Fuel Pricing 101

Study reveals impact of brand, proximity, captive consumers on retail pricing

Samantha Oller, Senior Editor/Fuels, CSP

ARLINGTON, Va. -- Fuel pricing is considered both an art and science, and as a recent analysis suggests, it is influenced by many factors beyond the need to turn a profit.

In a July 2010 study, "An Analysis of Strategic Price Setting in Retail Gasoline Markets," researcher Florencia Jaureguiberry presented several findings on the dynamics of gasoline prices. While the study--a dissertation for Jaureguiberry's doctoral degree in public policy analysis at The Pardee RAND Graduate School--was written as a guide to regulators, fuel retailers can appreciate some of the key findings.[image-nocss]

The first part of the paper weighed the importance of brand and the proximity to competitors in setting price by examining daily gasoline prices for more than 7,400 stations in California, through data from the Oil Price Information Service (OPIS) covering January 2006 to May 2007. Thirteen brands comprised 95% of the sites studied, and included c-store models such as 7-Eleven and Circle K, major-oil sites, supermarkets and truckstops.

Some of Jaureguiberry's research findings included: 7-Eleven charged higher prices, on average, than premium major-oil brands such as Shell (10 cents more per gallon on average) and Chevron (4 cents more on average) in the studied California markets. Here, Jaureguiberry suggested that the dime difference between 7-Eleven and Shell was a factor of location rather than brand equity. Consumers valued the brands equally, "but it just happens that 7-Eleven stores are located in isolated (facing no competitors), high-income places while Shell stations are distributed uniformly across California." Premium branding enabled some retailers to price gasoline about 11 cents per gallon higher than a discount brandfor example, Chevron locations vs. BP's ARCO sites, which have a low-price model. "Additionally, there appears to be no evidence that this characteristic becomes less important as prices increase, at least in absolute terms," Jaureguiberry noted. "It is clear that the FTC should be taking this dimension into consideration when they define the market and assess market power." Gasoline prices decreased nonlinearly when competition increased, the study found. Thus, the addition of a second competitor created more price competition than a third competitor. Jaureguiberry's analysis determined that consumers were willing to pay an extra 1 cent per gallon if the nearest competitor was at least 2 miles away. The closer the sites were located, the lower the fuel prices averaged. The price gap between regular and midgrade gasoline averaged 8 cents per gallon in these California markets, with an average gap of 5 cents between midgrade and premium.

The second part of the research analyzed the influence of uninformed or captive consumers on pricing by focusing on 20,000 stations within a 10-mile radius of airport car-rental sites, which served as an "extreme" example of local market power. The gas stations were located near the 30 largest airports as measured by passenger boardings, with gasoline pricing studied between January 2006 and February 2008.

The highlights included:

The price for regular gasoline at retailers near airport car-rental sites averaged 4 cents per gallon higher than other sites in the same market. Since most car renters fuel up with regular gasoline, the price differential for midgrade and premium was virtually nonexistent. Price elasticity for fuel customers at these sites varied depending on whether they lived locally or were visiting from out of town, Jaureguiberry found. The retailers adjusted their pricing to focus on the latter group.

"Since a gas station facing both types [of consumers] (such as a station close to a rental car location) cannot discriminate with two different prices, it is expected that its price increases with the number of uninformed consumers, or visitors in a market," she writes. "The higher mark-up compensates for the sales to lost local consumers."

Click hereto view the full dissertation.