Demystifying gas prices

Story, photo and graphic by Craig Hicks

Prices to fill up the gas tank vary across the nation, but in Kentucky, it varies a bit more often.

Screen Shot 2016-03-29 at 3.50.35 PMEastern Kentucky University student Brennan McMullen is a first year student from Maryland, but quickly noticed the fluctuations in gas prices in Kentucky.

“It’s not like this at home,” McMullen said. “It might go up 5 cents, but it can go from $1.89 to $2.20 in one day here.”

Gas prices fluctuate in Kentucky because of competition, location, market prices and distribution patterns, said Bob Riley, owner of Riley Oil Company.

Consumers migrate toward gas stations with the lowest price and those that reward their loyalty, like supermarkets.

Supermarkets hire people to think of as many ways possible to draw people into the store to shop, Riley said. After all of their research and thinking, and they come back with “cents per gallon.”

Supermarkets give people money at the pump because the customer thinks they are really getting the most bang for their buck, Riley said.

Petroleum Administration for Defense Districts divide the United States into five regions. Kentucky sits near the border of the Gulf Coast district and the Midwest district Riley said.

“Big price differences can exist between them and we feel it here,” Riley said.

The Gulf Coast district by nature is generally cheaper Riley said, but sometimes purchases are made from the Midwest district when the price drops. That is where some gas stations can find themselves in a bind and consumers will see some stations higher than others. If the price drops in one district, the stations cannot just switch over to another district to lower their costs.

“If they have a contract to buy from Midwest, you have to buy,” Riley said. “They have reserved it.”

The cost of the product in each district determines where the fuel consumers buy comes from.

The nearest terminals to Richmond are located in Lexington, Nashville and Knoxville. This is where the pipeline meets the holding tanks. From there, trucks deliver the product to gas stations within the “circle of influence,” Riley said.

Even though Richmond is located just south of Lexington, companies will buy from Nashville or Knoxville if the price difference is substantial enough because it is cheaper to drive it up here than to pay the extra cost per gallon at Lexington.

“Trucks from Nashville and Knoxville have driven right past Lexington to deliver product to Dayton, Ohio,” Riley said.

This can happen when fuel is 30 cent cheaper per gallon coming from those locations, Riley said.

When fracking increased a few years ago, the Midwest district was consistently cheaper than the Gulf Coast, Riley said.

“There wasn’t enough capacity to store it,” Riley said. “They had to sell it.”

Fuel companies had to drop the price to entice the sale of the gas.

Fracking was first introduced to Kentucky in the 1950s. Since 1980, more than 11,000 wells have been fracked in Kentucky, said Brandon Nuttall, a geologist with the Kentucky Geological Survey.

Fracking is now used predominantly for oil and gas production.

While some environmentalists disagree, Andrew McNeil, executive director of the Kentucky Oil and Gas Association, says oil and gas drilling going to be widespread in Madison County.

Counties in Eastern Kentucky account for about 98 percent of all gas production in the state of Kentucky, said McNeil. Five counties alone account for 75 percent: Pike, Letcher, Floyd, Perry and Harlan.

Kentucky has experienced a 75 percent increase in oil and gas production since 2011, Nuttall said.

In 2014, Kentucky produced more than 3 million barrels of oil, said McNeil. However, with the additional oil comes additional means of transportation.

Currently, there are more ways to move the oil, therefore a severe price drop is not necessary to raise demand to match the heavy supply.

The oil can be moved by pipeline, barge, ship and sometimes railroad, Riley said.

There are about 12,000 miles of pipeline used to transport that oil and gas, McNeil said.

This is how the fuel gets to the terminals, where it will be distributed from to gas stations.

Once it is delivered by truck to the stations, the stations begin to compete for the business of the consumer.

“It’s a very competitive business,” Riley said.

If the gas stations charges $2 per gallon, the cost to the company is not always below that value.

When the market price reaches or exceeds the selling price, companies begin considering a raise in the price consumers pay. However, nobody wants to be the first to go up.

“No one wants to be the first to raise their price first because it looks bad,” Riley said.

Once the first goes up, a split second later, everyone does, Riley said.

Since none of the stations want to look like the one who started the price rise, the profit margins get “mashed,” and when the prices finally do go up, they go up big, Riley said.

This is when the price war begins.

The “stepping stone” process starts and prices begin to drop, slowly, Riley said. Every station is trying to gain an advantage on the competition. If the price does not start going down, the cost of the product is rising and the margins are shrinking again.

Convenience stores sell about 80 percent of the nation’s fuel to customers according to the National Association of Convenience Stores. Over the past five years, these locations have made, on average, almost 19 cents profit for each gallon of gasoline they sell.

A two liter of Coca-Cola at one of these convenience stores can cost anywhere from $1 to $1.50.

“The average fill-up at the pump is 10 gallons,” Riley said.

Do the math and customers can choose between 50 cents at the pump or about a $1.25 Coca-Cola.

“They always take the 50 cents,” Riley said. “I have used the same example over the years; the products stay the same, the price of them just changes.”

McMullen answered the question, taking the two liter.

“I’ll take the drink, McMullen said. “What’s five cents anyway?”

Click on graphic to enlarge.

Screen Shot 2016-03-29 at 3.55.26 PM

Categories: Eastern Kentucky, Public Affairs

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