Gas pricing is probably the most visible single set of prices in our modern landscape. No other price is prominently displayed on giant signs along our roads and highways. Presidential elections have been swayed by them, and many people base their ideas of how well the economy is doing on how affordable gas is for them.
But what drives gas station pricing and how do gas stations make money?
I recently had a chance to sit down and chat with another professional pricer who had experience with setting gas station prices at one of the major chains. What she said confirmed some things I’d heard before and sent me off to do some additional research so that I could share the findings here.
As with any retail price, the dollars per gallon you pay at the pump are based on a number of different of elements.
The cost of crude oil typically makes up just over 50% of the cost of a gallon of retail gas.
An additional 14% of the retail price goes to cover the cost of refining the crude oil into usable gasoline.
Of these two, the cost of crude oil varies over time, according to the crude oil prices we sometimes see in financial reporting, though there’s a delay in how it affects actual prices at the pump.
Refining is more of a fixed cost per gallon, but there is some variation due to availability of refinery capacity. This can especially come into effect when there’s a major effect on refinery capacity, such as a hurricane which affects the refineries along the Gulf of Mexico.
On top of these costs are federal, state, and local gas taxes, which are included in the retail prices we see at the pump. These average about $0.50/gallon nationally but can vary quite a bit from state to state. If you see the price of gas change significantly when you cross a state line, it’s likely due to the different gas tax rates in the two states, not due to market factors.
Another 8% of the cost of a gallon of gas goes into distribution — getting the gas from the refineries to the individual gas stations using the tanker trucks you occasionally see on the highway or filling up the underground tanks at stations.
This leaves stations with about $0.40/gallon in gross profit on their gas sales. The precise amount will vary, because in addition to following the cost changes they experience from their distributors, gas stations also try to match prices from local competition and will often increase prices during weekend, particularly holiday weekends, while being more competitive during the week. The general industry wisdom is that weekend and particularly holiday drivers are less price sensitive while workday drivers are more price sensitive.
However, gross profit is not what the gas station owner gets to deposit in the bank at the end of the day. Out of that $0.40/gal he needs to pay for the cost of actually running the gas station. All the rest of the fuel price just goes to getting fuel into the pump and paying taxes on it. The $0.40/gal is how he pays the wages of his workers, the rent or mortgage on his property, maintenance, utilities, etc.
Suffice it to say that the actual gas station profit is often going to be only around 1% of the price of a gallon of gas.
However, there’s another way that gas stations make money too, and that’s on the snacks, drinks, and other products they sell in the gas station store.
While the gross margins (the difference between the price the gas station sell the product for and their cost to acquire the product, before they deal with covering operating costs) on gas are a little over 10%, the gross margins on food, drinks, and other merchandise averages around 50%.
This creates a surprising dynamic where although the 70% or more of a gas station’s revenue comes from selling gas, often only around 30% of their profits come from gas sales.
And while in-store sales average 30% or less of a gas station’s revenue, they are often responsible for 70% or more of their profits.
This dynamic has only become more pronounced in recent years as gas stations have seen total gallons of fuel sold decline. According to industry publications, the summer of 2024 saw same store sales in gallons decline by 4.5% versus 2023. And since 2019, the drop is huge: 24% or 20,000 fewer gallons per station sold in the summer months of 2024 versus 2019.
While I would at first be inclined to think this is a result of people driving less since Covid, according to the US government the number of miles actually being driven on US highways is actually up. So fuel industry studies believe that this is the result of the increasing number of electric vehicles and increasing fuel efficiency of gas-powered cars.
As a result, now even more than in the past, although we call the business a “gas station” and getting fuel is the primary reason why people stop there, fuel sales are not what provide gas stations with their profits.
This makes sense when you think about how highly advertised (and competitive) fuel prices are. The price per gallon of fuel is typically advertised on a big sign along the street or highway. Although branded gas stations like Exxon and Shell, charge slightly higher prices than un-branded stations, in general the price of gas is highly competitive and competition between locations keeps the margins on gas itself very low.
As a result, from a pricing point of view, gas prices become a traffic driver which brings customers into the store. But they are low enough that they do not result in much profit.
Instead, it is the less visible prices of incidental products which people buy out of convenience (because they are already stopped at the gas station) which provide the station with most of their profits.
This leads to one of the hints provided by my colleague who had worked in gas pricing: If you want the best prices for gas, seek out the chains that provide the best amenities, such as Sheetz which offers a full fast food drive through. These stations have higher sales of non-gas items, and they often use that edge to take their gas prices a few cents lower than local competition in order to attract even more customers.
After all, for them, gas is not the primary source of profit. It’s a magnet to get people to come buy their food.
By comparison, a station which has only a minimal store attached to it is having to make its money from the gas itself, and so often its gas prices will be a little higher.
This also explains why supermarkets and club stores such as Costco, BJs, and Sams Club often add on gas stations, and when they do typically offer very attractive gas prices. Those retailers already have a working profit model with their main store, and by adding on a gas station they are trying to also capture incidental purchases which might otherwise go to a convenience store. Plus, if your desire to fill up your tank gets you to Costco, you’re likely to go ahead and make a shopping run while you’re there.
Aside from providing insights into how a business we interact with frequently works, it’s useful to think about other businesses in which a highly visible product may not actually be the one which pays the bills, but rather something which brings people in the door.
Reading the article has now made me once again ask a question and wonder, as Levitt asked, "What business are these gas stations in? 🤔"
There is another angle to this. Reviewing it from a controlled market point of view. Even though the margins are strictly defined, it still rings true that the best margins are derived from non fuel income/alternative profit centres at the service stations.