Thursday, July 10, 2008

Prepaid card allows consumers to speculate on gas prices

(Naked Capitalism) Every bull market has its Pets.com moment. The oil market's may have just arrived. Is a market top is nigh?

The newsletter Springwise, whose theme is "new business ideas for entrepreneurial minds" showcases MyGallons.com:
Today's high gas prices are already forcing changes in the way many consumers live, but it's a pretty safe bet they won't look so bad in a year or two. A new service from MyGallons.com lets consumers prepurchase gas and lock in today's gas prices for the future.

Consumers who sign up for a MyGallons Card begin by paying an annual membership fee of USD 29.95. Up to three cards can be linked to one account, and the membership fee is backed by a 100 percent money-back guarantee if the consumer doesn't save money on at least one redemption during the year. Members can then monitor their current MyGallons price—a fluctuating quote that's good for purchase of unleaded gas at a particular point in time, including estimated local taxes—and prepurchase gas when they deem the price worth locking in. Purchasing gas is simply a matter of visiting a participating gas station, where the MyGallons Card is accepted much like a debit card, complete with four-digit PIN. The number of gallons pumped is deducted from the consumer's MyGallons account balance, with adjustments automatically made for more expensive grades or types of fuel and price differences caused by tax discrepancies or other local variations. If the consumer pumps fuel from a filling station for less than the lower end of the MyGallons range on that day, he or she will receive a credit, in gallons, to his or her account.

More than 80 percent of the prepurchase money consumers spend through MyGallons is placed in an escrow account and invested in money markets and US government-backed notes; the remainder is used for financial transactions to accommodate gasoline price changes, MyGallons says. There are no time limits on using the prepurchased gas, so consumers can save it for as long as they want, provided they maintain their MyGallons membership.

After a pilot program beginning in April, MyGallons.com just recently underwent a public launch. Due to an unexpected, last-minute pull-out by US Bank, it is in the process of negotiating with other payment networks to allow the MyGallons Card to be accepted at most stations in the US that already accept credit cards. Nevertheless, the service promises to be a taste of what's to come.

Now I will admit to not having thought about this concept too deeply (my instincts say it is certain to be a bad idea), but this screams basis risk to me. The company will (hopefully) have lots of retail customers making bets on gas prices. I see at least two problems. The first is presumably the software will aggregate the total "I want today's price" periodically, since each of trades will be way too small to hedge individually. How often do you aggregate them? Daily? How often do you change the posted price in the system? Even in a day, gas prices can move a lot.

Moreover, MyGallons has no idea how long it will be before consumers will buy gas at the locked in price, so how far forward do they buy futures? As we have discussed elsewhere, rolling contracts monthly has pretty high costs. This is a new concept, so they've had to make up some big time assumptions here if they do make staggered forward purchases. Yes, they get the float, but in a low interest rate environment, the yield on cash won't offset all that much risk.

Second, gas prices vary HUGELY over the US, partly due to differences in state taxes, partly due to delivery costs. What if someone like me gets a card to lock in prices for a driving holiday in Alaska or Hawaii? Oh, but the card is limited to "participating stations" and "with adjustments automatically made for more expensive grades or types of fuel and price differences caused by tax discrepancies or other local variations." It's a no-brainer that these adjustments will be made in a way that favors the house.

That is a long-winded way of saying this card either has a lot of teeny-print gotcha provisions that will annoy customers and doom the concept, or else has a lot of embedded options. Guess what. Consumers are very smart. Give them an option and they are guaranteed to use it against you.

Of course, it could simply be a Ponzi scheme, whether by design or by virtue of misreading the risks. Take cash, let people buy gas, hopefully get some media coverage so the cash commitments from existing and new customers exceed the outflow. That is, until the inevitable happens and the whole thing unravels.

The curious can examine the idea further at MyGallons.com.

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