The Future Price of Gasoline, According to Sam

by | published August 6th, 2010

Sometimes, an average guy who has no access to the decision-makers or the power barons can be just the person to tell you what is really going on.

Meet Sam.

He runs a gasoline station 12 miles from my house, in a little, suburban, out-of-the-way town. We have developed a friendship of sorts over the years. He’s one of the few people I meet on a regular basis who does not ask me where gasoline prices are going, because he tends to know himself, 48 hours before even his competitors do.

That is of great benefit to me, as you will see in a moment…

Usually, however, it is of minor help to his business.

My Barometer for the Local Gas Market

Sam serves a declining customer base. The local business community has been hit hard by the economic slowdown. Unemployment among residents is well above 15%, while the rest of his trade passing through (like me) has a base of operation in the city (Pittsburgh). His margins are narrowing, and what passes for a convenience store at his station is small.

That means he depends on selling gas from his six pumps to make ends meet – far more than some of the larger operations do. Having little to fall back upon, controlling his costs is a constant battle.

To cover the frequent budget shortfalls, Sam cannot just charge what he would like to, because the competition down the road, in larger communities, would eat him alive.

But he also cannot cut his prices to generate additional business, hoping to increase sales volume.

First, he has insufficient alternative revenue flow to make it for very long. Second, he is tied into a supply agreement with a major vertical oil company, the kind that controls the process from fields through refineries and distributors to setting the effective price at retail outlets, even those the company does not control.

That is becoming more commonplace these days.

The big five gasoline sellers in the U.S. – BP (NYSE:BP), Chevron (NYSE:CVX), Exxon Mobil Corp. (NYSE:XOM), Shell (NYSE:RDS), and Citgo (privately controlled by Venezuelan state oil company PDVSA) – actually own fewer stations outright than they used to.

Exxon is phasing out retail station ownership completely.

These big boys are nonetheless increasing aggregate control in gasoline sales… by tying retailers into long-term contracts.

Those, like Sam, who sell gas to the public, have few options. They need to obtain volume from somewhere; they certainly do not own their own refineries. And there are few independent refiners left. Even the likes of Valero (NYSE:VLO) – which used to be the leading independent – is now in the process of becoming a vertical.

Now here is where Sam is "stuck" (though I actually have another, more descriptive word in mind…).

If he does try to cut prices to generate business, the big boy providing the product will penalize him for undercutting the larger distribution market (one that may still contain stations owned by or leased from the vertical).

And in any event, the vertical makes far more money from controlling access to product area-wide than from what they are paid by the likes of Sam. So the major’s control over pricing is increasingly important to its bottom line.

This is how five oil companies effectively control well over 60% of daily gasoline sales in the U.S. market. They further coordinate control by using OPIS (the Oil Price Information Service), a very expensive provider of hundreds of thousands of gasoline pricing points from most of the stations nationwide several times a day. The companies need not talk to each other. They merely turn on their computers.

This is not the occasion to debate the merits of such consolidation or whether a more effective pricing structure would result from some added competition. But what it does mean it is impossible for small-time operators like Sam to buck the system.

What Sam can do is give a heads-up on where gasoline prices are moving.

He needs to operate on very thin supply margins. Too much or too little gas both mean sacrificed income – unused product in the first case, sacrificed sales in the second.

So Sam has worked out an arrangement with his local "big boy" truck supplier (ok, it’s the husband of his only sister) to receive his weekly shipment on Thursday. The bigger outlets get theirs on Saturday. He can better gauge station needs with a delivery during the week, he tells me, rather than on the weekend. And he passes on the wholesale cost to his customers with a standard markup (averaging about 6% in the local market over a standard year).

He is my perfect barometer for the local market.

The price posted at his place on Thursday is essentially the price going up everywhere else… two days later. Aside from the now quite infrequent gas wars, or restrictions some places still have on self-service pumps, Sam gives me the market for the next week.

And 48 hours to do something with the information.

We Will Benefit from This Early Indicator

Sometimes I negotiate client payments for my services in something other than money – stock options, discounted product volume, market access, etc. Several years ago, I contracted to get something unusual in return for consulting – 20-year access to a client’s OPIS account.

Sam provides me with something else.

By plotting the advance notice he gives me, I have been following a broader multistate area of retail sales for several years now, as well as beginning to compare regions.

Two days doesn’t sound like much. Yet having even a slight advantage allows me to factor change into a frequently revised model that projects pricing before it hits the market. In this way, I can equate it to refinery runs, crude oil differential supplies, and spreads between futures contracts in gasoline and several exchange-traded funds (ETFs) following that trade.

All of this started as an intellectual exercise. That changed two years ago. Now it’s a model for imminent profits.

By retro calculation from retail sales to sourcing and then comparing the patterns resulting, I received early warning of the retail price hikes in 2008, but was not positioned at the time to take full advantage of what was happening in the energy markets.

This time, it will be different.

I’ll be able to fill you in on who is likely to benefit first and where the pops are going to hit. Because demand is coming back, the retail sales and pricing patterns are again developing, and the current rise in crude prices is only the early indicator.

I still visit Sam each Thursday. The model is mine, as is the methodology and the way I use those otherwise mind-numbing columns of OPIS figures. But without Sam’s situation requiring an early gasoline delivery each week, I never would have had the idea.

Now if he can just stay in business a little while longer…


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