May 26, 2005 in Business

Pumping profits from sale of gas a difficult proposition

Thaddeus Herrick The Wall Street Journal

Last winter, as crude oil prices surged, pushing up the cost of wholesale gasoline, Sheetz convenience stores faced a dilemma.

The Altoona, Pa.-based chain could sharply raise gasoline prices at its 310 retail outlets and likely lose customers. Or it could gradually lift its prices, sometimes selling fuel below cost, in hopes of maintaining customer loyalty.

Sheetz opted for the latter, taking a loss on gasoline some days while trying to earn it back on coffee, snacks and other convenience-store items — goods that can carry margins up to five times as high as those at the pump. “We’ll take a lower margin (on gasoline) until we don’t have a choice,” says Stan Sheetz, the company’s chief executive. “No one wants to be the first to raise the price.”

The soaring demand that has pushed oil to around $50 a barrel and produced record profits for oil companies and refiners has been bad news for the businesses that actually sell gasoline to motorists. Margins for self-serve regular gasoline averaged 7.7 cents a gallon in the first quarter, compared with 9.1 cents for all of 2004, according to the Lundberg Survey of 7,000 gas stations around the country.

Oil prices make up more than 50 percent of the cost of gasoline. Considerably higher oil prices could push mom-and-pop retailers out of business altogether, analysts say.

Big oil companies already are exiting the business, discouraged by low profits and logistical headaches. In the past year, oil giants Chevron Corp., ConocoPhillips and Exxon Mobil Corp. have all sold off stations. Royal Dutch/Shell Group has trimmed its U.S. network to 16,000 gas stations, none of which are owned and operated by the company. That’s down from a total of 22,000 stations in 2001, when 800 were Shell-owned and operated. Overall, the number of company-operated stores in the U.S. declined to just over 10 percent of retailers in 2003 from almost 15 percent in 1999, according to the Department of Energy’s Energy Information Administration.

“The return on investment is just not that attractive,” says Dan Gilligan, president of the Petroleum Marketers Association of America, a trade group in Arlington, Va., that represents about 8,000 independent gasoline retailers. “What (the major companies) do well is find oil and deliver it to refineries.”

The economics of selling gas can be tough to untangle and predict. In recent weeks, service-station profits have improved as the price of oil has dropped. Just as retailers are slow to move their prices up, analysts say, they are also slow to bring them down. Still, service-station profits remain thin compared with most other retail businesses.

At the same time, gasoline sales and profits are looking increasingly good for a growing breed of gas retailers: big box, supermarket, and large megachains that also sell gasoline on the street.

These high-volume stores, Wal-Mart Stores Inc. and Costco Wholesale Corp. among them, tend to sell gasoline for about three to seven cents a gallon less than conventional service stations. Entering the gasoline business in the late 1990s, big-box discounters and grocers such as Kroger Co. and Randalls are growing their market share at a rate of about 20 percent a year, according to Energy Analysts International, a consulting firm in Westminster, Colo.

Numbers released this week by OPIS Retail FuelWatch estimate that gross margins for gasoline in the past 40 days at Costco stations have widened to 12 cents a gallon, a full 10 cents higher than estimates for the first quarter of 2005.

But retailers hoping to stimulate overall sales with competitive gas prices face something of a Catch-22: While they’re winning a bigger share of gas receipts, high gasoline prices are eroding sales of other goods, as motorists find themselves with less disposable income to spend on groceries or a snack.

Wal-Mart, for instance, blamed its disappointing first-quarter results on higher gasoline prices, among other factors. Sheetz, meanwhile, said high gasoline prices slowed its sales growth of in-store items to 3.5 percent, down from company expectations of 5.5 percent for the six-month period ended in March.

Customers are quick to acknowledge that they are indeed holding back. Sher Linlui, who put $10 of gas in her Buick Century last week at a Diamond Shamrock station in Houston, says higher gasoline prices translate to fewer purchases of sodas and chips at the station’s convenience store. “I start my diet instead,” she says.

Gasoline retailers are also getting squeezed by the increasing tendency of Americans to use credit cards to pay for their sky-high fuel bills. The credit-card issuers charge merchants fees of as much as 3 percent, or 6 cents on a $2 gallon of gas. Those tariffs alone can cut the profit margin of sale in half for a service station.

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