A Fine Primer on Gasoline Prices

From the Economist comes economic sense about gasoline prices. Excerpts:

…petrol prices in America depend, first and foremost, on the price
of crude oil. This is determined by global supply and demand, something over
which American politicians have only marginal influence. A gallon of petrol
at an American pump costs $2.85 on average, according to the American
Automobile Association (AAA), 75 cents more than it did a year ago.
Taxes account for a mere 18% of the price of filling an American car, compared with, say, 67% in Britain. So a surge in the price of oil leads toa proportionally bigger rise in the price of American petrol. Americans could reduce volatility by raising taxes, but not even Al Gore, who calls global warming “the most dangerous crisis we have ever faced”, is suggesting that Americans should pay just under $7 a gallon, as Brits do.
Although the global oil price is the main cause of American motorists’ woes, local factors also matter. Oil wells and refineries around the Gulf of Mexico have not yet fully recovered from last year’s hurricanes, and petrol stocks are low. Weathermen predict another busy hurricane season this year. And all this bad news comes at the start of the summer driving season, when holidaying families hit the road and prices traditionally rise to annual highs thanks to the increased demand.
However, prices were already at high levels in mid-May. In part that was due to the cost of crude oil. The hangover from last year’s hurricanes, which knocked out 10% of America’s refining capacity, also contributed, as facilities that had deferred maintenance work to compensate for (and profit from) the shortfall belatedly shut down. Furthermore, refiners around the world are struggling to adapt as crude supplies become more viscous and sulphurous, and so harder to turn into petrol.
Another crucial local problem arose from the removal of a chemical called methyl tertiary-butyl ether (MTBE) from petrol in Texas and several eastern states. The addition of MTBE helps to reduce smog from car engines. But researchers began to worry that it might be carcinogenic and was certainly seeping into groundwater, making it undrinkable. Retailers, fearing lawsuits, decided to switch to ethanol, which has similar properties. But petrol blended with ethanol, unlike MTBE, cannot be shipped by pipeline, since the two are prone to separate in transit. So distributors had to invest in new facilities to transport ethanol and mix it with petrol near the point of sale. Moreover, ethanol is in short supply, and therefore expensive.
At one point in late April, a handful of petrol stations actually ran out of fuel as a result of these accumulated woes. But by now, says John Felmy of the American Petroleum Institute (API), an industry group, distribution networks are up and running. The high price, meanwhile, has helped to attract imports of petrol, which have been running 36% above their normal level in recent months. Stocks are rising again, and prices have fallen on the futures markets as well as at the pump. The government now predicts that petrol will cost an average $2.71 a gallon over the summer-less than it does at the moment.
A similar story unfolded in the wake of last year’s hurricanes, when high prices attracted imports, which compensated for curtailed local supply. Members of the International Energy Agency, a club of oil-consuming countries, helped by releasing some petrol from their strategic reserves. Even if hurricanes wreak havoc in the Gulf of Mexico again this summer, Mr Felmy argues, America’s drivers should have no trouble refilling their tanks, as long as they can stomach the price.
Not all can, of course. According to most surveys, demand for petrol is atlast beginning to soften, as the poor or thrifty move about less or take the bus. The API reckons that America’s consumption fell by 0.7% in the first four months of the year. The Department of Energy calculates that it has risen, but at a fraction of the normal pace. Sales of the most gas-guzzling cars have also been falling for several years, which may have a more lasting effect.
In the long run, growth in America’s refining capacity (or the world’s) should also help to lower prices. But that will take time. Refining capacity in America rose by almost 300,000 barrels a day last year, a small fraction of 9m daily barrels of petrol consumed. It will take two or three years, according to Aaron Brady of Cambridge Energy Research Associates, a consultancy, to construct enough extra refining capacity for comfort.
For the most part, Americans are responding rationally to the high price of petrol. Suppliers supply more; consumers consume less. Politicians, however, take it as an opportunity to bluster. The House of Representatives has passed a bill barring “price-gouging”-that is, making it a criminal offence to charge more for petrol than some bureaucrat deems appropriate. This is popular; 69% of Americans even favour price controls. But in the long run, it would reduce the incentive for firms to invest in supplying petrol to Americans, and so would raise prices at the pump. With luck, the bill will die in the Senate.
Both parties tout their determination to free America of its dependence on jihad-fuelling foreign oil by some conveniently distant point in the future. Neither, however, proposes anything that might plausibly accomplish this. House Republicans passed a bill last week to allow oil drilling in Alaska’s Arctic National Wildlife Refuge, which would help a tiny amount at best, and in any case is highly unlikely to get through the Senate.
Both parties say they wish to promote ethanol, not just as an additive, but as a fuel in its own right. In practice, this means a futile attempt by government to pick promising new technologies, plus fat subsidies for midwestern corn farmers while cheaper Brazilian ethanol is kept out with tariffs. Lawmakers could free the ethanol market, but many would rather drive their SUVs to a petrol station a block away from their offices for a photo-op denouncing Mr Bush and Big Oil.

HT: Carroll Cagle