Number 65: August 18, 2004

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This week in Katydid:

• Pumping Up Pricing
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Pumping Up Pricing
Last summer a gasoline pipeline owned by Kinder Morgan Energy Partners burst near a construction site north of Tucson, Arizona. Because the pipeline carried the main supply of gasoline to Phoenix, our city saw shortages in supply for three weeks that drove the price above three dollars per gallon in some places.

The cause of the break was stress corrosion fracturing, which is another way of saying, "It broke." The result of the break was an education in gasoline pricing. Prior to the shortage, gas was selling for $1.54. It may surprise no one that the price has not been that low since.

Getting a handle on gasoline pricing means balancing many factors. The National Association of Convenience Stores has an excellent white paper (PDF) to help their members understand the underlying causes and explain them to their customers. Additionally, the Energy Information Administration (part of the Department of Energy – who knew?) has posted some research online to help understand the pressures on price.

Of course, those Phoenicians waiting in long gas lines on the hope that a truck would arrive that day, and those following fuel trucks around to see if they were going to pull into a station, and those pushing their cars into stations only to find the pumps empty knew only too well the laws of supply and demand. They were happy to pay the premium price for the standard grade.

What surprised many of us, however, was the fact that when the pipeline burst and when the last drops of fuel were sucked out of the stations, there was nothing left. I understood that most stations received their fuel from rack terminals supplied by the pipeline; but surely, the stations owned by the refineries would have their own supply. I figured they'd make out like bandits.

What we discovered is that most of the branded stations (Shell, Texaco, Union 76, etc) were only affiliates that got their gas off the same rack terminal. In fact, the percentage of stations owned by the integrated oil companies (the majors) is very small, and in Phoenix, the number was apparently zero.

So, we learned that all gasoline is the same. Well, you have three flavors and then boutique mixtures for Summer and Winter and to meet local regulations (Phoenix has a unique local blend for air quality that made it difficult to get resupplied; our Governor had to obtain an emergency waiver from the EPA in order to bring in new supplies.) But everybody gets the same stuff.

If that's the case, then what is V-Power® from Shell? What is Techron® from Chevron? What is CleanTech® from Arco? Apparently all the same thing as well. Stations that buy gasoline from the rack (most of them) get exactly the same gasoline. I've spoken with station owners, there's no bottle of additives they pour into their storage tanks. What comes off the trucks goes into your tank. The same truck that delivers to your Chevron station stops also at the independent station across the street. Only the independent station doesn't have to pay for the cute animated Techron commercials.

With the price of a barrel of oil hitting fifty dollars, you can bet you'll pay at the pump. That's just supply and demand right? Marketing 101. Some conspiracy theorists out there want to believe that there's price fixing going on in the industry, and the Enron scandal shows that it's at least a possibility. In fact, some may wonder, after the pipeline break, why prices went up all over the nation. The general response was that supplies were being redirected to Phoenix, but even the needs of the 10th largest city in the U.S. should have been met by the surrounding states. (And as I noted earlier, we couldn't even use the other mixes because of our pollution standards.) Into the demand equation goes the emotional factors of the purchaser and Americans are extremely emotional consumers.

At one point as we drove past another long gas line and saw the astounding prices on the pumps, I told my wife, "Mark my words, next summer, we'll see prices around two dollars again." The reasoning was that the entire oil industry would be watching very carefully to see how we responded as consumers to the price increase. (Ed. Note: I like to report conversations with my wife where I am right – a rare occurrence).

If crude went up to $100 a barrel tomorrow, the industry would eat that cost for as long as they could to keep prices from jumping immediately at the pump. In fact, many retailers take a loss on gasoline in order to earn your loyalty. They don't want a panic. But when an opportunity such as an accident comes their way, it's a good time to test consumer reaction – not at the site of the crisis but everywhere else where supply is plentiful. It doesn't require a conspiracy of oil barons; it only requires business sense and a reasonable excuse.

It works like adjusting the thermostat at your house. At my house, it's 105 degrees outside (it's been a fairly mild summer), so setting the air conditioner for 78 degrees is usually comfortable. However, those first few hot days come on fast, so at the beginning of summer I usually start at 76 degrees and work slowly up.

Now, at some point, the power bill arrives and I freak out a bit, so I crank up the thermostat. But I don't want the family to complain, so I inch it up a couple of degrees every day. At some point, my wife notices how hot it has become and she checks out the setting. If she sees 82 degrees, she'll usually make some comment about my sanity, the health of my growing children, and the money we'll make growing orchids, and then twist the knob back to 79 degrees. Which means I won – by one degree.

The point is we can take slow changes in price day to day, but once the price approaches a milestone number, usually something big and round, we react. Most of us remember a time when gasoline was under one dollar. There was a psychological cost when we broke that barrier. We groused and fretted but we kept on buying, which meant we hadn't reached our limit.

The gasoline shortage of last summer broke the two-dollar barrier for most of us. Once you've seen that number and paid it at the pump, the emotional energy is discharged. The oil industry used the shortage to figure out what we were willing to pay. Most every country is paying much more than we are per gallon. The difference is that they're used to it and we aren't.

It's possible we're being prepared for another milestone. Even though we marketers are sharp, we're not immune. There's a good reason every price ends in 99 or in this case nine tenths. If we reacted by buying cars with better mileage (as we did in the seventies) or by reducing our consumption, we might effect a change in the pump that left us some change at the pump. The current crisis may drive prices up to three dollars soon, and we may want to complain, but we'll have to pay for full service in order to speak to an attendant. He'll gladly pass on your comments to management.

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Kevin Troy Darling

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