Are Gas Stations Really Inflating Prices For Profit?

Authored by Alex Kimani via OilPrice.com,

Companies have been accused of price gouging at the pump this year due to high gasoline prices, a claim that is entirely unsubstantiated.

Most gas stations profit primarily from the products they sell inside their stores, as margins on gasoline range from 1%-2%, and actually make more money when prices are low.

Gasoline prices will fall slower than they rise, however, because if they pass a sudden discount on to customers then they may end up in the red when the next delivery comes.

About a month ago, American consumers were confronted with the highest retail gas prices in history when gas prices soared past $5 per gallon for the first time ever. Not surprisingly, Americans were treated to another round of political bluster and ivory tower jousting, with Republican lawmakers blaming  President Biden and his energy policies while Democrats rolled out new bills, investigations, and even sent letters to the heads of oil companies accusing them of price gouging. “Profit margins well above normal being passed directly onto American families are not acceptable,” President Joe Biden declared as he called on congress to suspend gas tax for at least three months.

However, former Treasury Secretary Larry Summers hit back against those calls, calling the idea of price gouging at the pump “dangerous nonsense” and warning that anti-gouging legislation could lead to shortages. “The ‘price gouging at the pump’ stuff … is to economic science what President Trump’s remarks about disinfectant in your veins were to medical science,” he said.

Whereas gas prices have dropped by more than a dollar per gallon from their July peak, roughly half of states are still paying gas prices above $4.00. No doubt some consumers [and politicians] eager for relief at the pump will continue suggesting that slashing those ‘‘fat’’ mark-ups is the answer to lower gas prices.

However, the reality of the American fuel retailing business is very different from what some politicians have been portraying.

Source: Bloomberg

Fuel Retailing In America

The United States is home to roughly 9,000 independent oil producers, each of which, including the majors, sells crude oil into a global market at the prevailing price. The country is also dotted with 145,000 gas stations that independently set pump prices based on wholesale costs of gasoline plus a host of other local competitive factors. 

Only 0.4% of all gas stations are owned by oil producers, with the vast majority being small independent businesses operating under a licensing agreement, hence the famous BP (NYSE: BP), Shell (NYSE: SHEL) or ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) signage. The cost of crude oil makes up roughly 55% of the price consumers pay at the pump, while the remainder is made up of an assortment of costs, including taxes, refining costs, distribution costs, and only then, profits for the retailer.  

But here’s the kicker: gas station profit margins are typically very low, in the range of 1-2%. Compare that to nearly 40% profit margin by gas pipeline transportation companies and over 40% for private equities and hedge funds.

“Basically nobody’s vertically integrated anymore. The big oil companies got out of retail a long time ago. There’s hardly any profit so why stay in the industry?” Patrick De Haan, head of petroleum analysis at GasBuddy has told Courthouse News Service.

A recent check by Upside on 30,000 gas stations in the U.S. found that on average, gas retailers’ net profit per gallon is around $0.03-$0.07- after factoring in costs like labor, utilities, insurance, and credit card transaction fees. This works out to a net profit margin of less than 2%. Gas stations profit primarily from the products they sell inside – the convenience store assortment. 

Over the long term, retail fuel prices constantly fluctuate with changes in crude prices. Gas prices move in tandem with oil prices, but not as much in either direction. Indeed, over the past 10 years, a 10% rise in crude prices has only produced about a 5% hike in gas prices. 

But one thing you have always suspected is actually true: pump prices do rise fast in response to a spike in crude oil prices, but not in the reverse. There is a logical reason for this, as well: Gas station owners set their prices on future deliveries. If they pass a sudden discount on to customers then they may end up in the red when the next delivery comes and prices have spiked. 

“There were days when the wholesale price of diesel went up by 75 cents a gallon. When wholesale prices are climbing, you’re losing money because you can’t raise your prices until other station owners do. Then you try to recoup your lost margin. And you’re reluctant to immediately pass along decreases because the wholesale price could spike the next day,’’ De Haan has told Courthouse News Service. 

It might seem counterintuitive but high crude prices actually hurt gas retailers’ margins, especially when they rise too fast. Most gas stations are actually far more profitable when prices are low because people buy less gas when prices go up.

Another allegation that has been leveled against oil producers is that they are taking advantage of the situation by limiting their production in a bid to keep prices high. Indeed, Exxon, Chevron, BP, and Shell spent more than $44 billion on stock buybacks and dividends in 2021 instead of spending on drilling. In fact, they’ve committed another potential $30 billion or more in additional buybacks this year. 

“It is extremely frustrating to see that there’s not a full-on return to production at the moment of crisis,” Energy Secretary Jennifer Granholm has lamented.

“Why aren’t they drilling? Because they make more money not producing more oil–the price goes up,” Biden mused at a press conference last week.

However, the biggest reason why Big Oil is reluctant to drill more is simply because their shareholders don’t want them to and also due to ESG concerns. Moreover, economists at the Dallas Fed have projected that U.S. production increases would only add a few hundred thousand barrels per day above current forecasts “even under the most optimistic view.’’ That’s hardly enough to bridge the deficit that will be created by the looming reduction in Russian oil exports due to war-related sanctions that could easily reach 3 million barrels per day.