By John Eichberger
For the past few years, some reporters, consumer advocate groups and politicians have tried to convince the nation that petroleum retailers have engaged in a long-term collusive effort to cheat consumers. They claimed a gas gouge they canâ€™t even see â€" hot gas â€" was ripping off drivers.
A standard U.S. gallon occupies 231 cubic inches. For more than 100 years, the petroleum industry has defined a stanÂdard motor fuels gallon as 231 cubic inches at a temperature of 60 degrees Fahrenheit. At issue is the fact that at 75 degrees, the same amount of fuel occupies 233.3 cubic inches, while at 45 degrees, that same fuel occupies 228.6 cubic inches.
The science is clear: Gasoline moleÂcules will expand and contract one percent for every 15-degree FahrenÂheit change in fuel temperature (diesel fuel expands and contracts approxiÂmately 0.6 percent). And a much quotÂed survey attributed to the National Institute of Science and Technology (NIST) â€" but derived from a survey conducted by an equipment manufacÂturer (the raw data for which cannot be found) â€" estimated that the average fuel temperature in the United States is 64.7 degrees Fahrenheit.
These two data points launched a frenzy of activity over the last couple of years:
- The media estimated consumers overpaid for fuel by more than $2 billion annually.
- State legislation proposed dividing states into different regions with difÂferent size gallons, based upon averÂage regional fuel temperatures.
- Legislation was introduced in the Senate requiring all retailers to retroÂfit their dispensers with automatic temperature compensation (ATC) deÂvices within six years, with an averÂage cost per dispenser estimated at $2,000.
- Multiple investigative hearings ocÂcurred in the House of RepresentaÂtives.
- The National Conference on Weights and Measures considered proposals to establish a method of selling petroÂleum that would either allow retailers to install ATC voluntarily or require ATC installation within 10 years.
- The U.S. Government Accountability Office released findings from its reÂport assessing existing information.
- More than 50 defendants were named in class action litigation claiming widespread collusion and coordinatÂed deceptive practice to defraud the consumer.
This debate, based upon broad assumptions, unreliable estimates and unsubstantiated allegations, can finally be put to rest with the early 2009 release of two definitive economic analyses:
- Fuel Delivery Temperature Study," prepared by the California Energy Commission (CEC), and
- An Economic Analysis of the CaliÂfornia Energy Commission Staffâ€™s Fuel Delivery Temperature Study and the â€˜Hot Fuelâ€™ Allegations prepared by Mike Flynn, principle at LECG.
These two reports reviewed the alÂlegations made in the debate over "hot fuel" and automatic temperature comÂpensation and analyzed the economics affecting the petroleum marketplace.
Thankfully, the conclusions completely refuted the charges levied against the industry by the media and consumer groups.
What happens now remains to be seen, however. While thereâ€™s been no further action on federal legislation, the litigation continues, the National ConÂference on Weights and Measures votes on the issue this July, and many state legÂislatures are now in session. Hopefully, this new information will resolve the hot fuel issue once and for all.
At the core of the hot fuel (also called hot gas) debate is the allegation that reÂtailers are collecting billions of dollars from consumers for fuel that consumÂers never receive. In its exposÃ© on the issue, the Kansas City Star used NIST state-level temperature data and the average retail prices on July 31, 2006, (the national average was $3.01 per galÂlon) to calculate how consumers have "overpaid" more than $2 billion annuÂally. These estimates have been used repeatedly in allegations of retailer profiteering. However, in his analysis, Mike Flynn with LECG proved that such excess profits were "illusory."
Figure 1 demonstrates that alleged hot fuel profits in many states exceed the average total pre-tax profits for the industry, indicating that the concluÂsions reached by the Star were overÂblown. Flynn noted, "It strains credulity to think that no one â€" not the U.S. ComÂmerce Department, the Internal ReveÂnue Service or the retailers themselves â€" appears to have noticed these pheÂnomenal results."
Flynn challenges the notion that reÂtailers enjoyed excess profits and susÂtained these profits through collusion by quoting statistics reported by the Risk Management Association. These statistics demonstrate that "the retail stores in the â€˜hotâ€™ parts of the U.S. actuÂally are no more profitable than their counterparts in the â€˜coldâ€™ regions." No evidence supports the hot fuel profit alÂlegations; rather, all evidence points to the contrary. Flynn concludes: There were no excess profits.
Itâ€™s well known that the retail petroleum marketplace is very competitive and that this competition strongly influences pricing decisions. However, each retailer must start the decision-making process with a target retail fuel price in mind. Hot fuel advocates often forget that this target price has already been adjusted for temperature variations.
Flynn explains in his report that reÂtailers receive only gross liquid galÂlons, even though they might pay a temperature-adjusted net price. In other words, as Figure 3 shows, at 60 degrees the retailer receives 8,000 gross gallons and pays for 8,000 net (temperature-compensated) gallons. However, at 80 degrees, the retailer still receives 8,000 gross gallons but pays an invoice that has been adjusted to a temperature-compensated net gallon equivalent of 7,889.6 gallons.
The effect on the retailerâ€™s target reÂtail price is simple to deduce: Divide the invoice amount by the 8,000 gallons reÂceived â€" and available for resale â€" to deÂtermine the actual cost per gallon. Hence, at 60 degrees, the retailerâ€™s cost is $2.875 compared to $2.835 at 80 degrees.
Consequently, the retailerâ€™s target retail price is $3.00 per gallon and $2.96 per gallon, respectively. The consumer pays less per gallon due to the price adÂjustment made to accommodate for the warmer fuel the retailer received. No phantom gallons generate excess profit.
Hot fuel advocates claim that automatic temperature compensation devices will ensure that consumers receive all the fuel they pay for. They mistakenly asÂsume that retailers would continue to sell temperature-compensated gallons at the same price as non-compensated gallons. But both Flynn and the CEC explain that retailers would have to adÂjust their prices an amount equal to the adjustment in volume or risk going out of business.
For example, a 15-degree change in fuel temperature would result in a one percent volume change in gasoline, as well as a one percent change in the tarÂget retail price. No retailer is going to give away free gasoline, and no competÂitor will allow a retailer to sustain inÂflated profits without losing customers.
Flynn and the CEC reached the same conclusion: Installation of autoÂmatic temperature compensation deÂvices would increase costs to consumÂers. The two reports differ in the magnitude of this cost, but the bottom line is unmistakable.
Figure 3 shows the costs estimated by CEC for implementing automatic temperature compensation. Although Flynn considers these estimates signifiÂcantly underestimated, they still proÂvide a solid basis for analysis.
The CEC found that the only potenÂtial benefit available to consumers would be through additional transparÂency at retail facilities (CEC sought to assign a monetary benefit to informing consumers that the size of their gallons had changed according to fuel temperaÂture variations), which it valued at $257,729 per year â€" compared to ongoÂing costs of $7.4 million annually that would be passed through to consumers. Even when using its low-cost estimates, the CEC concludes that ATC would cost consumers more than $245 million over 20 years.
The market, as it currently functions, serves both the interests of the retailers and the consumers. Retailers post their prices on large signage at the curb, enÂabling consumers to compare the price of a gallon of gas while driving by at 45 miles per hour.
This ability to comparison shop with such simplicity has empowered consumers to seek the best price in their market â€" in fact, 70 percent of consumers shop primarily on the basis of price, according the 2009 NACS Consumer Fuels Report. ConsequentÂly, retailers have to be conscious of competitive positioning, and as a reÂsult, provide consumers with the best value for their dollar.
The installation of ATC, as proven in two economic analyses, would do nothÂing but increase the price of gasoline to consumers and provide them with no tangible economic benefit.