Don't Forget About Gasoline Prices : LUSENET : Grassroots Information Coordination Center (GICC) : One Thread

Fair use for educational/research purposes only Don't Forget About Gas Prices By Thorsten Fischer 02/26/01 12:00 PM ET

The outlook for gasoline during the heavy driving season starting after Memorial Day is one of low inventories and high and volatile pricing. As the winter heating season draws to a close and refiners retool and gear up to increase the share of motor gasoline in total refinery output, the stage is set for a rerun of last year's supply crunch, complete with sharp regional price differences.

While gasoline inventories nationwide are some 9 million barrels above their level from a year ago, the increase is just 4.5%, and inventories remain low by historical standards (see chart above). At the same time, gasoline prices remained elevated throughout the off-season for driving. The average gallon of regular unleaded in the U.S. at the retail level sells currently at around $1.50 (see chart below).

Developments on the supply side depend on the availability and price of crude oil, refinery capacity and the potential for production bottlenecks, and environmental regulations. At an average price of $1.45, calculations by the Department of Energy show that the price of crude oil accounts for 45% of the total price of gasoline. Taxes contribute another 29%, and distribution, including marketing costs and profits, comprises 18%. Refining costs and profits finally make up the remaining 8% of the total retail price.

A severe price spike this summer is quite likely because in addition to gasoline inventories, crude oil stocks are also dangerously low. Indeed, crude oil stocks in the U.S. have just reached a 25-year low (see chart), and are even below last year's very low levels. As OPEC has tried aggressively to support the price of crude oil and to maintain the price for a basket of seven inferior crudes within its target band of $22-$28 per barrel, it has implemented production cuts and has hinted that more may be coming.

OPEC claims to be concerned with avoiding an oil glut in the spring when demand is expected to slow due to the end of the heating season and an anticipated global economic slowdown. It is anxious to avoid a repetition of the glut that ensued in 1998, and ultimately led to the collapse of global oil prices. However, the main effect of OPEC's supply management has been to prevent any meaningful rebuilding of crude inventories in major consuming nations.

Sufficient crude inventories are necessary to secure a smooth flow of supply and to provide a cushion should there be any supply disruptions. If inventories cannot fulfil this role, short-term fluctuations in supply and demand are amplified, and the results are higher prices and increasing price volatility. The resulting price volatility feeds from the crude oil markets directly into the refined product markets. Historically, product prices have tracked crude prices closely (see chart). Thus, as crude oil prices remain high, gasoline prices will remain at a high level, with a lot of potential for even greater increases on top of that.

Refinery capacity will remain tight throughout the year. Capacity utilization rates in the refining industry are among the highest of any industries and have remained near or above 90% for some time. This translates into very little extra capacity with which to deal with any unexpected events on the demand or supply side. At the same time, refineries are running at full-tilt, increasing the likelihood of shutdowns due to maintenance and repairs. Thus, there is a very real threat of bottlenecks and resulting regional shortages.

Also, burdensome environmental regulations increasingly vary by region, with different local authorities adopting different specifications. The result is a rising fragmentation of the gasoline market, making it ever harder for producers to substitute one type of gasoline meeting particular specifications for another. Mandates for reformulated gasoline in certain areas of the country will be another factor driving up prices. The end result this summer will be regional price spikes reaching above $2 per gallon in some areas. Prime candidates for these hikes are the Northeast and California, where plans to ban MTBE, an additive that ensures cleaner fuel burning and increases octane, will lead to shortages.

Demand is projected to increase moderately over last year despite the economic slowdown. Motorists had better prepare themselves for a rough, and expensive, ride come summer. Tight supply-demand balances for crude oil and refined production will ensure a high base for gasoline prices from which the vagaries of production and regulations will lead to large and frequent regional price spikes.

-- Martin Thompson (, February 27, 2001

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