A Pump Price Conspiracy?

Not really. Retail gas prices did remain high as wholesale prices slid, but now competition is pushing pump prices down

Dark talk of a conspiracy at the pump has been swirling for weeks. The reason? Retail gasoline prices clung to $3 a gallon, even as wholesale prices were dropping steadily. The result was clear: Gas station owners saw profit margins get fatter and fatter, even as drivers saw little relief.

Now, finally, pump prices are getting cheaper. According to GasBuddy.com, the average price for regular gasoline on Sept. 6 was $2.70 a gallon, down from $3.02 a month ago. AAA's Daily Fuel Gauge Report puts the average at $2.72, down from $3.03. These are the lowest prices since last April.


  Market forces may not have worked as quickly as most drivers would have liked. But station owners ultimately do get a clear signal when their prices are too high because nearby rivals begin to undercut them to attract more business. "When we start losing gallons (in sales) every day, we know something's wrong," says Richard D. Whitford, a co-owner of Lou's Getty in Closter, N.J., whose supplier is the Russian oil company Lukoil (LUKOY).

Barring a hurricane or its geopolitical equivalent, gas prices should keep falling to $2.60 or below in coming weeks, predicts Justin B. Fohsz, a broker for Starsupply in Englewood, N.J., a division of GFI Group (GFIG).

The anger toward the likes of Exxon Mobil (XOM), Chevron (CVX), and BP (BP) over perceived profiteering at the pump wasn't all unfounded. Back in July, the retail profit margin was at the rough historical average of 60 cents, with retail gasoline going for about $3 a gallon and wholesale prices on the New York Mercantile Exchange at about $2.40. (Not all of that spread is profit, of course, since the retail price includes taxes as well as ordinary costs of doing business.)

But then retail prices remained pretty close to $3 a gallon even as wholesale prices started to plunge to the current level of about $1.80 a gallon. Margins stretched to as much as twice their historical average. That's what got drivers fuming. Now those extremely generous spreads are gradually returning to more normal levels. With the retail price around $2.70, the spread is a little under $1 a gallon. If the price gets down to $2.50—or the wholesale price ticks back up—the spread will narrow even further.


  Why don't gas stations immediately cut their prices when the cost of the fuel they buy goes down? Because they're trying to maximize their profits. Economists say that prices are "sticky on the downside," which means they don't fall as rapidly as they rise. The range of prices is especially wide at times like this because some stations are cutting prices sharply, while others are trying to hold the line, says Jason Toews, co-founder of GasBuddy.com.

Eventually, though, the fear of losing business forces all stations to cut prices to what the market will bear. Says Sarah A. Emerson, director of petroleum analysis and research for Energy Security Analysis in Wakefield, Mass.: "When their costs are rising, they get squeezed on the other end. Their desire to recoup some of that is pretty typical, pretty normal—and probably can't last very long." Stations that sell a lot of gas tend to change their prices fastest because they turn over their inventory more quickly, says Bruce Lauver, petroleum operations manager for Lakeside Ampride in Council Bluffs, Iowa, a major station that sells about 2 million gallons of fuel a year.

With wholesale prices having fallen so far, pump prices stand a good chance of falling further in the next week or so, assuming no major bad news from weather, Iran, Nigeria, or other oil hot spots.

Unfortunately for motorists, gas prices won't keep slumping for long. The wholesale price for gasoline in the futures market trends upward over the next year. While the current October contract is at around $1.80 a gallon, the March, 2007, contract is around $1.90 and the September, 2007, contract is around $2.10. That's still not bad compared to this past summer, but it means that there's going to be a floor under the market. Don't even think about a return to the good old days of gas for less than two bucks a gallon.

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