The Economics of Everyday Things - 1. Gas Stations

Episode Date: January 23, 2023

In our first episode, host Zachary Crockett sidles up to the pump to ask:  Who owns your local gas station, and where do their profits really come from? 

US Americans, we just love our gasoline. We use 374 million gallons of gas every day. That's around 30 full tanks for every registered vehicle per year. Now relative to other countries, gas is actually pretty cheap in the US. Considering the sheer amount we use, though, every extra penny counts. When gas gets more expensive, we all look for someone to blame, politicians, oil executives. But the easiest target is the person who has to contend with disgruntled customers face to face. The gas station owner.

When the price of oil skyrocketed last summer, people on the internet created all kinds of memes about how much station owners were making. One shows a picture of Scrooge McDuck skiing down a mountain of cash. It's titled Gas Station Owners Right Now. But are gas station owners really swimming in cash? No, can I yell that any louder? Not at all. It's definitely not what people think.

For the Freakonomics Radio Network, this is the economics of everyday things. I'm Zachary Crockett. Today, gas stations. There are 145,000 gas stations in the U.S. A lot of them have science displaying a logo of one of the big oil companies, but that doesn't mean the company owns the gas station. Eight out of ten gas stations in the US are actually owned by independent operators. They pay oil companies for the right to use their branding and gas. Many of them came here 17 year old, 1976.

And two days after arrival, I was working at a sonic drive in food joint in Jackson, Mississippi. SETTI eventually made his way out to San Jose, California. Refriined from India offered to sell him a gas station with a convenience store. He didn't know much about the business, but he took a risk on it. October 10, 1980, I bought the store and I never looked back. I named it Penny Saver, a convenience store with two fuel pumps. I bought it for $80,000. Wasn't easy, probably worked seven days a week,

14, 15 hours a day, some time, and it was not the best location, but I got the taste of the blood and never stopped. Since then, Seti has owned more than 40 gas stations. He's made good money, but the gas itself is something of a footnote. You know, gas businesses, penny business. We don't count dollars. We count pennies for gallon. How is that possible? Well, the stations are at the very end of a long, complex, and expensive

supply chain. We get the majority of our oil from our own domestic production, primarily in Texas, in New Mexico, North Dakota, Montana as well. That's Garrett Golding, a senior business economist with the Federal Reserve Bank of Dallas. The oil company sells to the refiner. The refiner is going to sell it to a distributor. A distributor is going to sell it to the retail pump station or chain of stations. Golding says that most of what we're paying at the pump covers that very first step of the process, pulling that raw black stuff out of the ground in Texas or North Dakota.

Generally, between 50 and 60 percent of your cost of gasoline is that cost of crude oil. These percentages change quite a bit based on geopolitics, international trade, and a bunch of other factors. But let's say in the current climate, you buy a $4 gallon of gas. About $2 of that is going to cover the cost of crude. It's another $0.70 or so to refine it, $0.40 to move it from the refinery to the gas station, 50 cents or so for federal, state and local taxes. Altogether, you're looking at about $3.60 just to get it to the pump. When all is said and done, gas station owners make about 30 cents for every gallon of gas they sell on average.

And that 30 cents has to cover a lot of overhead. You got maintenance, you got electric bill, you have repairs, you got the rent, you got a pay, and you got all kind of liability, flat protection, slip and falls. So by the end of the day, they're averaging somewhere in the neighborhood of seven cents a gallon of profit. On average, a gas station sells roughly $4,000 gallons of gas every day. At $0.7 per gallon, that's a daily profit of around $300.

So why don't station owners charge more for gas? For starters, they have a lot of competition. Stations are often clustered together and well the guy across the street doesn't always play nice. I lowered a 10 cents and the guy competing with me lower 20 cents. So I lowered 10 more cents. He goes under 20 cents and he was making no money. I said, okay, I'm not gonna play this game so when up 20 cents, he went up 10 cents. It happens all the time.

Did the station owners ever just walk across the street and say like, hey man, let's just keep it at 4.15 in Gallon today? You know, they're not supposed to, but many do. And some don't, some hate each other, and they compete like anything. Station owners usually buy a few days worth of gas at a time, which they store in underground

tanks. Once they load up, their costs are locked in for the next 48-72 hours. But the price of wholesale gas changes every 24 hours. If your competitor buys in at a lower cost, he might be able to undercut you. So you have a choice to make. You can lower your prices and maybe lose money on every gallon of gas you sell, or you can keep a little profit margin and watch your customers go across the street. Ultimately, gas station owners are even more exposed to market fluctuations than their

customers are. You really don't have any leverage to negotiate. The prices set by day, the crude price and the refineries, they all set their prices. Station owners tend to insulate their customers from the ups and downs of the oil market. When crude prices go up, station owners are slow to pass on the extra cost to us at the pump. But when prices finally fall, well, they don't pass along the savings right away either. A station owner like SETI might keep his prices high for a while to make up for the bad

times. In the economics world, the energy nerds, we call this rockets and feathers, where the price of oil can go up like a rocket, but the price of gasoline comes down like a feather. This is a frustrating thing for consumers to witness, but one way that I try to explain this is generally consumers are not getting the full price run up as it is running up and they're paying for it on the way back down. So if gas isn't a big money maker, how do gas stations stay in business? That's coming up.

Back to gas stations. Gasoline draws customers in. But for gas station owners, the core of the business isn't at the pump. It's inside the store. We are a gas station slash convenience store. We also have a takeout restaurant inside, so we try to be a one-stop shop. That's Kai Trimble Lee. She owns a BP gas station in Milwaukee, Wisconsin. And she says that the bulk of her income comes from selling food. What kind of food? Oh, you know, the bad stuff, but that's good stuff. Pork jobs sandwiches, beef polishes to wings, to catfish, to shrimp,

po-boys, the corn beef sandwiches. We got some magic going on. Trimbley operates more like a bodega than a gas station. We sell a little bit of everything. Milk, eggs, bread, we sell fruit. You go to the gas station, you get some gas, and you go get a water. That's the business model. So fruit, you go to the gas station, you get some gas, and you go get a water. That's the business model.

You're definitely going to see more profit in the convenience store restaurant than I would do the gasoline. At J.P. Settys stations, the margins are 3 to 4 times greater inside than out at the pump. We always ran at about 33% gross profit inside the store. Your cigarettes are maybe 15% your beer runs 25% candies 40-45% coffee 50% what are the highest grossing items for you? I would love to sell you ice bags all day long typical ice bag will sell you for $1.49. Probably cost us 49 cents. That's pretty good. That's pretty darn good. But when gas gets more expensive, that business model

gets screwed up. Many of these station owners, anytime we have a big price spike, they make less money as prices go up than they do when prices go down or when they are low. Here's what happens when oil prices go up. Number one, that tight margin on gas gets squeezed even further. Number two, people buy less gas, meaning station owners are doing less volume. And number three, when people buy less gas, they're also buying less soda or bagged ice inside the store. Now you're having to choose do you want two candy bars or just one candy bar? Do you want a 18 pack of beer or a six pack of beer?

Higher gas prices also mean more problems outside at the pumps. For starters, theft. Most tanks are not locked because deliveries come at night so you got this people they have three four hundred gallon plastic tank in their truck pick up truck two three in the morning pitch dark they'll come with a hose open your tank and they will take of it three four hundred gallon gas. So you could lose a couple thousand on the other half of gas in those two, three hours. It's been happening quite a more often than ever before. And those price

wars between stations, well, they get worse too. They are really in the cat and mouse game with each other on who raises prices slowest because as the pump prices go up, consumers are going to go to the station that is three cents cheaper. It's not a great environment for those operators right now at all. Rising fuel prices are not great for business, but beyond that, station owners are facing a bigger problem, one that represents an existential threat to their livelihood, electric vehicles. Sure, today EVs only make up around 1% of all cars on the road, but nearly half of consumers

say that they would consider buying one in the near future. For station owners, installing EV chargers involves ripping up pavement and laying down cables. And the cost can run upwards of $100,000. That's a lot of ice bags. The billion dollar question here for the service station owners is how aggressive do you get with investment in something

that is going to take a few years to really have a broad customer base? Some station owners are waiting to suss things out a bit. Others like Kai Trimboly plan to install electric chargers soon. I can tell you we will have two coming in. I would say within the next year, you know, you have to be realistic with what the future is in telling, so you better try to be a part of it. [♪ OUTRO MUSIC PLAYING [♪

For now, there's at least one silver lining for gas station owners, as JP Setti discovers when his own car is running low. Are you gonna go to my own store, pay my own gas? Ha ha ha, That must be nice. At least I can make 30 cents a gallon. For the economics of everyday things, I'm Zachary Trockett. This episode was produced by Sarah Lilly and mixed by Jeremy Johnston with help from Greg

Ripon, Emma Torell and Eleanor Osborne. Our executive team is Neil Karruth, Gabriel Roth, and Steven Dubner. You're gonna motivate me to go find one. The Freakonomics Radio Network, the hidden side of everything. Stitcher. you