Sharing the Forecourt

A comment in an article on Brazilian ethanol in today's Financial Times got me thinking about how ethanol will move into the US retail marketplace, as it outgrows its current role as a gasoline blending component. The FT cited Ricardo Leiman of Noble Group, who remarked, "There is a conflict of interest between [fossil fuel] distributors and the newcomers." That's certainly the conventional wisdom, with E-85 pumps at major oil company stations as rare as hen's teeth. But I wonder if that gives sufficient credit to the marketing segments of these large enterprises, which have pursued profits in many other areas not directly related to the output of their own refineries. It also ignores the structure of the retail gasoline market, which could be quite hospitable to ethanol, once it reaches critical mass.

First, consider the composition of the retail motor fuels business in the US. Of the 169,000 retail fuel facilities across the nation, fewer than 10% are actually owned and operated by integrated oil companies such as ExxonMobil, Shell, ConocoPhillips or Chevron. The rest are run by retailers with varying degrees of independence. Some own their own facility, while others lease it from the company. Many receive their supplies through a distributor, rather than directly from the company. As a result, even if all of the major oil companies decided that E-85, biodiesel or some other alternative fuel represented an unacceptable threat to the petroleum products they produce, the number of stations at which they could enforce a ban on E-85 is only a small fraction of the total. For the vast majority of service stations, the question of whether to add a pump to sell E-85 or biodiesel isn't determined by corporate policy, but by the economics for the station owner.

Gasoline retailing is not a high-margin business. That's why there are so many convenience stores and co-branded food outlets, both of which offer much higher unit margins than for fuel. Total potential E-85 sales in a given area would be a function of the local flexible fuel vehicle (FFV) population and the number of other E-85 outlets in the same market. FFVs currently make up only 2% of the US car population, and until their numbers grow substantially, E-85 will be a low-volume business for most retailers. That combination of low margins on low volumes limits the return on the investment required to convert a station to sell E-85, offset by any available government incentives. And unless the owner is willing to add an additional tank, he must sacrifice the revenue on another grade of fuel to make this switch. The primary obstacles for introducing E-85 at most retail sites are strictly financial, and only time and the growth of the FFV fleet will overcome them.

Viewed from this perspective, the major oil companies are in a much better position than individual retailers to introduce E-85 selectively into a new market. Not only do they have the financial resources to absorb the costs of conversion, but they also possess sophisticated software that would allow them to determine the best sites to convert, and how to phase alternative fuel into the market, in synch with the expanding FFV fleet. Nor do I think the marketing groups of these companies will resist this, if it provides an opportunity to enhance both profitability and brand image.

Many people forget that the integrated oil companies are no longer the monolithic, command-and-control organizations they once were. Their marketing divisions are independent profit centers charged with earning an attractive return on their employed capital. Many of the executives responsible for these units have more in common with the people running other retail businesses than with their colleagues who run the refining or exploration and production segments. When I tried to get Texaco's marketing department interested in installing electric vehicle recharging facilities at service stations in Southern California in the late 1990s, their main worry was how they could make money on them, not their effect on gasoline sales. What counts is traffic, and if E-85 will bring them traffic, they will buy in. The best way to make sure that E-85 spreads quickly is to ensure that the major oil companies can take advantage of the same incentives for E-85 as independent retailers. Alternative fuel advocates should view major oil company marketing groups as natural partners, rather than potential opponents.

Energy Outlook will observe the US Independence Day holiday tomorrow and resume new postings on July 5.