BW: Is Big Oil Pumping Gas Prices?

BusinessWeek: With crude prices falling faster than gasoline, an old debate has erupted again, pitting drivers and gas-station owners against industry giants

Consumers packing up the family minivan for a getaway this Memorial Day will get a bit of a break when they fill up their tanks. Gasoline prices are down about 13% from their March highs, to a national average of $1.50 a gallon for regular unleaded as of May 21. But are gas prices as low as they could be? Crude oil has fallen 30% in the past two months, more than twice the drop that retail gasoline prices have witnessed in the same period.

Consumer advocates and gas-station owners say industry giants such as ExxonMobil (XOM ) and ChevronTexaco (CVX ) are playing games on pricing. Franchisees allege that they're forced to buy gas from major oil companies at inflated prices, and they say they're being pushed out of business by sky-high rent increases on company-owned lots.

A flurry of lawsuits and legislation has been initiated in recent years, as pump prices have climbed. But experts say it's not that simple. And as yet, there's no consensus in the courts or among academic researchers on whether American drivers are getting ripped off when they top off their tanks.

ROCKET AND FEATHER. "Wholesale and retail prices would probably be a lot closer if every station were unbranded and buying on the spot market, but that doesn't mean oil companies are violating antitrust laws," says Justine Hastings, a Yale University professor who has studied gasoline pricing. "They are maximizing profits in an imperfectly competitive market."

Academic research on the subject is a mixed bag. Economists have documented a "rocket and feather" phenomenon, in which retail gas prices soar skyward when crude is rising but slowly float down when prices drop. John Felmy, chief economist for the American Petroleum Institute, which represents major oil companies, says that's simply because it takes a while to work the higher priced gasoline out of inventory.

Franchise gas-station owners don't see it that way. One of those leading the charge against Big Oil is Dennis DeCota, who owns a 76 station in San Enselmo, Calif., and who also heads the California Service Station & Automotive Repair Assn., an industry trade group. DeCota says he has to buy gasoline from 76's parent, ConocoPhillips (COP ) at higher prices than what both a nearby company-owned outlet and an unbranded, independently owned gas station are paying.

TWINKIE MONEY. DeCota says he makes just a tenth of a cent profit on each gallon of regular unleaded he sells, and yet those rival stations sell gas at prices that are consistently 8 cents or more cheaper per gallon than his. Says DeCota: "I make my money on Twinkies."

Over the 25 years DeCota has owned his 76 station, his rent has jumped from $850 to $13,000 per month. Kristi DesJarlais, spokesperson for ConocoPhillips, says the rent it charges franchisees in Northern California is half of market rates. Regarding pricing, she says ConocoPhillips never charges franchisees more than it does company-owned outlets.

Service-station owners such as DeCota counter that oil companies have two methods for charging wholesale customers. One is called "zone pricing." The other is the difference between what are known as a "rack rate" and the "dealer tank wagon" price. Zone pricing refers to major oil companies' practice of basing wholesale prices on demographic and other factors in a gas station's particular neighborhood. Thus, a station in a locality with fewer competitors and a higher per-capita income might be charged a higher price than another station in a different part of the same city.

HELD CAPTIVE? Major oil companies also charge a "rack" rate to independent gas stations and gasoline wholesalers, but they charge their franchisees a "dealer tank wagon" price. In the past year, the tank-wagon price has averaged anywhere from 5 cents to 21 cents higher than the rack rate, according to the Oil Price Information Service (OPIS), an industry research firm. Recently, that difference was 19 cents.

Severin Borenstein, a professor at the University of California, Berkeley, who has studied gasoline markets, notes that the tank-wagon price includes the cost of delivery to the service station and also reflects the fact that stations paying that rate are buying in smaller amounts.

Thomas Kloza, chief oil analyst at OPIS, likens the two prices to the difference between a bank's prime borrowing rate and the higher rates charged credit-card borrowers. "This is a captive market," Kloza says. "Dealers who sign a 5- or 7- or even 10-year lease with a major oil company have put an awful lot of faith in their supplier's willingness to price fairly."

HOT TOPIC. Pricing controversy is hardly new to the oil industry. New York State conducted the first investigations into John D. Rockefeller's budding refining empire in the 1880s. Since then it has been a constant tug of war between oil companies, gas-station owners, and consumers. In December, 2002, New York Governor George Pataki vetoed a bill that would have banned oil companies from competing with their franchisees. And last year, the Hawaiian legislature approved wholesale- and retail-price controls on regular unleaded gasoline that will go into effect on July 1, 2004.

In a presentation to the Hawaiian legislature in January, Jerry Ellig, deputy director of the Federal Trade Commission's Office of Policy Planning, argued against the price controls. He cited a National Bureau of Economic Research study that showed company-owned stores as the most efficient means of distribution for high-volume stations. Another study found that a Maryland law prohibiting company-owned stations actually raised gasoline prices by as much as 7 cents per gallon in the state. Other investigations have cited the difficulties in manufacturing and distributing the various grades of cleaner-burning gasoline as a major cause of high gasoline prices.

Lobbying on the issue is heating up. A legislative committee in California recently rejected a proposed bill that would have allowed franchisees to shop around for their gasoline supplies, but another committee approved one that bars oil companies from charging different wholesale prices to company-owned stations and franchisees. Similar legislation has been introduced in Washington, for the second year in a row.

LEGAL STRATEGIES. Station owners and oil companies are also slugging it out in court. Peter Gunst, general counsel for the Service Station Dealers of America, which represents gas-station owners, says franchisees have had a tough time winning cases using federal price-discrimination law. Dealers have had more success recently suing for breach of contract in state courts. Last year, for example, ExxonMobil lost its appeal of a $2.2 million verdict handed down in favor of 51 Texas franchisees who claimed they were being overcharged.

Premlata Nair, a spokesperson for ExxonMobil, says the company was "deeply disappointed" by the verdict. "We believe that our pricing practices are fair and take into account the company's differing levels of investment and services provided," she says. The bottom line: Whether the pricing is fair and who is to blame for high prices depends on whom you ask.

By Christopher Palmeri in Los Angeles (Edited by Beth Belton)

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