Last summer, we zipped into summer lovin' with our Grease-themed review of summer fuel prices. This year, we're sticking with the theme. And this time around, prices are like greased lightning: full speed ahead. Check out the Energy Information Administration’s (EIA) Short-Term Energy and Summer Fuels Outlook for more, and read on for our analysis.
At some point every several years, the planets align around global oil price increases. This year, all the conditions are right for price hikes across the world. In the United States, barrels will average $12 higher than 2017, and EIA expects the retail price of regular-grade gasoline to average $2.74 per gallon, up from an average of $2.41 last summer. What are the contributing factors?
Firstly, consumers have short memories. Especially American consumers. As the economy has recovered, and consumers have had to spend less and less on fuel, the proposition of the Prius has become less appealing. Sales have dropped dramatically since 2014. A fleet of larger vehicles hits the road when wallets have the room to be loose. Combine this with an improving economy and a dropping unemployment rate and the demand shift has been undeniable.
Demand is like a pendulum. When prices get low, people believe — or at least act as though they believe — that prices will stay low. Consequently, they spend, sometimes on fuel. Demand grows. Additionally, in an attempt to control global supply, OPEC may make production cuts and oil companies may decrease rig counts, partially due to less-than-ideal exploration economics. In fact, beginning in 2015, OPEC implemented production quotas to address the glut of oil in the marketplace and rig exploration dropped considerably. Prices decreased to $35 a barrel for crude. In late 2014, that number was closer to $100 a barrel. Any good business person would have done the same — decrease production in order to improve the balance of supply and demand.
As such, the U.S. crude oil supply is also much shorter today — well below the five-year average. And due to economic recovery, demand is once again increasing. When demand increases, and supply decreases, prices will rise. It's a truth of every economic environment. Then when demand grows and prices increase, supply will start to ramp up. The increase in supply will eventually lead to lower prices and the pendulum swings back. It’s really just basic economics—price is the great equalizer between supply and demand.
As anyone from the industry knows, there are always external factors outside of traditional supply and demand economics that are weighing on this summer's speedily rising fuel prices. Geopolitical events also contribute to global price increases for oil. Today, these events include things such as the US exit from the Iran nuclear deal, the collapse of the Venezuelan economy and the tension across the Korean peninsula. For example, a clear and sharp price increase occurred the day it was announced the United States would pull out of the Iran nuclear deal, reflecting a generalized fear to a possible drop in Iranian oil to the global supply.
Last summer, we gave retailers a warning, of sorts, writing:
"The bottom line of the supply and demand story is that marketers can’t afford to chase gallons that are no longer available. So you need to benchmark your year-over-year volume performance against the market. To do anything else is going to sacrifice precious margin in a year that will already be margin-challenged. Keep in mind that the price run-up during the RVP (Reid vapor pressure) season this year was not as strong as previous years, thus presenting less of a margin-harvest opportunity. Manage your margin carefully in 2017."
The margin picture in 2017 was largely shaped by the harvest periods following Hurricanes Harvey and Irma, which drove costs up quickly and the slowly-descending prices afterwards allowed retailers to turn the year in a positive direction. Barring a similar occurrence in 2018, this year will likely prove to be even more margin-challenged than last.
Best-in-class retailers heed such a warning, reinvesting any strong profits such that when costs increase and the margin drops, these retailers can remain unconcerned about their business's ability to weather the storm. As the last three years have been remarkably successful for fuel retailers in terms of fuel margin at the retail pump. If retailers had reacted correctly during this success, they would have:
Today, as discretionary spend dissipates, consumers will become more price sensitive and shop harder over the summer. Profit margin will diminish. But there's good news for retailers: opportunity abounds. Numbers published by NACS and EIA are still forecasting a record number of miles traveled this summer. But discretionary spending still erodes, and impulse items aren't such a draw. It's up to retailers to identify areas where their offering could improve to draw a quality volume using more than just price.
Read more about the seven elements to discover how your strategic mindset can shape your volume and margin opportunities, even when fuel prices are moving like greased lightning.