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Gasoline
Questions and Answers
January, 2007
Why have gasoline prices fallen so much since the summer of 2006?In the long term, gasoline prices generally track the price of crude oil. The price of crude oil on world markets has been dropping since August of 2006. This has occurred for several reasons: Many of the Gulf of Mexico facilities damaged during the 2005 hurricanes have returned to production, international tensions – especially with Iran and Venezuela – have been reduced, and, most recently, the mild winter across the eastern half of the United States has resulted in significantly less-than-normal consumption of heating oil. These factors have led to a buildup of crude oil stocks that has depressed prices. Utah is a relatively isolated oil products market, however, and with limited transportation of these products in and out of the state, it typically takes longer for global market forces to affect prices here. While gasoline prices in Utah have sometimes been slower to respond to lower crude oil prices than other parts of the country, in the long run, we can expect to see sliding gasoline prices that reflect prices in the global crude oil market. Why have gasoline and diesel prices generally risen over the past few years?Global Demand: Global demand for oil has increased steadily in recent years. In 2001, world oil consumption was nearly 78 million barrels of oil per day. (One barrel equals 42 gallons). In 2005, the world consumed 84 million barrels of oil per day, an increase of 8% in four years. US Demand Increases: The United States is by far the world’s largest oil consumer. In 2001, the U.S. consumed 19.6 million barrels of oil per day; in 2005, we used, 20.7 million barrels per day, or 5% more. Chinese Demand Increases: The largest increase in oil use in recent years has been seen in China as that nation develops economically. From 2001 to 2005, Chinese oil consumption jumped from just under 5 million barrels per day to nearly 7 million barrels per day, an increase of 41%! No Oil Shortage Yet: Demand increases around the world have not led to shortages of oil because the oil industry has moved into new areas of the world to find oil and have expanded their production capacity. However… New Oil Sources Are More Expensive: The easiest-to-find and easiest-to-extract sources of oil are rapidly being depleted. This means oil companies must invest more in finding oil sources. They must also invest more in technologies to extract oil from difficult environments. For example, many of the newest U.S. wells are located in the deep-water areas (over 1,000 feet) of the Gulf of Mexico. Exploration and production costs for oil have therefore been increasing in recent years. Stretching the Transportation System: Sharp increases in global demand for oil have also stretched the capacity of the global oil transportation system (ships and pipelines), leading to increased shipping rates for both crude oil and oil products. Why did gasoline prices increase so suddenly last spring (2006)?An Annual Event: Prices have increased each spring for the past several years. This happens for several reasons:
International Tensions: Various international events helped contribute to high prices this spring. Among these events have been the growing tensions over Iran’s nuclear program, political unrest and hostage-taking in the oil region of Nigeria, and increasing tensions between United States and Venezuela (one of the U.S.’s major suppliers). When petroleum companies anticipate trouble in producing regions, they often seek to buy extra stocks, creating short term spikes in global demand. MTBE or Not MTBE: In some areas of the country, refiners are eliminating an additive – MTBE, which has been linked to groundwater contamination – from their gasoline and replacing it with ethanol in order to meet requirements of the Clean Air Act. However, Utah is not affected by these requirements and the MTBE phase-out has not had an effect on our prices. (For more, see below.) Hurricanes’ Aftermath: Many months after Hurricanes Rita and Katrina moved through the Gulf of Mexico – by far the United States’ major oil producing region, oil production in that region remains significantly below normal. As of June, 2006, oil production in the Gulf remained at 325,000 barrels per day, or 21%, below normal. Why are Utah gasoline prices sometimes lower than in the rest of the country?Regional Production: Virtually all of the crude oil used to make gasoline and other petroleum products for the Utah market comes from Utah, Wyoming, Colorado, and western Canada. Most of the gasoline produced for Utah is refined in the state; smaller amounts come from Wyoming, New Mexico, and California. Local crude oil production and refining help to reduce transport costs, which in turn helps to lower prices here. It also has the effect of partially insulating regional prices from global markets. This can serve to keep our prices relatively low when world prices are high. However, it can also mean relatively high prices locally if world prices drop suddenly. Arbitrage Caveat: In the oil industry, arbitrage is the name given to the business practice of buying a product for a low price in one location and then transporting and selling it in a different market where prices are much higher. When gasoline price differences between different cities are sufficiently large to be able to pay for transport costs, some gasoline marketers will send trucks to one market to buy supplies that they can sell for a profit in other markets. Thus, even though Utah is a relatively isolated gasoline market, arbitrage activity when Utah prices are low can artificially boost local demand. Thus, even though none of Utah’s gasoline comes from sources outside the western U.S. and Canada, in the long term, prices trends here still largely follow the rest of the country. Some states are having problems due to the elimination of MTBE from gasoline. Is this the case in Utah?What is MTBE: Methyl Tertiery Butyl Ether (MTBE) is a petroleum-based chemical that provides extra oxygen to gasoline blends, thereby both boosting octane and reducing tailpipe emissions. However, MTBE has recently been linked to cancer and is known to contaminate groundwater. How is Ethanol Related: Ethanol (grain alcohol) is also used as an oxygenate in gasoline. Under the Clean Air Act, metropolitan areas with severe pollution were required to use a special gasoline blend (reformulated gasoline) that contained at least 2% of an oxygenate. Except for areas of the Midwest, most refiners chose MTBE as their oxygenate. While some refiners have been able to achieve emission reductions without the use of an oxygenate and thus are no longer required to use either MTBE or ethanol, many refiners must still use an oxygenate. This spring, most refiners eliminated MTBE from their gasoline for fear of its health and water effects. This meant that demand for ethanol as an oxygenate skyrocketed, driving ethanol prices upward, and with them the price of the gasoline into which ethanol was blended. But Not in Utah: There are currently no areas in Utah that are required to use an oxygenate, therefore neither the elimination of MTBE nor the spike in ethanol prices have affected prices or supplies in the state. Will gasoline prices ever be low again?Not Likely: It is unlikely that gasoline prices will return to the levels of ten years ago in the foreseeable future. U.S. Department of Energy economic forecasts show the price of crude oil remaining near or above $50 per barrel for the next few decades. Growing Third World Demand: As currently underdeveloped countries industrialize and develop economically, global energy demand will continue to rise. This is especially the case for very large industrializing nations such as China (current population 1.3 billion) and India (population 1 billion). Easy Oil Already Gone: The easiest-to-develop and cheapest sources of oil are either already used up or are quickly being depleted. It will be difficult for the oil industry to keep up with demand without huge investments in new oil fields in difficult to reach or difficult to drill areas of the world. Such investments will be expensive and that price will be passed on in the cost of gasoline and other products. Efficiency and Conservation Antidotes: Future oil price increases could be offset by significant reductions in demand through greater energy efficiency, higher mileage vehicles, and conservation. Both oil consumers and oil consuming countries will need to determine the relative costs to themselves of expensive oil versus sometimes-costly – but energy efficient – technologies to conserve oil such as hybrid and electric vehicles. How much oil does the U.S. import?Nearly Two-Thirds of our Consumption: In 2005, the United States imported 3.67 billion barrels (154.16 billion gallons) of crude oil. This represents 66% of the United States’ crude oil consumption. The U.S. consumes almost 25% of global oil production, even though Americans are less than 5% of the world’s population. Each year, we import about 513 gallons of crude oil per American. In 2005, the U.S. also imported 732 million barrels of gasoline and other finished petroleum products. Are high prices here mostly the fault of Middle East/Persian Gulf oil-exporting countries?Not Really: The Persian Gulf states account for about 22% of all U.S. oil imports. Since 2001, Persian Gulf states have actually increased production by 8% in order to try to meet rising global demand. Canada and Mexico are actually America’s top two oil suppliers; both export more oil to the U.S. than does Saudi Arabia. Can new crude production in the United States bring gas prices down?Yes, But Not Immediately: Developing significant new oil reserves takes many years. Geological and geophysical studies must be undertaken to determine where the oil is. Further study is needed to determine how to extract it. Wells must then be drilled – not all will be successful. Systems for getting the oil from the well to refineries must also be built, including roads, pipelines, terminals, and ports. All of this takes many years, especially in areas that are difficult to reach. And Not by Much: While many oil reserves are awaiting development in the Mountain West, they represent a small percentage of U.S. total consumption. Utah, for example, accounts for only 1% of the U.S.’s current oil production and also has 1% of all U.S. reserves. What about reserves in the Arctic National Wildlife Refuge (ANWR)?It is Many Years Away: Even if work began on ANWR today, its benefits are years away. Current Department of Energy estimates are that the soonest ANWR production could begin is in 2015 and would not peak until 2024. A Small Part of U.S. Demand: ANWR could help improve U.S. crude oil supply, but would still only make up a small fraction of U.S. oil demand. The U.S. Department of Energy projects peak ANWR production at 780,000 barrels per day after 2024. That represents only 3.7% of current U.S. consumption and about 3% of projected demand in 2024. ANWR Would Lower Prices, But Slightly: The U.S. Department of Energy projects a decline of 79 cents per barrel (1.9 cents per gallon) for crude oil prices as a result of peak ANWR production in 2024. Crude oil prices are currently about $70 per barrel. If ANWR were producing at peak today, we would see a price decrease of slightly more than 1%. Are the oil companies “gouging” consumers?A Very Competitive Business: The oil business is simply too competitive for one company or small group of companies to control prices. The oil market is global and price and supply levels respond to a wide variety of national and international events. Crude Oil is Key: Crude oil prices are the most important component in the price of gasoline. Most refiners buy all or a large portion of their crude oil from other companies and thus have limited ability to set their input costs. Refiners generally must purchase crude at the price that the market has set. Refiners therefore have a limited ability to profit from high crude prices. Crude Markets Boom and Bust: Companies that produce crude oil are earning high profits from the current high oil prices. However, crude oil exploration and production is very capital intensive and risky. Many crude oil development projects fail after a company has invested millions – in some cases billions – of dollars. Oil companies also tend to have wide swings in profit margins due to the “boom and bust” economics common in the oil industry. Amid today’s high prices, most people don’t realize that only eight years ago the average global price for crude oil was @ $12 per barrel, compared to @ $70 per barrel today. Over time, oil companies’ profits are comparable to most other businesses. Over the past five years, oil and natural gas companies have averaged profits of 5.9% compared with 5.6% for all U.S. businesses. Retailers’ Margins are Steady: Retail gasoline stations typically maintain a steady profit margin of six to eight cents per gallon, regardless of the overall price of gasoline. They earn no extra profits when gasoline prices jump. Why do prices at the gasoline stations generally all increase on the same day?Replacement Costs: Gasoline stations and gasoline distributors generally price their products according what it will cost them to replace the product they have on-hand. Thus, if crude oil prices in a given region rise one dollar in one day, refiners know they will need to pay that extra cost to replenish their supplies. They charge the higher cost immediately in order to have the extra funds needed for replacement of the crude they already have in their tanks. The same happens throughout the distribution chain; refiners charge more immediately, raising costs for distributors, who also raise prices immediately, passing the cost on to retail outlets, who then raise their prices in the same manner. This is why most gasoline retailers will raise their prices within a few hours of each other – they are all responding to the same market signals and price increases from suppliers. What might the nation do to control or reduce gasoline prices?Reduce Demand: The major factor explaining oil and gasoline prices over the past few years is increasing demand, both inside and outside of the United States. The most effective way of controlling gasoline prices in the long term will be to reduce the amount of gasoline we consume. All of the following could play a role in reducing gasoline demand:
Increase production: While decreasing demand is likely to have a more important effect upon prices than raising production, there are some opportunities for lowering prices through new resource technological development.
What can individuals do to lower their gasoline bills?Look at Mileage when you Buy: The next time you buy a car, compare its fuel consumption with others you are considering. Buy the highest mileage vehicle that will fit your needs. The best vehicle mileage information is found at http://www.fueleconomy.gov. Perform Vehicle Maintenance: Perform recommended maintenance, especially keeping filters and plugs clean, maintain proper wheel alignment, keep tires at the recommended pressure. Keep it Smooth: Air flow over and around a vehicle is a key factor in gas mileage, especially with high speed driving. Be sure to remove unneeded racks and bins, roll up windows, close sun roofs, and keep your vehicle moving through the air as smoothly as possible. Drive Sensibly: Aggressive driving wastes gasoline. Excessive speed also uses more gasoline. When you double your speed, gasoline consumption increases by more than double. Also avoid unnecessary idling. Carpools and Public Transportation: Sharing the ride with others reduces the amount of fuel it takes to get you where you are going and reduces wear and tear on you car. More Gasoline Tips: For additional information and more tips, see the Utah State Energy Program’s Tips for Improving Your Mileage. |