Gasoline prices are among the most recognizable price points in American commerce, and with good reason: Nearly 40 million Americans fill up their vehicles every day, and gasoline purchases account for approximately 5% to 6% of consumer household spending per year.
Consumers recognize when gas prices change—sometimes so much so that they are willing to drive 10 minutes out of their way just save a few cents per gallon. Historically, we also know that about two in three consumers shop for fuel based on price, whether gas was as low as $1.62 per gallon at the start of 2009, or as high as $3.28 per gallon at the start of 2013.
Gasoline prices are ultimately affected by four sets of costs: crude oil, taxes, refining, and distribution and marketing (the costs after the fuel leaves the refinery). (www.eia.gov)
Crude oil prices have the biggest impact on retail gasoline prices. Given there are 42 gallons in a barrel, a rough calculation is that retail gasoline prices move approximately 2.4 cents per gallon for every $1 change in the price of a barrel of crude oil. While this is not an exact calculation, it helps demonstrate that as crude oil prices change, so does the price of retail gasoline.
Retailers selling fuel account for expenses like taxes, including a federal excise tax of 18.3 cents per gallon for gasoline, or a 24.3 cents per gallon excise tax for diesel. (www.eia.gov)
Less than 0.3% of all convenience stores selling fuels today are owned by one of the major oil companies, and about another 4% are owned by a refining company. Regardless of the brand of fuel sold, most convenience stores (95%) are owned by independent companies, whether one-store operators or regional chains. Each of these companies has different business strategies, which can dictate the type of fuel they buy and how they sell it.
There are four broad factors that can impact retail fuel prices:
- Fuel type: Typically, stores that sell fuel under the brand name of a refiner pay a premium for that fuel, which covers marketing support and signage, as well as the proprietary fuel’s additive package. These branded stores also tend to face less wholesale price volatility when there are supply disruptions.
- Delivery method: Retailers who purchase fuels via “dealer tank wagon” have the fuel delivered directly to the station by the refiner. They may pay a higher price than those who receive their fuels at “the rack” or terminal. In addition, a retailer may contract with a jobber to deliver the fuel to his stations or operate his own trucks—the choice will influence his overall cost.
- Length of contract: Even if they sell unbranded fuels, retailers may have long-term contracts with a specific refiner. The length of the contract—which can be 10 years, sometimes longer—and associated terms of that contract can affect the price that retailers pay for fuels.
- Volume: As in virtually every other business, retailers may get a better deal based on the amount of fuels that they purchase, whether based on volume per store or total number of stores.
Even within a specific company, stores may not each have the same arrangements, since companies often sell multiple brands of fuels, especially if they have acquired sites with existing supply contracts.
Fuel retailers face the same question that all retailers face: sell at a low profit per unit and make up for it on volume, or sell at a higher profit per unit and expect less volume? Location can also be a factor. For example, stores in areas where real estate costs are high may pass along this cost of business when setting their retail fuel prices. Some stores may factor in seasonality, particularly if they are in a location where customer traffic dramatically changes during the summer and winter months, and other stores may be located in a competitive market where consumers have ample choice of where to shop.
Other considerations come into play as well:
- Wholesale gas price changes: Competing retailers in a given area may have very different wholesale prices based on the terms of their fuel purchase (as noted above) and when they purchased their fuel, especially during times of extreme price volatility. Gasoline is a commodity, and its wholesale price can have wild swings. It’s not unusual to see wholesale price swings of 10 cents or more in a given day.
Depending on sales volumes and storage capacity, retailers can receive as many as three deliveries a day or as few as one delivery every three days. Due to competition for consumers, retailers may not be able to adjust their prices in response to an increase in wholesale prices because their competition may not have incurred a similar increase in their cost of goods sold. Conversely, a retailer may adjust gas prices when the competition adjusts prices, either following or in advance of a shipment.
Contracts: How retailers buy fuel can play a significant role in pricing strategy. Retailers sign long-term contracts (10 years is the norm) and these contracts may dictate the amount and frequency of their shipments. When supplies are tight, retailers with long-term contracts may have lower wholesale costs than retailers who compete for a limited supply on the open market. When supplies are constrained, those with long-term contracts may face allocations (a maximum amount of fuel that they may obtain) on the amount of fuel they receive, whereas those without such contracts may be unable to purchase fuel for a period of time or be forced to pay a significant premium.
- Brand: Where the retailer buys fuel also affects pricing strategies. Branded retailers often pay a premium for fuel in exchange for marketing support, imaging and other benefits. Branded retailers typically have the least choice in how they obtain fuel, or at what price, but that is offset by the benefits that a brand provides.
Each of these factors adds complexity to a retailer’s pricing strategy, and they can create unusual market dynamics. There are times when the retailer with the highest posted price in a given area could be making the least profit per gallon based on when, how and where the fuel was purchased.
No matter what their pricing strategy, retailers tend to reduce their markup to remain competitive with nearby stores when their wholesale gas prices increase. This can lead to a several-day lag from the time wholesale prices rise until retail prices rise. Likewise, when wholesale gas prices decrease, retailers may be able to extend their markup and recover lost profits, with retail gas prices dropping slower than wholesale prices.