Understanding how to price fuel in an ever-changing market is vital to being successful in selling fuel. There are many strategies for pricing fuel and many variables to consider.
One crucial point to understand is the amount of price elasticity present in the downstream fuel industry.
Understanding the concept of price elasticity and how that relates to the downstream fuel industry can help businesses make better pricing decisions to increase profit margins while maintaining volume sales during high or low gasoline prices.
This article will answer three questions:
- What is price elasticity?
- Are the prices of downstream fuel elastic or inelastic?
- How does this affect prices for the downstream fuel industry?
To fully understand the practical impacts of price elasticity on your fuel market decisions, you need to see all the data; spot & rack pricing in your market is not enough. You need to know precisely where the demand is for a given product. After all, if there is no demand, no price can be profitable.
DTN Refined Fuels Demand gives you a granular view of demand, so you know how, when, and where to put the most profitable product on the market.
What is price elasticity?
Price elasticity is the measurement of how much the demand for a product changes when its price increases or decreases.
It is a simple truth that the price of goods impacts its demand. A higher price creates less demand, and the opposite is also true.
However, this truth exists on a spectrum. A product’s price elasticity is the amount by which any fluctuation in price changes its demand. It measures how responsive customers are to any change in the product’s price.
Simply put, any seller needs to understand how elastic (or sensitive to pricing fluctuations) or inelastic (impervious to pricing changes) their product is to be able to set or change its price correctly.
You can calculate price elasticity with the following formula:
The higher the outcome, the more elastic the price, and the more sensitive consumers are to change.
As mentioned, there is a spectrum of price elasticity that spans from perfectly elastic (any price change significantly affects demand) to perfectly inelastic (the market will not change despite any change in price).
Items that are elastic tend to be those that have intense competition or can be easily replaced. For example, if one brand of sandwich bread raised its prices, consumers could easily purchase another brand’s almost identical sandwich bread.
Inelastic prices tend to belong to products with a monopoly, and the product itself is considered essential. In that scenario, consumers are loyal and will purchase regardless of price.
Gasoline is considered relatively inelastic, which means consumers are not very sensitive to gas and diesel fuel price fluctuations.
Why is that? Generally speaking, gasoline is considered essential because driving from one place to another is necessary for most—if not all—everyday errands and tasks.
While there are other options to driving (e.g., carpooling, walking, biking, public transportation), studies have shown that gasoline consumption remains consistent, despite raising prices or income uncertainty.
In fact, in some instances, income uncertainty contributes to dependence on gasoline. While more fuel-efficient and fully electric vehicles are on the market, consumers will hold on to older, less efficient cars longer if their incomes are uncertain. The fact is they do not want to take on a car payment if their current, less efficient vehicle is fully paid off.
For gasoline retailers, this creates healthy profit margins.
What is fuel’s downstream price elasticity?
The upstream segment of the oil and gas industry is reasonably elastic. Its commodities rise and fall with an almost direct correlation: An upstream producer’s price is based on the profit they can make selling a barrel of oil versus how much it costs to produce that barrel.
However, companies in the downstream sector are a bit different. Their profits are determined by the difference between the cost of acquiring the refined product and the final product’s sale price, after that company’s own additions and transfer cost.
Downstream fuel companies earn higher profit margins when their cost of refined fuels lowers, as their cost to produce a finished product is less, and of course, the inverse is true as well.
How does this affect prices for the downstream fuel industry?
While downstream fuel prices are somewhat inelastic, fluctuations from the upstream segment do impact downstream fuel marketing. Therefore, when upstream, price-influencing events occur, downstream companies will, in turn, adjust their prices to reflect those changes.
Since the upstream fuel prices change so often, a downstream supplier needs to have all the relevant data they can get to remain competitive.
Many factors can affect pricing decisions for most downstream fuel marketers, such as inventory levels, regional differences in consumption patterns, and government policies. In addition, other costs must also be factored in, such as transportation expenses.
Downstream fuel marketers need to balance the demands of retailers with the pricing fluctuations of both the upstream and midstream markets. As a result, prices change multiple times per day.
How can a downstream supplier stay informed?
Having real-time data on what is happening in the industry is key to a downstream supplier’s survival.
A downstream supplier has to be able to decide how and when to buy products in the marketplace and at what price. In most cases, this is done by using data from the downstream wholesale fuels market as well as the entire oil and gas industry upstream.
To manage these myriad, complex decisions, DTN offers wholesalers a suite of tools. From determining the actual temperature of product being transferred to the most accurate rack pricing to where specific demand occurs.
Get in touch today to learn more about how DTN can help you succeed in a volatile market.