Feature Article: Drilling for diesel

Todd Dills | March 01, 2010

Drilling for diesel

A price anatomy of trucking’s most volatile cost component


Drilling down into the component parts of the diesel price per gallon is a tricky business and involves assumptions that don’t and couldn’t possibly take into account the full complex reality of the fuel production, distribution and marketing businesses.

For instance, the primary governmental authority on the pieces of the diesel price pie, the U.S. Energy Information Administration, regularly provides a breakout of the percentages of diesel’s price that covers four broad areas — crude oil, refining, distribution and marketing, and tax. “It’s a very simple methodology,” says EIA Energy Information Specialist Jonathan Cogan, “measuring pricing at different points along the way.” But it’s an effective categorization, as it gives observers a way to determine the forces behind price increases or declines and to educate the consumers of diesel fuel — that’s you — about the way the market works.

“There are literally hundreds of thousands of individual decisions that go into the price at the pump, and they’re being made every day over and over again,” says Rayola Dougher of the American Petroleum Institute, pointing out the complexity of the world fossil-fuel-based energy markets.

 

CoverStoryGraph1This article uses $2.74 per gallon of diesel, which was the average price for October-December 2009, according to the U.S. Energy’s Information Administration.

 

Crude/diesel prices as economic indicators

ship-cover
It can take weeks for the price of oil to be reflected in the price of diesel.

What’s happened since 2005 with the dramatic rise in the price of crude is that a margin squeeze has been put on all parties down the chain, and it’s rippled throughout the wider economy. “Every recession we’ve had that I can remember, from the mid-’70s on,” says Jay Thompson, president of Transportation Business Associates, “you see spikes in oil prices driving it. [2008] was this turbo spike.” Immediately following that spike, as demand for all manner of things from diesel to toasters plummeted, we hit what Thompson says traditional economic models would in our times see as an appropriate crude level, the $30-40 a barrel of early 2009. “But we’ve doubled that again now,” says Thompson. “Any time you double that you expect an economic slowdown.”

Tom Kloza, in a post to his Speaking of Oil blog (speakingofoil.com) early this year, said the biggest fundamental in the 21st century oil market wasn’t supply or demand but “money flow” itself. “Large amounts of investment money tend to pour into mostly long positions in crude oil and refined products futures or options in the first few January sessions of a new year,” he wrote.

Kloza accounted for late 2009 and early 2010 gains in crude price with this, but Jonathan Kingston, news director at analyst and information service Platts, might well disagree. Much has been made of oil and fuels futures investment as a large part of the run-up in price the trucking industry suffered through in 2007-08, but Kingston’s “Diesel Dominance and Demand Destruction” article, written after the quick fallback of prices in late 2008, sings a different tune.

“A strong argument can be made that it was an unprecedented rise in the price of diesel fuel, not speculation or geopolitics, that dragged up the price of crude in its wake,” he wrote. “And similarly, it was a degree of demand destruction, and changes in refineries’ output mix, that sent it on its downward ride.” To read his analysis, search the article title on Google.


Crude oil:

65 percent/$1.78


The biggest contributor to the price of diesel and its constant up and down fluctuations is the world market for crude oil, which is bought by oil refiners on the big commodity exchanges, like the New York Mercantile Exchange, whose spot market index is the most commonly referenced on the airwaves for crude prices. For the week ending Jan. 22, 2010, NYMEX spot market average stood at $74.54 per barrel. Considering there are 42 gallons in a barrel, that equates to a price of $1.77 a gallon, and it was trending downward at the end of the week but in the longer-term moving up from the last half of 2009, when prices in the $60s per barrel were more common.

As goes crude, so goes diesel, says the EIA’s Cogan. “The crude oil market is the world market,” he says, and as such it can take several weeks for fluctuations in the cost increase of a barrel of crude to show up in the diesel price at the pump. In analyzing price, says Rayola Dougher of the American Petroleum Institute, that’s why “you need an average over time — a season, maybe — to accurately characterize who makes what and what they’re spending.”

The EIA does its price-per-gallon breakdown by looking at averages over time, publishing monthly.

As world market prices for crude oil have risen dramatically in the past decade, they’ve come to represent in the EIA’s analysis a much larger share of the price per gallon. In 2002, the first year for which historical price breakdown data from the EIA exists, crude typically accounted for just 45 percent of the price per gallon. It began to trend into the 50-percent and above range in March of 2005, a year in which crude jumped almost 50 percent in price to the $50 per barrel range by yearend. Average diesel prices pushed over $3 a gallon for the first time in the decade in October of that year, portending things to come.

Some economists see in current woes in developed economies the world’s powerhouses adjusting to new high levels of energy, or crude oil, prices; other analysts also note that U.S. diesel prices themselves are also dependent on the world diesel market insofar as demand for the distillate has grown exponentially in developing countries like China and India and in South America as their commercial engines rev up, and in Europe where more and more of the automobile population is composed of diesel-powered vehicles.

“Often in the summer months,” says Dougher, when distillate is in lesser demand in the northern hemisphere, “a lot of time we’ll be exporting to countries in the southern hemisphere,” or to Europe, where demand will be stronger in the U.S.


refining
U.S. refiners traditionally produced more gasoline than diesel.

Refining:

7 percent/$0.19


Generally, refiners buy crude and distill it down into a variety of products. Traditionally, U.S. refiners have produced a great deal more gasoline than they have the two products known as distillate — diesel and heating oil.

“If you’re a refiner,” says Dougher of the API, “there’s all kinds of crude. West Texas Intermediate is a light, sweet crude — meaning it’s a premium crude. It’s nice, and you can refine it readily into gasoline — it doesn’t take as much work as some of the more sour crudes.”

As in other industries, Dougher adds, individual refiners have different profiles. If you’re a refiner and can deal with more sour crudes, for instance, you might have a leg up in terms of what you can produce.

In winter 2008-09, when diesel retail prices fell hard with the price of crude, refiners were hit hard. “Refiner margins were really squeezed, and refiners were losing money,” Dougher says. They were awash in diesel after ramping up production for both use in the U.S. and for export.

“The product, whether it’s being imported or exported, will go where the money is,” says Cogan.

With so much diesel supply readily available in the U.S. in recent months, in the EIA’s analysis, refineries’ share of the retail diesel price had fallen to 7.9 percent, or about 22 cents, in December 2009, from as much as 21 percent, or 81 cents, in May 2008, at the height of the price spike as refiners hustled to keep up with ­demand.



distribution
The distribution part of the pricing picture is made up of a host of middlemen.

Distribution and Marketing:

11 percent/$0.30


The long “downstream” of diesel from the refinery to the retail station is represented in this category of the EIA’s monthly price-per-gallon analysis. It’s probably the most familiar of the categories to consumers but remains at once opaque in its complexity. The diesel distribution business is made of a host of buyers, sellers and transporters of varying types, including independent and branded distributors, diesel jobbers (reps with the rights to distribute to a collection of retail stations in a given area), pipeline operators, trucking companies, truckstop operators and more.

James Hedrick, with 16 years in the truckstop/travel center business, today manages a relatively new Wilco-Hess truckstop in Gordonsville, Tenn., about 50 miles from the primary sources for his diesel, several diesel terminals in Nashville, Tenn. One such terminal is located mere blocks from the downtown TravelCenters of America location off James Robertson Parkway with several “300,000-gallon storage tanks,” Hedrick says, operated by Marathon Oil company. “You may see an Eagle, Pilot, Flying J and a Love’s tanker filling up there all at once,” says Hedrick. “It just depends on how the buyer for each individual station approaches it.”

The Marathon terminal, says company rep Linda Casey, is supplied by the Colonial Pipeline, typically. The Colonial system’s westernmost origin point is in the Houston area, says pipeline Media and Marketing Manager Steve Baker. “There are a number of other origin points in Texas, Louisiana and Mississippi (and one in Alabama) before the Colonial Pipeline crosses Atlanta on its way up the East Coast to Linden, N.J.,” or New York Harbor. Houston-to-Nashville-bound diesel splits off the main pipeline to tank farms in the Atlanta area before rejoining a branch of the pipeline that runs through Chattanooga, Tenn., to Music City.

Pipeline common carriers file transport rates with the Federal Energy Regulatory Commission in the same manner pre-deregulation trucking companies filed rates with Interstate Commerce Commission. “A representative rate from Houston to Nashville is $1.16 per barrel,” says Baker, or almost 3 cents a gallon. “These rates are stable and don’t change with short-term market fluctuations. In other words, if the price of diesel jumps 10 cents, Colonial’s rates do not change.”

With retail diesel hovering just below $3 a gallon in most Nashville locations as of late January, pipeline transport accounted for at least 1 percentage point of the distribution and marketing piece of the fuel pie.

From the Marathon terminal downtown diesel is trucked out to stations. According to carriers serving that terminal, pricing of diesel loads can vary from 1 cent a gallon for cross-town 7,500-gallon loads to about 5 cents a gallon for a 100-mile trip, or $3.75 per mile. Though there are many exceptions to the rule, including summer 2009 supply disruptions in Nashville, the majority of diesel in the region is unlikely to travel overland much farther than that.

Using Hedrick’s Gordonsville, Tenn., stop, 50 miles outside of Nashville proper, as an example, $3.75 per mile would equate to 2.5 cents per distributed gallon, or just less than 1 percent of the price per gallon.

The Oil Price Information Service, which estimates margins for particular truckstops based on wholesale prices at and distance from the nearest supply source, put Hedrick’s stop’s estimated fuel margin at just 9 cents a gallon, as fuel was priced at $2.62 per gallon, quite low for the region (Hedrick’s station was just a few weeks old at that point). After subtracting 2.5 cents for transport, the 6.5 cents per gallon estimated markup, just more than 2 percent of the total price per gallon, may have left little profit for the station after taking personnel, land, franchise and other fees into account.

“Being at the end of the distribution chain, [truckstop operators] have no control over the price they pay” for fuel, says Holly Alfano, vice president of government affairs for the National Association of Truckstop Operators. “They want to be able to recover their costs and make some kind of reasonable margin on the fuel that will allow them to stay in business. They also need to consider the prices their competitors are posting. They realize customers are very cost conscious when it comes to fuel prices. Customers will go elsewhere to save a penny a gallon.”

More typical of Tennessee truckstops in OPIS’ Jan. 18 spread report was an estimated margin of around 20-25 cents per gallon, more in line with the profit of “5.4 cents on every dollar of sales,” or 16.2 cents per gallon at $3 diesel, says the API’s Dougher, that is the oil/fuels industry’s average profit.


CoverStoryGraph2A Crowded Piece of the Pie


Based on our analysis of this segment, for a diesel gallon traveling to the Nashville, Tenn., area from Houston, the snapshot here represents the pieces of the 30 cents a gallon the EIA estimates distribution and marketing costs and profits contributed to the price per gallon in the final quarter of 2009.

Compared to crude’s share of the price, it’s a small one, but within it, as within every piece of the fuel pie, there are a myriad of parties.

Barge transport of diesel, sources say, is a reality in movements to wholesale locations not near a pipeline. And in the “distributors” category, more than one entity might be involved in some situations. “In Cookeville,” says James Hedrick, manager of the Wilco-Hess stop in Gordonsville, Tenn., “Lamb Oil is the BP distributor [or jobber] for middle Tennessee.” Lamb might buy diesel from the manufacturer directly or, if in short supply, from another maker or distributor.



IFTA
Taxes are the most static part of diesel prices.

Tax:

17 percent/$0.47


This is the most easily dissected component of the price of a retail gallon of diesel fuel. The federal excise tax on diesel nationwide is 24.4 cents per gallon, and EIA’s average for the state excise taxes was in November 2009 an extra 23 cents, making up 47.4 cents per gallon of the then average $2.79 price, or 17 percent. Compared to other categories, the tax portion of a gallon of diesel in real terms is static. That’s why you’ll see the percent number there rise and fall in inverse relationship to diesel’s price itself. In the third week of January, with average diesel retail standing at around $2.92 per gallon, for instance, tax accounted for 16 percent of the price.

Tax is a primary reason diesel prices are different from state to state, with surcharges as low as 13 cents and as high as 38 cents in addition to the 24.4-cent federal tax. “I’d bet 90 percent or more of the difference” from state to state, says Rayola Dougher of the American Petroleum Institute, “is the difference in the tax base.”

In California, where API data on local, state and federal taxes puts overall diesel tax at nearly 71 cents per gallon, the January 20 average diesel price minus taxes was $2.40 a gallon according to the AAA Fuel Gauge Report; in the much lower tax state of Oklahoma (38.4 cents per gallon), the price minus taxes was $2.34, a pretty six pennies’ difference, but after all close enough to be accounted for easily in greater transport and other costs.


 

truckstopMinimal margin

Truckstops often have relatively little profit on diesel

By Misty Bell


When diesel prices go up, many times the eyes of consumers turn first to truckstops. But truckstop operator Jim Hays says this blame is usually misplaced.

“Sometimes we’re selling at break-even. Sometimes we might make 2 or 3 percent,” says Hays, owner of Dodge City Travel Center, located at Exit 299 on I-65 in Dodge City, Ala. “It’s very competitive, and the margin’s typically very low.”

In Hays’ situation, he actually is the wholesaler and the retailer because his company also functions as an oil stocker. Typically, he contracts with oil companies for supply, then sells the fuel at a mark-up to retailers, including the Dodge City Travel Center. From there, Hays says, “the travel center has a mark-up to retail.”

It’s mostly a game of give and take, with wholesale pricing often changing day to day and those prices taking a few days to get to consumers. Then, at times when prices are moving rapidly, “we won’t have any [profit] margins at the pump,” Hays says. “That’s just the nature of the beast. If one of my competitors doesn’t move up, I may stay down and have a little price war. It’s all about trying to be competitive.”

Ultimately, Hays says, prices are determined by supply and demand, over which he has little control. He uses Hurricane Katrina as an example.

“You had a situation where the pipeline from Texas … was actually shut down for a number of days,” he says, causing many retailers along the Gulf Coast to run out of fuel. “The stock market or the price being auctioned on the mercantile exchange during that time skyrocketed. … The merc jumped like $2 a gallon,” Hays says. Because of the decreased supply, the prices jumped at the oil company level, which led to the increased costs being passed to consumers. “So much of the anger was directed at the retailer, but the retailer, if he was actually able to get a load of fuel, he had to pay the increased price for it.”

In the end, Hays says while he is running a business, he recognizes the importance of looking out for the people who are buying from him. “It’s not rocket science,” he says. “We just try to make a little money and pass a good deal on to our customer. Without those customers, we couldn’t stay in business.”


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