The Pricing of Gasoline
MARCH 01, 1967 by HAROLD M. FLEMING
Mr. Fleming is a well-known journalist and author, specializing in business and financial analysis. This article is reprinted by permission from Chapter IV of Gasoline Prices and Competition. (Copyright 1966, Appelton-Century. Crofts, Division of Meredith Publishing Company. 96 pp. $3.75). Other chapters include "The Geography of Gasoline," "Who’s Who in Gasoline Marketing," "Estimating the Costs of Gasoline," "Gasoline Price Wars," and "Regulating the Market Place."
Gasoline prices, like the prices of many other commodities, are not easy to understand. Sometimes gasoline price wars seem to spell intense competition. At other times motorists, seeing the same prices to the decimal at nearby stations, may think they are up against conspiracy. Or again they may see across the street a price difference between a familiar and an unfamiliar brand and wonder what it means.
This is understandable. The whys and wherefores of gasoline pricing are of almost infinite variety. And they keep changing. They involve behavior patterns beyond the powers of the most fertile imagination. Despite the difficulty of comprehension, it is beyond doubt that the intense competition in the business has brought about a record of reasonable prices. In 1964 the average price of gasoline, not including taxes, was 7 per cent less than it was ten years before. And the 1964 variety was much improved.
I. The General Price Structure
The United States gasoline business has a going structure of prices. And these prices, as will be explained, relate only partially to manufacturing and handling costs.
To begin with, there are the base wholesale prices of gasoline in large quantities at refineries in the key regions.
Then there is a second level of wholesale prices: prices at terminals, before the final fan-out. These are sometimes still called tank-car prices, from the original medium of delivery out of these terminals.
The final and perhaps most important wholesale price is the tank-wagon price, from the supplier or jobber to the retail gasoline dealer, on delivery to the service station.
As to the retail price, there are, with few exceptions, no "manufacturer’s retail list prices" in gasoline. The supplier’s ownership of the gasoline generally ends at the service-station tanks, and the dealer is then free to set his pump at whatever retail price he chooses.
An important exception occurs when, as in New Jersey since the middle 1950′s, some suppliers avail themselves of state "fair trade" laws that permit the manufacturer to set a specific retail price as the minimum to be charged for his branded product.
But major-brand suppliers by no means lose interest in the price of their gasoline when they sell it to the service-station man. The supplier’s interest is natural. He wants his brands to be competitive. Most suppliers counsel with their dealers about staying competitive; but, in the absence of "fair trade" or other exceptional circumstances, the decision is strictly the dealer’s.
Independent chains operate differently for the most part. Their station operators are usually on salary. They don’t sell to the station operator, but through him. They don’t suggest the retail price. They set it.
To a small degree, major suppliers are engaged in direct retailing, too. At a station where any supplier is itself the retailer, it, of course, establishes the price.
All the prices mentioned above—wholesale and retail — are so interrelated that they are constantly pulling each other up and down, so what is generally called a price structure for the gasoline business might better be called a fabric of prices.
Private Brand Differentials: Lesser-known brands of gasoline often sell at a price below that of better-known brands. The differential — a frequent bone of contention — may run to several cents a gallon. It is not necessarily due to a difference in quality; but often it is due to a difference in familiarity to the automobile driver or to a difference between stations in services available. Lesser-known brands range in quality from mediocre to the best. They are sometimes said to be sold "on price" while major brands are said to be sold "on reputation." However, the private brander is naturally interested in building a reputation. In some instances these lesser-known private brands are actually owned and promoted by major suppliers.
Bulk Sales: There is a category of gasoline sales whose prices hardly fit into the above-mentioned structure or fabric of gasoline prices at all. These are sales to large-scale buyers such as bus lines, truck fleets, highway contractors, cab fleets, the federal government, states, cities, and so on. In the trade, these are generally called "consumer sales," because the buyers consume the gasoline themselves; they do not resell it.
Prices on such sales are often low — sometimes below those to jobbers or dealers. Some of the reasons are obvious. These are quantity sales. Costs are low and credit risks small. No advertising or merchandising is required. And they frequently are once-in-awhile sales. There is sometimes a further reason for them — distress surplus of product. This will be discussed later.
The Living Price Structure: Gasoline prices are even more than a fabric, with flexibility and stretch. The gasoline price "structure" is a living, changing thing, to which thousands of men contribute their thinking. As a result, it is constantly responding to all kinds of changes in such things as business conditions, weather, traffic, and customers’ habits and income.
II. Logistic and Other Problems
The daily forwarding of more than 175 million gallons of gasoline from refineries by varied channels to 211,000 service stations, and from there to millions of customers, recalls what lexicographer Dr. Samuel Johnson once said of a woman preaching or of a dog walking on its hind legs: "The wonder is not that it is done well, but that it is done at all." For it is not enough merely to have the supply lines. The gasoline must be dispatched to the right places, at the right time, in the right volume, all the way from the refinery.
For such movement, suppliers must prepare well in advance, clear back to the refinery. In the spring they must start increasing gasoline output for the summer months; but in the late summer they must start cutting back on gasoline to make more heating oils available for the winter.
Suppliers, however, must do more than merely try to have enough gasoline for expected demand at the right outlets at the right time. They must also be sure of being able to meet any unexpected additional demand. In this respect they are like fresh milk suppliers, or power companies, which must always have spare capacity on hand. Conversely, if they guess wrong and overproduce at any given time, they may find themselves with a troublesome excess of products to get rid of.
All this requires careful advance estimates of a host of diverse influences on the gasoline market. These include general business conditions and consumer buying power; population trends; changes in the public’s highway travel preferences; changes in consumption of oil products in competition with other lures for the consumer dollar; and above all, the weather. And these must be worked down into the details within areas, countries, and cities.
Mistakes Are Bound to Occur: Suppliers will use anything from a small market-forecasting department to a computer to figure this all out. But with competitors in all areas, of all sizes, all marketing methods, and all competitive moods, each supplier faces one more large-scale question mark: "How much of a market can we hold, or gain, in the face of constantly changing competitive conditions?"
Now let us sit in with a supplier’s marketing manager, and see an unavoidable mistake about to be made. He and his company have just estimated that during the following March, three months away, they will be able to sell 5 per cent more gasoline in his area than during the previous March. He is making the arrangements for movement of the proper amount of gasoline to his terminals and stations.
But when March arrives, it rains and it snows. Motorists stay home by the thousands. When the month is over, they have bought 5 per cent less of his company’s gasoline than in the previous March. And to complicate his problem — since it was cold, customers bought more heating oil than he had anticipated. Thus, he faced the headache of bringing in additional quantities of that product even though his storage facilities were already overburdened with unneeded gasoline.
Weather is the most unforeseeable force that can bring about market miscalculation. And it is a constant hazard to the refiner as well as to the marketer. The refiner may count on a cold winter and find by February that he has made too much heating oil and not enough gasoline. In the spring he may count on a good driving summer and find by August that he has made too much gasoline.
But other factors can also upset the best-laid plans. An aggressive competitor may take away business. Depressed prices in an adjacent area may drain away gallonage. Or the local crop may fail, or the local mills shut down.
What to Do with the Surplus?: Our unlucky supplier now has excess gasoline on his hands. What shall he do about it? He has three choices — basically those available to all sellers in the gasoline business when they find themselves with extra gasoline.
1. store the excess gasoline;
2. dispose of it through regular marketing channels; or
3. find a fast outlet.
Now let us consider his choices. For this is essentially a typical situation. It is a dramatization of the general problems involved in gasoline pricing.
The Costs of Storage: Let us now suppose that our marketing manager with excess gasoline on hand decides to hold it in storage until he can gradually work it off.
It isn’t a very satisfactory choice.
To begin with, gasoline storage is expensive in relation to gasoline’s price, which essentially can be kept low only by a timely flow to market. Stoppage in the movement of gasoline immediately begins to cost. For storage costs money.
But far more serious than the storage cost is the back-up effect. New product cannot be delivered to terminals until there is room for it. If storage space is short, refinery output may have to be cut back. The effect can be felt clear back to the oil field. If the refiner is part of a crude-oil-producing company, then the company’s crude-oil output may have to be cut. If the refiner gets his crude from outside his own company, he may run the risk of losing some of his regular crude-oil sources.
So the flow of gasoline may be compared to a river. If too much comes down the river, then the excess must be drained off into reservoirs or it will break the levee somewhere.
If, for instance, the refinery has already scheduled full runs for April, and now its outlet in our marketing manager’s area is reduced by the carry-over stored from March, it may be decided to run full anyway. But where to sell the extra? It will probably go either into the "spot market," as "distress gasoline," or be sold to another refiner who has a market for the product. The pressure is now off our marketing manager —but not off his company. No doubt the extra gasoline will show up somewhere in the business, and result in a downward pressure on prices. But it probably won’t show up in his area.
Thus, time is forever pressuring the supplier. Not only is gasoline costly to store, but the equipment to produce and move it is expensive to keep idle. In some supply-demand situations he may have to throw original cost estimates to the wind and consider primarily the cost of not selling promptly.
Disposing of Gasoline through Regular Channels: Now let us suppose our marketer elects to take the second way out of his gasoline surplus — that is, to dispose of it through regular trade channels.
Apart from marketing gimmicks — special promotions, flying flags, prizes, and giveaways—there is only one way to do this, and that is to cut the price.
Unhappily, however, one of the most notable things about gasoline is that demand is relatively constant.
The gasoline market is not like the market for television sets, stereo recordings, fresh strawberries, or trips to Europe, where a 50 per cent price cut can bring in large numbers of new, additional customers — or induce existing customers to increase their buying substantially.
This is not to say that motorists don’t read price signs. Some are highly price-conscious, look for cut-rate stations, and will converge on depressed price areas.
But in doing this, they do not increase their total purchases. They merely switch them from one station, or area, to another. They do not appreciably drive any farther, nor burn any more gasoline. Even the most drastic price wars do not increase total mileage in the affected areas.
This is called short-term "inelastic demand" — demand that does not stretch and expand with lower prices.
It is quite different with gasoline’s long-term demand, over years and decades. If the product weren’t so reasonably priced and conveniently available, people wouldn’t take so many trips nor even buy so many cars — as the European experience with extremely high-taxed, and so extremely high-priced gasoline has shown.
But it is a fact, unhappily, that a marketer’s customers won’t immediately increase their driving even when the price of gasoline is cut sharply. So if the marketer cuts his price, the only added sales he can make are sales to his competitors’ customers.
And his competitors know this as well as he.
They can match his price — and more than likely will do so if they suspect that his lowered tank-wagon price is merely an effort to shrug off an overload of gasoline at their expense. In fact, some of them may have made the same miscalculation of demand and have the same surplus problem.
So by trying the price route out of his current inventory trouble, our marketer may, in effect, do a Samson and pull down the whole area price structure around his own ears.
Finding a Fast Outlet: For our manager and his company, there is a third and final choice of how to dispose of the excess gasoline caused by weather. It is to find an outside, nonregular market and there to sell the gasoline for whatever it will bring.
The most notable of such outlets is sale on the open market — to brokers, "independent marketers," or other large buyers. Often such sales are in hundreds of thousands of gallons and sometimes they are made on sealed bids.
To turn to such a third selling choice, our supplier must take a deep breath and remind himself of the disadvantages of the two other courses.
As was mentioned earlier, such sales are often at low prices. But they are somewhat offset by comparatively low costs (due to quantity, credit, and other economies). Sales under distress conditions are usually at prices lower than normal bulk sale prices. The basic reasons for such often-profitless sales have been implied above. The supplier presumably has more gasoline on his hands than he wants to try pushing into regular channels, or storing. He has been "caught long." And as a result he is, in his own interest and after careful calculation, acting to avoid what might possibly be a very great loss under one of the other two alternatives.
Loss Today; Profit (?) Tomorrow
In some circumstances, for good and sufficient though temporary reasons, a refiner may be willing to produce and sell gasoline at prices well below the most optimistic estimate of last-barrel cost. The start of this dismal story may be when he finds he must lower his price to a certain level in order to hold his own against competition, and his accountants tell him that, at that price, "no matter how we figure it," there will be a loss on every barrel of output.
His natural first thought would be to curtail production or even to shut down.
But neither will save him much money. His fixed costs will keep on.
So it may be more economical to keep running and lose only a little money every day, rather than to slow down or shut down and lose even more money every day.
Besides, our refiner wouldn’t want to add to his other troubles the substantial costs of refinery shut-down and start-up, nor the disruptions of laying off labor, dropping crude-oil "connections" (sources of crude oil), and cutting off regular jobbers and dealers.
So he keeps refining, selling for whatever he can get, and hoping that the market may soon recover.
A marketer can find himself in a situation analogous to that of our refiner. He can find himself in a depressed market that he feels is only temporarily so. Assuming things will get better and knowing that he may lose his established marketing position if he closes up, he keeps operating in the area even though it may mean months without profit.
There is at least one other circumstance in which a gasoline refiner or marketer may for a time sell at a profitless price or even, where it is legal, at a price below the lowest possible estimate of his particular costs.
The circumstance might occur when he tries to break into a new market that to him looks lucrative for the future. As a new entrant in the market his costs are probably high for he lacks the local facilities necessary for efficient operation; yet he sets his price low to attract customers. He may figure that he will have to forego profits for a time, in the hope of getting established and making money later. Some economists would regard such losses as an investment.
"Predatory" Pricing: One form of taking business losses for future profit is only a historical memory: selling below cost in a particular area in the specific hope of ruining a weak or small competitor and then taking over his business and his customers. This, called a "predatory practice," was fairly common in the old days when the oil business was young and uncrowded. It is illegal now, but even if it were not, there would be very little chance in the gasoline business of so calling one’s competitive shots today. In any market there are too many eager competitors, major and minor, branded and unbranded —all ready to fight to preserve their own positions, and ready, too, to move into any market vacuum created by the demise of one in their ranks. Today, anybody in the gasoline business foolhardy enough to wage a predatory campaign would find its successful completion no simple matter.
In this age of gasoline marketing, a firm’s moving into a new area does not forebode less competition. It means more of it.
The Profit Is the Pay-off: Whether sellers taking a loss on a sale do so to avoid a greater loss, or to gain a future profit, it is a sometimes forgotten truism that profit is inevitably the ultimate motive.
While in the short run price must both meet competition and move the goods, in the long run it must more than cover costs. It is a certainty that no one can afford to handle gasoline in any branch of the business at a loss, knowingly and continuously.
In sound, profit-seeking business practice, every type of sale and every offering price must justify itself either by contributing to a profit, immediate or eventual, or by minimizing a loss.
IV. Some Premises of Gasoline Pricing
The value of a bulky commodity like gasoline varies "all over the place." Gasoline of the same specifications may be worth so much today, more tomorrow, and less the next day; so much here, and more there, or vice versa. Gasoline is not like diamonds or gold, the value of which varies little from San Francisco to London or from this year to next year. Its value is more like the value of such bulky staples as firewood, which may cost $20 a cord in New England near the woods, and 50 cents a stick in New York City. Perhaps the best analogy is with water — worth less than nothing in flood, but worth a great deal in the desert.
The Flexibility of Gasoline Prices: Due to the almost infinite variety of circumstances in which gasoline finds itself from market to market and from time to time, it is hard to figure any fixed formulas for pricing it.
Yet there is always the imperative profit-seeking command that prices must be arrived at that will move the goods most economically to wherever they are most wanted at the moment.
Gasoline prices are never in equilibrium with all the supply and-demand forces that affect them. They are chronically in need of adjustment. Pricing decisions must be made without delay. These decisions may be wrong half the time. (If they are wrong too often the maker leaves the scene.) But they have to be made by those closest to the circumstances. To learn everything about the hows and whys of gasoline pricing at any particular moment, you would have to talk with about everybody in the business.
The Art of Guessing Right Prices: The quoting or bidding of gasoline prices cannot be a science. It has to be a day-to-day art —a matter of trial-and-error dependent basically on judgment. The factors that go into the pricing of gasoline will always be hard to figure. Prices are always experimental.
On the supply side, the seller must figure on costs that are arguable to start with and that may vary inversely with a volume that is unpredictable. And on the demand side, he faces changing weather, business conditions, and competition. Overall estimates of national consumption can tell him lamentably little about the next few months in City X, County Y, or State Z.
The gasoline marketer has no slide rule to tell him how far, in a good market, he can afford to expand; nor how far, in a poor market, he can figure to keep selling at a loss to avoid a greater loss.
This is what has given the business, through its price system, its remarkable flexibility, pliability, challenge, and life.
Speaking of his early experiences as a borrower, John D. Rockefeller once said: "In the early days there was often much discussion as to what should be paid for the use of money. Many people protested that the rate of 10 per cent was outrageous, and none but a wicked man would exact such a charge. I was accustomed to argue that money was worth what it would bring — no one would pay 10 per cent, or 5 per cent, or 3 per cent, unless the borrower believed that at this rate it was profitable to employ it. As I was always the borrower at that time I certainly did not argue for paying more than was necessary."
Wasn’t old John D. about right?
The best and quickest cure for high prices is high prices, and by the same token, the best cure for low prices is low prices.
If there is a shortage of anything, the quickest way to get more of it produced is to let the producers take a good profit. This will encourage competition and the price will soon fall, along with the margin of profit.
From The William Feather Magazine, November, 1965