July 13, 2006
GASOLINE ZONE PRICING
By: Daniel Duffy, Principal Analyst
You asked (1) for an explanation of gasoline zone pricing, (2) how it affects the retail price of gasoline, (3) if zone pricing takes place in other states, and (4) how the 2006 zone pricing bill would have affected prices in Connecticut.
Under a zone pricing system, gasoline suppliers set their wholesale price according to where a retailer is located. Each supplier decides for itself whether and where to have price zones. Where price zones exist, suppliers consider such factors as local competition among retailers and geography.
Retailers set their own prices for gasoline and consider many factors, with the cost of acquisition being one. As such, zone pricing has an indirect effect on the retail price.
Zone pricing is apparently a national phenomenon. The Federal Trade Commission has studied it at least twice.
Zone pricing legislation has been considered by the General Assembly seven times since 1997. It is controversial because its effect is not predictable. Advocates argue that it will lower prices in high-price zones while opponents argue the opposite. The 2006 legislation and a summary of it is enclosed.
Zone pricing is a gasoline industry practice of selling the same brands and grades of fuel to retail sellers at different prices depending on the “price zone” in which the retail seller is located. Price zones are not established by law. Instead, gasoline suppliers determine their own price zones. They may establish as many or as few as they determine best suits their needs. It is a way of setting the wholesale price.
In a 1997 General Law public hearing, Tom Hinchman of Mobil Oil (now ExxonMobil) described the practice of creating price zones. He said that Mobil, at the time, had 46 different price zones in Connecticut. He stated,
We carefully analyze the competitive conditions in order to determine the boundaries of a given market so that purchases supplied by Mobil in different zones do not compete significantly with each other. The analysis often takes into consideration such factors as competition, gasoline taxes, type of product, traffic patterns, distance, natural barriers such as rivers and parks, and man-made barriers such as highways.
His description of the process did not identify the specific information used or the criteria applied. Mobil, like the other gasoline suppliers, has not identified its price zones.
In addition to not disclosing where the boundaries are, gasoline suppliers do not disclose the price differentials between zones. Hinchman in 1997 said that the differential ranged between 2¢ and 5¢ per gallon. That year, the retail price of gasoline in Connecticut ranged between $1.25 and $1.40 per gallon.
A recent Federal Trade Commission report described gasoline price zones as being “roughly drawn to define an effective area of local competition among retailers, based on geographic features and local demand patterns” (Statement of Commissioners Anthony, Swindle, and Leary, File No. 981-0187). The statement said that the FTC found no evidence of coordination by refiners in their use of price zones or in the zones' geographic locations or dimensions.
EFFECT ON THE RETAIL PRICE
Zone pricing has an indirect effect on the retail price of gasoline. The law does not regulate gasoline prices or determine the way in which gasoline retailers set prices. Retailers consider many factors when setting their prices. These factors undoubtedly include the cost of acquisition. If a gasoline supplier has instituted zone pricing for its products, it will affect the retailer's cost. Retailers will also consider other factors when setting prices, such as the cost of doing business, the anticipated cost of acquiring the next delivery, prices charged by competitors, and a return on their investment.
ZONE PRICING IN OTHER STATES
Zone pricing occurs nationally. The Federal Trade Commission examined gasoline price zones at least twice, in its 1988-2001 Western States Gasoline Pricing investigation and in the 1998-99 investigation of the Exxon-Mobil merger. We found no law in any other state that bans the practice.
EFFECT OF THE 2006 BILL
The controversy over gasoline price zones began in 1997, when the General Law Committee raised a bill that would have prohibited all gasoline suppliers from establishing price zones. It reported a bill that would have allowed suppliers to establish price zones but limited the price differences between zones to 5¢. The apparent rationale behind the 5¢ differential was to allow sellers to recoup higher transportation costs.
The issue has been discussed each year since then, and there have been bills to ban, modify, or investigate zone pricing in 1998, 1999, 2001, 2002, 2005, and 2006. Zone pricing was one of the issues considered by the 1997 Task Force on Gasoline Pricing in Connecticut; the task force, among other things, recommended banning zone pricing (OLR Report 98-R-0205). The bills to ban or modify zone pricing were substantially like either the raised or reported 1997 bills.
Each year, the controversy involves the unpredictability of the effect of the proposed legislation. Under a zone pricing system, suppliers set lower prices in some zones and higher prices in others. Suppliers argue that the legislation will cause them to raise prices in the low-price zones. Retailers argue the opposite, that the legislation will compel suppliers to lower prices in the high-price zones.