Homer Alaska - Business

High fuel prices in rural Alaska, up to $8 per gallon in some communities, are caused by a complex web of transport, storage and logistics costs and the small scale of fuel retail outlets, which creates inefficiencies.

No one is making big profits from the business.

That's the conclusion of two reports prepared independently and released Feb. 18. One report was by the state Department of Law. The second was by the University of Alaska's Institute of Social and Economic Research.

Both reached the same conclusions.

"One of the challenges of being the largest, most geographically diverse state in the union is the logistical cost of transporting fuel to all of our communities, which leads to high prices," state Attorney General Dan Sullivan said in a statement.

Ginny Fay, the ISER economist who prepared the university's study, echoed Sullivan's conclusion.

"Our economic analysis of the rural fuel price situation found that the high costs of transporting fuel long distances to remote and challenging locations that require large storage facilities in isolated communities leads to high prices," Fay said in her statement accompanying the release of the ISER study.

State attorneys doing the rural fuel study had access to confidential financial data from fuel suppliers. Sullivan said that when the high costs are taken into account, "the average rate of return on invested capital for wholesale suppliers was unremarkable."

"While this study does not categorically conclude there have been no illegal practices in rural wholesale and retail fuel pricing, investigators found no evidence of such illegal activity," Sullivan said. "Our investigation included a review of the financial records of these wholesale suppliers."

"Based upon the information examined for the period under review, the rate of return for these suppliers did not appear excessive, and was consistent with typical returns in the fuel transportation industry," the report said.

Investigators found a wide variance in retail fuel prices, sometimes in communities located near each other.

The investigators did not have access to financial data on retail operations, so they were unable to determine if the local markup of wholesale prices were within an appropriate range.

Some rural retailers marked wholesale prices up 100 percent while others sold at much lower margins.

"Retail margins are the result of conditions that vary among communities. Retail operations in rural Alaska are of a significantly smaller scale than they are in urban areas. Accordingly, costs associated with these operations must be spread over smaller volumes, which contribute to higher prices," Sullivan said.

The ISER report concluded that the local community distribution and retail costs add significantly more to the price paid by consumers than did the transportation of the fuel from the refinery to a regional rural bulk tank farm and subsequent shipment in smaller barges to more remote locations.

Shipment of the fuel from the refinery to a small Western Alaska village typically amounted to about $1 per gallon. Local costs added another $1.60 per gallon on average, the ISER report found.

"That's simply a generalization. In reality, retail markups vary sharply by community, and prices are inconsistent. To hold down fuel prices some (retail) owners probably don't collect for all the expenses they should; others may collect more, to help pay for other community expenses," Fay wrote in a summary of the ISER report.

Also, managers of rural retail outlets, many owned by village corporations, were often not charging enough to set aside money for tank maintenance and eventual replacement.

A condition of the federal Denali Commission and the state's Alaska Energy Authority in helping fund bulk fuel tank upgrades and replacements is that the local operators adhere to business plans that include set-asides for repair and replacement.

That has been one factor driving up fuel prices in communities that have benefitted from the upgrades, Fay said.

However, construction of larger, modern tanks in some villages also has reduced costs, for example in allowing delivery of an entire year's supply of fuel in one shipment rather than two, she said.

Fuel distributors and suppliers also have had their share of higher costs in recent years. They have had to repair and replace aging tugs and barges, and to recover the investment in the prices charged for fuel transport. New federal rules requiring the use of double-hulled barges will add to expenses, Fay said in the ISER report.

Bulk purchasing by cooperative organizations has demonstrated that discounts on prices can be negotiated. Alaska Village Electric Cooperative, which operates small rural utilities, does bulk purchasing on behalf of its 53 small rural utilities.

Another organization, the Western Alaska Fuel Group, purchases in bulk and negotiates prices for several Western Alaska communities.

The purchasing power of a large industrial operator also can help local communities bring down fuel prices. Iliamna Development Corp. purchases and transports fuel for several small communities in the Lake Iliamna region and also for the Pebble Partnership, the company exploring the Pebble mineral deposit.

The large volume purchased by the Pebble operator makes the arrangement possible and brings down costs for the small communities that purchase through Iliamna Development Corp.

Fay said there's not a lot that can be done to ease the high cost of fuel in rural communities.

"Conventional interventions aren't likely to produce optimal results," she wrote in the summary of the ISER study.

"There is currently enough competition, or threat of new competition, to cause businesses to minimize costs. Regulating fuel prices would be administratively burdensome, and could even drive prices higher, because distributors would feel free to replace aging equipment with a more certain return on investment," she wrote.

"Fuel price subsidies, another potential option, remove the market signals that cause people to conserve energy when prices rise," she wrote in the summary.

What can work are programs that increase energy efficiency such as weatherization improvements and upgrades in lower power generation and transmission lines, all of which will reduce the use of costly diesel fuel, the ISER report said.

Tim Bradner is a reporter for the Alaska Journal of Commerce.