PMAA: U.S. Petroleum Marketers Facing Dramatic Change

Phillip R. Chisholm
Executive Vice-President

• U.S. Marketers' Makeup [54626 bytes]
• U.S. Marketers' underground storage tank cleanup status [31080 bytes]
• Regulatory delays affecting site cleanup [38031 bytes]
• U.S. refiner sales of gasoline by distribution channel, 1995-1996 [53416 bytes]
• U.S. refiner sales of petroleum by distribution channel, 1995-1996 [68791 bytes]
• Marketer investment, 1994-1997 [58300 bytes]

For U.S. petroleum marketers today, change is a way of life.

In fact, one might argue that the only constant in the life of a petroleum marketer is change. And both his previous and future business success depends on how he handles and adjusts to an almost constantly shifting landscape.

As petroleum marketers plan ahead, there are several factors with which they will have to contend if they hope to remain viable in an increasingly competitive marketplace. These factors include government regulations, supplier consolidations, and the competitive marketplace.

None of these are particularly new developments, with the possible exception of supplier mergers. But even there, marketers have previously witnessed and responded to such events as the Chevron acquisition of Gulf and Texaco's consolidation with Getty in 1984.

But while the factors themselves are not new, U.S. marketers will face different twists on each which will again challenge their ability to remain efficient and innovative.

Government regulations

Perhaps the greatest myth in petroleum marketing is that decontrol of gasoline and crude oil occurred in 1981, when President Reagan removed the price and allocation controls that had plagued the industry for nearly a decade.

In reality, one set of government controls were substituted for another-only this time the controls were incrementally applied. While these new controls-represented by legislation with names such as Resource Conservation and Recovery Act (RCRA), Comprehensive Environmental Response, Compensation and Liability Act (Cercla), Clean Air Act Amendments, and the Oil Pollution Act-did not directly control the price and supply of petroleum products, their indirect impacts were, and remain, considerable.

Marketers got their first sign of regulatory relief in 1994 with the election of a Republican Congress and promises of a new day in Washington.

While the performance has not yet matched the hype in terms of reduction in the number of regulations applicable to marketers, the increase in new laws placing additional restrictions on businesses has been slowed considerably.

On the plus side, Congress passed and the President signed the Small Business Regulatory Enforcement Fairness Act.

Although still untested, the act holds real promise to protect small companies from regulatory agencies run amok.

But while there has not been a rash of new laws in the last 3 years, the effects of all the old ones remain strong. As a result of regulations required by RCRA, passed in 1986, marketers must have all of their underground storage tanks upgraded by Dec. 22, 1998. According to PMAA data, fewer than 40% of all marketers have completed this process, less than 20 months from that deadline (see related story, p. 43).

Last December, EPA issued new proposed standards for ozone and particulates that will force marketers to spend more to comply with the new standards.

Most recently, EPA finalized regulations to include petroleum bulk storage terminals in the list of companies that must report under the Toxic Release Inventory (TRI) program.

So while there has been a reduction in the passage of new laws adversely affecting marketers, effects from regulations implemented under the old statutes continue almost unabated.

Enforceability question

But all of the historic regulatory challenges facing marketers may not match the unique problem that may be on the horizon.

That problem is how-and in some cases if-all of these regulations will be enforced.

Ten years ago, a suggestion that the regulations might not be enforced would have been laughable. Suggesting that marketers would be interested in aggressive enforcement would have also been a howl.

But today, with a shrinking federal budget and with more pressure applied to state resources, the prospect of enforcement is both a question and a concern.

The concern is best seen from the 1998 underground tank upgrade requirements. Marketers have spent millions of dollars in anticipation of being in full compliance by the deadline. They have also closed thousands of facilities that did not justify the upgrade investment.

In choosing whether or not to upgrade a particular facility, a number of factors had to be considered. Not the least of these is the relative profitability of the facility after 1998, when many competitive facilities would either have to make the same investment or else shut down. What if those competitive facilities neither upgrade or close down? Will there be a "cop on the beat" to ensure compliance with the law?

Among many marketers, there is concern that the "cop" will not exist. Those concerns are not assuaged by conversations with federal and state environmental officials.

Unfortunately, where this program may be headed is where marketers may see other regulatory programs move in the future: self-enforcement.

Today some marketer groups (not PMAA) have suggested various means of having these regulations enforced. One idea is to make it illegal to deliver product into a tank that has not been upgraded. This ignores the issue of how one knows whether a tank has been upgraded or not. Another suggestion (again not by PMAA) has been to pass state laws giving marketers the right to sue other marketers who may not be in compliance with the regulations.

For its part, EPA has tinkered with the idea of third-party enforcement but has been inconsistent in its approach to that idea. EPA participants in an ASTM committee rejected third-party enforcement as part of a compliance program dubbed Alice. However, only a month after that meeting, EPA circulated to the states a document touting third-party service programs, including a Pennsylvania program on third-party enforcement.

As a result of all this uncertainty, the ultimate irony may occur: Marketers, who have historically been the most vociferous opponents of government regulations, may themselves be the ones pleading for state and/or federal officials to come out and enforce the law against non-complying marketers. This may be the only way they can protect the "investments" they make in complying with existing laws.

Supplier consolidations

It has been a common belief among marketers that two of the most important ingredients to their survival is access to supply and the flexibility to shop among suppliers.

One, if not both, of these is being challenged as major suppliers seek to reduce costs and improve efficiencies by merging. Tosco has acquired the refining and marketing assets of Unocal; Diamond Shamrock and Ultramar merged and now are attempting to buy Total North America; Citgo and its parent Petroleos de Venezuela SA acquired the other half of Unoven it did not already own.

But perhaps the poster child for downstream mergers and acquisitions in the 1990s is the Shell-Texaco alliance. This alliance merits that status for two reasons: First, both companies are strong marketer companies with nationwide brand recognition; second, if government officials do nothing to prevent this merger from going forward, it will open the floodgates for additional, previously unimagined alliances.

Already, Marathon and Ashland have struck a deal. The trade press is full of rumors that Amoco and Mobil are looking to combine, and the latter company is already part of a joint venture with BP in Europe.

Marketers intellectually understand why these mergers are occurring. After all, mergers and consolidations among marketers have been occurring for the past 15 years. However, understanding does not lessen marketer fears that the outcome for them will not be positive. Fewer suppliers means less flexibility; less flexibility for the marketer means greater control for the supplier. Greater control for the suppliers probably means fewer marketers selling much larger volumes.

This latter result could be positive for those marketers that are among the chosen few but is little solace for smaller marketers who may not be able to meet minimum volume requirements in contracts or comply with restrictive provisions in franchise agreements.

Perhaps the most negatively affected marketer in this brave new world will be the one whose primary business is commercial accounts. Suppliers looking to build retail market share may not be interested in the business of a traditional jobber that serves farmers and small fleets.

The wild card in all of this will be the extent to which access to independent supply continues to exist, with the most likely source being imports. Foreign producers who are left out of the musical chair dance currently taking place among major domestic suppliers may welcome the opportunity to provide product to independent marketers seeking to maintain their independence.

In exchange, the marketers must remain vigilant against any efforts to impose fees, tariffs, or other restrictions on those imports.

Competitive marketplace

Perhaps the greatest challenge for marketers in the next decade will be a familiar one: surviving the rigors of a competitive marketplace that will undergo some significant changes.

Perhaps the most significant change will be the entry into the market of large, nontraditional motor fuel vendors. These include the large grocery store chains that already are a major factor in Texas and "price club" type wholesale outlets with pumps in front of the facility. Some predict that the future of gasoline marketing in America will be the large hypermarts that populate Europe-one-stop shopping for food, gasoline, groceries, and almost anything else you want.

Perhaps the biggest threat these facilities pose to traditional gasoline marketers is their motivation to be in the gasoline business. The owner of one grocery chain was reportedly quoted as saying that his company wrote off their losses on gasoline as an advertising expense of the company. Advertising is designed to bring in more customers and, historically, cheap gasoline has proven to do likewise.

How does a traditional marketer compete with this philosophy? He probably can't, unless he adopts a similar philosophy and has another profit center large enough to justify his losses on gasoline. We all know that advertising strategies change over time, and perhaps these chains, faced with mounting government regulations coupled with their losses on gasoline, will seek to invest their "advertising" dollars elsewhere.

However, it will be difficult for the typical marketer, competing against such an operation, to survive long enough to see if that will ever happen.

Notwithstanding the challenges from these large nontraditional motor fuel retailers, marketers must also continue to meet the competitive challenge of competing against each other. And the future promises to be just as intensely competitive as the past.

The good news is that marketers will likely face less competition from outlets owned and operated by major oil companies.

The number of direct-operated outlets is on the decline and will likely continue. One reason for this is that suppliers, utilizing franchisees, may be able to retain the same type of control over their retail market share provided by operating their own stations.

This can be and is being done through restrictive franchise agreements that limit the franchisee's flexibility. This frees up supplier capital, which might otherwise be invested in retail stations, to be used for refinery upgrades and other purposes.

Perhaps the greatest marketing challenge in the petroleum business will be the ability of marketers to either differentiate their product from that of their competitors (is brand differentiation enough?) or to add value to the product by adding service.

The best historic example of this has been marketer participation in the cardlock programs. Commercial users purchase product from a cardlock, usually without a posted price, and get billed once a month. The marketer adds value by billing once a month, thus avoiding the need for drivers to carry cash, and by providing detailed records that allows the customers to know precisely where and when fuel was purchased and, in most cases, eliminating the need for the customer to maintain his own underground storage system.

Marketers in the next decade will again be searching for other marketing strategies that allow them to add value to what many consumers believe to be a fungible product.

Conclusion

Making predictions about the oil industry is as about as risky as a novice visiting the dog track for the first time and generally less successful.

The past is littered with the theories of economists, journalists, and others who have tried to make sense of the petroleum marketplace, only to be proved dead wrong.

Despite that, if one accepts the propositions advanced here, then there are some conclusions that may be reasonably drawn:

• First, there will be fewer and fewer independent marketers; however, those that remain will likely be considerably larger than the average marketer today. The bad news is that the industry has always been driven by volume, not necessarily profits. As a result, larger has not always equated to more profitable. The push for volume by suppliers is likely to continue. Successful marketers will figure out ways to make it profitable volume.

• Second, there will be a decrease in the number of marketers that have multiple branded motor fuel suppliers. This is the logical consequence of the supplier mergers. If there are fewer suppliers, these suppliers may insist on a greater degree of brand loyalty than in the past. An unfortunate consequence of this may be that marketers become less independent as fewer suppliers have the opportunity to choose the franchisees they want and who are willing to accept the terms of the franchise agreement.

• Third, marketers will continue to seek ways to diversify their businesses. This is necessary, given that the marketplace will remain intensely competitive; that businesses will demand a high level of investment to comply with environmental regulations; and that motor fuel will, in some cases, be used as a loss leader to promote other products. Marketers in the recent past have not been able to count exclusively on being profitable in motor fuels to sustain their businesses. There is no reason to believe that trend will change. Diversification will likely take two forms. One form will be an attempt to sell other products along with the motor fuel. This would include, but not necessarily be limited to, convenience stores and fast-food tie-ins. The second type of diversification is one where companies try to differentiate themselves from competitors or add value to the product such as with cardlocks. Marketers have an entrepreneurial spirit that allows them to find the right niche in their market that only they can fill.

• Fourth, marketers will operate more sophisticated businesses. This will be the consequence of operating a fairly large company in a heavily regulated and highly competitive environment, as well as keeping pace with the technological advances that are occurring almost daily. These advances will take the form of changes in the operational aspects of the business, such as improved pump technology and the transfer of information over the Internet. It will also take the form of improvements in automobile technology as cars that get better mileage and need less maintenance roll off the assembly line. While the companies remain primarily family businesses, the successful ones will integrate outside experts into the mix in order to deal with the ever-changing environment. These "outsiders" will have greater opportunity to both advance within and possibly, one day, run the company.

• Fifth, marketers will remain strongly opposed to new laws and regulations that restrict their business. However, they will be more focused on seeing the laws and regulations now on the books-with which they have complied-enforced. Some marketers will go to previously unheard-of extremes to ensure that a non-complying competitor gets caught. This almost certainly will include reporting the competitor to state and federal authorities and may also result in citizen suits against the competitor.

• Finally, the success or failure of marketers in the future will not be very different than it has been. It will hinge on the ability to read and react to the changing circumstances that they face. Most of the marketers in business today have demonstrated their resilience. They survived the oil embargoes and the price and allocation controls of the 1970s. In the 1980s, they survived the carnage that followed decontrol; they survived the onslaught of laws and regulations that required, in some cases, millions of dollars of investments; they survived the supplier consolidations that were forced by T. Boone Pickens' and other such efforts to liquidate major companies. In this decade, they have survived the Persian Gulf War and the price inversions that followed; they have survived even greater regulatory costs imposed by laws that were previously enacted. They have survived natural disasters and efforts by their government, their suppliers, and indeed their fellow marketers to put them out of business.

They will survive in the future because they fill a need in their market, a unique market that is one of thousands that exist all across the U.S. Because all of these markets are different, they defy being accommodated out of a national office in Houston or Chicago or Los Angeles.

Marketers will survive, and indeed prosper, because they understand the special needs of their market and fill those needs better than anyone else.

PMAA: U.S. marketers marking progress on UST compliance

U.S. PETROLEUM MARKETERS ARE continuing to expend money and time in an effort to comply with the U.S. Environmental Protection Agency's underground petroleum storage tank (UST) regulations.

Outlays for financial assurance, UST equipment, and site cleanups continue to be considerable, says the Petroleum Marketers Association of America in its 1996 summary report of UST compliance status, released earlier this year.

Marketers are currently in compliance with EPA's financial assurance regulations and leak detection requirements and are moving steadily toward compliance with the December 1998 deadline on UST technical standards.

Marketers report that, as of yearend 1996, 65% of total USTs were in compliance with EPA technical standards, up from 61% in 1995. At the marketer level, 32% reported that all of their USTs have been upgraded, and 60% have brought more than half their tanks into compliance. Only 20% had no tanks in compliance, down from 23% in 1995.

Of the 68% of marketers not in full compliance in 1995, 6% expected to complete their upgrades in 1996 and 33% by yearend 1997. Almost 57% of those surveyed last year said they do not plan to reach compliance until 1998, and 4% will not reach full compliance by the deadline.

Increasing compliance rates also are reflected in expenditure data that show 63% of marketers in 1996 reported some type of equipment outlay during the year, with an average of $95,000. Average spending is expected to increase in 1997, with total equipment outlays (projected by 57% of marketers) averaging $120,000.

Marketers also continue to face large cleanup spending, although the proportion of marketers that conducted a cleanup in 1996 declined to 38% from 42% in 1995 and 50% in 1994. Marketers involved in cleanups reported spending an average of nearly $120,000 cleaning up 1.5 sites each. Per site costs averaged about $95,000.

The huge expenses associated with EPA regulations have mushroomed marketer demand for capital. At the same time, lender liability concerns have reduced the availability and increased the cost of financing for marketers. Almost 90% of marketers in 1996 said that banks are less likely to grant loans because of concerns over liability. Ten percent of marketers applying for a loan were rejected, most because of bank liability fears, and 2% of all survey respondents did not even apply for loan because they were told in advance that they would be rejected. Of marketers that obtained a loan, 41% reported that loan terms were made more stringent because of lender liability concerns.

Financial responsibility among U.S. independent marketers continues to be high, with only 5% of them reporting that they are without coverage. The majority of marketers, 79%, continues to rely on state funds, although this percentage fell the past 2 years-mainly because of financial woes in various states.

On the other hand, the percentage of marketers with private pollution liability insurance increased last year to 24% from 17% in 1995. Eleven percent of marketers report reliance on some other type of method. Of marketers with state fund coverage, only 36% characterized their fund as financially sound, while 37% said the fund was adequately funded but in need of capital, and 26% called their fund inadequately financed.

Marketers, who have historically been the most vociferous opponents of government regulations, may themselves be the ones pleading for state and/or federal officials to come out and enforce the law against non-complying marketers. This may be the only way they can protect the "investments" they make in complying with existing laws.

There will be fewer and fewer independent marketers; however, those that remain will likely be considerably larger than the average marketer today. The bad news is that the industry has always been driven by volume, not necessarily profits. As a result, larger has not always equated to more profitable. The push for volume by suppliers is likely to continue.