Home > Reports and Fact Sheets > Regional Variation in Gasoline Prices

Regional Variation in Gasoline Prices

At times, gasoline prices can vary significantly from one city to the next or even from one retail outlet to another. Variations in product prices from market to market across Canada are generally a reflection of differences in provincial and municipal taxes, market structure, local competition and costs. The most important of these factors is the regional difference in provincial and municipal taxes.

The retail margin is the other piece of gasoline prices that varies from market to market. In 2004, the retail margin on regular unleaded gasoline in Canada averaged 4.5¢/L. This margin must cover the costs of marketing and distribution as well as provide the marketers with a reasonable rate of return on their capital. It can differ significantly from city to city. The retail margin represents a very small fraction of the cost of a litre of gasoline.

The Conference Board of Canada (2001) credits most of this attention to the fact that gasoline is the only commodity in our society for which the price is posted on large signs than can easily be read while driving by. They note that both motorists and other service station operators become aware almost immediately of price changes among their competitors. It is because of this visibility that Canadian motorists are very sensitive to gasoline prices and, to save a few cents on an average fill-up, will change service stations for price differences smaller than a penny. For this reason, gasoline retailers are concerned about losing sales and therefore reduce their prices almost immediately to match their competitors.

This type of behaviour leads to a continuous battle over market share in many Canadian cities. Gasoline prices change frequently as oil companies and distributors price their products to meet competition and maintain market share. The result of this competitive environment is that prices seem to move in unison, sometimes from very low to very high levels. As prices fall, the motorist benefits at the expense of the refiner and retailer whose margins are reduced. At the end of a price war, consumers will frequently see a uniform and large price increase. During price wars, gasoline retailers are often selling below cost in an attempt to increase market share. This competitive activity can sometimes lead to large discrepancies in prices between neighboring cities.

Local market conditions in each city ultimately determine the retail pump price and the retail margin available to marketers. One of the primary drivers for gasoline pricing is the average throughput, or sales per outlet in a particular market. This explains why prices may differ from area to area or outlet to outlet. An outlet with lower sale volumes may have to charge a higher price to generate sufficient revenue to cover the outlet's fixed operating costs. Cities with low average throughputs, such as Saint John, New Brunswick, have much larger retail margins than those that have a large average throughput, such as Toronto. Because the retailer with the lowest marginal cost often sets the price for a particular market, the average throughput helps to explain why outlets in small communities tend to have higher prices than retail outlets in large centres.

The number of outlets for a given population size can also be very important in determining the size of the retail margin in a particular market. Although, at first glance, one may anticipate that this is directly related to the average throughput, the number of outlets serving a given population adds another dimension to the analysis. More people visiting a retail outlet provide an opportunity to sell more ancillary products (like snacks and refreshments). This in turn reduces the retailer's dependence on gasoline sales to cover operating costs. In fact, big box retailers such as Wal-Mart and Costco view low cost gasoline retailing as a way to attract customers to their stores and increase their ancillary sales. The emergence of these retailers has reduced the retail margin on gasoline in several Canadian cities.

The number of brands in a particular city or region is another contributing factor to the size and variability of the retail margin. Price wars are far more prevalent in markets with a greater concentration of small, independent firms and price fluctuations are accelerated and amplified in markets with lots of small firms. Stable pricing, on the other hand, is prevalent in markets with few small firms. Therefore, the number of brands in a particular market can have a significant influence on the retail margin.

Other prevailing conditions in a marketplace include the availability and proximity of supply, the different costs of operation and consumers' demands and preferences. These are also important factors in establishing the price at the pump. In each market, the price setter tends to be the lowest cost retailer.

Within local markets, the degree of competition is critical. Price wars, which indicate fierce competition, are most evident in areas where retailers are seeking to increase their market share. Prolonged price war activity often results in the closure of the less efficient service stations. In centres where equilibrium is reached (the players are comfortable with the size of their market share and their return on investment) price wars tend to be less frequent.