NPN MarketPulse: Northeast Petroleum Markets Report - Part 2: The petroleum market in five states in the Northeast

Northeast Petroleum Markets Report - Part 2: The petroleum market in five states in the Northeast

Wholesale and retail gasoline markets in five Northeast states were studied for a recently released report that was commissioned by the attorneys general of Maine, Massachusetts, New Hampshire, New York, and Vermont. mp1

The report is designed to help officials in the five states analyze what factors influence price changes, and in turn, help consumers, according to the attorneys general in those states.

In its Sept. 20 issue, NPN MarketPulse covered the release of the report and reproduced a section on petroleum distribution.

Here, lightly edited, is a portion of the report that summarizes the workings of the wholesale and retail gasoline markets in the five states (the five states are referred to in this excerpt as “the states”):

Summary of Section IV: Wholesale and Retail Gasoline Markets
The price of crude oil is the single largest variable cost in the production of gasoline, accounting for approximately 55 percent of the retail price of gasoline. Consequently, changes in the world price of crude oil are the primary determinant of changes in retail gasoline prices over time. While there are persistent differences in the level of retail gasoline prices across the various regions of the U.S., regional retail prices tend to move together over time, reflecting the fact that they are all heavily predicated on the same world price of crude oil. For the five States examined in this report, over 80 percent of observed variation in average retail gasoline prices in recent years is explained by variation in the average price of crude oil. However, there are still many other factors in the distribution of gasoline from the wholesale terminal to the retail gasoline station that may influence both wholesale and retail gasoline prices, including wholesale market structure (part of which was discussed in the section on terminalling), retail market structure, and governmental actions such as environmental regulation and taxes. Section IV outlines the ways in which gasoline is distributed from wholesalers at distribution racks to retailers who sell to end consumers. There are several ways in which wholesale gasoline is supplied to retail gasoline stations. Some retail stations are owned and operated directly by a refining company that markets retail gasoline (refiner-marketer).

Refiner-marketers supply their own retail outlets with gasoline, selling their brand of gasoline directly at the retail level. In some cases, a refiner-marketer might own a gasoline station, but it may also lease the station operation to a franchisee. This retail franchise is typically supplied directly by the refiner, but is operated by the franchisee under the terms of the franchise or lease agreement. In both of these cases, the refiner-marketer directly supplies the retail station with its marketed brand of gasoline. In general, when stations are directly supplied by a refiner-marketer, the refiner has more influence over the wholesale price that each station pays and the retail price that the station charges. The majority of the gasoline stations in the States are not directly supplied by refiner-marketers, but are instead owned by individual proprietors who purchase wholesale gasoline from refiners at the terminal rack. These stations are typically supplied by jobbers – intermediate firms that deliver gasoline from terminals to gasoline stations for a fee. Jobbers may supply many individual stations, each of whom markets various brands of gasoline or unbranded gasoline. Jobbers may maintain relationships with multiple sources for refined gasoline, purchasing gasoline from different wholesalers or different distribution racks depending on the relative posted prices of gasoline, giving them some ability to arbitrage persistent price differences that may exist between local distribution racks.

Recently, retailers such as BJ's, Costco, and Sam's Club have begun selling retail gasoline. These outlets are often referred to as hypermarkets because they focus on selling large volumes of gasoline, typically at a low margin and typically without a particular gasoline brand name. Depending on the best wholesale price, these firms can purchase from different refiners at different distribution racks or on the spot market. As discussed in greater detail in the text, these different types of ownership structures imply varying levels of refiner control over the retail station and its prices, and so varying abilities for retailers to respond to changes in relative wholesale prices when they differ significantly across suppliers.

This section analyzes survey data on retail gasoline stations in metropolitan and surrounding areas in the States. In each of the States, jobber-supplied retail stations are the most prevalent. Even so, the relative share of retail volume contributed by jobber-supplied stations varies considerably across the States: market shares for such jobbers range from just over 50 percent in New York to approximately 97 percent in Vermont. In each of the five States, Mobil (owned by ExxonMobil) is the brand with the largest retail market share, selling between 21 percent and 31 percent of total gasoline volumes. Other firms with relatively large shares when measured at the statewide level include Citgo, Exxon, Sunoco, and Shell. (Exxon-branded stations in the States are owned by ConocoPhilips.)

Collectively, unbranded stations account for approximately 8 percent (in Maine) to 20 percent (in Massachusetts) of gasoline sold at retail in the States.

Section IV then discusses various government regulations that may affect retail and wholesale gasoline prices. For example, differences in state and local excise and sales taxes across states and regions of the country contribute to observed regional differences in gasoline prices. In general, gasoline prices in the Northeast region (which includes the States studied in this report) are higher than in the South or Midwest regions of the country. One significant component of cross-state variation in retail prices is the wide disparity among state and local gasoline taxes. New York, for instance, had motor gasoline taxes of 62.3 cents per gallon as of July 2006, making it the third most heavily taxed state in the country, behind Connecticut and California. Partly due to this, average prices for gasoline in New York are more than 15 cents per gallon above the national average. Of the states examined in this report, Vermont and New Hampshire had the lowest total gas taxes 38.4 cents and 39.0 cents per gallon, respectively and were approximately 8 cents per gallon below the national average.

Environmental regulations are another important factor that may contribute to persistent differences in wholesale and retail gasoline prices across geographic regions. The Federal Clean Air Act Amendments of 1990 (CAAA), administered by the U.S. Environmental Protection Agency (EPA), regulates air emissions from stationary and mobile sources. Among other things, the CAAA regulations mandate certain levels of oxygen content in gasoline, prescribe specific requirements associated with the preparation of reformulated gasoline, and establish limits for Reid Vapor Pressure (RVP), which measures the propensity of a fuel to evaporate. The three main motor-fuel content requirement programs are the Reid Vapor Pressure Program, the Oxygenated Gasoline Program (which seeks to control the volume of carbon monoxide produced from the combustion of gasoline fuel), and the Federal Reformulated Gasoline Program (which limits the contents of gasoline and sets certain standards for emissions). Because these regulations only affect counties and localities that are in violation of federal air quality standards and those that voluntarily opt-in to one of the programs, the effects of these regulations on gasoline supply vary across the nation.

Within the States, three types of gasoline are predominantly used: conventional gasoline, reformulated gasoline (RFG), and fuel characterized by a Reid Vapor Pressure of 7.8 pounds per square inch (7.8 RVP). RFG here refers to a particular blend that is used throughout the East Coast from Delaware to New Hampshire. It is sold in high volumes across a large, contiguous geographical area, which helps to mitigate its vulnerability to a potential supply disruption. Massachusetts requires the use of reformulated gasoline statewide, although others of the States mandate its use only in certain areas. For example, New Hampshire requires the use of RFG in populated areas around Manchester and Nashua in the southeastern corner of the state, but it permits the use of conventional gasoline elsewhere. Similarly, New York permits the use of conventional gas throughout most of the state, but not in New York City and its surrounding metropolitan area, where reformulated gasoline blended with ethanol is instead required. Maine allows conventional gasoline during most of the year, but the use of 7.8 RVP fuel is mandated in the summer months. Of the States observed in this report, only Vermont permits the use of conventional gasoline throughout the state on a year-round basis. It is thus not surprising that differences in retail prices for gasoline are observed across the States, given such variations in local regulations (and in the application of federal rules) and the non-uniform mix of fuels.

In February of 2006, the EPA amended its regulations to further allow refiners greater flexibility in the manner in which they blend gasoline to meet emissions and pollution goals. Nationwide, refiners now produce at least fourteen types of boutique fuels, so called because of their relatively lower production quantities and specialized blends.

Generally speaking, boutique fuels are produced to accommodate state or local regulations and thus are sold in fairly circumscribed geographic areas. One concern with the proliferation of boutique fuels is that areas employing these fuels may be especially susceptible to price spikes in the event of a supply disruption. However, as will be discussed in the text, the precise impact of boutique fuels on retail gasoline prices is not clear, since particular characteristics of market structure can also impact on the degree to which the price of any particular gasoline product can be increased.