that govern the industry’s competitive nucleus,

where companies seek to defend their incomes by means of different

strategic actions. Examples are entry barriers against potential competi-

tors and developing huge negotiating power with, among others, suppliers

and customers.

emphasis is given to the evolution of industrial concentra-tion, entry barriers and the vertical relationships betweenthe dominant operator and the distribution agents. Onevital aspect that largely conditions the industry’s structureis governmental intervention, in the form of fixing the finalretail price. The structural analysis goes in depth into theregulator’s controversial actions, whose purpose should bein principle to maximize social welfare. In this caseconsumers should be protected from possible abuses ofpower by the dominant operator, in an excessivelyconcentrated market. However, these actions do notpromote competition, as they fail to encourage newoperators to enter; the final prices are viewed as limitingthe investments needed to compete in this sector, and thusfavour Repsol.Next we analyse company behaviour, taking into

account the dominant operator’s enormous negotiatingpower to impose vertical restrictions and bring aboutunequal distribution of the value generated within theindustry. From an economic perspective, the traditionalapproach has been to consider vertical restraints as(optimal) responses to market failures and imperfectionsand thus help coordination between agents at differentlevels of the production, supply and distribution chain.More recent literature recognizes that restraints may have abenign effect as well as an adverse effect by dampeningcompetition between rivals. Our analysis takes the biva-lency of the imposition of specific vertical restrictions intoaccount.2

Our main conclusion is that the sectors’ current state islargely due to the failure of the opening and liberalisationprocess. Effective competition has not happened in thissector, for the following two reasons.

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tha

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200

First, the Spanish LPG cylinder prices have always beenfixed below other EU prices3, even though it includeshome delivery. Thus final prices, which maximizeconsumer surplus, are held. However, these prices don’tadequately remunerate distribution activity, and conse-quently discourage new operators. The regulator admin-istratively fixes the prices, and hence convergence with

llips (2000). The second perspective emphasizes the restrictions of

tain practices on rivalry and competition. Hence, it concentrates on

dying the anticompetitive effects that have arisen that may significantly

m the interests of final consumers. Vertical agreements can facilitate

lusion, make market entry difficult for potential competitors, and

lude or drive out established competitors. In any case, the detriment to

sumers is significant. See Klein and Murphy (1988), Martin et al.

01) and Elliott et al. (2003).

Prices in Spain in January 2005, before the current taxes, were lower

n in other EU countries by the following percentages: Portugal 66%,

nce 156% and Italy 159%. (Boletın Estadıstico de Hidrocarburos,

5).

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6000

7000

Production

4

wh

pri

pri

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–3605 3597

the liberalized European market prices hasn’t comeabout.4

Consumption

�

0

1000

2000

3000

4000

5000

France Italy Norway Poland Spain U.K

KT

ep

Germany

Fig. 1. European LPG supply/demand. Source: WLPGA Statistical

Review of Global LP Gas, 2004.

Second, despite the Spanish market being theoreticallyopen and liberalized, the industry is in fact characterizedby a high degree of concentration and high entrybarriers. In practice the dominant firm, Repsol Butano,controls all the activities in the industry’s value chain,and its market share is 80%.

The paper is organized as follows. In Sections 2 and 3,we describe the most outstanding competitive character-istics in the Spanish LPG industry. In Section 3, we analysein depth the retail distribution activity, the differentparticipants’ most striking characteristics of the activity’sdifferent participants, and their role in the negotiationprocess. We conclude with a viability study of the business,given the current competitive conditions. The principalconclusions are drawn in Section 4.

2. The Spanish LPG industry: Peculiarities and

characteristics of the competition

2.1. The LPG industry

The LPGs, propane and butane, originate either fromthe refinery process or from natural gas extraction; inEurope the estimated shares are 60% for natural gas and40% for refineries. World LPG supply is relatively highlyconcentrated. North America accounts for 32% ofproduction, the Middle East 19%, Asia 15%, and Centraland Western Europe 19%. Distribution of LPG produc-tion depends on two factors, the locations of natural gasdeposits and refining capacity. World production hasexperienced accumulative annual growth of 3.2% between1991–2005. In 2004 consumption was around 207 milliontonnes (WLPGA—World Liquefied Petroleum GasAssociation—Statistical Review of Global LP Gas).

In the European market, there are significant differences,in terms of production levels and national consumption.Fig. 1 shows that there are important producing countriessuch as Norway (6800KTep) and the UK (5400KTep),whereas in others like Poland LPG output is very low(1900KTep). Spain can be considered a medium levelproducer, like France, Germany, and Italy. One importantdeduction of this graph is that important producers havehuge exportable surpluses, while in others such as Poland,Italy, and to a lesser extent Spain, consumption levelseasily exceed production and substantial imports arerequired.

These previously mentioned disparities between produc-tion levels and consumption give rise to commercialtransactions between countries with exportable surpluses

A similar case in Spain is the liberalization of petrol and diesel prices,

ich were traditionally lower than in the rest of the EU. Since 1998, when

ces were definitively liberalized, they have converged with European

ces. (See Contın et. al., 2001a, b).

and those needing imports. For such trade exchanges andconcentrating on those within EU countries, attentionshould be drawn to the following two factors:

�

5

refi

the

eno

There is some separation between production and finaldistribution, as the majority of countries exchangesignificant quantities, but this may bear little relation-ship to the net import export balance. The clearestexample is France, where production and consumptionlevels are similar, but imports equate to 80% ofconsumption and exports to some 60% of production(Comite Franc-ais du Butane et du Propane, 2004). Thisis substantially different for Spain, where the companiesare vertically integrated and total production is used tosatisfy internal demand.5

�

Secondly, imports from the other EU countries aremostly under 50%; for example, France 37%, Poland26%, Spain 38%, the UK 41% and Italy 16% (WLPGAStatistical Review of Global LP Gas). DifferentEuropean countries have different commercial supplystrategies, and obtain most of their imports from Africa,the Middle East and Russia.

One other distinctive trait of the industry is thesignificant differences in consumption by sector amongthe countries. Countries such as Norway, the UK andGermany have elevated industrial LGP consumptions of85%, 50% and 35%, respectively. While in others, house-hold consumption is greater: France (58%), Germany(45%), Italy (65%), and especially Spain, where householdconsumption accounts for over 80% of total LPG demand(WLPGA Statistical Review of Global LP Gas, 2004). Atthis point it is useful to ask why in Spain are LPGs still animportant source of energy in households, not just in ruralareas but also in urban centres, when this is not so in othercountries. There are two reasons. First, the slowness overthe last 50 years in installing the infrastructure necessary to

Repsol Butano supplies over 80% of internal demand using its own

ning capacity, which accounts for 60%. The remainder is bought from

other national refineries, Cepsa and BP, who do not possess large

ugh networks to distribute their refining capacity.

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European LPG Prices

jan-00 abr-00 jul-00 oct-00 jan-01 abr-01 jul-01 oct-01 jan-02 abr-02 jul-02 oct-02 jan-03 jul-03 jan-04 abr-04 jul-04 oct-04 jan-05 abr-05 jul-05 oct-05 jan-06

cC/Kg

Austria Belgium Denmark France Italy Portugal Spain EU

Fig. 2. Comparison of bottled LPG prices: Spanish versus European Prices. Source: Bulletin for Hydrocarbon Statistics, 2000–2004.

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–36053598

distribute natural gas (De Quinto and Watt, 2003), thisdirectly promoted cheap alternative sources of energy suchas LPGs. Second, there has been low use of LPGs inindustry and transport sectors. Traditionally, the industrialsector has made a marginal use of LPGs compared withcoal, electricity, or fuel oil; besides the penetration of theLPGs in the transport sector is very low compared to therest of Europe, where the penetration has now reached: 4million vehicles and 3000 buses use LPG, and 9000 servicestations sell LPG.

For these motives, aspects related to competition arevery important as they currently affect over ten millioncustomers. As we shall later see, they largely explain thecurrent situation that the final LPG distribution sector fordomestic use is going through.

Further differences among countries are the degrees ofconcentration. Spain is quoted as the European countrywith the highest industrial concentration; the Hirschmann/Herfindahl index (HHI) is 6719 points.6 Nevertheless,most European countries have high indexes: Portugal 3200,Ireland 4921, UK 4852, France, 2200 and Italy 2800 (TheCompetition Authority, 2003; IEA European reports, 2003and own elaboration).

6The Hirschmann/Herfindhal index is a sum of the market quotas of

different companies expressed as a decimal, squared, and multiplied by

10,000. The index’s maximum value of 10,000 reflects a situation where a

single company enjoys 100% of the final market. According to the United

States Department of Justice a figure over 3000 indicates that a big

company can exercise market power. Given the results in this industry are

much higher, it is reasonable to presume that the principal operator is

positioned to exercise significant market power, and merits the attention of

the regulatory and competition authorities.

Using the information in Table 1, this gives

Finally, Spanish bottled LPG prices are the lowest in theEU; in 2005, 66% lower than that of Portugal, 156% lowerthan that of France and 159% lower than that of Italy (Fig. 2).These two distinctive characteristics of the Spanish

market, high concentration and low government regulatedprices, show the great complexity and difficulties associatedwith the sector. Especially affected are those involved withthe final distribution, and these are analysed in depth in thefollowing sections.

2.2. Competition and Regulation within the Spanish LPG

Industry

In this section we analyse competition in the SpanishLPG industry. We approach the current state of theSpanish retail GLP distribution sector using the methodo-logical framework of competition analysis approach byPorter (1980). We concentrate on those key aspects thatexplain the level of competition achieved: seasonality,maturity and stagnation in demand, the degree ofintervention in the sector, the industrial concentration,the threat of substitution and the existence of entrybarriers. The intensity of these diverse forces determinesthe market’s level of competition.

(footnote continued)

Xn

i¼1

1000S2i ¼ 10000ðS2

REPSOL þ S2CEPSA þ S2

BP þ S2DISA

þ S2PRIMAGAS þ S2

TOTAL þ S2GALP þ S2

SHELLÞ

¼ 10000ð0:8112 þ 0:09372 þ 0:019042

þ 0:042982 þ 0:01562 þ 0:00342 þ 0:009282 þ 0:007282Þ

¼ 6719.

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0

50

100

150

200

250

300

January

February

MarchApril

May

June

July

August

September

October

November

December

Kt

Fig. 3. Evolution of inter annual LPG consumption. Source: Spanish

Department of Industry (2004), and own elaboration.

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–3605 3599

2.2.1. Demand characteristics: Seasonality, stagnation and

maturity

In Spain demand for LPGs exceeds national production.National production comprises 62% of consumption;consequently, when demand is high imports are necessary,basically during the winter months from October to March(Fig. 3). These imports are from: Africa 52.96%, Europe37.69%, America 4.32% and the Middle East 2.03%; theyconstitute the remaining 38% of total consumption.7

Recent evolution of demand for LPGs has had animportant impact on competition. In recent years stagna-tion in quantities demanded has been documented, withoutan accompanying growth in demand for alternative energyproducts, which has been the case of others alternativeenergies, such as electricity or natural gas. This is the resultof two opposing forces, a fall in demand for bottled LPGs,principally 12.5 kg cylinders, as a consequence of beingreplaced in the residential sector by natural gas; bulk LPGconsumption has experienced an increase.

This general situation has generated great instability anduncertainty among the competitors, and has reduced thesector’s appeal for potential competitors to make sub-stantial investments. Moreover, the various players knowthat sharing distribution profits is linked to forwardvertical integration of activities; and they, principallyCepsa and Bp, already have refining, bottling and storagecapacity, but small own retail chains where significantinvestments are needed to be more competitive.

8It is pertinent to state that this law was not developed in a regulatory

2.2.2. Regulation of the sector

The 1998 Hydrocarbon Law (R.D. Law 34/1998, 7thOctober) is the regulatory framework for all activities inthe Spanish petroleum sector, and consequently for allLPGs. It states that the commercialization of bottled LPGscan be freely carried out by any firm, and prohibitsexclusive contracts between the LPG operators anddistributors, except those pertaining to agency contracts.As we will later see this is practically the only form ofcontract between operators and distributors. Moreover,

7In recent years there has been a new tendency in the origin of imports,

now the sources are more diverse. In 1998 the imports came exclusively

from North Africa.

agents are obliged to provide home deliveries, should finalconsumers require it.8

Another vitally important aspect is that the Hydro-carbon Law considers that, out of general economicinterest, all activities relating to LPG production anddistribution is the domain of EU Community law. Thiscondition implies that companies working in this sectormay be subject to specific public service obligations,imposed by the relevant authority. The law establishestwo obligations that affect retailers, and that could bebrought under the notion of a universal service; they areobliged to provide home delivery and technical assistance.Finally, regulations establish that prices of petroleum

products be free from controls. Despite being a formallyliberalized sector, the law establishes that when LPGcompetition is not considered sufficient, the Governmenthas the regulatory right to apply a maximum retail salesprice formula; and this has been in place since 1993.The Government formula, through the Ministry of

Industry, to fix LPG prices is based on three components:international raw material prices, international transportcharges, and the expression C that brings together thecommercialization costs. The equation used is the follow-ing:

P ¼

Pi¼n�7

i¼n�2

0:8CBut_iþ0:2CProp_iþFi

1000

� ��ei

6

þ Commercialization_Costs;

where, P is the maximum price without taxes in Euros/kg,Cbut,i the average of international prices for FOB POST-INGS/contracts, in dollars/metric tonne (mT) of North Seabutane (BPAP) and Saudi Arabia (S. Arabia) published inPlatts LPGASWIRE and corresponding to month i, Cpro,i

the average of international prices for FOB POSTINGS/contracts, in dollars/mT of North Sea propane (BPAP) andSaudi Arabia (S. Arabia) published in Platts LPGASWIREand corresponding to month i, Fi the monthly average indollars/mT of the lowest and highest transport charges ofRass Tanura-Mediterraneo for 54.000–75.000m3 ships,published in ‘‘Poten and Partners’’ and corresponding tomonth i, ei the dollar/euro exchange rate monthly average,published in the ‘‘Official Gazette’’ or by the CentralEuropean Bank and corresponding to month i, and n thefirst month of the application of new prices.The theoretical aim of applying this formula is to avoid

monopolistic behaviour by the dominant company, byplacing the price higher than competitive prices. Thisoccurs when demand is price inelastic, especially withproducts of basic necessity, where no immediate substitutesare available. Nevertheless, these price formulae are the

manner, it is a result of the application of the 1992 Regulation of Activities

of Liquefied Petroleum Gas (D.R. 1085, 1992). This leads to confusion

over the interpretation of certain principles in the 1998 law (D.R. 34,

1998).

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Table 1

National balance of LPGs in 2003

Consumption ¼ 2510KTep Production Commercialization

National production 61.4%

Repsol Butano 50.54% 82.23%

Cepsa 42.17% 9.33%

Bp 7.29% 4.76%

Other operatorsa 0 3.68%

Imports 38.6%

Source: Spanish Department of Industry, 2004 and own elaboration.aThe other operators in Spain are: Total (0.34%), Disa (4.3%), Shell

(0.73%), Galp (0.93%) and Primagaz (1.56%). Their market shares are in

brackets.

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–36053600

subject of much controversy, since various sector reports(2000, 2003 and 2004) by the Spanish Energy NationalCommission (2005) indicate they are incomplete andunclear.

Here, it is appropriate to indicate the political sensitivityof LPG cylinder prices for domestic use, as it forms part ofthe basket of goods that make up the retail price index(RPI). For example, a h1 increase in the price of a cylinderwould increase the RPI9 by 0.1%.

Since imposing the price fixing system in 1992 theGovernment has on numerous occasions modified thecriteria for updating LPG prices, and essentially hasresponded to reduce inflationary pressure, by temporarilyneutralizing the effects of petroleum product price in-creases.

Added to this is the great social sensitivity attached toLPG prices, whose consumption is as we will later seepositively correlated with lower incomes and with greaterinelasticity of demand. These factors are probably takeninto account by the regulatory authorities when fixingprices.

2.2.3. High concentration within the industry

National LPG production is oligopolistic in nature.Three companies, Repsol Butano, Cepsa and Bp, controlall the Spanish refining capacity, their respective produc-tion quotas are 50.54%, 46.17% and 7.29%. These factorsare grouped into the following table.

It shows that Repsol Butano is vertically integrated, andhas strong control throughout the industry’s vertical chain.This advantageous position is a consequence of the twofollowing main points. First, is its huge participation in thefinal retail market where it has over 80% of the marketshare. This additionally gives it huge upstream negotiatingcapacity, compared to the other operators with refiningcapacity. These other operators are unable to sell all theireffective production capacity. Cepsa produces 634.9mTand commercializes 219.42mT in the final market, and Bpproduces 110.5mT and commercializes 39.46mT. Second,it inherited the former monopoly, and owns most of theindustry’s assets of reception, storage and gas bottling.Although these assets are not essential and can easily bereproduced, their importance is greatly increased by RepsolButano’s control over the final market.10

The LPG industry’s competitive structure is character-ized by the presence of one dominant firm, which controlsthe vertical chain’s main activities. This means thathorizontal concentration is comparatively higher than in

9There is technical consensus about the overinclusion of bottled LPGs

in the basket of goods that make up the Retail Price Index, relative to the

underinclusion of the alternative energies that have made great inroads,

such as natural gas.10Contın et al. (2001a) indicate that if the integration of very specific

road vehicle fuel distribution assets is justified by the reduction in

opportunism and underinvestment, then the problem of monopoly warns

us about the potential for abuse. They recommend regulating the

utilization of, and access to, these assets.

any other European market (World Liquefied PetroleumGas Association).Among the many existing methodologies on measuring

concentration are Curry and George (1983) and Clarke(1985). If we consider the concentration ratio C and theHirschmann/Herfindahl Index HHI, results show a sig-nificant degree of company concentration within theindustry (Table 1). The HHI is 6719 points.This situation demonstrates that the push towards

competition within the sector, attempted by the 1998Hydrocarbon Law, has not reduced the levels of industrialconcentration in the industry. Moreover, LPGs wereomitted from the ‘‘D.R. 6/2000’’ law of ‘‘Urgent Measures

to Intensify Competition in the Goods and Services Market’’.This law constituted one of the measures with the greatestimpact in opening and liberalizing strategic sectors inSpain. The omission of LPGs demonstrates a lack ofinterest and concern by the regulator, with regard to thesector’s high concentration and low effective competition.

2.2.4. The threat of substitution

The existence of substitute products may place a ceilingon company products, cause market incursions and soreduce its attractiveness. Key issues are if a substituterepresents a threat of obsolescence for the company’sproduct or service, gives it greater benefits or perceivedvalue, and the ease for buyers to switch to the substituteproduct.The threat of substitution for LPGs is closely related to

the following technical characteristics; first, LPGs have agreat advantage due to their production processes, as thegases are liquid in state, the equivalent volume in terms ofenergy content is 270 times smaller than it is as a gas. Thisrepresents an important cost saving in terms of storage andtransport, whether it be by boat, pipelines or trucks;secondly, the facility and reduced storage costs andcharacteristics mean that LPGs are great reserve energies;thirdly, appropriate use of LPGs provides substantialsafety margins, compared to alternative energy sources, asthey have a limited range of flammability and highcombustion temperatures; and finally, the investment

ARTICLE IN PRESSA. Bello, E. Huerta / Energy Policy 35 (2007) 3595–3605 3601

requirements for specific uses such as residential heatingare considerably lower than with other energy sources.

From an environmental point of view, LPG combustionhas limited effects, as very few particles and nitrous oxidesare emitted, and there is no sulphur dioxide. Moreover,atmospheric emissions are reduced as they are pressurizedduring storage and transport. As a result the environmentalconsequences of LPGs, in terms of greenhouse gasemissions, are much lower than for other forms of energy.

Despite these characteristics, and in contrast to alter-native sources of energy, demand for LPGs has beennotably decreasing on a yearly basis. According to theBulletin for Hydrocarbon Statistics, since 2000 there hasbeen an annual 1.1% decrease in final demand for LPGs.

Fall in demand can largely be explained by thesubstitution effect in the residential sector. Principally inurban centres, the mainly 12.5 kg household LPG cylindershave been replaced by natural gas or electricity. Thissubstitution effect, which has mainly occurred in cities, hasbeen determined by two factors: level of income and thepenetration index.

Substitution of LPGs for natural gas is positivelycorrelated to an increase in regional levels of income, andto the penetration index of natural gas. The regions withhigher levels of income have registered lower levels ofbutane consumption. It is also true that generally theseareas have developed new natural gas infrastructures, andthese regions have experienced greater penetration. Eco-nomic growth, the improvement in standards of living, therenovation of primary residential sectors, and the hugepenetration of natural gas all largely explain the annualpercentage drop in LPG demand.

However, in regions where natural gas distributioninfrastructures have not been developed, principally ruralareas, or in the ‘‘Canary Islands’’ where all gas consump-tion is in the form of LPG; in these cases, LPGsrelationship with the aforementioned products could bedescribed as complementary, and is associated with theabsence of natural gas infrastructures in the area.

2.2.5. Entry barriers

Entry barriers are other competition forces within theindustry, and their elimination would be a great advancetowards genuine effective competition. In our in-depthanalysis we basically define two basic entry barriers: (a)those due to the dominant company’s strategic behaviour,and (b) those due to administrative factors.

(a)

11The 1998 Hydrocarbon Law limits the commercializers’ obligation to

provide home deliveries, via exclusive contracts with wholesale operators.

Nevertheless, the vast majority of distributors maintain these types of

contractual links; thus, the consequent liberalization and elimination of

the aforementioned obligation did not bring about the required effects.

Obviously, within the competitive framework, home delivery should be

left to the freewill of the parties concerned; i.e. the supplier and the

customer.

Strategic behaviour by the sector’s main company canbe explained by the market’s quasi-monopoly, whichpermits substantial dominance throughout the indus-trial vertical chain. As previously seen Repsol Butanoadditionally benefited from careful and from protec-tionist treatment through the different governments’administrative norms and regulations, when comparedto liberalization and opening processes in other sectors.So Repsol Butano, the dominant company, is

positioned to raise and/or maintain important entrybarriers throughout the industry, against present andpotential competitors.

(b)

We can differentiate between the administrative bar-riers that originate from maintaining the aforemen-tioned regulations, and those brought about by theprice regime.

Current LPG activity regulation (Article 24) requiresretailers to supply bottled LPGs and to be backed up witha prior formal contract. This makes it difficult for newoperators to enter, as it increases the costs of changingcommercializing company, and links the final consumer toa specific brand. Moreover, this regulation obliges homedelivery to all consumers, regardless of place of residence(Articles 25 and 26). This condition discourages potentialcompetition, especially as final prices are regulateduniformly throughout Spain. New competitors may beobliged to provide costly deliveries, in order to penetrateattractive markets with great density of demand, butwithout much financial compensation at least in thebeginning.11

As for the pricing regime barriers, it is important toremember that Spanish prices of bottled LPGs are thelowest in the EU, in 2005, 66% lower than in Portugal,156% lower than in France, and 159% lower than in Italy(Fig. 1). It was traditionally argued that Spanish priceswere the lowest because of the efficient distributionnetwork; in fact it is due to other factors. First is socialsensitivity regarding butane cylinder prices. Second is theimportance of LPGs in price indexes, it forms part ofthe basket of goods that make up the RPI. Third are theGovernment estimates of the price formula’s components,principally the term C that groups commercialization coststogether. All these may lower unit costs for distributionagents.With this low final price scenario, the perceived rewards

in the form of commissions by distribution agencies are thelowest in the EU. Such a state of affairs has two immediateeffects. Since the price acts as a price limit, there is anabsence of wide-ranging effective competition. This dis-courages potential competitors, and dissuades existingcompetitors from investing in the capillary distributionnetwork. Furthermore, there is a predictable deteriorationof quality of service and security, due to the poorremuneration.To summarize, we have seen how one company that

enjoys an advantageous position markedly dominatescompetition in the Spanish LPG sector. The important

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issue is that market power is exercized throughout thevertical chain.

�

First, Repsol Butano exerts considerable negotiatingcapacity over the other competing companies. Given thecompetitors’ low participation in the final market, thereis an imbalance between their refining storage capacityand commercializing capacities. � Secondly, as the final price is fixed administratively,

market power is exercised over commercializing agentsthrough the determining of commissions and contrac-tual terms. These terms contain unequal distribution ofcommercial costs, and can only be imposed becausethere are no alternative suppliers.

� Third, the Spanish retail prices are fixed administratively

by the Government and are substantially lower than theretail prices in other European countries, and act as‘‘price limits’’. New foreign operators wishing to enterthe market see the current prices as a barrier to makingthe investments needed to enter the Spanish market.

3. Vertical restrictions: the distribution business

In this section, once we have seen this sector’s mostpronounced characteristics, principally its structure, reg-ulation and effects on the competition; we will centre ourattention on analysing current final distribution andviability. This is very important, since the significantdifficulties and loss of profit that LPG retail distributionhas experienced raises doubts over the sharing of the valuecreated by the industry. Key to resolving this issue is theenormous difference in size between the dominant firm andits distribution agents, and the nature of governmentalintervention in fixing final prices.

3.1. Repsol Butano: The principal

What can the dominant operator do, given the currentstagnation in demand, the high substitution rates of LPGsfor natural gas and electricity, and regulated prices that arelower than the European average? We believe that the useof negotiating power is key to Repsol making the businessprofitable. This power is shown in two stages of the verticalchain.

Downstream Negotiating Power: We previously statedthat, in order to satisfy demand in the final market, RepsolButano needs to use its own refining capacity andpractically all the other companies’ refining capacity too;Table 1 shows that the others do not sell all theirproduction capacities. Cepsa produces 634.9mT andcommercializes 219.42mT in the final market, and Bpproduces 110.5mT and commercializes 39.46mT.

Until 1992 transfer prices among refineries were stateregulated; however, since then the contracts betweenRepsol Butano and the other operators, Cepsa and Bp,have been negotiated freely. These are normally 2- or3-year contracts, and are drawn up with respect to two

terms: the FOB prices for imported crude propane andbutane plus the estimated transport costs of their import,and a discount of approximately 4–6 dollars/mT.The sum of these two terms is lower than the price of

imported LPGs, it is also lower than the materials currentlyused by the Government in determining the final prices. Asa result Repsol Butano, makes a profit by purchasing rawmaterials from the other LPG refining companies, this isthen added to the profit margins and commercialization.One vitally important advantage that allows the main

operator to assert its dominance throughout the verticalchain is its inheritance of the reception, storage andbottling assets from the old LPG monopoly. These assets,and more importantly still their strategic geographiclocation, enable Repsol Butano to control virtually allLPG production by Spanish refineries, and to exercisemonopsonistic power in the price contracts it draws upwith the supplying refineries. The latter have excesscapacity due to insufficient demand caused by their lowparticipation in the final market.

Upstream negotiating power: Four fundamental aspectsexplain how the dominant operator puts its negotiationpower over the distribution agencies into practice:

Asymmetry of size: The difference in size of thenegotiating companies is evident. Agencies have very littlenegotiating power, as they buy small quantities comparedto the operator’s total sales. Under no circumstances doesany possible backward integration of their activities pose athreat to Repsol Butano. The latter achieved sales of h1200million, with an operating profit of h166 million andprofitability in recent years of around 10%. Moreover, it ispresent in various European and South American coun-tries, and is part of Repsol–Ypf, a huge energy basedmultinational (Repsol–Ypf Annual Report, SABI Data-base). Conversely, distribution agencies are small, oftenrun by families that depend exclusively on this business,and have average annual turnovers of h400,000.

Goodwill: One vitally important aspect that significantlyrestricts distributors’ negotiating power is that they dealwith final customers as Repsol Butano representatives, andas such Repsol Butano exclusively owns the goodwill.Consequently, costs of changing supplier are so high forthe agencies that changing their supplier poses no threatwhatsoever for Repsol Butano.

Price fixing: For two main reasons, regulated final priceshave a direct bearing on sharing the value created by theindustry. First, the Government, via its maximum pricesformula predicts the value created in the industry; itestimates raw materials, transport and commercializationcosts. Second, as these costs may not adequately remune-rate the activity, they maintain the Spanish tradition ofhydrocarbon prices being below the European average.The negotiation of contract terms, such as obligations andcommissions, put the dominant operator against the smalldistribution agencies.

Threat of exclusion: With over 3500 points of sale,Repsol has the largest network of service stations; this

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Table 2

Standard costs for typical agencies in 2005 (Euros/cylinder)

Annual sales of cylinder in

the exclusivity zone

Density of demand

100% urban centre 25% others 75%

urban centre

50% others 50%

urban centre

75% others 25%

urban centre

100%

others

Average

cost

p50,000 3.63 3.65 3.59 3.53 3.43 3.58

50,001–100,000 2.87 2.89 2.83 2.77 2.73 2.82

100,001–300,000 2.66 2.68 2.62 2.56 2.52 2.61

300,001–500,000 2.21 2.23 2.17 2.11 2.07 2.16

500,001–700,00 2.15 2.17 2.11 2.05 2.01 2.10

X700,000 2.01 2.03 1.97 1.91 1.87 1.96

Average 2.59 2.61 2.55 2.49 2.45 2.54

Source: Federacion Espanola de Asociaciones Provinciales de Empresas Distribuidoras de GLP (2002) updated 2005, and own elaboration.

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–3605 3603

constitutes a real threat to the LPG distributors asproducts could be distributed by other establishments.

Taking these aspects into account, now we analyse theagents’ business, emphasizing the relationship between theestimated commercialization costs, term ‘‘C’’ in theGovernment’s price formula, and the returns or commis-sions received by the independent distribution agencies.Our objective is to explain the worsening of the activity,which has experienced an ongoing reduction in numbers ofagents in the Spanish LPG capillary distribution.

3.2. Commercialization costs and estimated returns. Is the

business viable for the agents?

Analysing the activity’s returns requires that twofundamental aspects be taken into account. First, whetherthe Government’s estimation of commercialization costsadequately rewards the activity; and secondly, how theregulator should distribute these costs. To do this, wehave estimated the Government’s commercialization costsusing the formula for maximum prices,12 and we haveestimated the retail distribution development costs fordistribution agencies, and the contractually agreed com-missions with Repsol Butano for carrying out theactivity.13

12As previously mentioned it is unclear how the Government estimates

the proposed formulae, as they do not specify the nature of commercia-

lization costs. We used the composition of commercialization costs in

accordance with the Order of 28th April 1994, as this is the only official

reference to its components; more important still is each activity’s

weighting within the term. We can only approximate at the Government

current estimate; however, we can make a good approximation of

distribution retail returns, as estimated by the Government in its latest

Ministerial Order.13To study the commissions we used data provided by the commercia-

lizing agents in the survey carried out by the Federacion Espanola de

Asociaciones Provinciales de Empresas Distribuidoras de GLP headed by

A. Lafuente of the University of Zaragoza in 2001. The information has

been updated using the monthly Retail Price Index provided by the

Spanish National Statistics Institute.

The Government’s maximum prices formula currentlyfixes estimated costs at 0.353643 h/kg (IFC 2475/2005).According to the 1994 Ministerial Order, the Government’sestimate of returns received by commercializing agents forretail and storage and distribution are 0.167 h/kg, or2.0915 h/12.5 kg cylinder.The survey collected information about agencies

regarding: company location, surface area and operationzone, company size, detailed breakdowns of companies’assets, and fixed and variable costs. To estimate thesecosts information was collected about logistics, transportand delivery, marketing, technical service and capitalcosts.In Table 2 we present standard costs for typical agencies,

according to annual sales and density of demand in theexclusivity zone. They are the sum of total annual costs forthe different types of typical agencies, divided by thecorresponding volumes of activity, measured in terms ofcylinders distributed. We should say that such standardcosts incorporate a 10% return on investment.From this table we deduce that the estimated average

unit costs for 2005, updated from the estimated 2001 costs,are h2.54/cylinder. Secondly, that the estimation demon-strates economies of scale in distribution activities at all thelevels of demand density considered; i.e. average costsdecrease in accordance with the volume of cylinderscommercialized. Definitively, the presence of economiesof scale give rise to significant unit cost dispersion, in termsof the size of market served. Unit costs for smaller agenciesare double those of larger agencies. Thirdly, a somewhatsmaller dispersion is also noted, according to the char-acteristics of the delivery zone. Agencies operating in 100%urban zones incur higher costs than those which are inperipheral or rural zones. This combination of high unitcosts, an urban agency and a sales volume under 50,000cylinders makes costs double those of the lowest costagency, with ‘‘100% others’’ and sales over 700,000cylinders.Finally, after estimating the distribution agencies’

unit costs, it is important to compare them with the

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Table 3

Description of the commissions received by agents (Euros/cylinder), 2005

Average Minimum Maximum

C-2005 1.70 1.60 1.92

C-2004 1.64 1.54 1.85

C-2003 1.59 1.49 1.79

C-2002 1.55 1.45 1.74

C-2001 1.49 1.39 1.67

C-2000 1.46 1.36 1.65

C-1999 1.41 1.32 1.56

C-1998 1.38 1.26 1.54

C-: Basic commission and variable returns for the cylinders UD-125/Ud-

110 and K120.

Source: Federacion Espanola de Asociaciones Provinciales de Empresas

Distribuidoras de GLP (2002) updated using the 2005 RPI, and own

elaboration.

A. Bello, E. Huerta / Energy Policy 35 (2007) 3595–36053604

commissions for their activities. Table 3 summarizes theaverage annual commissions received during 1998–2005.

According to Table 3, average minimum and maximumcommissions received by the distribution agencies between1998 and 2005 are significantly lower in h/cylinder, thanestimated unit costs. They were h1.70 in 2005, compared toestimated unit costs of h2.54/cylinder (see Table 3). Whencapital investment costs are included, capital costs see-mingly do not permit the incurred costs to be recuperated.

Secondly, commissions have not increased much in theyears studied, and this should be put in the context of thefall in demand. We infer a reduction in overall incomethrough commissions, despite the substantial increase incosts.

Putting to one side the estimated unit costs incurred bythe distribution agencies, if we analyse the commissionsreceived for the activity and the Government’s estimatedcosts in the most recent Ministerial Order ITC 2475/2005,we prove the commissions received are much lower that theGovernment’s estimated costs. They were h1.70/cylinder in2005 (adjusted in line with the RPI) compared to theGovernment’s estimation of h2.091/cylinder. Furthermore,the Government’s estimations are closer to, although theywere lower than our estimated commercialization costs.

On average the distribution agencies receive commis-sions that are lower than the average costs incurred. It ishardly surprising that year after year many distributionagencies leave the activity, as carrying on these activitiesimplies a continual decapitalization.

4. Conclusions

The GLPs are a segment of energy consumption andsupply which is not often given serious attention, despitethe fact that LPG is a crucial source of energy to manyhouseholds, in many countries in Europe and in the rest ofthe world. Spain is one of the European countries withLPG’s major consumption in households, with more than11 million clients. These clients are distributed not only in

rural areas but also in the cities. In this paper we havecarried out detailed analyses of the Spanish LPG industry,with special emphasis in the final distribution. We centreour attention on analysing the Spanish LPG sector’sstructure, and its impact on the competition. The continualreduction in numbers of distribution agencies demonstratesthat the bottled LPG segment is ceasing to be profitable,and in this study we have sought to justify this behaviourwithin this sector.We consider the main explanation for the sector’s

current situation is the failure of the liberalization ofLPG activity in Spain. The regulatory framework, whichshould oversee the liberalization and opening process untila high degree of effective competition is achieved, has beenshown to be incapable of doing so. This is so for twoprincipal reasons.In the first case, it has not opened up the sector, so the

dominant operator has maintained its position throughoutthe vertical chain, especially in retail distribution. RepsolButano maintains a quasi-vertical integration with itsnetwork of distributors, using its significant negotiatingpower to apply contractual terms and conditions, which inmany cases is incompatible with the current competitionregulations.In the second case, as the regulatory price fixing system

acts as a price limit, it impedes the sector from opening,and is a disincentive for the incorporation of andinvestments by potential entrants. The regulator justifiesthis price fixing system by arguing that it protects finalconsumers from possible abuse of power by the dominantcompany. However, this system produces significantlycontrary effects on competition.

�

Final prices in Spain are fixed lower than in the otherEU countries, in 2005, 66% lower than in Portugal,156% lower than in France and 159% lower than inItaly. This is because the prices are fixed, not to reflectthe activity’s actual costs, but using other criteria suchas social sensitivity with regarding butane cylinder pricesand/or the importance of LPGs in defining the RPIs. � Potential entrants and competitors see the final market

price as a limit that discourages entry; it may be difficultto convert entry costs into a profit, or to increasecapacity in the national market.

� These low prices generate a continual departure of

distribution agencies, the decapitalization of manyexisting agencies, a reduction in investments to reposi-tion, instability in assistance and supply commitments,and deterioration in the quality of services.

The paradoxes of the regulator’s actions are clear. Theytry to promote the opening and liberalization of the sector,and conversely they establish mechanisms to regulate theactivity. Uneconomic prices that discourage the veryprocess that has been initiated are fixed. They permitRepsol Butano to maintain its dominant position. Theseactions, theoretically directed at consumer protection,

ARTICLE IN PRESSA. Bello, E. Huerta / Energy Policy 35 (2007) 3595–3605 3605

negatively affect their interests and reduce the surplus, atleast from a medium and long term dynamic perspective.Currently, there is a deterioration in distribution activity,which may affect the quality of service and employment.They produce infra investment in new assets and reposi-tioning, and potentially give rise to a short term lack ofsupply in some areas.

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