I was very interested to read that Valero, the largest independent refiner in the US, is designing its new gas stations to offer a much wider variety of energy products, including natural gas, E85 ethanol, and potentially recharging facilities for electric vehicles. This is an announcement I've been expecting for more than ten years, and there are good reasons why other companies are likely to follow. At the same time, the economics of doing this now, when the market for non-petroleum fuels is still comparatively small, look challenging. Some will call this a vanity project, and they won't be entirely wrong, even if it also represents the template for the new retail energy facilities that will be built in the next several decades.
Valero's new station design, at least as described in the articles I've seen, embodies the result of trends that my former company, Texaco Inc., identified in the late 1990s in a scenario called Multiple Choice Energy. That view included a combination of new vehicle technologies such as hybrids, EVs and fuel cells, as well as a vision of the retail network that would meet their needs. As attractive as the idea was to many of the top executives to which our team presented, it was a tough sell, because retail fuel is such a difficult business. Margins are slim, competition high, and major redesigns of existing facilities--for rebranding or any other purpose--very hard to justify financially. Several companies have dabbled with elements of this vision, including my former employer, but I'm not aware of anyone deploying the full suite of options in one location.
I think this development, and the company pushing it, is significant for several reasons. First, Valero has already made a major commitment to non-petroleum fuels through its acquisition of ten ethanol plants, bought during a period when the US ethanol industry was being squeezed by poor margins and scarce credit. Those facilities contributed 18% of Valero's operating income in the first quarter of this year, even though they accounted for less than 4% of total output by volume. Adding E85, a blend of 85% ethanol and 15% gasoline, at the company's new stations merely completes a supply chain in which it is already well-established.
Incorporating these capabilities when a station is built, rather than adding them later, is also crucial. It saves a significant amount of money by avoiding the business disruption involved in retrofitting later. E85 faces other challenges, as I discussed recently, but this kind of planning overcomes one of the major impediments to its wider penetration in the US market, which already has millions of flexible fuel vehicles capable of running on it. And for this reason it's especially notable that this initiative is being taken by Valero, which has been expanding its retail network and investing in new sites. That's in contrast to the major oil companies, some of which have been exiting retail, either gradually or on an area-by-area basis, to free up capital for more profitable opportunities in exploration and production.
Adding natural gas and electricity to the array of fuels sold at retail sites is a natural evolution of this strategy but financially much riskier, given the small number of EVs and NGVs on the road so far. Although the company can take advantage of generous tax credits for installing some of these capabilities, the return is likely to be low for some time. EV recharging also requires a large footprint and extra caution, to ensure that it can be done safely in proximity to combustible fuels. Local agencies and fire marshals have definite ideas about this, as I learned when I was involved in plans for recharging facilities for GM's earlier EV-1 plug-in vehicle in the late '90s.
As with the market penetration of the alternative fuel vehicles they will serve, it will be some time before most retail stations offer quite as much choice as Valero's new multi-fuel facility. It takes time to roll out such changes, and the infrastructure can't get too far ahead of the demand for it without its owners going bankrupt in the process. Nor will every new fuel succeed. Methanol blends looked like the next big thing in the 1980s, but they never took off. Still, it wouldn't take many such facilities in each market to break the "chicken-and-egg" barrier that any non-petroleum transportation energy alternative faces. The success of this initiative depends on the demand for these fuels actually materializing. Launching when the average US gasoline price is just a couple of cents below $4.00 looks like good timing to me.
Showing posts with label retail margin. Show all posts
Showing posts with label retail margin. Show all posts
Tuesday, May 03, 2011
Thursday, October 14, 2010
Splitting the Baby on E15
I've been going over the EPA's ruling yesterday partially granting the waiver request from Growth Energy, an ethanol trade association, to allow gasoline with up to 15% ethanol to be used in cars not specifically designed as flexible fuel vehicles. The request had created a serious dilemma for the EPA, because granting it could jeopardize the integrity of millions of consumers' car engines and fuel systems, but turning it down would call the entire national renewable fuels strategy into question. What looks like the agency's attempt to find a middle ground that could satisfy all parties might turn out to have little practical impact on the ethanol market for some time, while still unleashing a potentially very disruptive shock wave on the entire motor fuels industry in this country.
If that sounds contradictory, you have to look at the specifics of what the EPA has agreed to here, and overlay them on the highly-competitive, relatively low-return network of gasoline blending, distribution and sales infrastructure through which it must eventually feed. Instead of approving E15, a blend of 15% ethanol and 85% gasoline for all vehicles, or even just for vehicles produced since 2001--as many had speculated they would--the agency has only given the green light for putting this fuel into cars made in the last four years. I might note that this interval includes some of the lowest US car sales rates in recent memory, so yesterday's ruling affects just a fifth or so of the total US light-duty vehicle fleet. The decision for another tranche of cars built between 2001-2006 is to be made after further study, perhaps by the end of the year.
In essence this means that no fuel producer can afford to stop supplying the E10 (or less) fuel that is compatible with all those pre-2007 cars, and precious few retailers are likely to take a bet on switching one of their tanks to a new fuel that only a fraction of their customers can take advantage of, once all the other legalities of introducing E15 into the market have been satisfied. So while this decision might seem to be about promoting the use of more home-grown, renewable fuel in preference to petroleum products that depend on deepwater wells and foreign suppliers, its implementation hinges on a very lopsided business decision for a group of mainly independent fuel retailers and distributors, rather than the major oil companies whose brands we see on filling station polesigns.
A retail gas station has a finite number of product dispensers drawing on an even smaller number of underground storage tanks. In order for a retailer to introduce a new fuel without ripping up the forecourt (which entails being out of business for several months and possibly longer, should he have the misfortune to discover a leak in the process) then he must do the math on how many gallons per month of the new product he might sell, and at what margin, against how many gallons and how much margin he'd lose from the discontinued product. This is the dynamic that has contributed to the excruciatingly slow lift-off of E85, which is at the heart of why E15 even became an issue. It was never supposed to be necessary, because the extra ethanol mandated under the federal Renewable Fuel Standard (RFS) was intended to be sold in big, 85% at-a-time chunks, not little 10-15% slices, and into a gasoline market that was still growing at its historical 1-2% per year clip.
So as a retailer--a small and not very lucrative business--do you give up premium unleaded? Seems an obvious choice, since it's probably your lowest-volume offering. But unless you have a dedicated mid-grade tank, you need premium to blend in the pump to make mid-grade, which accounts for more of your sales. Worse yet, your margin per gallon on premium is your best, followed by your margin on mid-grade. Or you could give up diesel, though if you do, you'll never see those customers again: not on the forecourt, and not in your store, where you make much of your monthly profit. The alternative is an expensive investment in a new tank and dispenser, against a highly questionable return. By now it should be obvious this is a losing game for retailers, who as far as I can see would choose to continue to sell E10 to everyone, including post-2006 cars affected by the E15 ruling, and just ignore the EPA.
The folks who won't be able to ignore the EPA will be the refiners and major fuel blenders. That's because they continue to fall under the authority of the steadily increasing RFS mandates, requiring them to sell a higher percentage of biofuel every year until 2022, or pay large penalties. And while the EPA was kind enough to reduce the mandate for cellulosic ethanol last year and this year--for the very good reason that it isn't yet available in the expected quantities--the chances of getting a waiver in the future because a company has run out of room to blend ethanol into E10 look pretty low, when the EPA can just insist that you make E15 or E85, both now legal. This sets up a situation in which suppliers will shortly need to induce their retailers to take on one or both of these products and make it worth their while, further depressing the margins in this part of the business and making an exit strategy even more attractive.
It's hard to gauge exactly what this could mean for consumers. At a minimum, it might lead to drivers of older cars pulling into some gas stations only to find that the unleaded fuel advertised on the sign is actually not compatible with their particular car. (The EPA as part of yesterday's ruling has promised pump labeling sufficiently clear that no one will fill up with E15 by mistake.) Or in a bigger station, all the E10 pumps might be over on one side of the convenience store, and all the E15 pumps on the other. And of course this raises the awkward question of why consumers would ever consciously choose to fill up with a fuel containing at least 2% fewer BTUs and thus offering 2% lower mpg and range, unless it's going to be cheaper for them--which is inconsistent with E15 carrying sufficiently higher margins to make it worth the retailer's effort to sell.
The result looks like a dog's breakfast, although I can't honestly say I'd have ruled much differently if I were running the EPA and only charged with upholding the RFS and making this ruling on the basis of whether it would increase the overall pollution from the affected vehicles, rather than on whether its policy and ostensible environmental benefits outweigh its costs and risks for vehicle longevity and consumer value. The EPA's supporting documents included evidence that a significant proportion of E10 already approaches 11% ethanol, so E15 means routinely exposing engines and fuel systems to a mix of 16% or more ethanol, even if they were only designed with 10% in mind. Who will bear the liability for the expensive repairs that some cars will require? There are few aspects of this situation that offer consumers any upside, but I see ample downside, if only from having to bear the additional costs that will be passed on by retailers who are in no position to absorb them.
If that sounds contradictory, you have to look at the specifics of what the EPA has agreed to here, and overlay them on the highly-competitive, relatively low-return network of gasoline blending, distribution and sales infrastructure through which it must eventually feed. Instead of approving E15, a blend of 15% ethanol and 85% gasoline for all vehicles, or even just for vehicles produced since 2001--as many had speculated they would--the agency has only given the green light for putting this fuel into cars made in the last four years. I might note that this interval includes some of the lowest US car sales rates in recent memory, so yesterday's ruling affects just a fifth or so of the total US light-duty vehicle fleet. The decision for another tranche of cars built between 2001-2006 is to be made after further study, perhaps by the end of the year.
In essence this means that no fuel producer can afford to stop supplying the E10 (or less) fuel that is compatible with all those pre-2007 cars, and precious few retailers are likely to take a bet on switching one of their tanks to a new fuel that only a fraction of their customers can take advantage of, once all the other legalities of introducing E15 into the market have been satisfied. So while this decision might seem to be about promoting the use of more home-grown, renewable fuel in preference to petroleum products that depend on deepwater wells and foreign suppliers, its implementation hinges on a very lopsided business decision for a group of mainly independent fuel retailers and distributors, rather than the major oil companies whose brands we see on filling station polesigns.
A retail gas station has a finite number of product dispensers drawing on an even smaller number of underground storage tanks. In order for a retailer to introduce a new fuel without ripping up the forecourt (which entails being out of business for several months and possibly longer, should he have the misfortune to discover a leak in the process) then he must do the math on how many gallons per month of the new product he might sell, and at what margin, against how many gallons and how much margin he'd lose from the discontinued product. This is the dynamic that has contributed to the excruciatingly slow lift-off of E85, which is at the heart of why E15 even became an issue. It was never supposed to be necessary, because the extra ethanol mandated under the federal Renewable Fuel Standard (RFS) was intended to be sold in big, 85% at-a-time chunks, not little 10-15% slices, and into a gasoline market that was still growing at its historical 1-2% per year clip.
So as a retailer--a small and not very lucrative business--do you give up premium unleaded? Seems an obvious choice, since it's probably your lowest-volume offering. But unless you have a dedicated mid-grade tank, you need premium to blend in the pump to make mid-grade, which accounts for more of your sales. Worse yet, your margin per gallon on premium is your best, followed by your margin on mid-grade. Or you could give up diesel, though if you do, you'll never see those customers again: not on the forecourt, and not in your store, where you make much of your monthly profit. The alternative is an expensive investment in a new tank and dispenser, against a highly questionable return. By now it should be obvious this is a losing game for retailers, who as far as I can see would choose to continue to sell E10 to everyone, including post-2006 cars affected by the E15 ruling, and just ignore the EPA.
The folks who won't be able to ignore the EPA will be the refiners and major fuel blenders. That's because they continue to fall under the authority of the steadily increasing RFS mandates, requiring them to sell a higher percentage of biofuel every year until 2022, or pay large penalties. And while the EPA was kind enough to reduce the mandate for cellulosic ethanol last year and this year--for the very good reason that it isn't yet available in the expected quantities--the chances of getting a waiver in the future because a company has run out of room to blend ethanol into E10 look pretty low, when the EPA can just insist that you make E15 or E85, both now legal. This sets up a situation in which suppliers will shortly need to induce their retailers to take on one or both of these products and make it worth their while, further depressing the margins in this part of the business and making an exit strategy even more attractive.
It's hard to gauge exactly what this could mean for consumers. At a minimum, it might lead to drivers of older cars pulling into some gas stations only to find that the unleaded fuel advertised on the sign is actually not compatible with their particular car. (The EPA as part of yesterday's ruling has promised pump labeling sufficiently clear that no one will fill up with E15 by mistake.) Or in a bigger station, all the E10 pumps might be over on one side of the convenience store, and all the E15 pumps on the other. And of course this raises the awkward question of why consumers would ever consciously choose to fill up with a fuel containing at least 2% fewer BTUs and thus offering 2% lower mpg and range, unless it's going to be cheaper for them--which is inconsistent with E15 carrying sufficiently higher margins to make it worth the retailer's effort to sell.
The result looks like a dog's breakfast, although I can't honestly say I'd have ruled much differently if I were running the EPA and only charged with upholding the RFS and making this ruling on the basis of whether it would increase the overall pollution from the affected vehicles, rather than on whether its policy and ostensible environmental benefits outweigh its costs and risks for vehicle longevity and consumer value. The EPA's supporting documents included evidence that a significant proportion of E10 already approaches 11% ethanol, so E15 means routinely exposing engines and fuel systems to a mix of 16% or more ethanol, even if they were only designed with 10% in mind. Who will bear the liability for the expensive repairs that some cars will require? There are few aspects of this situation that offer consumers any upside, but I see ample downside, if only from having to bear the additional costs that will be passed on by retailers who are in no position to absorb them.
Monday, September 15, 2008
The Storm Spike - Updated
If you're wondering why the price of gasoline at your local stations has suddenly spiked, despite little movement in crude oil prices, and even if you don't live anywhere near Texas or the path of Hurricane Ike, here are a few factors to keep in mind:
- Although the price of oil is a major component of the cost of a gallon of gasoline, the crude and refined product markets are separate and distinct, and if there aren't enough refineries to turn it into transportation fuel, the price of oil isn't very relevant to the price at the pump. In the short term, refineries without electricity matter more than damaged oil platforms.
- US gasoline inventories were already extremely low, before Ike made landfall, both in absolute terms and in days of supply. That's the result of months of high oil prices and weak gasoline demand, which together have crushed refining margins and made producing gasoline a break-even proposition.
- Prices are set by supply and demand. For the moment, with many Gulf Coast refineries shut down or running at reduced rates, we are a nation that uses 9 million barrels per day of gasoline but has less than 8 million barrels per day of supply, including the million barrels or so we routinely import. Extra supplies from Europe and elsewhere are at least 10 days away. When supply and demand are so mismatched and inventory so low, the only choices for rationing supply are higher prices or gas lines and run-outs, which we may yet see in some areas. In general, our gut instincts about "gouging"--fed by misinformed or cynical politicians--are deeply unhelpful in such circumstances. Panic buying is even worse, because it can create a shortage by itself.
- Service station owners have also been squeezed between weak demand and high prices this year. When they saw spot wholesale gasoline prices spike over $4/gal. on Friday, they knew their next deliveries were likely to cost them a lot more. Stretched by months of weak retail margins, they are in no position to absorb that hit without raising prices in anticipation of it.
Saturday, September 13, 2008
The Storm Spike
If you're wondering why the price of gasoline at your local stations has suddenly spiked, despite little movement in crude oil prices, and even if you don't live anywhere near Texas and the path of Hurricane Ike, here are a few factors to keep in mind:
1. Although the price of oil is a major component of the cost of a gallon of gasoline, the crude and refined product markets are separate and distinct, and if there aren't enough refineries to turn it into transportation fuel, the price of oil isn't very relevant to the price at the pump.
2. US gasoline inventories were already extremely low, before Ike made landfall, both in absolute terms and in days of supply. That's the result of months of high oil prices and weak gasoline demand, which together have crushed refining margins and made producing gasoline a break-even proposition.
3. Prices are set by supply and demand. At the moment, with many of the Gulf Coast refineries shut down, we are a nation that uses 9 million barrels per day of gasoline but has less than 8 million barrels per day of supply, including the million barrels or so we import every day, with any extra supplies from Europe and elsewhere at least 10 days away. When supply and demand are so mismatched and inventory so low, the only choices for rationing supply are rapid and significant price increases, or gas lines and run-outs, which we may yet see in some areas. Our gut instincts about "gouging"--fed by misinformed or cynical politicians--are deeply unhelpful right now.
4. Service station owners have also been squeezed between weak demand and high prices. When they saw spot wholesale gasoline prices spike over $4/gal. yesterday, they knew their next delivery was going to cost them a lot more. Stretched by months of weak retail margins, they are in no position to absorb that hit without raising prices in anticipation of it.
If the Texas refineries haven't sustained major damage, most should be able to restart within a week or two. Imports will increase in the meantime, and refineries not damaged by the storm can run at higher rates, to make up for lost production and rebuild inventories, allowing prices to come back down pretty quickly. If the damage turns out to be significant, however, we're going to be paying a lot more for gasoline and diesel fuel for a while, no matter what happens to crude oil prices.
1. Although the price of oil is a major component of the cost of a gallon of gasoline, the crude and refined product markets are separate and distinct, and if there aren't enough refineries to turn it into transportation fuel, the price of oil isn't very relevant to the price at the pump.
2. US gasoline inventories were already extremely low, before Ike made landfall, both in absolute terms and in days of supply. That's the result of months of high oil prices and weak gasoline demand, which together have crushed refining margins and made producing gasoline a break-even proposition.
3. Prices are set by supply and demand. At the moment, with many of the Gulf Coast refineries shut down, we are a nation that uses 9 million barrels per day of gasoline but has less than 8 million barrels per day of supply, including the million barrels or so we import every day, with any extra supplies from Europe and elsewhere at least 10 days away. When supply and demand are so mismatched and inventory so low, the only choices for rationing supply are rapid and significant price increases, or gas lines and run-outs, which we may yet see in some areas. Our gut instincts about "gouging"--fed by misinformed or cynical politicians--are deeply unhelpful right now.
4. Service station owners have also been squeezed between weak demand and high prices. When they saw spot wholesale gasoline prices spike over $4/gal. yesterday, they knew their next delivery was going to cost them a lot more. Stretched by months of weak retail margins, they are in no position to absorb that hit without raising prices in anticipation of it.
If the Texas refineries haven't sustained major damage, most should be able to restart within a week or two. Imports will increase in the meantime, and refineries not damaged by the storm can run at higher rates, to make up for lost production and rebuild inventories, allowing prices to come back down pretty quickly. If the damage turns out to be significant, however, we're going to be paying a lot more for gasoline and diesel fuel for a while, no matter what happens to crude oil prices.
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