Fuel Market's Reaction to Harvey Follows Historic Norms
Fuel Market's Reaction to Harvey Follows Historic Norms
An analysis of market data following Harvey shows that the retail increase at pumps is not keeping pace with the increase in wholesale prices.
When retail gasoline prices increase, everyone takes notice – especially after a natural disaster like Hurricane Harvey. The story line often proceeds with a discussion of the rapid rise in prices followed by questioning the justification for the increase. And while the market may seem to react immediately to a disruption, what most don’t understand is that the retail increase they witness is not keeping pace with the increase in wholesale prices. An analysis of market data following Harvey shows that this trend continued following the devastation in Texas.
In 2001, the U.S. Energy Information Administration released a report analyzing how long it typically takes for a change in the wholesale price of gasoline to be fully passed through to retail. The conclusion – full pass through might take as long as eight to 12 weeks. Today, this might be considered outdated analysis since the volatility in the wholesale market for gasoline has increased, putting greater pressure on the retail market to respond, and pricing technology has improved to give retailers better information to make the most competitive decision in their retail pricing strategies. But it serves as a basis for looking at how the market reacts to changing conditions.
After Hurricanes Katrina and Rita in 2005, the market reacted and the delay in retail response was repeated. According to the Oil Price Information Service (OPIS), the week after Katrina made landfall, wholesale prices increased 19.6%, but retail only increased 13.6%. The week after Rita, wholesale went up 9.5%, but retail only increased 4.5%.
Some observers assert that retail prices go up like a rocket but come down like a feather. In some circumstances, this may be true. For retailers, when they incur an increase in wholesale prices they would like to recover that high cost immediately by raising retail prices. But competition for a very price sensitive customer prevents them from doing so. Consequently, their gross margins (difference between wholesale and retail prices, from which all operating expenses and profit are derived) decline and sometimes invert to become losses on each gallon sold. This situation may develop quickly as retailers chase the market to catch up. Once the wholesale markets begin to retreat, retailers again compete with each other while trying to recover the margins they lost on the way up.
The impact on the retail market following Harvey is consistent with this experience. According to daily pricing data provided by OPIS to the Fuels Institute and NACS, wholesale prices have indeed outpaced retail prices throughout the country. In fact, from August 23 (the date a hurricane watch was issued for Texas) through September 4, the national average wholesale price for gasoline increased 21.1% while the retail price increased only 12.7%. This is not to diminish the economic impact on consumers of a 12.7% increase in retail prices over two weeks, but demonstrates that retailers also incurred a significant economic impact during this time period.
Looking more specifically at the various regions of the country, the experience has been replicated in every PADD. The East Coast (PADD 1) experienced the greatest increase in wholesale prices (28.9%) due to the reduced supplies that originate from the Houston area and are transported via pipelines that were shut down and/or operating at reduced capacity. That market, which boasts some of the strongest regular demand for fuel, incurred a retail price increase of only 17.2%. During this time frame, retailers in this region saw their gross margins drop by 28.8%.
As the following chart demonstrates, when wholesale prices in PADD 1 began to increase, retail prices held steady and margins declined. However, once wholesale prices stabilized, retail price increases slowed and retail margins began to recover. This is a perfect example of how the retail market reacts to changing wholesale prices. It also means that, as of September 4, retailers have not returned to pre-hurricane margins and have not recovered margins lost when the market was increasing.
NACS has been monitoring OPIS reported weekly wholesale and retail price movements since 2006, and the market reaction experienced with Hurricane Harvey is consistent with historic norms. The impact of Harvey will continue to be felt in those regions directly impacted either by the storm or by disrupted supplies, even after market activity returns to normal. The market itself needs time to reset itself to pre-storm levels – this will be helped by consumers returning to their normal refueling behavior. However, the incoming storms could exacerbate the impact of Harvey and delay the market’s recovery.
The motor fuel distribution system is a complex, interconnected network. Disruptions have the ability to affect all regions throughout the network, and restoration to market stability following a disruption takes time. For more information about how this network operates, read the Fuels Institute report, “Assessment of the U.S. Fuel Distribution Network.”
John Eichberger is the executive director of the Fuels Institute. He can be reached at jeichberger@fuelsinstitute.org.
When retail gasoline prices increase, everyone takes notice – especially after a natural disaster like Hurricane Harvey. The story line often proceeds with a discussion of the rapid rise in prices followed by questioning the justification for the increase. And while the market may seem to react immediately to a disruption, what most don’t understand is that the retail increase they witness is not keeping pace with the increase in wholesale prices. An analysis of market data following Harvey shows that this trend continued following the devastation in Texas.
In 2001, the U.S. Energy Information Administration released a report analyzing how long it typically takes for a change in the wholesale price of gasoline to be fully passed through to retail. The conclusion – full pass through might take as long as eight to 12 weeks. Today, this might be considered outdated analysis since the volatility in the wholesale market for gasoline has increased, putting greater pressure on the retail market to respond, and pricing technology has improved to give retailers better information to make the most competitive decision in their retail pricing strategies. But it serves as a basis for looking at how the market reacts to changing conditions.
After Hurricanes Katrina and Rita in 2005, the market reacted and the delay in retail response was repeated. According to the Oil Price Information Service (OPIS), the week after Katrina made landfall, wholesale prices increased 19.6%, but retail only increased 13.6%. The week after Rita, wholesale went up 9.5%, but retail only increased 4.5%.
Some observers assert that retail prices go up like a rocket but come down like a feather. In some circumstances, this may be true. For retailers, when they incur an increase in wholesale prices they would like to recover that high cost immediately by raising retail prices. But competition for a very price sensitive customer prevents them from doing so. Consequently, their gross margins (difference between wholesale and retail prices, from which all operating expenses and profit are derived) decline and sometimes invert to become losses on each gallon sold. This situation may develop quickly as retailers chase the market to catch up. Once the wholesale markets begin to retreat, retailers again compete with each other while trying to recover the margins they lost on the way up.
The impact on the retail market following Harvey is consistent with this experience. According to daily pricing data provided by OPIS to the Fuels Institute and NACS, wholesale prices have indeed outpaced retail prices throughout the country. In fact, from August 23 (the date a hurricane watch was issued for Texas) through September 4, the national average wholesale price for gasoline increased 21.1% while the retail price increased only 12.7%. This is not to diminish the economic impact on consumers of a 12.7% increase in retail prices over two weeks, but demonstrates that retailers also incurred a significant economic impact during this time period.
Looking more specifically at the various regions of the country, the experience has been replicated in every PADD. The East Coast (PADD 1) experienced the greatest increase in wholesale prices (28.9%) due to the reduced supplies that originate from the Houston area and are transported via pipelines that were shut down and/or operating at reduced capacity. That market, which boasts some of the strongest regular demand for fuel, incurred a retail price increase of only 17.2%. During this time frame, retailers in this region saw their gross margins drop by 28.8%.
As the following chart demonstrates, when wholesale prices in PADD 1 began to increase, retail prices held steady and margins declined. However, once wholesale prices stabilized, retail price increases slowed and retail margins began to recover. This is a perfect example of how the retail market reacts to changing wholesale prices. It also means that, as of September 4, retailers have not returned to pre-hurricane margins and have not recovered margins lost when the market was increasing.
NACS has been monitoring OPIS reported weekly wholesale and retail price movements since 2006, and the market reaction experienced with Hurricane Harvey is consistent with historic norms. The impact of Harvey will continue to be felt in those regions directly impacted either by the storm or by disrupted supplies, even after market activity returns to normal. The market itself needs time to reset itself to pre-storm levels – this will be helped by consumers returning to their normal refueling behavior. However, the incoming storms could exacerbate the impact of Harvey and delay the market’s recovery.
The motor fuel distribution system is a complex, interconnected network. Disruptions have the ability to affect all regions throughout the network, and restoration to market stability following a disruption takes time. For more information about how this network operates, read the Fuels Institute report, “Assessment of the U.S. Fuel Distribution Network.”
John Eichberger is the executive director of the Fuels Institute. He can be reached at jeichberger@fuelsinstitute.org.
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