The Impact of Alternative Fuels

The political momentum to bring renewable energy products to the pumps is strong and growing. But with all the added costs to rebuild the nation’s petroleum infrastructure, is it worth it?

By John Lofstock, Editor.

Preparing for the future is a complex issue retailers should always be pondering. But in the fuel business this question is not easily, if ever, fully answered. What is required today could be irrelevant tomorrow as federal fuel requirements are frequently altered by politics, funding and emerging technologies. 

If you ask experts from across the fuel and automobile industries to predict where the fuel market is going to be 10 years from now you will get answers that vary wildly. Some believe there will be very little change in the nation’s dependence on foreign crude oil, while others are predicting the country could see a dramatic 44% reduction in crude demand by 2025 as Corporate Average Fuel Economy (CAFE) standards and renewable fuel requirements seize control of the automobile industry.

Where it winds up is anyone’s guess at this point, but groups like NACS, the Petroleum Marketers Association of America (PMAA) and the Society of Independent Gasoline Marketers of America (SIGMA), along with leading industry retailers, are investing a lot of time and resources to prepare for future, whatever it may hold.

“We face many questions about where to invest our capital at a time when we are already experiencing a 2-5% decline in fuel demand,” said Carl Boyett, president of Boyett Petroleum and the immediate past president of SIGMA. “Do we upgrade storage tanks or invest in new fuel pumps today knowing that some new fuel standard could come along in five years and require us to completely overhaul our investment? These are tough choices that could have serious repercussions on the long-term viability of any company.”

What we do know is that under the Obama administration a slew of federal requirements aimed at reducing the country’s dependence on foreign oil are gradually set to kick in over the next 13 years. The regulations are a two-pronged attack on crude demand that aim to make new car engines more efficient and to increase the volume of renewable fuels consumed across the U.S.

“Right now, convenience store retailers need to deal with the reality of the situation, which is that under the Energy Independence and Security Act of 2007 (EISA), the Renewable Fuel Standard (RFS) increased the volume of renewable fuels required to be blended into transportation fuel from nine billion gallons in 2008 to 36 billion gallons by 2022,” said John Eichberger, vice president of government relations for NACS. “This reality laid over the miles per gallon (mpg) requirement of 54.5 mpg that is to be implemented fully by 2025 means the industry as whole could be looking at a 40-44% reduction in petroleum demand.”

While Eichberger called such a drastic reduction in consumption the “worst case scenario,” retailers need to take note. As cars do begin to get better mileage, it stands to reason that there will be fewer trips to the gas station for fuel, thus fewer trips inside the convenience store.

But there are other factors to consider that could keep the fuel demand consistent and visits to convenience stores stable. The nation’s growing population means more cars will be on the road 10-15 years from now. The U.S. population in July 2011 was 311.8 million, according to the U.S. Census Bureau. The agency expects the population to continue on a sharp upward trajectory over the next few decades. The estimated population for 2020 is 336.03 million. The bureau expects the population to soar past 400 million in 2043 and reach a staggering 420 million by 2050, nearly double the U.S. population from 1975.

Plus, to get to the 54.5 mpg standard, automobile manufacturers are going to be equipping cars with smaller gas tanks to keep the weight down. That should also help preserve visits to convenience stores and gas stations.

Understanding the Regulations
The proposed 54.5 miles per gallon CAFE standard, to which all mainstream auto manufacturers will be bound, is well in excess of the 35.5-mpg goal set by the current CAFE legislation that runs through 2017. The Obama administration and 13 car companies broadly agreed to this CAFE standard in July.

Some analysts said the automakers, pressured from environmental interests on one side and political interests on the other, may have had little choice but to agree. Others told Convenience Store Decisions that these economy standards will never come to fruition.
“A lot of hoopla that came out of the White House is merely politicking with the environmental community to get credit for something that is probably never going to be implemented,” said Dan Gilligan, president of PMAA. “I would bet that we won’t even be over 50 miles per gallon 20 years from now, let alone 54.5 by 2025. It’s just too hard to get there.”

The good news for fuel retailers is that the new standards that will be implemented will be introduced gradually. Starting with 2011 models, the average fuel economy for cars is required to improve from 27.5 mpg, where it has been since 1990, to 37.8 mpg by 2016. The truck standard has to rise from 23.5 mpg to 28.8. This means cars must improve by 37% and trucks by 23%. Combined, cars and trucks in 2016 should average 34.1 mpg, up 35% from the current 25.3 mpg, a jump of 5.1% per year.

Achieving these goals will require various engine and transmission technologies, as well as improved aerodynamics, tires with lower rolling resistance and materials that reduce weight. Government analysts expect that the incremental costs of better mileage will boost the price of an average 2016 model by $926 (over a 2011 model). On the other hand, the government estimates that each of those vehicles will save about $4,000 in fuel costs over its lifetime.

“As these regulations take effect, it is fair to say that beginning in 2016 the industry can expect to see roughly a 3-5% decline in overall gallons sold,” Eichberger said. “But we need to see how that relates to the number of transactions at the convenience store. With smaller tanks the drop off in transactions may not be quite as significant.”

Renewable Fuels
As with the CAFE standards, the Renewable Fuel Standard aims to make a big impact on reducing foreign crude oil consumption. To achieve EISA’s 36-billion gallon requirement by 2022, the Environmental Protection Agency (EPA) will calculate a percentage-based standard for all fuel manufacturers for the following year. Based on the standard, each refiner, importer and non-oxygenate blender of gasoline or diesel determines the minimum volume of renewable fuel that it must ensure is used in its transportation fuels.

Four separate standards are required under the RFS program, corresponding to four separate volume requirements. The percentage standards represent the ratio of renewable fuel volume to non-renewable gasoline and diesel volume. Thus, in 2012 about 9% of all fuel consumed in the U.S. will be from renewable sources. The proposed standards for 2012 are:
• Biomass-based diesel (one billion gallons; 0.91% of overall fuel consumption)
• Advanced biofuels (two billion gallons; 1.21%)
• Cellulosic biofuels (3.45-12.9 million gallons; 0.002–0.010%)
• Renewable fuels (15.2 billion gallons; 9.21%)

“Currently, the U.S. is importing about 65% of its crude oil and that is just way too much. We have to figure out how to reduce our dependence on foreign energy,” said Scott Zaremba, president of Zarco 66 Earth Friendly Fuels, which operates nine stores in Kansas that feature 16 different types of on- and off-road alterative fuels, including four different ethanol blends and four varieties of biodiesel. “Prices have been stable for a few months, but once demand starts to peak again prices are going to rise and people are going to be looking for relief at the pumps. Alternative fuels provide price relief.”

But widespread use of alternative fuels necessitates a series of costly changes. Right now the fuel infrastructure in place is for liquid fuels that can be modified to accommodate renewable liquids like ethanol and biodiesel. But there are all sorts of automobiles in production that run on everything from natural gas to electricity. Could these power sources compete with liquid fuels? If so, what will that mean for gas stations?

“It would require a major, major overhaul of the entire country’s fueling infrastructure to adopt widespread use of electric or even natural gas,” Zaremba said. “I don’t see how we would ever get there in this economy.”

Change Coming Slowly
Financing the upgrades across the nation’s fuel network is likely going to slow the spread of all alternative fuel sources, especially as tax subsidies for the producers of these fuels, and the consumers that buy them, begin to dry up.

“The transition to alternative fuels to is going to be a much longer journey than Washington wants to admit because the federal government is running out of money. The American people are fed up with energy subsidies, especially after the Solyndra case,” Gilligan said. “The $7,000 tax credit for buying an electric car expired on Dec. 31, and it likely won’t be renewed. That is going to put a big dent in the electric car market. A lot of handouts that have been given to companies to develop fuel cell technology are going away. Change is not nearly going to come as quickly as everyone thinks.”

Just two years ago the Obama administration was calling for one million electric cars by 2014. “Without the tax credit we are not going to see 40,000 on the road by 2014,” Gilligan said. “When reality sets in you wind up with a different outcome. Look at what’s happening with petroleum. With all the drilling in North Dakota and the Canadian tar sands all of a sudden we are cultivating new local sources of crude oil.”

Survival of the Fittest
To Gilligan’s point, just last month Marathon Petroleum Corp. refinery in Canton, Ohio began refining crude oil from Utica shale deposits in Ohio. The company plans also plans to begin refining shale at its refinery in Catlettsburg, Ky. The Ohio Department of Natural Resources estimated that the Utica field has up to 5.5 billion barrels of recoverable crude oil.

“Drilling technology and our ability to find oil and refine will continue to make oil an affordable transportation form of fuel, even with all the natural gas we are finding,” Gilligan said. “So, in the worse case scenario, we could see a 40% reduction in 10-15 years if all of these new fuel sources develop as they are projected. But being a little more realistic, a 10% decline in volume is more likely, which is still very significant for our industry. When those volumes are lost, the smaller, less profitable motor fuel outlets will close because they will likely be hit with a lot of other regulations as well.”

For example, the EPA has recently come out with a new 400-page rule on underground storage tank requirements (see page 28.) When that is all said and done a new round of tank regulations could put pressure on a number of low-volume gas stations to simply close their doors, Gilligan said.

History tells us that massive tank overhauls could dramatically impact the number of stations across the country. In 1998, Gilligan estimated that about 100,000 tanks were shut down, which resulted in about 25,000 stations being forced to close permanently. “It’s mind boggling how much government can dictate the success or failure of a fuel business,” he said. “Retailers have to be able to make money or they are going to walk away from the store.”

Boyett, of Boyett Petroleum, is already seeing stations on good corners closing their doors in California and Florida as they are unable to keep up with new state and federal regulations.

“There aren’t a lot of new sites being built because there are a lot of stores that are in foreclosure in suburban markets across the country that you can buy for one-third of the cost to build a new site,” said Boyett, who operates 10 Cruisers convenience stores in California and distributes Valero, Arco and ConocoPhillips fuels in addition to its proprietary KWIK SERV brand, which is available at more than 50 stations.

Preparing for the Future
One of the problems plaguing Boyett and other operators in dense markets is that there are too many gas stations and convenience stores at a time when it’s difficult to break even on fuel alone.

“The cold, hard reality is there are too many gas stations in the U.S. They need to go away entirely, whether that means converting them to a restaurant, a car wash, a dry cleaner, whatever,” Boyett said. “Nobody is buying stations right now and the banks don’t want them. There are ultimately going to be fewer and fewer people in the business because real estate values are going up. It used to be you could get some value out of the real estate to fund other deals, but the market is so depressed right now that you can’t do that anymore.”

To keep afloat in the future, Eichberger strongly recommended taking advantage of whatever tax subsidies are available to test alternative fuels. “Washington money is tight, but if you can find tax breaks to test biodiesel or upgrade your tanks to carry more ethanol products it’s probably not a bad investment because it gives you some flexibility to stay in front of some of these fuel trends,” he said.

This is a strategy closely followed by Thorntons Inc. in Louisville, Ky. Over the past 12 months the company expanded the availability of E-85 to 20 locations from seven. “Alternative fuels are not a big part of our business, but when we are building a new store or doing a remodel we look for the subsidies that are available to invest in fuels like E-85,” said Tony Harris, chief operating officer of the 162-store chain. “In many cases we are able to add the pumps and upgrade the tanks at very little additional cost to us.”

Building the convenience store as a standalone destination with multiple profit centers is another winning strategy, said Zaremba, of Zarco 66.

“As we transitioned to focusing on alternative fuels we took the time to start investing in higher-end foodservice products and coffees to go after restaurant sales to help put more business under our roofs,” Zaremba said. “That was an important part of our strategy. We recognized that there would ultimately be fewer trips to the gas station, so we are giving customers a reason to keep coming back to our convenience stores when they don’t need gas.”

Similarly, Boyett is looking to build foodservice sales at his chain of Cruisers convenience stores. “The bottom line is that we don’t know what the future holds for us, but we can control our own destiny by getting better in other areas so we won’t have to depend on gasoline,” he said. “There are still opportunities for folks to be successful with gasoline and diesel, but the operators that are going to be the most successful are the ones that offer great service on a great corner. Fuel standards may change, but the need for great service and convenience is the one constant that we can all count on.”

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