Page images
PDF
EPUB

Restructuring of gasoline marketing by FRS companies involved three major adjustments. First, the FRS companies consolidated the geographic scope of their gasoline retailing operations. The FRS companies no longer attempted to have gasoline retailing operations in all States, reducing their presence in many parts of the country.237 This consolidation continues, as evidenced by Unocal's recent announcement that it will no longer market petroleum products in the Southeastern United States, Ashland's sale of 51 Florida retail outlets, BP America's withdrawal from the California market, and Sun's withdrawal from Iowa, Missouri, and Oklahoma.238 Unocal had previously announced its plan to sell 140 truck stops in the Southeast and Northeast and concentrate on its California operations.

239

The second adjustment involved the way in which the FRS companies operated their remaining gasoline outlets. The trend among the FRS refiner/marketers has been to focus on high-volume self-service and convenience store operations rather than traditional fullservice stations. This adjustment, together with the elimination of lower volume outlets, greatly raised outlet productivity: average volume of the FRS companies' branded outlets quadrupled over the two decades following the Arab Oil Embargo (Figure 44). Third, as far-flung marketing networks were being reduced in size and scope, major refiners were increasing their use of wholesalers, mainly jobbers.

[blocks in formation]

Table 44. Shares of FRS U.S. Refining/Marketing Dispositions of Refined Motor Gasoline by Channel of Distribution, 1977-1993

[blocks in formation]

237 For example, a comparison of the National Petroleum News, Mid-June, 1992, pp. 35, 38, and 41, with National Petroleum News, Mid-June, 1993, pp. 35, 38, and 41 indicates that only 3 of the 19 companies listed increased the number of States in which they operate, while 10 reduced the number of states in which they operate. The story is slightly different, however, when the number of branded outlets for the two years is examined because 13 of the 19 companies reduced their number of branded stations while 6 increased the number of their branded outlets.

238 Energy Information Administration, Performance Profiles of Major Energy Producers 1992, DOE/EIA-0206(92) (Washington, DC, January 1994), pp. 44-45. 239 Energy Information Administration, Performance Profiles of Major Energy Producers 1991, DOE/EIA-0206(91) (Washington, DC, December 1992), p. 41.

The FRS companies active in gasoline retailing sought to lower costs in every possible way, including labor costs. Tax provisions, such as accelerated depreciation and the investment tax credit (which was repealed in the Tax Reform Act, 1986), provided incentives to substitute depreciable expenses for those not depreciable (e.g., purchasing additional pumps and converting a conventional service station to a self-serve operation). In effect, capital was substituted for labor, leading to reduced employment in gasoline retailing as attendants and mechanics were replaced by fewer numbers of cashiers, and pumping capacity was expanded.

Despite substantial efforts at cost reduction, marketing costs have shown a varied pattern over the post-embargo period. The increase in marketing costs between 1979 and 1981, (Figure 43) was widespread, with 17 of 23 companies reporting increases; while the rise between 1983 and 1985 was largely accounted for by companies acquiring large blocks of downstream assets during the mega-merger period of the early 1980's. Costs subsequently declined as these assets were either integrated into ongoing operations, sold, or otherwise disposed of. However, unit marketing costs increased more than 50 percent between 1988 and 1992, with 16 of 18 FRS refiners reporting higher marketing costs. This increase in recent years has partially resulted from compliance with increasingly stringent environmental quality requirements. Whatever the sources of the increased marketing costs, their rise played a key role in the deterioration in U.S. downstream profitability in recent years, as discussed in the next section.

Profitability, Margins, and Costs

The profitability of the FRS companies' U.S. refining/ marketing operations has shown great volatility over

the past two decades. Foreign as well as domestic events have had a considerable impact on the FRS companies' U.S. refining operations (see the box entitled "Overseas Developments and U.S. Product Markets"). As measured by return on investment,240 U.S. refining/marketing profitability reached 10 percent in the context of the oil price escalations following the Iranian revolution, plunged to near zero in 1984, rebounded to 15 percent in 1988, and fell below zero in 1992 (Figure 41). There is a very strong relationship between profitability and the FRS company refined product margin.241 The FRS data demonstrate the strength of this relationship even through the vicissitudes of downstream petroleum's financial performance (Figure 45),242

[merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][ocr errors][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small][merged small]

240Rate of return was measured as contribution to net income/net investment in place.

241The refined product margin consists of refined product revenues less raw material and product purchases and other refining and marketing expenses divided by refined product sales volume.

242To demonstrate the relationship between refining returns and net refining margins, a regression was run using FRS refining return on investment (ROI) ratios against the FRS refined product margin (constant dollars) for the years 1977 to 1993.

The regression results were:

ROI = -1.3 + 6.5 (FRS Margin)

R2 = .84.

The regression produced a t-statistic of 8.42 for the independent variable, indicating that the probability of the above association between ROI and margins occurring by chance is nearly nil.

Overseas Developments and U.S. Product Markets

During the late 1970's and early 1980's, the majors' domestic refining operations were also adversely affected by events overseas. The top four FRS companies ranked according to assets (Exxon, Texaco, Chevron, and Mobil) were Aramco partners. After the price escalation of 1979, Aramco purchases of crude were especially favorable for buyers as contract price adjustments tended to lag spot price levels during a period when spot prices were rising sharply. The FRS database shows that the Aramco partners did enjoy approximately a $1per-barrel price advantage on the costs of their U.S. crude oil inputs during the years 1979-1981 when compared to the non-Aramco FRS companies. However, the Aramco advantage did not translate into higher Aramco profitability relative to the non-Aramco FRS companies. The return on investment for the domestic refining/marketing operations of the non-Aramco FRS companies was nearly 4 percentage points higher than for the Aramco partners. The FRS data indicate that although the Aramco partners benefited from lower raw material input costs, all other operating expenses for the Aramco partners tended to be substantially higher than for the non-Aramco group of companies. This was particularly true of the Aramco group's higher marketing expenditures per unit of sales. Further, the Aramco group was less successful in passing on the rising costs of crude to their retail customers as demonstrated by the fact that their average sales prices for refined products tended to trail the non-Aramco group of companies.

Starting in 1981, crude oil prices began to fall. Over the years 1982 through 1985, Aramco companies had been characterized as being disadvantaged relative to their non-Aramco partners. During the era of "disadvantage," interestingly, Aramco companies still paid less for their crude oil inputs, although the Aramco purchase price advantage had narrowed to roughly 20 cents per barrel. Over this period, the Aramco partners still retained a higher cost structure-less crude oil purchase costs and continued to realize lower returns on U.S. downstream operations than the non-Aramco FRS companies.

During the mid-1980's, events in Europe also had a substantial impact on U.S. petroleum product markets. One byproduct of the British coal strike of 1984-1985 was a surge in the demand for alternative electricity generating fuels--primarily residual fuel oil. However, increased production of residual fuel oil also meant increased production of gasoline and a European gasoline glut. The excess supply of gasoline in Europe wound its way to the United States. Between 1983 and 1985, U.S. imports of gasoline rose by more than 50 percent, resulting in a domestic glut of gasoline, a sharp decline in the domestic price differential between gasoline and other refined products, and reduced refined product margins.

The broadest definition of refined product margin is the spread between refined product sales price and the purchase price of raw material inputs and refined products, termed the gross margin. However, included in the gross margin are the costs of energy to run refineries, maintenance of marketing networks, and other refinery operating expenses. The gross margin less these costs represents the net margin—which is the major determinant of bottom line results. The value of these and other components of the refined product margin (in 1993 dollars) for the peak and trough years of U.S. refining/marketing profitability are presented in Table 45.

Improved profitability in 1979 (and 1980) largely came from refined product price increases which outpaced the sharp rises in crude oil prices243 and added nearly a dollar a barrel to the gross margin in 1979 (Table 45). Also of importance was the FRS companies' reduction in operating expenses, but this gain in efficiency was nullified by higher marketing expenses and higher energy costs.

All factors worked to reduce refining profitability in the early 1980's, resulting in a near-zero return on investment in 1984 (Figure 41). Marketing and energy expenses together increased by more than a dollar a barrel, and the FRS companies' refined product sales

volumes fell by 2.8 million barrels per day, a 19-percent decline, from the 1979 levels (Table 45).

The rate of return on the FRS companies' U.S. refining/marketing operations reached a low point in 1984, but then improved to an all-time high in 1988. Perhaps the most remarkable feature of the surge in refining/marketing profitability between 1984 and 1988 was that the spread between refined product prices and raw material purchases played almost no role in this improvement in financial performance. Instead, greater profitability during this period stemmed from cost reductions and increased demand.

While FRS company refined product sales volume fell 19 percent between 1979 and 1984, between 1984 and 1988, it rose 17 percent.244 Marketing costs were reduced as the FRS companies further consolidated their marketing operations along regional lines of competitive advantage and marketing operations that were gained in earlier mega-mergers were integrated into the surviving corporations. Energy costs were halved between 1984 and 1988, falling by $1.37 per barrel (in 1993 dollars), in large part reflecting the 55percent fall in (real) crude oil prices over the 1984-1988 period. Lower crude oil prices, which in turn led to lower product prices, were also the main sources of the 17-percent gain in FRS petroleum product sales. Refinery operating expenses changed little.

Table 45. FRS U.S. Refined Product Margins and Costs per Barrel Sold, Selected Years, 1977-1993

[blocks in formation]

aRefined product revenues less raw material and product purchases divided by refined product sales volume. "Calculated from unrounded data.

Source: Energy Information Administration, Form EIA-28.

243 This is corroborated by the "Composite Refiners Margin," which rose from 11.5 cents per gallon in 1978 to 19.4 cents per gallon in 1979. Energy Information Administration, Annual Energy Outlook, 1992, DOE/EIA-0384(92) (Washington, DC, June 1993), Table 5.21. 24Energy Information Administration, Form EIA-28.

The steep decline in refining/marketing profitability since the late 1980's (and persisting through 1992) can be traced to weak product demand and an upswing in marketing costs. The recession of 1990-1991 had an adverse effect on petroleum product demand. For the FRS companies, refined product sales volumes were off 7 percent between 1988 and 1992 (Table 45). Softened demand also put a squeeze on gross refining margins, which were down by over $1 a barrel over the same time period. Marketing cost increases were widespread among FRS companies: 16 of 18 refiners reported increases in unit marketing costs. The reasons for these increases are not altogether clear, but increased advertising outlays245 and the costs of complying with leaking underground storage tank requirements were contributing factors. Slightly lower energy costs and refinery operating expenses were minor offsets.

The volatility of U.S. refining/marketing profitability over the past two decades is thus seen to be due to a combination of wide swings in crude oil input costs and in marketing costs which, despite the massive restructuring of marketing networks by FRS companies, have shown a varying pattern over time with no tendency toward long-term decline. Even so, efforts to lower refinery energy expense and other expenses of operating refineries have clearly been successful.

Liquids Pipelines

The FRS companies, as a group, account for the bulk of investment in U.S. liquids pipelines (oil and petroleum products). The FRS companies have accounted for over 70 percent of U.S. interstate liquids pipelines' ownership over the past two decades, as measured by share of barrel miles246 (Table 46). The FRS companies accounted for 71 percent of the U.S. total in 1991 (the last year of available data). Liquids pipelines have traditionally dominated the FRS companies' rateregulated pipeline activities, with 19 companies reporting assets in liquids pipelines in 1993 but only a few of them significantly involved in natural gas pipelines. The investment base in this segment, as measured by the rate of return, has been the most profitable of the transportation segments for FRS companies (Figure 46).

[blocks in formation]

245 Energy Information Administratic., Performance Profiles of Major Energy Producers, 1992, DOE/EIA-0206(92) (Washington, DC, January 1994), p. 35.

246 American Petroleum Institute, Market Shares and Individual Company Data for U.S. Energy Markets: 1950-1991, Discussion Paper #014R, Washington, DC, October 1992, pp. 92, 97, 98.

« PreviousContinue »