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California's Competitive Gasoline Marketplace: Facts & Perspectives for Bay Area Consumers

By Dave Reeves, General Manager, Retail Marketing
Chevron Products Company

Concord, California

If you watch the news -- and talk to your neighbors -- you know there's been a lot of interest in Bay Area gasoline prices in recent years.

Chevron is a major Bay Area company, with several thousand people located in half-a-dozen locations -- Concord, San Ramon, Richmond, San Francisco and other places. We're also a leading supplier of gasoline. So we want our Bay Area customers and neighbors to feel informed about our business.

Why does gasoline cost what it does here? Why are prices different in different locations and between different cities and areas of the state? How does the gasoline business really work?

I'll try to answer all those questions, plus a few more. But first, I'll tell you a little bit about Chevron, as well as the current world oil situation in terms of prices and supplies.

Chevron traces its roots back 120 years in California to a small outfit called Pacific Coast Oil Company.

In 1900, John D. Rockefeller's Standard Oil Trust acquired Pacific, and when the government broke up the trust in 1911, we emerged as an independent company -- Standard Oil of California.

We grew up in this state, and over time, we became an international company. We were the first company to strike oil in Saudi Arabia in the 1930s. We played a major role in building the oil industry in Indonesia. We've been for many years one of the most important producers in West Africa. In 1984, we acquired Gulf Oil in what was -- at the time -- the biggest merger in history . . . $13.5 billion. And in 1993, in the Central Asian Republic of Kazakhstan, we established the first joint venture to develop a major oil field in the former Soviet Union.

Today we have 35,000 employees worldwide, a million barrels of oil production a day and about $40 billion in annual revenue.

We're a major player in refining and transportation fuels in Asia, Africa and North America, where we have six refineries, including the major plants in L.A. and Richmond, which have been operating for most of this century

You'll find the Chevron brand on about 8,000 U.S. service stations, including 1,400 in California, where we are neck-to-neck with Arco as the number-one gasoline marketer. About 275 of those are located in the greater Bay Area.

Twenty years ago when I joined Chevron, a typical speech about energy would have been mostly on one subject -- oil supplies. In 1978, America was about to get its second oil shock of the 1970s, and oil soon afterwards hit $40 a barrel.

Right now, this is kind of a non-issue because oil is plentiful and world oil prices are about $13 a barrel. If you adjust for inflation, the last time we saw oil prices this low, Woodrow Wilson was in the White House. The forecast is for flat prices in the next few years and ample supplies of crude oil for 40 to 50 years.

In the United States today, we consume about 17 million barrels of oil a day and we import over 50 percent of that. Oil production in the United States is in a permanent decline. But for now, the federal and state governments have made a policy decision to allow very little new exploration or oil production in the high-potential areas. That means that they've also made a policy decision to let other countries supply more of America's oil needs. It also means that oil companies now have another reason to invest more in other countries than they do at home.

So it doesn't look like we'll be seeing much new oil development in our state. For many years, California was self-sufficient in oil. But today we produce less than half of the two-million barrels of oil we consume every day. Most of the rest comes from Alaska, with imports making up the balance.

There's more oil to be found in Alaska, in other areas of the U.S. and in the waters off the California coast, but even though the industry has shown it can work safely in sensitive areas, the nation will continue to import more of our oil needs.

Most of us don't buy crude oil, of course. But we do buy gasoline, and right now Californians buy about a billion gallons a month -- roughly 23,000 gallons a minute.

So let's take a look now at the gasoline situation. Nationally, gasoline has been selling for some of the lowest prices in recorded history. The U.S. average last month was about a dollar and five cents for regular, which is 87 octane. That's cheaper than just about any other liquid, including bottled water. It works out to about a nickel a mile on average -- roughly one third the cost-per-mile that Americans were paying in 1980.

Now you might ask: what about California relative to the rest of the country? I know you wonder why gasoline prices are higher here. One big reason is taxes. At almost 50 cents a gallon, we've got one of the highest rates in the nation. Washington and Sacramento account for most of it. The state excise tax is 18 cents a gallon. The federal excise tax is 18.3 cents. And they each take their cut with every fill-up, no matter which way the gasoline market is going.

But what really galls me is that in California, the sales tax is imposed on top of those taxes -- not just on the price of the product. So consumers pay a tax on a tax at the pump. Pump taxes in Georgia, by comparison, are 15 cents lower than ours. In Kentucky and Alabama, they're about a dime lower.

Unfortunately, people tend to forget these factors when they compare California pump prices to the national average or to other states.

Another major influence is California's unique gasoline formula. Since 1996, state law has said that the only gasoline we can sell here is California cleaner-burning gasoline. The formula costs 5 to 15 cents more per gallon to make. And just like the higher taxes, this difference tends to get overlooked when you see local prices compared to the national average or other states.

Our state is not the only region required to use a particular recipe. California gas is different from Arizona gas, and both of those are different from the one required in Phoenix. I could give other examples from around the country. But the point for consumers is that regulating gasoline formulas to improve air quality has also changed the dynamics of the gasoline marketplace.

To make California's unique gasoline formula, the state's refiners invested about $4 billion upgrading their facilities. Chevron alone spent a billion dollars on its refineries in L.A. and Richmond to become the state's largest supplier of California gasoline.

With just a few exceptions outside the state, only California refineries can make large quantities of the California gasoline. Those refineries are set up to make all the gasoline California needs -- but since the new formula started in 1996, California's supplies are more dependent on how well these refineries perform.

This means our marketplace can be more volatile from the rest of the country. If our supplies get tight -- as they sometimes do -- we can't bring in gasoline from multiple sources the way other states do, especially those along the Gulf Coast. So this is one more factor to keep in mind when comparing California prices to the national average.

Even with our higher refining costs and taxes, however, Californians are driving more cars more miles with less pollution at a lower cost per mile than they have in many years. If we look at things that way, we have something to celebrate about gasoline in our state, along with all the things we disagree about.

Let me turn now to the issue of different gasoline markets within California.

Motorists in the Bay Area typically pay more at the pump than those in Los Angeles -- about six to 10 cents a gallon, on average, since 1994. Sometimes it's more -- up to 15 or 20 cents -- and sometimes it's less. In October 1997, L.A. was 2 to 3 cents higher. But either way, consumers, elected officials and news media have all noticed those differences. The issue has died down somewhat because gas prices are so low right now, but people have expressed a lot of concern this year about the differences between markets.

So let's take a look at Los Angeles. It's the biggest gasoline market in the world and one of the most competitive in the country. When they have gas wars in L.A. -- like the one in late 1997 -- on some days, probably nobody, not the refiners and not the dealers, covers expenses selling gasoline.

Consider that Unocal 76 not long ago sold all its stations to Tosco, and Thrifty leased its entire station network to Arco. Apparently, they decided real estate was better than gasoline marketing in L.A. And recently, Texaco and Shell formed a joint venture and combined their networks. Why would they do that? Because gasoline marketing is a tough business, and it is a very tough business in L.A.

I'll tell you this -- if we could earn more in the L.A. market, we'd be doing it, and believe me, that's what we try to do every day. In 1992, Exxon completely withdrew from marketing in L.A. Chevron bought 20 of their stations. Exxon couldn't make money so they got out.

Since 1995, Chevron has been trying extremely hard to build our business in all of California, both with our own investments and through the investments of independent Chevron dealers. So far we have added over 80 Chevron outlets in L.A. and only 30 in the Bay Area.

The fact is, it's easier to build in L.A. Costs are lower, real estate is available, permits are granted, and it shows in the station counts. More stations, more competition. More competition, more price pressure. Pretty simple. Stations here in the Bay Area have to compete for business with the guy across the street, but stations in L.A. have to compete even more. The markets really are different.

The Bay Area has a competitive gasoline marketplace. However, some elected officials seem to really want to make it more competitive. To achieve that, I believe they should help gasoline retailers give consumers more options on what to buy and where.

And they could do this by making it easier for investors to get permits for new service stations which would add new players to the competitive mix on the street. One of the last Bay Area stations we built, a facility in Contra Costa County, cost us nearly $4 million. Over half that cost was for land and permit fees.

Let's look a little closer now at this issue of differences between markets.

I know that people tend to think of gasoline as different or special, because it's a necessity. That's understandable. But in a very real sense, gasoline and gasoline markets are no different than other products and their markets. The fact is, every region, city and area is driven by its own mix of market factors.

And there's nothing wrong with that. It's the nature of our economy and it works well for the buying public, regardless of what product you're talking about.

You may have seen the report recently that said milk prices in California are the highest in the country. The group Mad About Milk blames the higher prices partly on the fact that California has its own unique milk-formula standards, and this apparently makes it harder for milk brought in from other states to compete. It sounds kind of like our situation with the California gasoline formula.

In any case, it might interest you to know that San Francisco has the third-highest milk prices in the state. They're paying an average of $3.19 a gallon for all types, which is a dime higher than Los Angeles -- according to A.C. Neilsen -- while the national average is $2.67.

I don't know the exact reasons for this. As a consumer, I might not like hearing it. But again, just because there's a difference doesn't mean that something's wrong. You could probably find a rational explanation just by looking at the market characteristics between the two regions.

Or let's consider home prices.

Now you might say to me: "Hold on Dave, I'm not going to sit here and let you compare home prices to gasoline prices." But I'd say, bear with me for a moment, because both homes and gasoline are necessities, and the prices of both reflect local competition and market conditions.

According to the California Association of Realtors, the highest average home prices in the state right now are in Silicon Valley. It's not necessarily because Redwood City -- with an average home price at $373,000 -- is a nicer place to live than Walnut Creek at $282,000 on average, or Pleasant Hill at $216,000.

It's because the job growth in Silicon Valley has attracted so many people that the number of home buyers has overwhelmed the inventory of available homes. So San Jose's average home is $100,000 higher than Concord's.

Again, we all know that as products, houses and gasoline aren't much alike. But like gasoline markets, housing markets reflect the forces of supply and demand -- and they reflect consumer choices and values.

Or let's look at hotel rooms.

If you do enough business-travel, the rooms all start to look alike -- or at least they all have the same appeal compared to being at home. The standard rate quoted by the Concord Hilton is $132, but it's $169 at the downtown San Francisco Hilton. I doubt the beds are much different, but the higher rate across the Bay reflects the tourist element, while the local rate probably reflects more of a business-travel clientele.

The standard rate at the Marriott in San Ramon is $179, while the Marriott downtown Oakland is $154 and the Marriott at the San Francisco airport is $229. Each price reflects the different market factors for hotel rooms in that area. Higher still is the Marriott at the Moscone Center in San Francisco, probably a market-place reflection of both the tourist element and the location close to the convention center. And the Sheraton Palace in San Francisco, at a standard rate of over $300 a night, is another market altogether -- sort of the rough equivalent of buying a tank of premium gasoline from a full-serve station in Alamo.

Of course, if nobody wanted the Palace rooms or the full-serve premium, they wouldn't exist in the marketplace. And even with all the variation in hotel rates, you don't see any politicians calling for an investigation and you don't hear anyone demanding that we pass a law to make all hotel rates match those in the cheapest market.

If room rates in a particular area get too high and there are no choices or options, people won't stay at those hotels. The market will adjust prices accordingly, or somebody who wants to get the hotel business in that area will come in and build a cheaper option.

Similarly, if a service station tries to charge more than its customers will accept, it's going to lose those customers. In short, the competitive gasoline market regulates itself. It isn't broken, and it doesn't need to be fixed.

None of this should be surprising to consumers or business people.

But still, people judge gasoline by some kind of different standard, and over the years, we've seen a steady flow of proposals for new regulations to push prices back down where they supposedly belong.

People start to think the market needs new controls or restrictions, and one typical suggestion is to start regulating gasoline like a public utility. I can assure you, if that happened, you wouldn't be paying the low prices for gasoline that you see today.

Look at what's happening in the utility industry right now. Basically, the trend is toward de-regulation of electric power and natural gas, to bring price competition into the marketplace, just like you have with gasoline and other products.

In my view, the fact that these things are necessities makes it all the more important that we let the marketplace do the managing. Deregulation and the emphasis on free market forces is one of the most sweeping trends of the late 20th Century -- and its popularity is no accident. It doesn't guarantee that every market will have the lowest price. But it does ensure that the larger marketplace and each market will be as competitive as they can be.

I can understand how people might be frustrated with price differences. But again, there's nothing unusual -- or wrong -- with paying a different price in one market than people pay in a completely different market, especially one like Los Angeles.

This brings me to a very important point. One of the essential things to understand about the gasoline business is that price is only one element in the buying decision. In fact, only one out of four motorists shops entirely for price.

Location to many people is often far more important than price because they put a value on convenience. Or they stop at Chevron because their kids want one of these Toy Cars. Other people just like a particular dealer or the young person working at the counter. Does anybody here have a favorite clothing store or a favorite haircutter? Other consumers prefer a particular brand or quality of gasoline. Does anybody here have a favorite type of car or a car dealer you like to do business with?

Some gasoline consumers look for a pump-card reader, or clean restrooms, or a car wash or a station that does repairs or smog checks. Some will pull into any station where they don't have to wait in line. Or they want to fill up the tank and also get a lottery ticket at the convenience store, or a newspaper or a cup of coffee.

Gasoline might seem like it should just have the same cheap price everywhere. But a service station isn't just an outlet. It's a retail business. Most stations don't compete only on price or just one product. They try to compete on value -- on the total buying experience from selection to service -- just like a restaurant or a sporting goods store.

Now you may be thinking: "Dave, why can't you just admit that you take advantage of the market to make a profit just because you can."

We get this question from news media sometimes. And to that I'd say: show me a business that isn't setting prices to meet market conditions -- any business represented in the community -- and I'll show you a business that's not long for this competitive world. In this market and every other -- for each day that Chevron earns a good profit -- we have to expect another day when the market's going to hand us the opposite. So of course we try to make profits when we can.

No business should have to apologize for that. If that was against the law, you'd have to lock up all your local newspaper publishers, your TV station owners and probably a good percentage of your leading citizens.

Costs go up, sales go down, a new player comes on the scene -- these fundamentals apply to gasoline just like they do for other products and services.

At this point, some of you are probably wondering: "Wait a minute Dave. If things are so tough and competitive in the oil business, how come I keep reading articles about the huge profits of the oil companies?"

O.K. -- let's take a look at that one, and I'll stick to my end of the business, which is refining and marketing in the United States. In general, during the 1990s, the consumer's gain has been the refining industry's loss. In the first half of 1998, for example, Chevron reported net income of $283 million on our U.S. refining and marketing operations.

That's a big number -- no doubt about it. But you have to remember, Chevron is a very large company in an enormous industry. If you divide that $283 million by the number of gallons sold in that period -- all the diesel, gasoline, jet fuel, motor oil and other products -- you get a profit of about 3 cents a gallon. That's a return on sales of just 6 percent, hardly anything to brag about, and downright poor compared to a lot of other industries.

That's how we evaluate our business. We put the oil in one end of the refinery and we try to make money distributing and selling the total slate of products that comes out the other end. Sure, we often do better than just a few cents a gallon on gasoline. But on a lot of days, Chevron still makes more profit selling one of our Toy Cars than we do on a fill-up.

Or you can measure it another way. Our U.S. refining and marketing in the last five years has averaged just 5 percent return on investment. We could have done better in Treasury Bills, with virtually no risk and a lot less volatility. These kinds of low returns are typical of the general refining industry, and the analysts who follow the oil stocks blame the stiff competition for the poor performance.

And this is the same competition that has been rewarding consumers with low gasoline prices for most of the 1990s.

Let's get back to our local market here in the Bay Area. How do you be sure it's competitive?

First, look at the service stations and how they behave. I've already talked about the dozens of different features. Clearly, dealers want to earn more profit as retail businesses and they're trying to grab each other's customers in the process. So they have to price their gasoline at a level that people will accept.

Next, look at wholesale prices -- this is what the dealers pay for their supplies before they add their gross profit and the taxes. In a healthy market, these prices will change regularly. For example, this year in your area -- average wholesale regular has ranged from about 86 cents to 69 cents per gallon -- and that includes all brands.

Then look at pump prices. They should change all the time in a healthy market. And in fact, on average, the 1998 price of regular gasoline at the pump in the Bay Area has fluctuated between $1.38 a gallon and $1.21.

And last, look for a daily range. The fact is, on any day of the year, you can find a 20-to-30-cent per gallon difference -- or more -- between local stations right here within your region. On some days, you can read that in the newspaper, when they print lists of the lowest prices in the area. That's right. In the same articles where they try to tell you the market isn't competitive, they publish hard evidence that proves otherwise.

I know that some consumers will never believe it's O.K. for somebody in another city to pay less at the pump than they do here. But I also know that there's nothing wrong with differences between different kinds of markets. And I know that both choice and competition are alive and well right here in your Bay Area gasoline market.

Updated: October 1998