This blog contains posts and comments written by students in Dr. Tufte's economics classes at Southern Utah University.
4/15/2005
Gas dealer are getting low profit margin in gas price increases
Gas dealers are seeing a slide in profit margins from an increase in gas prices. Gas dealers are experiencing 20 year low. The article stated that the decrease in profit is due to more individuals using credit cards to pay for gas. In addition, more consumers are purchasing unleaded gas as opposed to premium. Gas dealers are finding they have to find other ways to stay competitive. For example, Chevron in Los Angeles is offering 10 cents off gas if you get your car washed at their station. This is truly economics at work. The pressure builds and companies have to find a way to survive the market.
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4 comments:
The oil companies are making profits because they have been effectively prevented from building refineries for 2 decades.
The not-in-my-back-yard (NIMBY) mentality has been something that these firms have responsed to by 1) not building new refineries, and 2) putshing older, dirtier refineries to work harder. Now we want the gasoline, and we are pushing these firms up their marginal cost curve
Recall that at a minimum profits per unit are the difference between marginal cost and average (total) cost - and that they are even higher if the firm has market power and can set price higher than marginal cost.
This is a signal for free entry, or to build new refineries. However, that signal cannot be acted upon in our current social environment.
In some sense, our society couldn't have created a better circumstances for oil refiners to make profits when the economy is doing well.
I would like to know: If gross profit on consumer purchases of gasoline when the retail price was 1.50 was 20 cents, when gas prices are 3.00 per gal is the gross profit increased proprtionatly to 40 cents? That is, does the percentage profit remain the same? If it does, I'd like to know how it can be justified, since aside from the slightly inreased carrying charges on the price the dealer pays for the gas, his fixed expenses remain the same regardles of the price he pays for the fuel. Rent, insurance, labor electric etc remain constant and are not affected by the price he pays for gas. It cost him X to store and pump the stuff no matter what he pays for the product.
Dan
I think this is a very good question for which I don't have a decent answer.
I think there are three ideas that need to go into an answer though.
1) Pricing of undifferentiated products (like gasoline) is a prisoner's dilemna: every seller has both the ability and incentive to undercut their competitors. This would tend to keep profits per gallon at the same level.
2) Rate of return arbitrage would say that investors tend to prefer firms with a higher rate of profit as a percentage of revenue. In this case, if gas station owners profit per gallon remained the same as prices rose, then gas stations would be an undesirable asset to own, and their price would drop. Any gain that you made by buying a station cheaply would add to your profit per gallon. This would continue until the profit rate on gas stations equalled that on other assets.
3) Don't forget that gas station owners incur a lot of risks that may be difficult to recognize if they do not come to fruition. But ... they must still be compensated for those risks that might (or might not) happen. So, I think it is pretty reasonable for station owners to be making more profits right now. The reason is that they are bearing the risk of some form of government regulation that might take away their ability to earn profits in the future. I'll bet you that gas wholesalers in Hawaii are mighty glad they made those profits while they could - now that the state has capped their ability to even cover their costs (much less make a profit).
Being a gas station owner the profit margins have been an issue for the last 37 years in my business. To make the deserved .25 to .35/gal. on a product costing 5 times what it did years ago only makes good business sense. With the increase costs of wages, rent, insurance, federal permits, underground tank replacement due to EPA regulations ($150,000+ dollars), meter updates to compensate for pricing over $3.00 ($500 ea.), local laws (Fire Suppresion, Signage,underground tank monitors). then add into the mix credit card costs of between 2.5% to 3%. I've been told by my banker when inquiring on a loan for a new lift "You do realize that a gasoline service station is one of our least favorable business's to loan to due to the high risk involved in gasoline costs. For you to turn a product costing $15,000 for 5000 gallons and realizing a profit of maybe $500.00 just dosen't make good business sense in the financial world." Then he says "I would have to say as far as business's go, right now a service station is the least valued business on the market due to cost of product vs G.P. returned." I did not get the loan, had to purchase from the retailer at a higher rate - but without the lift our repair business would have suffered - and thankfully that's where we turn a profit that is respectful. Hope this has given some insight to the crazy world of the service station. When I first pumped gas going to high school it was .19/gal. and I can remember the owner making .5 to .6 cents per gallon, giving out "Green Stamps", washing windows, checking oil, tires, trying to find the gas cap, and learning how to repair cars - then it was the thing to do! Today I have a tool chest full of tools and one full of high tech meters, computers and software to ply my way each day to hopefully repair a car.
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