Higher octane grades of gasoline – such as midgrade, premium, and super-premium grades – have an increasing role in the Canadian fuels market, and also in allowing automakers to achieve rising fuel efficiency standards. These grades made up a combined 13.5 percent share of retail gasoline sales in 2015. However, the market share percentage of higher octane fuels had been declining significantly, from a high of 23.0 percent of retail gasoline sales in 1996, to a low of 12.5 percent in 2006, and has slowly climbed since. This analysis will consider trends in penetration rates, as well as pricing of higher octane gasoline grades, with a particular focus on premium grade (91 octane) gasoline.
Demand for Octane: The Role of Vehicle Technology and Price
Higher octane grades are generally recommended in higher compression (turbocharged) engines to control the timing of ignition, preventing early detonation, which can cause engine damage and hurt vehicle performance. Smaller turbocharged engines, combined with high octane fuels, can have a significant impact on vehicle performance, increasing fuel efficiency and ultimately lowering GHG emissions. High performance engines are an increasingly essential component in automakers’ compliance strategy for rising fuel efficiency standards. This has resulted in a higher percentage of vehicle sales having turbocharged engines, and by extension, more vehicles on the road that require (or recommend) the use of premium fuel. By 2020, it is expected that turbocharged engines will represent 39 percent of vehicle sales in North America, growing from 23 percent in 2015 (Honeywell), and up from just 7 percent in 2011. This is the primary reason for the recent rise in premium fuel sales in North America.
What caused the significant decline in the use of premium fuel that preceded the recent rise? Largely, it was related to price, and the high elasticity of consumers’ purchasing decisions for these grades of gasoline prior to 2005. Consumers that do not require the use of premium fuel have the ability to easily substitute regular grade gasoline when the price of premium fuel (or gasoline in general) increases. Prior to 2010, only a small fraction of the cars on the road actually required premium fuel, and so consumers simply moved away from its use as gasoline prices rose, giving up the perceived benefits in exchange for lower relative fuel costs. There is a nearly perfect negative correlation between the price of gasoline and the percentage of premium fuel sales between 1996 and 2005 (-0.87); over that time gasoline prices doubled, while premium sales (as a percentage of total volume) was halved. (Figure 1)
The Turning Point: Less Elastic Demand
Sales of premium fuel bottomed out in Q1 of 2006 (just below 7%) and it is likely that this approached the percentage of cars on the road that actually required (or recommended) premium fuel – estimated to be slightly below the 7% figure at that time. This is important in understanding how the relationship between price and premium sales then changed; the correlation became much weaker (-0.17) between 2006 and 2015. While consumers still responded to price shifts with changes in their premium fuel buying habits, the responses were far more inelastic, suggesting that it was less feasible for consumers to substitute their premium fuel purchases with regular gasoline when prices rose. Since that point in early 2006, premium sales in Canada have been driven primarily by two factors: seasonality, and the percentage of cars on the road that require the use of premium fuel.
The Impact of Seasonality
Demand for premium fuel increases in the summer months due to a greater number of high-performance vehicles on the road. This is especially true in Canada, where many performance vehicles will be parked for the winter months and brought out once the roads clear. Figure 2 shows the average percentage of premium fuel volume by quarter, and since 2005 there has been an average increase of nearly a percentage point (representing an 8 percent rise) between Q1 and Q3. This seasonal pattern of premium fuel consumption in Canada has been remarkably consistent from year-to-year.
Rising Price Differentials
Another aspect of premium fuel consumption is the price differential between regular and premium grades. Figure 3 shows the relative stability in the wholesale and retail differentials up to 2008, when they began a fairly steady rise of 5 cents per litre respectively. Both wholesale and retail differentials increased at nearly identical rates, suggesting that the rise was being driven by pricing decisions at wholesale. The average retail margin on premium fuels has remained fairly consistent since 2008.
The rise in the relative wholesale price of premium gasoline is likely a function of both cost pressure and the current inelasticity of premium fuel demand. Relevant cost-related pressures would include: the increased use of heavy oil and cracking units at refineries, as well as the increased use of lighter shale oil, all of which tend to produce less of the high octane blending components required to make premium gasoline. This essentially puts demand pressure on octane at the refinery, and ultimately drives up the price of blending for higher octane.
What is the outlook for premium grades of gasoline? With an expected increase in sales of turbocharged engines, the use of higher octane fuels is likely to increase. However, with price differentials on the rise, it is unlikely that consumers will net any ‘value’ from their fuel efficiency gains. Alternatively, consumers could choose regular gasoline in vehicles recommended for higher octane fuel, in effect, sacrificing engine performance and fuel economy for lower costs. This is one instance where the use of higher ethanol blends (E15 and above) may be a benefit, as ethanol provides a significant octane boost, but can be relatively cost effective.