The Weirdness Of Gasoline Pricing

Why is it fair to charge $4 for $2 gas?

Gas prices are creeping up again, getting close to $3, and unrest in the Middle East is likely to drive oil prices even higher, so I guess we can soon expect to see more criticism of price gouging.

I’ve never seen an explanation of one common complaint, so here goes. We’ll use representative round numbers in these examples, for simplicity’s sake. We’ll also assume the station is selling gas at cost hoping to get you to come in and buy beer and cigarettes and milk.

How is it that a gas station buys gas for its 1,000 gallon tank at $2, but if gas prices go to $4 a gallon, they immediately raise prices and charge that much? They only paid $2 a gallon. Isn’t it price gouging to charge $4 for gas when you only paid $2?

As far as the station owner is concerned, the amount paid for what’s in the tank is irrelevant. At the end of the month when the gas man comes, he has to pay the going rate to refill the tank. If gas is $4 now, that’s what he has had to charge if he is going to have enough money to replace it. If he continues to charge $2 per gallon when gas is $4 a gallon, he will discover at the end of the month that he has collected $2,000 and owes $4,000 to replace it. The gas account is a revolving fund that has to keep gas in the store’s tank in order to sell it

Ah, you say. But he still made a big profit on the $2 gas; why can’t he keep enough money in the account to cover an increase in the price? Well, it isn’t profit if you have to turn it over to the gas supplier for the same amount of gas as you bought last month.

Let’s look at it in reverse. Gas is $4 when the store owner fills the tank. But during the month the price of gas falls to $2. I’m sure the store owner would appreciate it if you stopped in and continued to pay the $4, because after all, that’s what he paid for it. I suspect you’ll drive on down the road and buy $2 gas at another station. So the store owner is forced to reduce the price of gas to the market rate, regardless of what he paid. But if he gets $2 for it, when he paid $4, he will still have enough money in the account to fill the tank at the end of the month.

But that big profit he got selling $2 gas for $4 gets wiped out.

Smart convenience store owners keep a separate account for gasoline and use it like an accordion that stretches and collapses with the vagaries of gasoline prices. The ones who don’t are the ones who aren’t around long or they have plastic bags over the pump handles for long periods of time.

The hurricane that disrupted gas supplies is still in recent memory. It was an issue in Bill Haslam’s run for governor. Pilot got hit with accusations of price gouging.

I remember it well. I appreciated that Weigel’s and some other stations kept the price at $3 or below. But we soon discovered they didn’t have any gas. Panic buying filled tanks until it was all gone.

But if you had to have gas to get to work you discovered you could buy it at Pilot for close to $5 a gallon. You didn’t like paying $5 a gallon, but at least you had some to put in your tank. Nobody panic-buys $5 a gallon gas. You only buy it when you have to—but it’s there when you have to have it.

Stations make their profits on the stuff you come inside and buy—at convenient but outrageous prices. None of them are getting rich on gasoline. Gasoline is the cost of attracting business to stop at the station.

Okay, let the bitchin’ begin.

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Comments » 1

phildaulton writes:

Frank, your article is about the best example I have seen for explaining the economics of gas pricing. Thanks for putting that out. My Dad ran a gas station for a few years, and he once told me that the "profit" on gas to the retailer is only a cent or two a gallon; at least it was on his level. Maybe not for the Pilot boys. It's like milk at a grocery store; a loss leader to get you in the door. I understand the petroleum products in general are getting to the scarcity point of costing more to produce them than their BTU yield, compared to other energy sources.

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