Implications of Recent Trends and Changes within the Supply Chain of the UK Petroleum Retail Market

Answer

Implications of Recent Trends and Changes within the Supply Chain of the UK Petroleum Retail Market

This construction presents the implications of recent trends and changes within the supply chain of the UK petroleum retail market. In order to better understand such implications, it first uncovers the general picture of the petroleum retail market in the UK including aspects such as size and main drivers of demand and the way these have changed over time. It also looks at how technological changes are likely to impact the retail industry in the next one decade.

Petroleum Retail Market

Definition and Size

In the context of this construction, the UK petroleum retail market shall mean sales of diesel and petrol from forecourts (commonly called petrol filling stations- PFS) of retail fuel in the UK. Overall, total retail sales volume went up from almost 28 million tons in 1997 to a high of more than 29 million in 2007 (Energy Institute 2009, p. 47). Since then, there has been a significant decline in recent years, bringing the volume to below 27 million tons. Notably, retail volumes of diesel have gone up whereas retail volumes of petrol have come down. In terms of worth, the value of the UK petroleum retail market has been going up with time, a fact owed to rising diesel and petroleum costs.

Prices of Retail Fuel

According to the Energy Institute (Great Britain) (2009, p. 11) the prices of retail diesel and petrol have gone up significantly in recent decades. In fact, they are more than double now than what they were in 1991. Imperatively, the changes in retail prices coincide with those of prices of crude oil. However, the magnitude of these changes varies (between crude oil and retail fuel) since prices of crude oil are only one part of those of retail fuel. Prices of retail fuel are also influenced by the costs associated with refining crude, storage, transportation, distribution, and duties and taxes (Institute of Petroleum 2004, p. 26).

Retail Prices Breakdown

Retail fuel prices consist of the following components:

Product cost/ex-refinery price: is the wholesale price of fuel.

Retail/ex-refinery spread: includes profits and costs of fuel retailer and fuel wholesaler. Major costs include transportation, marketing and promotion, as well as operation costs.

Fuel duty and VAT: this component is charged by the government.

Market Size Key Drivers

Retail price and volumes of the fuel sold stand out as the key market size drivers. The following factors drive volumes of fuel:

• Total number of vehicles-The number of households owning cars in the UK has increased significantly and this has implications in terms of fuel usage (Department for Transport 2011, n. p).
• Fuel type
• Average annual mileage
• Average fuel consumption (of vehicles)

Note should be taken that the impact of the factors above on market size varies as is evident when considering that some (like increase in number of vehicles) leading to more fuel consumed whereas others (like decrease in yearly mileage) implying less fuel consumption. Currently, higher prices of fuel, better fuel consumption, and less mean vehicle distances are leading to a declining (or flat) market as regards total volumes, although the total number of registered vehicles is going up by the day. A direct implication here is that petrol filling stations are operating and competing in an ever-contracting market. Arguably, trends in decline of petrol volumes and growth of diesel volumes is unlikely to change in the future, especially considering the present benefit-in-kind and road taxation regimes that levy relatively lower taxes on vehicles using diesel on grounds of their low carbon dioxide emission (Niewenhuis and Wells, 2003, p. 19)

Changes in the UK Petroleum Retail Market

It is imperative that these changes be understood, so that implications can also be better explored and comprehended.

Indeed, an array of significant changes has occurred in the petroleum retail market in the UK in the last few decades. The changes are summarized as thus:

• The number of petrol filling stations has decreased drastically from almost 38,000 in 1970 to the current figure of less than 9,000. This implies more than three quarters of PFS have been closed down. In as much as the closure rate has significantly reduced in the last few years, the closure trend is likely to have (as it has) implications in the larger retail market.
• The closure of petrol filling stations basically comprises closure of company-owned and dealer-owned stations, while on the other hand hypermarkets-owned stations have continually grown and/or expanded. Cohen (2008, p. 205) informs that the growth of hypermarkets in this context coincides with growth of hypermarkets in grocery retailing. Naturally, hypermarket-owned entities are associated with more fuelling positions and higher sales volumes when compared to those that are company-owned or dealer-owned. This development has led to higher market share by volume than by number of petrol filling stations.
• Business models employed by independent dealers continue facing a lot of pressure, a direct result of competition from and other company-owned sites, more so on price.
• Non fuel sales, more precisely convenience store sales, have over time become increasingly significant in boosting the viability of a petrol filling station model (Massey 2006, p. 5). These non-fuel sales present excellent opportunities for larger players to grow. The result has been growth of big independent dealers (like Rontec) with multiple petrol filling stations. They are better positioned to take advantage of economies of scale, therefore developing compelling convenience stores at their petrol filling station sites.
• As concerns supply, (in recent decades) there has been a certain level of rationalization of secondary distribution networks and distribution terminals (including tankers). Major oil firms opt to outsource their operations (as may have to do with road distribution). This has resulted in efficiencies as well as savings on costs in the sector. With more petrol filling stations closed, there has been a reduction in the system’s space capacity.

What potential risks emerge for the petroleum retail market in the UK?

Currently and in times to come, major risks in the petroleum retail market are:

• It is unlikely that the pressure on PFS (especially dealer-owned) business models will cease. In particular, smaller independent dealers owning only single sites will face more pressure due to competition and constraints related to working capital. Besides, fuel suppliers are now offering different forms of contracts that are fundamentally without the component of ‘margin protection’, implying business owned by independent dealers are more exposed to wholesale prices. Arguably, these pressures are likely to culminate in more closures. In the same breath, hypermarkets are expected to grow and dominate the stage even more.
• The storage capacity of petrol filling stations will reduce due to closures. Nevertheless, considering that most independent dealers do not fully put into use and maximize their storage capacities, it implies reduction in fuel stock held in the ground is far less compared to storage capacity reduction.
• It is likely that the minimum time it takes to drive to a filling petrol station will increase due to expected further closures. Closure would also mean a reduction in the number of petrol filling stations conveniently reachable within considerable driving time. Note should be taken that the degree of impact of this development will vary from one region to another, much the same was as in types of areas-can be urban or rural.
• The fuel supply chain may further be fragmented if major oil firms exit from the downstream and/or upstream petroleum market(s).
• There is likely to be more dependence on imported petroleum products since the hypermarket-owned petrol filling stations mainly import their fuel through independent fuel suppliers. All the same, overreliance on fuel imports is highly likely if more refinery closures occur in the UK.

What are the implications for resilience besides security of supply in the UK arena?

In the context of this report, energy resilience shall mean the system’s capacity to cope with or withstand short term disruptions (to supply). As for security of supply, it shall mean the system’s capacity to squarely and securely meet fuel demand in the long term. Key implications of recent trends and changes (in the UK petroleum retail market) are presented below:

Storage capacity of petrol filling stations

Concerning supply, the PFS network’s onsite storage capacity will be greatly reduced by further closures. The percentage reduction of storage capacity in recent years has been high, although note should be taken that most PFSs closed were those of smaller capacity. Now that the remaining petrol filling station sites have a bigger storage capacity, further closures will significantly impact the system. For instance, in time of disruptions, days of cover will be reduced hence negatively affecting the system’s energy resilience. In consideration of the fact that the number of petrol filling stations being closed is more than the number of new ones being opened, limitations arise as far as overall expansion of overall storage capacity is concerned (with minimum capacity requirements being placed on PFSs) (Rics Valuation Faculty, & Trading Related Valuation Group 2008, p. 27). In addition, deliberations with industry stakeholders suggest that costs associated with upgrading of capacity could be significantly substantial. The implication here is the potential to improve the system’s resilience by facilitating expansion of capacity is limited.

Fragmentation of the Supply Chain

Barnet and Bubley (2004, p. 6) present that considerable fragmentation has been witnessed in the supply chain of fuel in recent years. This has included storage terminals being rationalized, fuel road distribution networks being outsourced, and major oil firms exiting from the refining scene. Due to these changes, the spare capacity of the system has been dented, in as much as the efficiency of the supply chain may have improved. For instance, the capacity of the road tank distribution network has been significantly reduced. Overall, these changes are likely to reduce the system’s resilience in the event of disruptions to the supply chain.

Importation of petroleum products versus domestic production

The growth of hypermarkets witnessed in recent years is likely to continue. The operating arrangement in this context is that hypermarkets source products from independent suppliers who mainly import the same (Hunt and Evans 2009, p. 23). If this arrangement is maintained, it is highly likely that imports of fuel will continue meeting the local demand in the UK. In this breath, imported petroleum products will penetrate the local market and thus increase not only the system’s resilience but also the security of supply. This will be possible through an increase in flexibility (of the chain of supply) even in the event of disruptions in the domestic refinery supply. Quite conversely, more imported petroleum products would mean more exposure (of the UK) to the international supply chain of petroleum products (Institute of Petroleum 2007, p. 37; Wlazlowski 2007, p.75)).

More sites with higher volumes

As already mentioned, hypermarkets are dominating the market as they own more petrol filling stations whose sales volumes are higher than those of dealers and companies. Hypermarkets are able to meet high demand by constantly refueling their storage capacities considering space limitations and additional costs that would be incurred if larger storage was to be installed. The implication here is that during supply disruptions, these sites are likely to run dry quickly since they rely on frequent refueling.

Access of petrol filling stations by consumers

Closure of petrol filling stations has also affected consumers in terms of limited choice and reduced access in some regions. It is not disputable that if the trend of closure continues, the aspects of choice and access will deteriorate; implying consumers may have to drive longer distances to reach the nearest filling station. The scenario would be worse in case of disruption in supply where the nearest station would run dry and force customers to drive even further to reach a station with fuel.

The tank capacity of vehicles

It is possible that consumers may not be able to fill their vehicles’ tanks every time they go refilling (at a PFS). This would significantly affect the system’s resilience since fuel stocks in vehicle tanks at any given time would be less, meaning the number of days of cover would also be less especially if disruptions last long.

Impact of technological changes on the retail industry for the next decade

Technological changes are expected to impact the retail industry in a number of ways, some of which are highlighted below:

 Besides green building design, an important yet seldom talked about environmental impact and/or aspect of retail anywhere in the world is underlying efficiency in terms of space. Notably, a good percentage of retail inventories in the UK are made up of enclosed malls. Considering technological advances even in design and architecture, it is expected that much of the inordinately high percentage of retail space per capita that is largely unproductive will be converted to yield more inventory per square meter. Arguably, there is going to be a shift from enclosed mall construction to outdoor formats which will offer tenants lower rents as there will be no need of maintaining climate-controlling enclosed common areas.

Quite conversely to the above argument, technology is likely to affect development patterns which are known to have a direct co-relation with fuel prices and the retail landscape in general. With advances/changes in technology, there is likely to be shrinking shopping distances with related infrastructural improvements. That would increase the potential for community-sized retail nodes. Developers will be prompted to think locally as road congestion and perhaps increasing retail prices will work to the effect of increasing the constraint of retail distance for customers.

Indeed, the world is moving towards a tipping point as far as the development of energy-related technologies that could yield      higher energy productivity, perhaps on a scale not witnessed since the Industrial Revolution (Benes at al. 2012, n. p). In the coming decade, it is highly likely that some technologies will prove disruptive to the petroleum retail industry. Such technologies include electric vehicles, unconventional gas, solar, as well as energy from light-emitting diodes. Their development on scale might come as a surprise for many retail managers who have perhaps been watching them develop for years but cannot believe they can reach an appreciable scale any time soon. The accelerating pace of transformation in energy could mean that in the next one decade, some technologies might achieve commercial viability and as such affect the petroleum retail market by tilting prices as may be dictated by competition, reliability, efficiency, and customer preference. As it were, it is possible that technology advances significantly on the margins over long periods of time but does not significantly affect established players. In the coming decade, developing technologies may maintain their uneconomical position on average, though that might be the time innovators make breakthroughs.  Notably, once a given technology is pocket-friendly and delivers performance considered materially superior to the status quo, there is likelihood that it will be adopted and embraced en masse. Overall, such technologies can render current business approaches in the retail industry untenable, maybe in less than a decade. Looking at this through an economic lens, a decade is not so long a period. Technological developments mean changes in the manner the world produces and utilizes energy. From prices, efficiency, operations, and approaches to customer preference, the petroleum industry is likely to be affected.

Conclusion

In light of the implications discussed in this construction, it remains to be seen how different players in the UK petroleum retail market will react to changing circumstances, especially as may be precipitated by different categories of market drivers. Indeed, hypermarkets, company owned sites, and independent dealers have different capacities to respond to contextual trends and changes. Most certainly, considering hypermarkets’ scale as well as financial position, they have a better capability of dealing with various business drivers in the petroleum retail market. It is expected that they shall continue to effectively bargain in business deals with suppliers.  As for company owned sites, it is highly likely that parent companies will remain under financial pressure to act to the effect of reducing costs. Smaller independent dealers seem to be the most vulnerable to current trends and changes. It is also clear the retail industry will be affected by technological changes in aspects like price, efficiency, operations, approaches, and customer preference.