Gasoline prices surge: Thinking about Some Causes

Nominal gasoline prices are at an all time high. However, in real terms, April prices were not the highest. May prices might be, depending on how you calculate it (hard to figure it out since May’s CPI is not yet out). From the Washington Post:

Gas Price Close to Historic Record Regular Unleaded Just Shy of ’81 Mark

By Steven Mufson
Washington Post Staff Writer
Tuesday, May 22, 2007; Page D01

Gasoline prices last week came within a half penny of tying the modern era’s inflation-adjusted record set in March 1981, the Energy Department said yesterday.

The nationwide price of unleaded regular gasoline hit $3.218 a gallon, barely below the adjusted $3.223 a gallon level 26 years ago. Behind the rise were high crude oil prices and disruptions in output at oil refineries.

The 1981 record was set two years after the Iranian revolution brought down the pro-American shah, seven months after war broke out between Iraq and Iran and two months after President Ronald Reagan ended U.S. oil price and allocation controls.

The current rise in prices has been harder for consumers to understand. While Nigerian insurgents have curtailed production by about 800,000 barrels a day, there hasn’t been any major cut in crude oil supplies, and crude oil inventories are adequate.

Instead, industry analysts blame a series of refinery accidents, breakdowns and maintenance closings that have choked off enough gasoline production to drive up prices — and refinery profit margins — just before the summer driving season.

Crude oil prices don’t reflect $3.20-a-gallon gas prices,” said Frank A. Verrastro, director of the energy program at the Center for Strategic and International Studies. Europeans pay more than twice as much at the pump because of gasoline taxes.

Francisco Blanch, oil analyst at Merrill Lynch, said in a note to investors this month that the “unprecedented” drop in U.S. gasoline inventories had reduced stocks to “the lowest seasonal point in almost two decades.” Blanch said that “refinery outages have curbed domestic gasoline production and imports are not coming through due to stiff competition” from other countries.

Oil analyst Philip K. Verleger estimates that refinery problems have lowered gasoline output by 90 million barrels this year, squeezing supplies.

Top Democrats in Congress jumped on the chance to blame oil companies and the Bush administration. “The oil companies have two words to say about these new record high gas prices: mission accomplished,” House Democratic Caucus Chairman Rahm Emanuel (Ill.) said in a written statement. “For six years, Republicans did nothing to make our nation energy independent while handing out taxpayer funded giveaways to big oil. Now the American people are paying the price.”

Figure 1 shows gasoline prices (all grades), as recorded by the Energy Information Administration. The May price is for weekly observations through May 21st.


Figure 1: Nominal (red) and real CPI-deflated gasoline (blue) prices (cents per gallon, all grades). Source: Energy Information Administration, and BLS via St. Louis Fed FRED II, and author’s calculations.

Examining 12 month changes in log gasoline and oil prices, it does seem like the most recent period has been marked by more rapid increases in gasoline prices relative to oil.


Figure 2: Twelve month difference in nominal gasoline (blue) and oil (red) prices. Source: Energy Information Administration, and BLS via St. Louis Fed FRED II, and author’s calculations.

This should manifest itself in bigger a “crack spread”, the profit margin a refinery makes by “cracking” petroleum into petroleum products. And this is exactly what is happening, at least according to anecdotal evidence. See e.g., here. What’s the time series evidence? I don’t have the actual spread series, but I do have the percentage rate from EIA:


Figure 3: Share of gasoline prices associated with petroleum (blue) and refining (red), in percent. Source: Energy Information Administration.

There’s no doubt that the recent refining share has gone higher, although the share has been higher in the past. (Note: With a higher gasoline price, the spread in dollars is going to be higher even with a constant share.) A quick glance reveals obvious seasonality in the refiner’s share. To get a feel for how we stand relative to the same time in previous years, Figure 4 presents the refiner’s share over the current and past three years.


Figure 4: Share of gasoline prices associated with refining, in 2007 (blue), in 2006 (red), in 2005 (green), in 2004 (black), in percent. Source: Energy Information Administration.

The graph confirms the impression that the refiner’s share has been particularly high for this time of the year, although there have been higher peaks, specifically in 2004.

One bit of policy analysis. The Washington Post article quotes the assertion that the wide spreads are due to policy inaction over the past six years. There is indeed a temptation to ascribe the wide spreads to cartelization, or opportunistic shutdowns of refineries (and I won’t rule either of those out — remember Enron and California in ’00-’01…). However, high spreads are also consistent with the view that there is no coordinated reduction of supply and the view that if conservation had been encouraged over the past six years (instead of tax breaks for SUVs), the spread would be smaller. That’s because theory predicts that the greater and more inelastic the demand, the greater the resulting price-cost margin.

So one way of thinking about what policies could have mitigated the crack spread is to consider both demand management and supply enhancement. The Administration until recently focused almost solely on the latter.

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31 thoughts on “Gasoline prices surge: Thinking about Some Causes

  1. Bruce Hall

    Another case of well-meaning, but educationally stunted activists who successfully disrupted the marketplace and then blame the very industry they disrupted for the “gouging” and all manner of nefarious plots against the poor, the hard-working average man, etc.
    This is no different from blocking nuclear power expansion and then complaining about using fossil fuels for generating electricity.
    Myopic, well-intention, stupid people complaining about the results of their actions.
    Want gas? Want electricity. Then get out of the way and let industry meet the demands of the marketplace. Too much politics; too little thought. Don’t block refineries, don’t block oil exploration, don’t block nuclear power expansion. Recognize that an increasing population is going to require more resources to sustain it. Let the marketplace decide how to do that. Don’t screw it up with corn subsidies for ethanol that ruin the corn food market. Too much politics; too little thought. Don’t complain when refineries are restricted and refiners get more for their scarce product. Get out of the way and let the marketplace work.
    Got that Nancy?

  2. wcw

    Mr. Chinn, a good piece. Like you, I am pretty sure that there is no Enron acting in the crack-spread drama (though when in doubt in fuels, I always check BP first; they’ve been caught and fined for minor misdeeds more than is seemly). Yeah, refinery utilization has been unseasonable, but that’s almost certainly more dumb luck and post-Katrina fallout than anything malign. The thing that’s puzzled me is that imports have been low, too. I am shocked that crack spreads sitting several months out are north of $20 while refined import volumes continue well below normal. If you have any insight there, let us know.
    Mr. Hall, er.. what? No offense, but that was incoherent even for the internets. An unregulated refining industry would almost certainly not “meet the demands of the marketplace” much better than the status quo, if at all. Take imports, which provide the marginal gallon of gas you pump every year. Surely you don’t blame their low level this year versus recent range on regulation? The profit motive is no magic bullet. I do not know what’s going on with imports, but I am as close to certain as I can get that there were no new Bush-administration regs that cut product imports this calendar year.

  3. Menzie Chinn

    Bruce Hall: I think you only internalized half my message. One can reasonably ask whether the crack spread, and gasoline prices in general, would be so high if we didn’t give tax expenditures to business to purchase SUVs, and if we had somehow altered the capital stock of automotive vehicles by changing the relative aftertax price of gasoline going back to when the VP Cheney led the energy task force (in 2001), instead of focusing so relentlessly on supply enhancement.

    wcw: Afraid I don’t know why the confluence of high crack spreads and low imports. Perhaps the market is anticipating a rapid reopening of closed refineries. But that’s just a guess.

  4. donna

    No doubt Exxon will report record profits again, and another 400 mil for its CEO, while we wonder why gas prices are so high….

  5. Dan

    Dr. Chinn – first thanks to you and JDH for covering issues such as these.

    One thing I notice is that you don’t discuss imports. Given that the US imports a non-trivial amount (I believe between 12 and 15%) of its desired gasoline, I wonder how imports play into increased prices and spreads.

    Does not higher US gasoline prices help attract gasoline onto US shores?

    And wouldn’t it be true that the weaker the dollar the higher the price (expressed in dollars) would have to be for said imported gasoline?

    And, even if US refiners increased their capability annually to adjust for the ever growing (due to population increases?) US appetite for gasoline, wouldn’t imported gasoline prices have to still rise to make up for a weaker dollar?

    If, as we saw clearly demonstrated in the Katrina aftermath, imports are the “swing refiners” so to speak, does that make foreign refiners a strong influence on US gasoline prices, somewhat out of the reach of the US congress?

    It seemed to me to be something worth investigating.

    One more thought – given that refiners have a (limited) choice of what kind of products to make out of the original stock (oil), I wonder how the spread between gasoline and oil compares to that of diesel, jet fuel, naptha, etc.

  6. jla

    Paul Sankey, of Deutsche Bank, in his Senate testimony on May 15th:
    Anybody who blames record high US gasoline prices on “gouging” at the pump simply reveals their total ignorance of global oil supply and demand fundamentals. The real reason for high pump prices is the lack of global gasoline supply relative to demand. Just in the US, overall US refining capacity, at 17 million barrels per day (mb/d), is far below demand at 22 mb/d. In turn, pump prices are effectively set by import prices. With strong demand outside the US on the back of global economic growth and a weak dollar, the era of abundant US oil supply augmented by willing international sellers is dead.

  7. Bruce Hall

    While I agree that government incentives to business in the form of tax breaks for GT 6000 lb. GVW vehicles may have increase some purchases of larger vehicles, I would guess that is relatively unimportant in the imbalance equation.
    My “ranting” was purposeful: to point out that whether the meddling was from the government or special interest groups, the effect was the same… reduced domestic oil exploration and refinery capacity. This is exactly the same problem we are facing with regard to generating electricity over the next 2 decades.
    Had the “marketplace” been allowed to run its course, the U.S. would have been more likely to find itself in France’s position of electric power surplus which could have been used to provide cheap “fuel” for hybrid vehicles. Meanwhile the oil industry would have responded with more wells and refinery capacity to respond to that competitive challenge. We would not be facing activist-induced “price gouging” which is nothing more that the medicine we get for making stupid decisions in the past.
    Regardless, with greater oil and electricity capacity, out present options would be much greater. We wouldn’t have to ruin the corn market with subsidies to produce ethanol which is only 75% as fuel effective per gallon as gasoline. We would have the electricity capacity to have a massive push toward hydrogen “powered” cars (hydrogen really being a storage medium that requires large amounts of electricity to produce).
    You are correct that stupid incentives to buy SUVs when they were not legitimately needed for business contributed to the gasoline shortfall… but that is not the underlying cause of the situation.

  8. Charlie Stromeyer

    The FTC says that high gasoline prices are due to refinery outages, increased demand and decreased imports:
    Representative John Conyers also said that OPEC may be one of the reasons for higher gasoline prices, and the House approved the “NOPEC” legislation which would allow the federal government to sue OPEC under antitrust laws – which the Bush administration promises to veto.

  9. Ken Ambrose

    Is there a currency neutral price of oil index? With the dollar dropping against the Euro so much in the last few years, I’m wondering what part of the change in the nominal price of oil is related to supply and demand of oil vs the changing value of the dollar.

  10. Buzzcut

    Well, I was at BP’s refinery in Whiting, Indiana just yesterday, and saw the compressor unit that caught on fire earlier this month. The refinery is not totally down, but it’s capacity is much reduced.
    Anybody who thinks that a refiner would purposefully take down a refinery is certifiably insane. Seriously, get some Prozac, get some therapy, you have a problem.
    Refiners measure loses in the millions of dollars per day when a refinery is down. There is no way they would accept such losses because the capital and personel costs are higher than the profit margin at other refineries.
    What are some of the issues that Menzie didn’t consider?
    1) The EPA is relentlessly purging sulfur from the fuel supply. Ultra-low sulfur diesel was just phased in in January. All the refiners have been focusing on getting the sulfur out, not on increasing capacity.
    The only way that some refineries can make the ULSD is to use low sulfur (sweet) crude. That costs more than higher sulfur (sour) crude. To get the sulfur out of the sour stuff you need more refining. That takes capital, which has a cost. Also, when the hell can a refinery come down to make the upgrades? They’re running all out to keep up with demand.
    Whiting is starting a $4.3B expansion to be able to refine crude coming from the Canadian Tar Sands, which has very high sulfur. They’re trying to do it without taking the refinery down, which would be an amazing feat if they could pull it off, but unlikely in my opinion.
    2) Refiners have serious personel issues. There simply aren’t enough engineers to do all the work that needs to be done. Refining has been an awful business to be in for over 20 years, there have been layoffs and hiring freezes for a long time. As a result, the existing work force is old and nearing retirement age, and there is literally no one to take their place.
    I myself left the refinery equipment industry in ’04, because the market was so bad. Since then, it has improved, obviously. But the only way I would consider going back in is to get paid an insane amount of money. You know, tenured full professor money, at least.
    3) Refining is a heavily unionized industry. Unions are in a very good position to “get their share” at this point in time. They were beaten down during the bad years of ’86 to ’04, and now they’re going to get payback.
    3) Menzie, your comment about tax subsidized SUVs is a joke. The number of individuals who take that deduction is trivial. At the very least, it should be a known number from the IRS, and you economists should be able to make a graph or model showing the effect of that particular tax deduction. There is no need to speculate!
    4) Relentless demand: demand keeps going up and up. I read that demand in Chicago inceased 3% in the first quarter. Now, since then prices have increased by over a $1 per gallon, so maybe demand has dropped since then. However, price volatility is such that a drop in prices might materialize in the mid term, and demand would go right back up.
    And don’t just reflexively think that more gas taxes are the answer. Chicago has a retail sales tax on gas. The higher the price, the higher the tax. You could contrast demand between, say, tax happy Chicago with tax averse East Chicago in Indiana to see how the gas taxes are effecting price and demand. I mean, an economist could.
    Just driving around, it doesn’t seem like there is a big difference in prices between the high tax areas and the low tax ones.

  11. odograph

    I don’t really worry about the onshore refinery issue, because I assume that refiners have been drifting overseas (to where they find lower costs and lower regulation).
    Am I wrong?
    If there is a global change in “crack spread” that would imply to me that it is less about regulation (or even SUV credits) in a single country, and more about global demand.
    We are back to “everybody” using more gas.

  12. PaulS

    Odo, I don’t know what that graph tells me. I don’t even know how to know what it tells me.
    According to its own labels, it’s in “2005 dollars”. Now in the last few years, the US$ has been dropping and prices have been skyrocketing – except for those prices that have not skyrocketed. Only the stable prices (e.g. for stuff like electronic luxury goods, which aren’t that big a chunk of most people’s spending) seem to be included in the headline inflation rate. If I convert US$ retail gas prices to euros, they haven’t gone up much for a while. So what’s an honest deflator? Certainly not any variant of the US CPI. So maybe if you use the euro exchange rate as a deflator, the graph, at least the higher cases, won’t turn out that badly.

  13. odograph

    I’ve always had a feeling that “inflation adjusted energy price” was a concept chasing it’s own tail. That’s true.
    But … I’m not sure I follow you. Isn’t the chart for US consumers, and about US buying power? Does a recalculation in euro imply that we can all go buy hemis and enjoy the low fuel prices to come?
    FWIW, I think that the EIA does the lazy and politically correct thing. They tell a happy story. And they let the future take care of itself.

  14. Bill Ellis

    In order to understand the disconnect between oil prices and gasoline prices you need to consider the seperate limitations of the two industry segments.
    The supply of crude oil is independent of refinery capacity (in daily terms.) When a refinery is shut in, there is less demand for oil, and that should be reflected in a lower price for oil, while at the same time reducing the supply of refined product with the predictable result of higher retail prices. Accordingly, the divergence noted in the graphs should be expected.

  15. PaulS

    Odo: because of the tail-chasing aspect I’m not 100% sure what I’m articulating either. What a “consumer” probably cares about, in rough terms, is not so much the size of the unit of account as the number of hours he or she has to give up to obtain a gallon of gas. Despite it looking like a labor theory of value, maybe we ought to have an hours-per-gallon projection. Or a graph of gallons purchasable by the average Social Security check.
    In any event, if I need more dollars this year than last year to maintain the same living standard, that’s inflation. If it’s harder to earn that standard of living this year than last year, that’s falling real wages. Our politicos – and economists – have conflated these two things to the point where price graphs are little more than Rorschach tests.
    And economists have multiplied the confusion with “hedonics” – I don’t care a whit that HDTVs have higher resolution, when the upshot of HDTV is only that I need more dollars to receive the same vast wasteland of mindless commercial-laden rubbish. But somehow, the added resolution magically reduces the official inflation rate, and thus my parents’ Social Security checks.
    Anyway I don’t disagree strongly with the high case of their graph as an honestly deflated real-price projection. I do expect gasoline to cost more in hours in the future – and that’s falling real wages.

  16. calmo

    I donno Buzzy
    Anybody who thinks that a refiner would purposefully take down a refinery is certifiably insane. Seriously, get some Prozac, get some therapy, you have a problem.
    but the “overkill” here (not just for me izit?) actually fosters my conspiratorial instincts (are U doinit on purpose?) [I’d ask you for further directions but…I hesitate, you know?]
    In response to Buzz’s
    1) Isn’t Menzie talking about “share” ~profits, not prices and those huge costs of getting to the new “ultra low sulphur standards”…wrought on us by the evil EPA…and not the progressive Shanghai School of Business that thinks there is nothing sacred about ‘The sky is blue.’…really grey, brown and black are colors too.
    2) Get a grip and realize that academics are grossly underpaid compared to their business equivalents in the Finance industry. (Such a gratuitous and self denigrating remark, buzzy.)
    3) Review the Texas janitors and fuel your union worries with some real baking soda.
    4) Review the number of SUVs that were sold compared to the smaller vehicles and realize legislation paved that road.
    5) Relentless demand. Sorta like those braincells in that cavernous barn looking for something to run into in that head of yours. Would you say that the per capita demand for gas was as relentless as the shareholders for higher profits? Would the relentlessness be indicated by the graphs that Menzie has assembled for our benefit (that would be my and your information, education, stimulation) or something in stark contrast?

  17. spencer

    I suggest we look at this as the natural working of the market. For two to three decades refining spreads have been very low and refining has been one of the least profitable industries in the economy.
    Why? It is the markets way of saying we have sufficient refining capacity and do not need any more. Yes, government actions have made building a refinery more expensive. But government actions have not prevented the existing refineries from raising refining margins to cover the additional expenses. Now, the excess refining capacity seems to have used up and guess what, refining margins are improving. Boy, does that sound like the working of a relatively free market to me. If we don’t watch out someone might get carried away and actually build a new refinery.
    I get so tired of people reciting the administration talking points of factors that maybe at best account for some 5% to 10% of the reason no new refineries have been built and completely ignoring the naturally competitive factors that explained some 90% to 95% of the failure to build new refineries.
    Moreover, if we are really at peak oil maybe we really do not need new refineries. I would not be at all surprised over the next few years to see refining capacity expanded sharply and thus creating another extended period of excess capacity and low refining profits. Guess what, that is the way market normally work.

  18. DickF

    I see that the numbers are adjusted for CPI inflation but are they adjusted for taxes?

  19. FredW

    It seemed like a few years ago we had articles about the closing of even profitably refineries to “tighten” the market. Here’s an interesting item from Knight-Ridder from 2005. “Over the past 25 years, 176 refineries have closed in the United States. A new U.S. refinery hasn’t been built since 1976.”
    And, “In a 1996 internal memo, Mobil officials called for a ‘full court press’ to stop an independent company from restarting a refinery in California that might reduce gas prices by 3 cents a gallon. The effort was successful.”
    Aren’t we just seeing the expected results of an artificially constrained market.

  20. Buzzcut

    Aren’t we just seeing the expected results of an artificially constrained market.
    What refineries were closed, and why were they closed?
    They were older, smaller refineries that were not profitable in the post 1986 refining environment, which was quite a difficult time for the industry.
    Also, the regulatory environment was such that the smaller refineries were essentially closed by the EPA.
    There are various levels of refining. As refineries get larger, they generally do more refining, turning more of the low value product (asphalt) into higher value stuff like gasoline and whatnot. It takes more capital to do that, thus it only makes sense in the larger refineries.
    Refineries evolve over time. Their capacity increases, their product mix changes. Just because a refinery is existing doesn’t mean that its capacity hasn’t increased so much that, in effect, there has been a new refinery built.

  21. FredW

    Buzzy – Seems to me that a tacit understanding to maintain market share while limiting supply would be highly profitable for all concerned. Also, very hard to prove. Like you point out, the refiners can always argue antiquated facilities. My guess is the FTC is using lawyers rather than chemical engineers to verify industry statements.
    This tacit agreement could also involve offshore refiners. I guess you’re arguing that this industry is somehow so noble that it would never stoop so low?

  22. Buzzcut

    This tacit agreement could also involve offshore refiners. I guess you’re arguing that this industry is somehow so noble that it would never stoop so low?
    No, I’m saying that, from just an examination of the history of anti-trust, in all industries, not just refining, anyone who thinks that there is a “tacit agreement”, or any other conspiracy, is insane.
    Anyway, let’s talk about offshore refineries. Did you know that Reliance of India, the owner of the largest refinery in the world, located in Northwest India, is building a clone of its refinery right next door? They’re taking the exisitng engineering drawings for the old plant and just building the same exact thing right next door!
    From what I’ve read, the output of this plant is slated to go to California.
    So maybe offshore refineries are the future. It seems strange to me. What could be the reasons for building in faraway Northwest India rather than Califoria? Anyone? Buehler?
    What are the logistical hurdles that must be overcome to operate a refinery halfway around the world from the market it is serving?

  23. odograph

    “What are the logistical hurdles that must be overcome to operate a refinery halfway around the world from the market it is serving?”
    Compared to the benefits of decreased regulation and lower operating costs?

  24. Buzzcut

    Compared to the benefits of decreased regulation and lower operating costs?
    Obviously, those are benefits. But it is going to be a lot harder to run a refinery that is half a world away from the market it serves.
    We see what happens when refinery output is not in line with supply. Prices spike. It happens every year when the switchover is made to summer gasoline. And that’s with refineries that are in the markets they serve.
    Now you throw weeks and weeks of barge time into the equation. What’s going to happen then?

  25. Buzzcut

    I understand that. What I don’t understand is people who react to the totally forseeable but unintended consequences of their own policy choices with talk of conspiracies and other insane behavior (boycots, for example).

  26. wogie

    From today’s NYT:
    “In hearings before Congress last year, oil executives outlined plans to increase fuel production by expanding existing refineries. Those plans would add capacity of 1.6 million to 1.8 million barrels a day over the next five years, for an increase of 10 percent, according to the National Petrochemical and Refiners Association.
    But those plans have since been scaled back to more than one million barrels a day, according to the Energy Information Administration, an arm of the federal government.
    If the national policy of the country is to push for dramatic increases in the biofuels industry, this is a disincentive for those making investment decisions on expanding capacity in oil products and refining, said John D. Hofmeister, the president of the Shell Oil Company. Industrywide, this will have an impact.
    Lawrence Goldstein, an energy analyst at the Energy Policy Research Foundation, an industry-financed group, has been warning for nearly a year that the governments twin goals of encouraging refiners to increase production and promoting increased supplies of biofuels work against each other.
    These two policies are not complementary, Mr. Goldstein said. These policies are in conflict.
    In addition, Mr. Goldstein said, an emphasis on ethanol might lead to increased volatility in fuel prices.

  27. russ

    I think it is time to shut down the economy. Everyone take a day off work (except emergency services). these gas refiners and our elective representatives need a wake up call.

  28. ROGER

    Exon made $80,000,000,000 PROFIT . Sounds like a lot? The percent of profit is less than Walmart and alot of other business. The goverment got $100,000,000,000 in TAXES. And THEY want more from them and us. The old Clinton BTU TAX. Now called the CARBON TAX!

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