Gasoline Prices: Conspiracy or Plot?

Get ready for the yearly panic at the pump

Just as robins return in the spring, so too do worries about the price of gasoline. For example, a March 20 headline in Rhode Island's Providence Journal headline warns "Gasoline prices continue to rise." The newspaper notes that prices have risen 37 cents per gallon since February and the national average price is now $2.55 for a gallon of gas.

Jumping into the Nexis WABAC Machine (wayback), headlines from the same week for the past 10 years reveal a pattern. Detroit News, 2006 "Gasoline Prices: How High Will They Go? (average $2.50); AP 2005 "Gas prices hit record high and are expected to rise more in the months ahead," (average $2.13); Times-Picayune, 2004, "Running Hot: With gasoline prices spiking this spring, how long will it be until they cool off again?," (average $1.77); Columbus Dispatch in Ohio, 2003, "Effects of War: Oil-Price Volatility Not Seen At Gas Pump," (average $1.77); Morning Call in Allentown, Penn., 2002, "Gas prices up 22 percent since December," (average $1.29); Virginian-Pilot in Norfolk, Va. 2001, "Gas Prices Down Nearly 10 Percent Over Last Year Some Analysts Fear That The Cost of a Gallon May Soar this Summer," (average $1.43); Dallas Morning News, 2000, "Gas prices beat record for 4th straight week," (average $1.53); AP, 1999, "Gas prices soar nearly 8 cents per gallon," (average $1.09); Intelligencer Journal in Lancaster, Penn., "Gas prices swing up, mostly down," (average $1.08).

Even when gas prices are at historic lows the Intelligencer Journal warned, "the end to plummeting prices is probably in sight. With summer driving weather approaching, prices should slowly start climbing in May."

"Ever since 1989, the first year that federal EPA regulations set caps on vapor pressure in gasoline, the tendency has been for gasoline prices to rise in the spring rather than in the summer," says Trilby Lundberg, the head of the California-based fuel market research firm, the Lundberg Survey. She also attributes the recent run up in prices to a combination of the new federal requirement to blend ethanol in gasoline, demand growth, seasonal switching from making winter blends to summer blends, hiccups in planned and unplanned maintenance at refineries, and earlier daylight savings time.

Let's consider the effect of EPA vapor pressure mandates on the price of gasoline. Energy Security Analysis Inc. senior consultant Mark Routt analogizes vapor pressure in gasoline to fizziness in soda pop. In the winter more fizziness (high vapor pressure) means that when you turn the ignition on a cold morning it sparks the gasoline and your car starts. However, in the summer you want "flatter" gasoline (less vapor pressure) because fizzier gasoline evaporates on hot days and contributes to smog. While EPA regulations help reduce smog, they also make it more costly to produce gasoline with lower vapor pressure. Lundberg estimates that summer blends can cost between 3 to 15 cents more to make than winter blends, depending on the exact formulation, time and place.

In addition, Routt pointed out that the regulations have produced several distribution bottlenecks that temporarily boost prices in the spring. "Everybody jams the exit at the same time," explains Routt. What he means is that gas station owners have essentially one week to switch from a winter blend to a summer blend. So in order to get their supplies in a timely manner they end up paying a premium of 8 to 12 cents per gallon to distributors and tank truckers. In contrast, in the fall, retailers can switch over a period of weeks from a summer blend to a winter blend and so price spikes don't typically occur in the fall. Routt suggests that the EPA relax its vapor pressure regulations allowing retailers to more slowly switch to summer blends. However, he doubts that this policy could ever be adopted since it would characterized by activists as "an attack on the environment."

Every one of the six analysts I talked with pointed out that the federal ethanol mandate adds substantially to gasoline prices. Ethanol costs more per gallon than gasoline; it contains less energy per volume so a blend of 90 percent gas and 10 percent ethanol delivers 3 percent fewer miles per gallon; and ethanol has a higher vapor pressure which makes it even more expensive for refiners to meet EPA summertime vapor pressure maximums. The ethanol mandate also adds to costs for blending gasoline because companies now have to manage different two fuel supply chains. Lundberg notes that when California adopted its ethanol mandate, it boosted prices by 10 cents per gallon.

And U.S. demand for gasoline is stronger than expected. Jim Rittenbusch, president of the oil trading advisory firm, Ritterbusch & Associates in Galena, Ill., says that demand is up 3 percent over this same time last year. Generally, refiners plan for demand to rise by about 1.5 percent per year. Lundberg speculates that the switch to earlier daylight savings time this spring may be boosting gasoline demand by as much as 1 percent. She points out that demand for gasoline rises in the summer, not just because of vacation trips, but because increased daylight encourages more shopping trips as well. March daylight may promote March mall madness.

As noted, every year, refiners have to gear up for summer gasoline production. For the past five years, summer demand for gasoline has averaged about 12 percent higher than it does in winter, notes Lundberg. For example, Americans consumed 355 million gallons of gas per day in January 2006 and 394 gallons per day in August 2006.

All of the analysts trotted out the usual excuse that refining is a just-in-time business with very low inventory. Refineries also schedule maintenance at the time that they switch over from winter to summer blends which temporarily slows down production. Still, Tim Evans, an energy analyst from Citigroup Futures Research in New York, points out that the production of gasoline by domestic refiners is up 5 percent over what it was last year at this time. But the question still nags: why haven't some refiners expanded their production capacity in order to take market share from their lagging competitors and smooth out these predictable fluctuations?

No new refineries have been built in the U.S. since the 1970s. Why? NIMBY, nobody wants an oil refinery in their neighborhood. Also, environmental regulations are much tighter than they used to be. Ritterbusch estimates that it would cost $5 to $7 billion and take 7 years to build a new refinery in the U.S. Routt says oil company executives who vividly recall the oil crash of the 1980s when refineries hemorrhaged money are reluctant to make such huge investments in a volatile energy market. Nevertheless, refining capacity at existing facilities increases at rate of about 1.5 percent per year.

But help, in a manner of speaking, may be on the way. How? Gasoline imports. Europe is switching to diesel which frees up the continent's gasoline refineries to supply the U.S. In addition, a huge amount of refining capacity is coming online from a number of other countries. The U.S. is currently importing about 800,000 barrels of gasoline per day, down from about 1.1 million barrels per day last March. The Energy Information Administration projects that U.S. demand for liquid transport fuels will increase by 5.8 million barrels per day by 2030. The EIA projects that ethanol will supply 8 percent of our transport fuels by then. So, without new refineries, a good deal of our future demand for gasoline will be met from imports.

So what goes into the cost of a gallon of gasoline? The EIA calculates that crude oil accounts for 54 percent of it. Distribution and marketing are responsible for 15 percent. Refining is another 11 percent and taxes add 20 percent. The only conspiracy behind increasing gas prices is in plain sight–government fuel mandates and taxes. They may be worth it but they do cost consumers. Also, it is clear that looking back over the past ten years, the fluctuations in the price of crude oil swamp all of the other factors. Back in 1999, when a gallon of gas cost $1.09, crude oil accounted 37 percent of the price of a gallon of gasoline.

What's the bottom line for this year? All the analysts basically agreed that gasoline prices are probably close to their peak for the year and that they will fall soon. Prices may rise again toward the end of the summer, but unless all hell breaks loose-say a war with Iran or gigantic hurricanes assaulting the Gulf coast-gas prices should not exceed $2.75 this year.

Ronald Bailey is Reason's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.