Viva Energy’s Scott Wyatt would never admit it publicly but he is the clear winner from the outcome of two years of negotiations with supermarket chain Coles over a new fuel distribution agreement that runs until 2029.

While it is true that Wyatt was forced to make a one-off payment to Coles of $137 million to get the Coles Express convenience store deal over the line, that is small beer compared to the benefits that flow to Viva from having 100 per cent control over its fuel supply chain.

Under the old arrangements Coles Express had the power to impose its own profit margin on top of the wholesale fuel price charged by Viva. This profit margin on top arrangement was pushed through by former Coles managing director John Durkan. It made the Coles fuel offering uncompetitive.

Lo and behold, motorists showed they were unwilling to pay for the most expensive retail fuel in Australia. They deserted Coles Express in droves and fuel volumes collapsed from about 100 million litres a week to about 60 million.

One abiding feature of the strategic alliance between Viva and Coles has been and continues to be the opaque nature of the financial metrics. Neither party revealed the fuel margin enjoyed by Coles and now neither party will reveal the commission earned by Coles Express for each litre of fuel sold through Coles Express outlets or the royalty paid to Viva by Coles on convenience sales.

Given the secrecy over key terms of the agreement it was no surprise to discover on Wednesday that the opaqueness extended to the financial relationship between Coles and Coles Express which was paying Coles a “brand fee” of $30 million a year.

In other words, Coles was enhancing its profits with an internal transfer that a cynic could have viewed as accounting game playing. Of course, this game was unsustainable when Coles became a separately listed company through the demerger from Wesfarmers and there was a renegotiated fuel contract at Coles Express.

It could be slightly disturbing for those Wesfarmers shareholders who read the Coles scheme booklet to find out on Wednesday that Coles Express, which once earned about $130 million, might now only earn about $20 million or $30 million a year.

Viva and Coles had to agree to a new fuel deal although the precise reason why Wyatt was able to have such a resounding victory over Coles chief executive Steven Cain is not clear. There is speculation that the plunging fuel volumes at Coles Express could have led to the breach of a minimum fuel volume clause.

We will never know if this clause existed or whether it would have allowed Viva to boot Coles Express off its property. Either way, Cain was willing to agree to a deal that hurt the Coles share price, triggered market wide profit downgrades of Coles earnings and led to a 13 per cent surge in the Viva share price.

Viva, which floated in July last year, is now only 12 per cent below its listing price. At its worst in December the stock was down 31 per cent from its listing price.

Both Coles and Viva said the fuel deal is a “win win” transaction. There is certainly logic in allowing each company to do what they are supposed to do best.

Viva can enjoy an integrated supply chain that works in an optimal manner when fuel volumes are growing while Coles Express can focus on building its convenience store operations, which will expand through Viva’s commitment to open about 20 new sites a year.

The glue that holds much of the alliance together is the Flybuys reward program which is half owned by Coles and Wesfarmers. Wesfarmers owns 15 per cent of Coles.

The bottom line for Coles shareholders is that Coles Express is now a tiny part of the overall profit of the supermarket chain. It does not slip into irrelevance because the Coles Express network is such a visible manifestation of the brand.

The new agreement means the financial success of Coles Express is inextricably linked with the performance of Viva, which has an incentive to slash the price of fuel sold under the Shell brand and get fuel volumes up to at least 75 million litres a week.

Extracted from AFR