How High Will It Go?

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How High Will It Go?

As the nation's average gasoline prices hit record highs this spring, convenience and gas retailers, and their wholesale suppliers, have found little to cheer. Falling consumer demand, squeezed margins, overwhelming credit transaction fees, penny-pinching customers -- what's a gasoline retailer to do?

C-store/gas operators are scrambling to keep track of volatile price changes, many wondering if the business model for selling gasoline at a profit in the United States has changed for good.

"Opinions on this are divided," noted Dan Gilligan, president of the Petroleum Marketers Association of America, based in Arlington, Va. "Some think current high prices will result in reduced consumption and increased production, which means lower prices."

Gilligan believes that climate change restrictions, Environmental Protection Agency rules and biofuel mandates will continue to crimp production and supply, and keep prices high.

"I heard one environmental economist say it would take $7 gasoline to truly reduce [the petroleum industry's] effect on climate," said Gilligan. "Others say provisions in the Lieberman-Warner bill can be implemented for 40 cents a gallon, which in today's market, when there are 40-cent swings in a day, isn't shocking."

Last fall, Sens. Joe Lieberman and Robert Warner proposed a mandatory, market-based cap-and-trade program that would cover 80 percent of U.S. greenhouse gas emissions, reducing them to current levels by 2012, 10 percent below current levels by 2020; and to 70 percent below current levels by 2050.

Gilligan also predicts a huge post-election gas-tax hike next year, as Democrats look for sources of revenue to rebuild the nation's crumbling infrastructure.

"The economic proposition of selling gasoline has changed," he said. "Some new number crunchers and analysts will be needed to define it."

As it stands, lower consumer incomes, the weak dollar and increased investment in commodities are likely to keep demand for gasoline weak as wholesale and street prices stay high, industry players predict. A spring snapshot of the industry supports this: The average retail price of regular gasoline jumped from $2.96 in mid-February to more than $3.26 at the end of March. (At the time, the media eagerly covered a gas station in Gorda, Calif., whose closest competition is 40 miles away, retailing regular gasoline for $5.40.) As of the second week of April, the average price of regular unleaded gasoline was $3.343, according to an AAA and OPIS survey.

After staying relatively strong through post-Katrina price spikes and $3-plus averages, U.S. demand has flattened this year. It decreased in nine of the first 10 weeks of 2008, with demand down 1.7 percent for the week ending March 28, compared to the year prior, according to MasterCard Advisors. Motorists pumped an average of 9.043 million barrels per day in the week ending April 7 -- 2.5 percent lower than demand the previous week, and 6.8 percent below year-ago levels, MasterCard's weekly SpendingPulse report stated.

This year, U.S. demand is expected to increase just 0.3 percent over 2007, according to the U.S. Energy Information Administration, based in Washington. For the past six years, gasoline demand has grown an average of 1 percent annually.

The Automobile Association of America (AAA) predicts the price of self-serve regular will average $3.50 by Memorial Day. "What makes it difficult to forecast are the many signals that the economy is moving from bad to worse," said Geoff Sundstrom, a national AAA spokesman. "One would expect there to be some sort of demand fall-off for gasoline, to the extent much of Americans' discretionary driving will disappear, and there could be weak spring and summer travel seasons [because of] the economy and high price of gasoline. But like everyone else, all we can do is watch it unfold day by day. There is no guessing a peak price."

The average price for a gallon of regular gasoline may peak at $3.50 to $3.75 in the near term, then decline a bit after Memorial Day, according to Fred Rozell, director of retail pricing for Oil Price Information Service, based in Gaithersburg, Md.

"I expect demand will drop off later in the summer, like it usually does, and we may see street prices fall a bit, although many variables come into play," he said. "I wouldn't suggest gas prices will drop to 80 cents a gallon, but I don't see it going to $4 or $5 a gallon anytime soon, unless there is some sort of event in the Middle East or something catastrophic."

Rozell also predicts the new administration will put more emphasis on conservation and new auto technologies, which will reduce demand and have some staying effect on retail price in the long term.

Consumer Behavior

Still, consumers already are reacting to record gasoline prices. Nearly half (45 percent) of the 1,215 adults surveyed from Dec. 26, 2007, to Jan. 4, 2008, by NACS, The Association of Convenience and Petroleum Retailing, said high gasoline prices have significantly affected their spending behavior. Nearly three-fourths named price as the main factor in selecting where they purchase gasoline (compared to 66 percent in 2007), according to the 2008 NACS Consumer Fuels Report. In 2000, the retailer's location was the primary factor consumers considered.

"When we hit $3 a gallon, the economy was stronger," AAA's Sundstrom noted. "All of this decade, with each new record price, we said consumers would not cut back on driving based on price alone. Changes in driving patterns only happen when people are worried about their personal economic fortunes, which is happening now."

Americans' budget constraints contributed to waning customer loyalty, with nearly one-third of the NACS survey's respondents saying they would make a left turn across a busy street to save 1 cent per gallon. More than half would do the same to save 3 cents a gallon.

Retailers may want to rethink their marketing strategies, as more than 30 percent of the consumers said they'd walk into the store to pay cash to save a penny a gallon. Almost half of the respondents would do that to save 3 cents per gallon, according to the report.

What's more, 23 percent of consumers would drive five minutes out of their way to save that 1 cent per gallon. To save 3 cents, more than 40 percent would drive past other stores.

Andrea Goodwin, a stay-at-home mother of two who lives in Noblesville, Ind., tries to fill up at the gas station with the best prices. "I very rarely am in a position where I don't have the luxury of being picky," she told Convenience Store News. "I plan ahead and will fill up. I am more apt to wait and get gas midweek because it seems like the price goes up on Thursdays for the weekend."

She often uses her Kroger rewards card, which gives her 10 cents off a gallon once a month. "I gravitate toward the same station in my area because I know they've got the best prices and they are close by," she added, noting the high price of gasoline will probably mean she will be making fewer trips north this summer to visit family.

To save gasoline, Mike Clyne, a married father of one living in Sterling Heights, Mich., recently traded his Dodge Durango for a four-cylinder Saturn Aura. "It saves me six gallons per fill-up, which is about $20 per week at current prices," he said, adding that he has carpooled for two years, since gasoline hit $2 a gallon in his market.

Having enrolled in Speedway SuperAmerica's Speedy Rewards program, Clyne tries to buy gasoline at one of those stations as often as possible. "I save 2 cents a gallon at the pump, and depending on my accumulated points, I can save up to 50 cents a gallon on a fill-up," he noted. "But I also will buy gas at a traditionally lower priced station that I know is going to be the lowest in the area. I won't go more than a couple miles out of my way though."

Still, in a trend that may spell trouble for some c-store foodservice programs, he and his wife are saving money by ordering takeout less often.

Michelle Dawson, a part-time working mom of two from Pacific, Mo., is blunt. "I won't shop big brands. They have enough money. I go to the cheapest place."

But whether retailers are finding themselves on the winning or losing end of the customer chase, it's a sure bet they are sharing one experience: quickly diminishing gasoline profits.

In 2007, the average retailer made approximately 5-percent profit margin, OPIS' Rozell said. "That was down from about 12 percent five or six years ago. It's getting more and more difficult to make money [selling gasoline].

"You have to really monitor what gas prices are doing when they are changing 5 cents a week -- especially smaller retailers, who don't have sophisticated systems to help them manage the price volatility," Rozell said.

For the foreseeable future, Rozell expects profit margins to remain tight. "But the volatility is more of a problem because it is hard to price from one day to the next when they are gyrating. Retailers should expect to see violent price swings."

Making the profit picture even worse is 35 percent of the consumers surveyed said they are more likely to pay by debit or credit card when gas prices increase. After factoring in credit card fees and other costs, NACS estimated the break-even markup for a gallon of gasoline to be 12 to 13 cents per gallon, leaving retailers with an average profit of 1 to 2 cents per gallon.

Add to this squeeze costs associated with higher fuel inventory prices and suppliers' fuel surcharges. Many wholesalers are rethinking their accounts receivable policies.

"Many of our [wholesale supplier] members have huge receivables out there and huge credit card fees," Gilligan noted. "There are [retailers] who are slow paying. If a wholesaler has 80 dealers and he drops off a $7,000 load and hasn't been paid yet for the last load, what does he do?"

The savviest wholesalers will recognize which retail customers are weakest and move to cash deliveries, the industry executive noted. "If a retailer is unable to pass on the higher wholesale costs because the operator across the street won't raise his price, it makes for a very scary time. I could see some smaller operators bagging their pumps temporarily."

Refiners, too, are feeling the pinch. "Oil prices are well above $100 a barrel, and retail gasoline prices around $3.25, about the same they were last May, when oil prices were only $65 a barrel," noted Bill Day, a spokesman for San Antonio-based Valero Energy Corp. "The price of oil has shot up by more than 60 percent in less than a year, yet gasoline is only now surpassing its 2007 peak [price]."

At $109.92 per barrel, oil costs $2.62 per gallon, Day explained. "Add in the average 45 cents or so per gallon in local, state and federal taxes, and you get very close to the retail price of gasoline, before you've even gone through the process of refining the barrel into gasoline and then transporting it to the station. It isn't good for refiners for gasoline to be this high."

The fundamentals and business model of selling gasoline have and will continue to change, said Becky Shotwell, president of Stop N Go Inc., of Medina, Ohio. "We will have to continue evolving."

Customers at the chain's 10 stores complain more about gas prices, she said, but don't necessarily aim those complaints at the retailer. "There is general frustration and apprehension in the air about what is to come and how the general election is going to affect things," Shotwell told CSNews.

"People are certainly more in-tune to the media. When oil prices go above $100 a barrel, they start to project what might happen this summer. As a company, we continue to gather more information about the gasoline consumer buying habits to understand where we need to adapt ourpricing strategies."

Harsh winter weather and changes in the competitive landscape make it difficult to judge how big an impact higher street prices have had on her customers, Shotwell said, noting Stop N Go's unbranded gasoline is competitively priced in each market. "But we know credit card usage continues to climb," she said.

Even retailers who clearly have seen gains in gallons sold are feeling unprecedented pressure.

"If I didn't have to sell gasoline, I'd stop in a heartbeat, period," said Monica Schmidt Musich, president of Grand Forks, N.D.-based Valdak Inc., operator of eight Valley Dairy stores. "If there was a viable alternative, I'd jump on it."

"Phenomenal amounts" of credit transactions, small-town price competition and regulatory issues are starting to outweigh Valley Dairy's business advantages, such as a strong relationship with its wholesale supplier, the market's healthy farming economy, and a deluge of Canadian tourists taking advantage of a beneficial exchange rate and relatively cheaper gasoline.

Although Valdak Inc. has sold more gallons during the first quarter of 2008 than it did in the same quarter last year, Musich is feeling the heat. "People get mad at you when you raise the price. I never hear, 'You want to charge me 75 cents for a candy bar?' I could raise the price of a candy bar 15 cents and not hear a complaint. If I go up 3 cents on gasoline, I do."

Still, she said, most of her customers understand she is not making a windfall on the sale of gasoline, which in late March retailed for $3.14 for regular, below the then-national average of $3.26. "If a competitor goes down a penny, I typically will not, unless everyone on the street does. But I will not be the first to raise prices, either," she said. "Our customers are pretty loyal, because they know Valley Dairy tries to price the best we can, and inside we price very competitively. Our stores are clean, and we have nice employees. If they are paying an extra 8 or 15 cents on a fill-up, they wont leave us.

"I have no problem telling them that I have to pay this price for gasoline too. I buy it from our stores. We're not the one making all the money on our gas sales."

Luckily, for some retailers, not every consumer makes price-per-gallon a top priority. "The most important factor for me is location," said Phyllis Ward, a resident of Fort Myers, Fla. "As prices go up, I'm more loyal to the gas station I usually use, because the owner is a nice guy."

Opportunities For Operators

Unable to control the price at the pump, consumers are looking for ways to limit how much gasoline they buy, which can spark new marketing opportunities for c-store operators.

Six in 10 drivers surveyed by Opinion Research Corp. for the Automotive Aftermarket Industry Association said their driving behavior has changed due to rising gas prices. One-third of the 500 adults responding to an online survey said they would make changes when the price of gasoline reached $3 a gallon; another one-third said they would make changes if prices reach $4 per gallon.

Ninety-two percent of those who have already changed their behavior said they are driving less; 75 percent revealed they are better maintaining their vehicle.

"Many more customers are aware they won't spend as much on gasoline if their vehicle is running properly," noted Rich White, senior vice president, marketing and member relations, for the Automotive Aftermarket Industry Association, based in Bethesda, Md.

With more motorists looking to do light car maintenance themselves (almost half of those surveyed), c-store operators may want to reach out to them with pump signage reminding them to keep their tires inflated, White suggested. "Driving with under-inflated tires is like driving with the parking brake on," he noted. "Retailers may want to point out their air hose or sell tire gauges at the counter."

They may also want to remind customers to change their oil frequently or sell gas caps. "People lose the caps or drop and crack them when they are filling up," White said. "A great deal of fuel dissipates and is wasted. Selling them could be a way for c-store operators to connect with their customers."

Consumers who are changing their driving behavior also said they were carpooling (31 percent), purchasing more fuel-efficient vehicles (30 percent) and making greater use of public transportation (24 percent).