(Reprinted from HKCER Letters, Vol.34, September 1995)
A Reply to Competition in H.K.'s Water Heating and Cooking Fuel Industry by Dr. W. David Walls
Editor's Note: The last issue of the HKCER Letters carries an article by Dr. W. David Walls commenting on the report Assessing Competition in the Domestic Water Heating and Cooking Fuel Market by the Consumer Council. We received a reply by the Consumer Council but regret that we were not able to include it in the same issue. The following is the reply.
The primary objective of the Council in conducting the study is to evaluate, in a comprehensive manner, the degree of competition in the domestic water heating and cooking fuel market following the Structure-Behaviour-Performance framework and the Contestable Market Theory. The report studies market concentration as well as economic barriers like cultural, technical, and legal factors that affect substitutability of other alternate fuel supply, e.g. electricity and liquefied petroleum gas (LPG). The simple econometric exercise which the Council conducted serves only as an additional support for the conclusion drawn from the other analyses. The elasticity estimation is hence placed in the appendix rather than in the text.
Dr. Walls rightly acknowledged that "to a large extent, consumers are captive customers of their gas supplier." Regarding profitability measures, the Council is aware of the limitations of return on sales (ROS) and return on assets (ROA), which are both accounting measures, in reflecting the true (economic) profitability of the company. Therefore, the Council's report also examines profitability in terms of excess returns by the company over that suggested by the Capital Asset Pricing Model (CAPM), a framework widely used in financial economic research as a benchmark for comparisons of corporate profitability.
To address the issue of: "Is there evidence that the current market organization is economically inefficient?", in addition to the above factors, the Consumer Council also looked at market share; the continuous growth by Hong Kong and China Gas Co., Ltd.; the consumer's ability to choose and switch; potential entrance by other companies; and the company's profitability in economic terms before arriving at the conclusion in the report of market dominance and the threat of monopoly power.
With regard to the issue of decentralized market exchange, the Council welcomes Dr. Wall's suggestion of unbundling of gas supply and its transmission as an alternative structure. The suggestion of "contract carriage" is, in very broad terms, similar to the common carrier suggestion by the Council. In both cases, the objective is to achieve competition in the market place, which promotes economic efficiency and consumer welfare.