2008 Gas Price Kit

How Do Retailers Get – and Sell – Gasoline?
Retail gasoline prices directly reflect wholesale prices. However, how – and when – retailers purchase wholesale gasoline can differ significantly, leading to varying prices and/or margins on the gasoline they sell.

The wholesale market has complexities that lead to retailers having different cost structures, whether they are branded or unbranded, have long-term contracts or buy on the spot market or, in the case of tight supply periods and rising wholesale prices, even the time of day that wholesale product was purchased can play a role in determining the retail price.

Retail Gasoline Supply
Retailers obtain gasoline supplies based upon the nature of their relationship with their suppliers, and because there are several different ways that retailers can purchase gasoline, the cost structure and availability of gasoline may vary greatly from one retailer to another, even those operating under the same gasoline brand. There are three primary supply arrangements influencing a retailer's operations:

• Major oil owned and operated – Less than 5 percent of the approximately 164,000 retail gasoline facilities in the United States are owned and operated by the major oil companies. (About 2 percent of the more than 115,000 U.S. convenience stores selling gasoline are owned and operated by major oil companies.) These retail locations receive product directly from the corporation's refinery assets and their profit or loss is integrated into that of the corporation.
  
• Branded independent retailer – Approximately 52 percent of retail gasoline facilities are operated by independent business owners who sign a supply contract and sell gasoline under a brand owned or controlled by a refining company. Not every contract is drafted equally, and various market conditions can influence the terms of the contract. Branded retailers pay a slight surcharge per gallon for using the refiner's brand, benefiting from the supplier's marketing and ensuring a more secure supply of product. Their wholesale costs are established by their refiner supplier. When supplies are constrained, these retailers are given a higher level of priority for accessing product, although access to supplies may be restricted.
  
• Unbranded independent retailer – Approximately 43 percent of retail gasoline facilities are operated by independent business owners who do not sell gasoline under a brand owned or controlled by a refining company. These retailers purchase gasoline off the unbranded wholesale market, which is comprised of gallons not dedicated to fulfill a refiner's contracts. These retailers do not pay a marketing surcharge like their branded competitors do; consequently, unbranded gasoline is typically sold at all levels of trade for a lower price than branded gasoline. However, when supplies are constrained, these retailers have the lowest level of priority to access gasoline, often incur the largest wholesale price increases and may be completely denied access to product. Their wholesale costs are also established by the refiner supplier(s).

A company's supply contracts and size determine its options for obtaining gasoline. Branded independent retailers have one option for gasoline – the refiner that provides it with supply. Some larger unbranded independent retailers also may have contracts with a specific refiner, or even multiple refiners. Others may simply purchase product off the open market.

Most retailers are small businesses that obtain their gasoline at a terminal, also known as "the rack." Prices at the terminal are known as "spot" prices, and these typically experience the most price volatility.

For those purchasing fuel at the rack, there are two options for delivery. Some companies may elect to have gasoline delivered to their stores by a "jobber" who delivers fuel to their store – branded or unbranded – for a delivery fee. Other retailers have invested in their own fleets of trucks that go to a specific terminal – or terminals – to obtain gasoline. These companies may also serve as jobbers to other retailers.

Some larger unbranded retailers may purchase gasoline futures, attempting to lock in specific prices for delivery on a specific date in the future. This type of purchase, commonly referred to as "hedging," helps these retailers manage their costs in anticipation of volatile wholesale prices.

Retail gasoline pricing considerations
Wholesale gasoline is a commodity that is traded on the open market. As such, its price can change by the minute, which may influence the cost structure for a retailer.

In 2006, convenience stores sold, on average, about 3,350 gallons of gasoline per store per day. The average underground storage tank has a capacity of 8,000 or 10,000 gallons, so many retailers average a shipment of gasoline once every day or so. However, high-volume retailers – those selling three or even four times that amount – may receive multiple shipments each day. The cost of each delivery can vary significantly, especially when wholesale prices are in flux.

Competitive Considerations
While wholesale costs are a significant factor in retailer prices, the retail pricing decision also is heavily influenced by market conditions and local competition. Ultimately, movements in wholesale gasoline prices influence the cost structure of a retail facility, but competition for customers will dictate the store's profitability. 

How a retailer reacts to wholesale market conditions is based upon its individual pricing strategy, which varies greatly from retailer to retailer.

For example, a retailer may seek to maintain consistent margins, matching its retail price with variations in the wholesale cost based upon a certain formula. This strategy may result in a retailer pricing gasoline contrary to the prevailing competitive market conditions. Consequently, when wholesale prices increase, the retailer may, in fact, become one of the more expensive stores in the market in order to maintain a consistent margin. The result could be reduced customer counts and diminished overall revenues. However, when wholesale prices decrease, the retailer may in turn become one of the least expensive stores in the market, thereby recovering customer counts and overall revenues. Margins for this retailer would remain consistent over time.

Conversely, a retailer may seek to remain competitive in the market place, in spite of changing wholesale market conditions. This strategy may enable the retailer to maintain customer counts and overall revenue by setting competitive prices; however, it could lead to reduced or even negative margins. Competitive retail prices may not increase as quickly as wholesale prices, resulting in lost margins for the retailer. This strategy anticipates that during a declining wholesale market, local competitive conditions may enable the retailer to recover lost margins by slowly reflecting wholesale price changes at the pump. This type of retailer is focused on the complete market cycle, trusting that market forces will result in an average positive margin on gasoline sales over time.

With either strategy, gross margins are likely similar over the course of a year. In 2006, a gasoline retailer's average gross margin (before expenses) was 13.9 cents per gallon, or 5.8 percent gross margin, according to NACS data. This percent margin was the lowest recorded by the industry since 1983. After expenses, typical net profits per gallon are a few cents per gallon, at most. NACS estimates that in 2007 the break-even mark-up for a gallon of gasoline was 12 to 13 cents per gallon, and the Oil Price Information Service (OPIS) reports that average gross margins on gasoline in 2007 was 13.8 cents per gallon.

Replacement Costs
In a rapidly raising market, a gasoline retailer faces the significant challenge of maintaining sufficient operating capital to cover the cost of the product that will replace the inventory it is selling.

A gasoline retailer typically seeks to establish a retail price based on the cost of replacing the gasoline currently at the retail location, not the cost of that product itself. Basing prices on "replacement costs" is especially critical when wholesale prices fluctuate frequently. A retailer must generate sufficient cash from its current retail sales to purchase its next delivery of gasoline; otherwise, the retailer would be constantly using debt to finance wholesale gasoline purchases. When wholesale gasoline prices hit $3.00 per gallon, a fill-up of even 6,000 gallons of gasoline can cost a retailer $18,000.

With pricing influenced by replacement costs, there can be consumer misperceptions when prices rise, as some consumers observe prices changing at a retail location even though the station did not receive a new shipment of gasoline. However, the store may be responding to a notice from its supplier about how much its next shipment will cost. But even these decisions to respond to anticipated changes in wholesale costs are strongly influenced by competitive pressures and, often, a retailer is unable to adjust retail prices to match the change in wholesale costs. When prices retreat, market competition again influences a retailer's pricing decisions. Each retailer makes its own pricing decisions based upon its calculations of the best volume/margin equation to maximize its profits. During these periods, consumer interest in prices wanes and they usually don't notice that prices dropped even though a new shipment has not arrived.

Also, even if a store receives multiple shipments in one day, each priced differently, some states, such as New Jersey, limit retailers to one price change per day.

Retailer Costs
In addition to wholesale prices and competitive pressures, gasoline retailers must consider the following costs and expenses:

• Federal, state, and local excise and sales taxes, which average approximately 47 cents per gallon in the United States. (The federal gasoline tax is 18.4 cents per gallon and each state has additional gasoline taxes.)
  
• Transportation fees (1 to 3 cents per gallon, depending on distance).
  
• Credit card transaction fees (approximately 2.5 percent of the price of each transaction on plastic).
  
• Retailer overhead (employee wages, rent, electricity, depreciation and other costs of doing business).
  
• Retailer net profit (varies from day to day and market to market – retailer net profits can range from negative numbers to several cents per gallon). NACS estimates that the average retailer had a net pretax profit of between one and two cents in 2007.

There is a difference between gross retail margins (the difference between the tax-paid wholesale cost of gasoline and the retail price of gasoline at the dispenser) and net retail margins (the gross retailer margin minus the costs of doing business outlined above). For 2007, NACS estimates that a retailer's break-even margin was approximately 12 to 13 cents per gallon.

Wholesale Gasoline Pricing
Wholesale gasoline prices generally are tied to one of two data points:

• A price based on a differential from the current price of a future gasoline delivery contract from a commodities exchange (New York Mercantile Exchange, known as "the Merc" or "Nymex") or from a gasoline price tracking service, such as Platts, Oil Price Information Service, or DTN; or,
  
• A price based on the "cash" or "spot" market for gasoline.

Nymex- or Platts-based wholesale pricing is used primarily for short-, medium- and long-term contracts for gasoline supplies between refiners, blenders, importers and traders and gasoline wholesalers and retailers. Such a contract might call for a supplier to sell a certain quantity of gasoline at "Nymex plus 2 cents" or "local OPIS low rack minus one cent."

Spot market-based wholesale pricing is used primarily by gasoline wholesalers and retailers for immediate delivery of gasoline supplies by these parties. Such pricing might call for immediate delivery of 10,000 barrels of 87 octane unleaded at New York harbor for a set price.

Nymex and spot market gasoline prices move independently and are influenced by many factors, including national and regional gasoline inventories, the price of crude oil, weather and market events such as pipeline disruptions and refinery shutdowns.

When market conditions become more volatile because of weather or crude oil events, Nymex -based prices may rise somewhat, while spot market prices may soar. A gasoline market in which spot market prices are higher than NYMEX prices for future deliveries is termed a "backwardated market" and generally indicates that the markets believe that current upward pressures on prices will ease in the future.

Many gasoline wholesalers and retailers use the Nymex to hedge their gasoline supply needs, thereby reducing their exposure to future gasoline price movements. However, many trades of Nymex futures contracts are undertaken by "paper traders" – brokers and speculators that never expect to take physical delivery of a gallon of gasoline from a Nymex futures contract. These paper traders tend to lead Nymex contract prices up or down based on market conditions and breaking news events.

Wholesale prices for gasoline generally are reported by most sources as excluding federal, state and local taxes, without the transportation costs from the wholesale market to the retail outlet, and do not include any retailer-related costs, including overhead, credit card fees and any profit margin the retailer may seek. Thus, a spot market price of $2.50 per gallon for 87 octane unleaded gasoline does not include any of the below the "rack" costs and expenses that ultimately determine a retailer's "laid-in" costs of gasoline. These costs vary by market and by other conditions, but generally add approximately 60 cents to the retail cost of gasoline.