Energy Markets
Understanding Current Gasoline Prices and Potential Future Trends Gao ID: GAO-05-675T May 9, 2005Gasoline prices have increased dramatically in recent weeks and currently, California has the highest gasoline prices in the nation. Consequently, consumers are expected to spend significantly more on gasoline this year than last. Specifically, EIA recently projected that, because of higher expected gasoline prices, the average American household will spend about $350 more on gasoline in 2005 than they did in 2004. Understandably, the public and the press have focused on these higher gasoline prices and some have questioned why this is happening. Moreover, people are concerned about the future, with some analysts projecting prices of crude oil--the primary raw material from which gasoline is produced--to remain at current high levels or even increase. Other analysts expect prices to fall as new oil supplies are developed and as consumers adjust to the current high prices and adopt more energy-efficient practices. This testimony, as requested, address factors that help explain today's high gasoline prices in the nation as a whole and specifically in California. In addition, potential trends that may impact future prices of crude oil and gasoline are addressed.
Crude oil prices and gasoline prices are linked, because gasoline is derived from the refining of crude oil. As a result, crude oil prices and gasoline prices generally follow a similar, albeit not identical, pattern over time. For example, from January 2004 to the present (April 25, 2005), the price of West Texas Intermediate crude oil rose by almost $20 per barrel, an increase of almost 60 percent, while over the same period, average gasoline prices rose nationally from $1.49 to $2.20 per gallon, an increase of 48 percent. Explanations for this large increase in crude oil and gasoline prices include rapid growth of world demand for crude oil and petroleum products, instability in the Persian Gulf region, and actions by the Organization of Petroleum Exporting Countries (OPEC) to restrict the production of crude oil and thereby increase its price on the world market. In addition to the cost of crude oil, gasoline prices are influenced by a variety of other factors, including refining capacity constraints, low inventories, unexpected refinery or pipeline outages, environmental and other regulations, and mergers and market power in the oil industry. Gasoline prices in California, and in other West Coast states, have consistently been among the highest in the nation and recent experience is no different. For the last week in April, the price of regular grade gasoline in California was $2.63 per gallon, about 43 cents above the national average. Explanations for California's higher than average gasoline prices include (1) California's unique gasoline blend, which is cleaner burning and more expensive to produce than any of the other commonly used gasoline blends; (2) a tight balance between supply and demand in the West Coast, and the long distance to any viable sources of replacement gasoline in the event of local supply disruptions; and (3) California's higher level of gasoline taxes--California currently taxes a gallon of gasoline at 30 cents per gallon more than the state with the lowest taxes, Alaska. Some sources have also attributed high gasoline prices, in part, to the fact that California's refining sector is more concentrated in the hands of fewer companies than in other refining areas, such as the Gulf Coast. Future gasoline prices will, in large part, be determined by the supply and demand for crude oil and its price on the world market. World crude oil demand is projected to rise, so new sources will have to be developed or prices will rise. Technological innovations that reduce the cost of finding or extracting crude oil could reduce prices, other things remaining constant. Greater conservation, or improvements in energy efficient technologies could also mitigate rising demand and reduce upward pressure on prices. In addition, alternative fuel sources may become more economical, thereby supplanting some of the demand for crude oil and gasoline in the future. America faces daunting challenges in meeting future energy demands, and policy makers must choose wisely to ensure that the country can meet these demands, while balancing environmental and quality of life concerns.
GAO-05-675T, Energy Markets: Understanding Current Gasoline Prices and Potential Future Trends
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Testimony:
Before the Committee on Government Reform, Subcommittee on Energy and
Resources:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 1:00 p.m. EDT:
Monday, May 9, 2005:
Energy Markets:
Understanding Current Gasoline Prices and Potential Future Trends:
Statement of Jim Wells, Director, Natural Resources and Environment:
GAO-05-675T:
GAO Highlights:
Highlights of GAO-05-675T, a report to House Committee on Government
Reform, Subcommittee on Energy and Resources:
Why GAO Did This Study:
Gasoline prices have increased dramatically in recent weeks and
currently, California has the highest gasoline prices in the nation.
Consequently, consumers are expected to spend significantly more on
gasoline this year than last. Specifically, EIA recently projected
that, because of higher expected gasoline prices, the average American
household will spend about $350 more on gasoline in 2005 than they did
in 2004. Understandably, the public and the press have focused on these
higher gasoline prices and some have questioned why this is happening.
Moreover, people are concerned about the future, with some analysts
projecting prices of crude oil”the primary raw material from which
gasoline is produced”to remain at current high levels or even increase.
Other analysts expect prices to fall as new oil supplies are developed
and as consumers adjust to the current high prices and adopt more
energy-efficient practices.
This testimony, as requested, address factors that help explain today‘s
high gasoline prices in the nation as a whole and specifically in
California. In addition, potential trends that may impact future prices
of crude oil and gasoline are addressed.
What GAO Found:
Crude oil prices and gasoline prices are linked, because gasoline is
derived from the refining of crude oil. As a result, crude oil prices
and gasoline prices generally follow a similar, albeit not identical,
pattern over time. For example, from January 2004 to the present, the
price of West Texas Intermediate crude oil rose by almost $20 per
barrel, an increase of almost 60 percent, while over the same period,
average gasoline prices rose nationally from $1.49 to $2.20 per gallon,
an increase of 48 percent. Explanations for this large increase in
crude oil and gasoline prices include rapid growth of world demand for
crude oil and petroleum products, instability in the Persian Gulf
region, and actions by the Organization of Petroleum Exporting
Countries (OPEC) to restrict the production of crude oil and thereby
increase its price on the world market. In addition to the cost of
crude oil, gasoline prices are influenced by a variety of other
factors, including refining capacity constraints, low inventories,
unexpected refinery or pipeline outages, environmental and other
regulations, and mergers and market power in the oil industry.
Gasoline prices in California, and in other West Coast states, have
consistently been among the highest in the nation and recent experience
is no different. For the last week in April, the price of regular grade
gasoline in California was $2.57 per gallon, about 37 cents above the
national average. Explanations for California‘s higher than average
gasoline prices include (1) California‘s unique gasoline blend, which
is cleaner burning and more expensive to produce than any of the other
commonly used gasoline blends; (2) a tight balance between supply and
demand in the West Coast, and the long distance to any viable sources
of replacement gasoline in the event of local supply disruptions; and
(3) California‘s higher level of gasoline taxes”California currently
taxes a gallon of gasoline at 30 cents per gallon more than the state
with the lowest taxes, Alaska. Some sources have also attributed high
gasoline prices, in part, to the fact that California‘s refining sector
is more concentrated in the hands of fewer companies than in other
refining areas, such as the Gulf Coast.
Future gasoline prices will, in large part, be determined by the supply
and demand for crude oil and its price on the world market. World crude
oil demand is projected to rise, so new sources will have to be
developed or prices will rise. Technological innovations that reduce
the cost of finding or extracting crude oil could reduce prices, other
things remaining constant. Greater conservation, or improvements in
energy efficient technologies could also mitigate rising demand and
reduce upward pressure on prices. In addition, alternative fuel sources
may become more economical, thereby supplanting some of the demand for
crude oil and gasoline in the future.
America faces daunting challenges in meeting future energy demands, and
policy makers must choose wisely to ensure that the country can meet
these demands, while balancing environmental and quality of life
concerns.
www.gao.gov/cgi-bin/getrpt?GAO-05-675T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202) 512-
3841 or wellsj@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
I am pleased to participate in the Subcommittee's hearing to discuss
today's gasoline prices and the factors behind future trends in those
prices. Soaring retail gasoline prices have garnered much media
attention and generated much public anxiety, particularly in a state as
dependent on gasoline as California. According to data published by the
American Automobile Association, since a year ago, average national
gasoline prices have increased 23 percent to $2.20, with average prices
in California currently at $2.57 per gallon. In the Los Angeles area,
prices have increased 19 percent to $2.60 in the same period. According
to the Department of Energy's Energy Information Administration (EIA),
which compiles and analyzes energy statistics, higher expected gasoline
prices in 2005 will increase the average American household's spending
on gasoline by about $350 over 2004 expenditures. Nationally, each
additional ten cents per gallon of gasoline adds about $14 billion to
America's annual gasoline bill. Still, when adjusted for inflation,
gasoline prices are not at an all time high--the highest inflation
adjusted prices occurred in 1981 and were equivalent to a price of
about $3.00 today. In addition, U.S. consumers pay less for a gallon of
gasoline than consumers in many other industrialized nations, in large
part because the United States imposes much lower taxes on gasoline
than these other countries.
The availability of relatively inexpensive gasoline has helped foster
economic growth and permitted a quality of life not widely available
across the globe. Large price increases, especially if sustained over a
long period, pose long term challenges to consumers. In this regard,
some recent analyses suggest that gasoline prices may stay at today's
relatively high level or even increase significantly in the future. For
example, some analysts have projected that the price of crude oil--the
primary raw material in the production of gasoline--while changing from
day-to-day, may remain in the vicinity of current levels for some time.
One analysts has even projected that oil may reach $105 per barrel in
coming years--almost double the current price. In contrast, others
suggest that crude oil prices--and therefore, gasoline prices--will
fall as oil companies invest in more crude oil producing capacity and
as consumers respond to higher prices by adopting more energy-efficient
practices. Regardless of what happens in the future, the impact of
gasoline prices is felt in virtually every sector of the U.S. economy
and when prices increase sharply, as they have in recent months,
consumers feel it immediately and are reminded every time they fill up
their tanks or read in the newspapers about high oil company profits.
It is therefore essential to understand the market for gasoline. In
this context, you asked us to discuss (1) how gasoline prices are
determined nationally, (2) what factors cause California's prices to be
consistently among the nation's highest, and (3) some of the important
factors that will determine gasoline prices in the long run. You also
requested that we provide some graphical depiction of gasoline prices
and other relevant data and we include these in appendix 1 of this
document.
To respond to your questions, we relied heavily on previous work on
gasoline prices and other aspects of the petroleum products industry
and collected updated data from a number of sources that we deemed
reliable. This work was performed in accordance with generally accepted
government auditing standards.
In summary, our work has shown:
* Crude oil prices and gasoline prices are inherently linked, because
crude oil is the primary raw material from which gasoline and other
petroleum products are produced--when crude oil prices fluctuate,
gasoline prices generally follow a similar pattern. In recent months,
crude oil prices have risen significantly--from January 2004 to the
present, the price of West Texas Intermediate crude oil, a benchmark
for international oil prices, has risen by almost $20 per barrel, an
increase of almost 60 percent. Over the same period, average gasoline
prices rose nationally from $1.49 to $2.20 per gallon, an increase of
48 percent. Explanations for this large increase in crude oil and
gasoline prices include rapid growth of world demand for crude oil and
petroleum products, particularly in China and the rest of Asia,
instability in the Persian Gulf region (the source of a large
proportion of the world's oil reserves), and actions by the
Organization of Petroleum Exporting Countries (OPEC) to restrict the
production of crude oil and thereby increase its price on the world
market. Figure one illustrates the relationship between crude oil and
gasoline prices over the past three decades. The figure shows that
major upward and downward movements of crude oil prices are generally
mirrored by movements in the same direction by gasoline prices.
Figure 1: Gasoline and Crude Oil Prices--1974-2004 (Not adjusted for
inflation):
[See PDF for image]
[End of figure]
* While crude oil is a fundamental determinant of gasoline prices, a
number of other factors also play a role in determining how gasoline
prices vary across different locations and over time. For example,
refinery capacity in the United States has, in recent years, not
expanded at the same pace as demand for gasoline and other petroleum
products--during the same period we have imported larger and larger
volumes of gasoline from Europe, Canada, and other countries. It is
important to note that imports are not, in and of themselves a problem-
-frequently imported goods are available at lower prices than
domestically produced goods. However, the American Petroleum Institute
has recently reported that U.S. refinery capacity utilization has
increased to 92 percent. As a result, domestic refineries have little
room to expand production in the event of a temporary supply shortfall.
Further, the fact that imported gasoline comes from farther away than
domestically produced gasoline means that when supply disruptions occur
in the United States, it might take longer to get replacement gasoline
than if we had excess refining capacity in the United States, and this
could cause gasoline prices to rise and stay high until these new
supplies can reach the market. In addition, refinery accidents and
other localized supply disruptions have at times caused price spikes
especially at the state or regional level. Recently, a tragic fire at a
BP refinery in Houston killed 15 people and temporarily shut down about
3 percent of the nation's refining capacity--while this event has not
been definitively linked to increased prices, such events in the past
have, at times, had major effects on prices.
* The volume of inventories of gasoline, maintained by refiners or
marketers of gasoline, can also have an impact on prices. As with
trends in a number of other industries, the petroleum products industry
has seen a general downward trend in the level of gasoline inventories
in the United States. Lower levels of inventories may cause prices to
be more volatile because when a supply disruption occurs, there are
fewer stocks of readily available gasoline to draw from, which puts
upward pressure on prices. Regulatory factors also play a role. For
example, in order to meet national air quality standards under the
Clean Air Act and amendments, many states have adopted the use of
special gasoline blends--so-called "Boutique Fuels." Many experts have
concluded that the proliferation of these special gasoline blends has
caused gasoline prices to rise and/or become more volatile, especially
in regions such as California that use unique blends of gasoline,
because the fuels have increased the complexity and costs associated
with supplying gasoline to all the different markets. Finally, the
structure of the gasoline market can play a role in determining prices.
For example, we recently reported that some mergers of oil companies
during the 1990s led to reduced competition among gasoline suppliers
and may have been responsible for an increase in gasoline prices by as
much as 2 cents per gallon.
* Gasoline prices in California, and in other West Coast states, have
consistently been among the highest in the nation and recent experience
is no different. For example, for the last week in April, when the
national average price for regular grade gasoline was $2.20, the
California price was $2.57. Explanations for why California's prices
have been higher than the national average include (1) California's
unique gasoline blend, which is cleaner burning and more expensive to
produce than any of the other commonly used gasoline blends; (2) a
tight balance between supply and demand in the West Coast, and the long
distance to any viable sources of replacement gasoline in the event of
local supply disruptions; and (3) California's higher level of gasoline
taxes--California currently taxes a gallon of gasoline at 30 cents per
gallon more than the state with the lowest taxes, Alaska.
* Future gasoline prices will reflect world supply and demand balance.
If demand for oil and petroleum products continues to rise as it has in
past years--EIA projects that U.S. demand for crude oil will rise about
38 percent by the year 2025--then oil supply will have to expand
significantly to keep up. Currently, world surplus crude oil production
capacity--the amount by which oil production can be increased in the
short run without installing more drilling equipment or developing new
oil fields--is very small. Moreover, many of the world's known and
easily accessible crude oil deposits have already been developed and
many of these are experiencing declining volumes as the fields become
depleted. As a result, new production facilities will have to be built,
and perhaps new oil deposits will need to be developed, to meet rising
demand for gasoline and other petroleum products. In so doing, entities
may encounter higher costs of extracting and processing oil. For
example, there are large stores of crude oil in tar sands and oil
shale, or potentially beneath deep water in the ocean, but these
sources are more costly to extract and process than many of the sources
of oil that we have already tapped. To the extent that extraction and
processing costs rise, the price of crude oil and the petroleum
products made from it will have to rise to make supplying it
economically viable. If, on the other hand, technological innovations
improve our ability to extract and process oil, this will increase the
available future supply and ease pressure on petroleum product prices.
* Although demand for crude oil is projected to increase, it could fall
below current expectations if consumers choose more energy efficient
products or otherwise conserve more energy. Such a reduction in demand
could lead to lower-than-expected future prices. For example, in
response to high gasoline prices in the United States, in the 1980s
many consumers chose to switch to smaller or more fuel-efficient
vehicles, which reduced demand for gasoline. Environmental issues could
also have an impact on world crude oil and petroleum product prices.
For example, international efforts to reduce greenhouse emissions could
cause reductions in demand for crude oil and petroleum products as more
fuel-efficient processes are adopted or as cleaner sources of energy
are developed. Additional factors that will likely influence future oil
and gasoline prices include geopolitical issues, such as the stability
of the Middle East; the valuation of the U.S. dollar in world currency
markets; and the pace of development of alternative energy supplies,
such as hydrogen fuel cell technology.
Background:
In 2004, the United States consumed about 20.5 million barrels per day
of crude oil accounting for roughly 25 percent of world oil production.
A great deal of the crude oil consumed in this country goes into
production of gasoline and, as a nation, we use about 45 percent of all
gasoline produced in the world.[Footnote 1] California alone presently
consumes almost 44 million gallons of gasoline per day. To put this in
perspective, in 1997 (the last year for which we found available data
for international comparisons), only the rest of the United States and
Japan consumed more gasoline than California.
Products made from crude oil--petroleum products, including gasoline--
have been instrumental in the development of our modern lifestyle. In
particular, gasoline, diesel, and jet fuel have provided the nation
with affordable fuel for automobiles, trucks, airplanes and other forms
of public and goods transportation. Together, these fuels account for
over 98 percent of the U.S. transportation sector's fuel consumption.
In addition, petroleum products are used as raw materials in
manufacturing and industry; for heating homes and businesses; and, in
small amounts, for generating electric power. Gasoline use alone
constitutes about 44 percent of our consumption of petroleum products
in the United States, so when gasoline prices rise, as they have in
recent months, the effects are felt throughout the country, increasing
the costs of producing and delivering basic retail goods and making it
more expensive to commute to work. It is often the case that prices of
other petroleum products also increase at the same time and for the
same reasons that gasoline prices rise. For example, today's high
gasoline prices are mirrored by high jet fuel prices, which have put
pressure on airline companies, some of which are currently in the midst
of financial difficulties.
Gasoline prices vary a great deal over time. For example, in the 10-
year period April 1995 through April 2005, the national average price
for a gallon of regular grade gasoline has been as low as $0.89 and as
high as $2.25 without adjusting for inflation. In addition, gasoline
prices vary by location and, in recent years, California has
consistently had among the highest prices in the nation.
The future path of gasoline prices is difficult to predict, but it is
clear that the use of petroleum products worldwide is going to increase
for the near term and maybe beyond. Some analysts have predicted much
higher crude oil prices--and as a result, higher prices of petroleum
products--while others expect prices to moderate as producers respond
to high prices by producing more crude oil and consumers respond by
conserving more, and investing in more energy-efficient cars and other
products. In either case, the price of gasoline will continue to be an
important part of the household budgets of Americans for the
foreseeable future and therefore, it is important to understand how
prices are determined so that consumers can make wise choices.
Gasoline Prices Are Determined by the Price of Crude Oil and a Number
of Other Factors:
Crude oil prices feed directly into the price of gasoline, because
crude oil is the primary raw material from which gasoline is produced.
For example, according to our analysis of EIA data, crude oil accounted
for about 48 percent of the price of a gallon of gasoline on average in
2004 in the United States.[Footnote 2] When crude oil prices rise, as
they have in recent months, refiners find their cost of producing
gasoline also rises, and in general, these higher costs are passed on
to consumers in the form of higher gasoline prices at the pump. Figure
2 illustrates the importance of crude oil in the price of gasoline. The
figure also shows that taxes, refining, and distribution and marketing
also play important roles.[Footnote 3]
Figure 2: Elements in the Price of a Gallon of Gasoline (Average for
2004):
[See PDF for image]
[End of figure]
Because of the prominent role of crude oil as a raw material of
gasoline production, in order to understand what determines gasoline
prices it is necessary to examine how crude oil prices are set.
Overall, the price of crude oil is determined by the balance between
world demand and supply. A major cause of rising crude oil prices in
recent months has been rapid growth in world demand, without a similar
growth in available supplies. In particular, the economy of China has
grown rapidly in recent years, leading to increases in their demand for
crude oil. In contrast, oil production capacity has grown more slowly,
leading to a reduction in the surplus capacity--the amount of crude oil
that is left in the ground, but could be extracted on short notice in
the event of a supply shortfall. EIA has stated that the world's
surplus crude oil production capacity has fallen to about one million
barrels per day, or just over one percent of the world's current daily
consumption, making the balance between world demand and supply of
crude oil very tight. This tight balance between world crude oil demand
and supply means that any significant supply disruptions will likely
cause prices to rise. For example, a workers' strike in Nigeria's oil
sector in October 2004 forced world crude oil prices to record highs
(Nigeria is the world's seventh largest oil producer, supplying an
average 2.5 million barrels per day in 2004).
Another important factor affecting crude oil prices is the behavior of
the Organization of Petroleum Exporting Countries (OPEC)--members of
which include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria,
Qatar, Saudi Arabia, United Arab Emirates, and Venezuela. OPEC members
produce almost 40 percent of the world's crude oil and control almost
70 percent of the world's proven oil reserves. In the recent past and
on numerous other occasions, OPEC members have collectively agreed to
restrict production of crude oil in order to increase world prices for
that commodity.
In addition to the cost of crude oil, gasoline prices are influenced by
a variety of other factors, including refining capacity constraints,
low inventories, unexpected refinery or pipeline outages, environmental
and other regulations, and mergers and market power in the oil
industry.
First, domestic refining capacity, has not kept pace with growing
demand for gasoline. As demand has grown faster than domestic refining
capacity, the United States has imported larger and larger volumes of
gasoline and other petroleum products from refiners in Europe, Canada,
and other countries. EIA officials told us that, in general, this
increase in imports has reflected the availability of gasoline from
foreign sources at lower cost than building and operating additional
refining capacity in the United States would entail. However, the
American Petroleum Institute (API) has recently reported that capacity
utilization has been high in the U.S. refinery sector. Capacity has
typically averaged over 90 percent, and has recently increased to 92
percent--much higher than the rate in many other industries, which API
reports are more typically operating at around 80 percent of capacity.
As a result, domestic refineries have little room to expand production
in the event of a temporary supply shortfall. Further, the fact that
imported gasoline comes from farther away than domestically produced
gasoline means that when supply disruptions occur in the United States,
it might take longer to get replacement gasoline than if we had excess
refining capacity in the United States, and this could cause gasoline
prices to rise and stay high until these new supplies can reach the
market.
Gasoline prices may also be affected by unexpected refinery outages or
accidents that significantly disrupt the delivery of gasoline supply.
For example, in a recent report, we found that unexpected refinery
outages had been a factor in a number of prices spikes in California in
the 1990s. More recently, the tragic explosion and subsequent fire at a
BP refinery in Houston, that killed 15 people, temporarily shut down
about 3 percent of the nation's refining capacity. While we have not
analyzed the potential impact on gasoline prices of this specific
event, similar events in the past have caused temporary increases in
prices until alternative sources of supply can be brought to market.
Pipeline disruptions can have a similar effect, as was seen when
Arizona's Kinder Morgan pipeline broke in July 2003 and average
gasoline prices jumped 56 cents in a month in Arizona. In addition,
tanker spills, and other similar events can all have an impact on
gasoline prices at various points in time because they cause
interruption in the supply of crude oil or petroleum products, such as
gasoline.
The level of gasoline inventories can also play an important role in
determining gasoline prices over time because inventories represent the
most accessible and available source of supply in the event of a
production shortfall or increase in demand. Similar to trends in other
industries, the level of inventories of gasoline has been falling for a
number of years. In part, this reflects a trend in business to more
closely balance production with demand in order to reduce the cost of
holding large inventories. However, reduced inventories may contribute
to increased price volatility, because when unexpected supply
disruptions or increases in demand occur, there are lower stocks of
readily available gasoline to draw from. This puts upward pressure on
gasoline prices until new supplies can be refined and delivered
domestically, or imported from abroad.
Regulatory steps to reduce air pollution have also influenced gasoline
markets and consequently have influenced gasoline prices. For example,
since the 1990 amendments to the Clean Air Act, the use of various
blends of cleaner-burning gasoline--so-called "boutique fuels--has
grown. A number of reports by government agencies, academics, and
private entities have concluded that the proliferation of these special
gasoline blends has put stress on the gasoline supply infrastructure
and may have led to increased price volatility because areas that use
special blends cannot as easily find suitable replacement gasoline in
the event of a local supply disruption. However, these special gasoline
blends provide environmental and health benefits because they reduce
emissions of a number of pollutants. GAO is currently working on a
report on special gasoline blends that will look at these issues and
discuss the effects of these special blends on emissions and on the
supply system.
Finally, we recently reported that industry mergers increased market
concentration and in some cases caused higher wholesale gasoline prices
in the United States from the mid-1990s through 2000.[Footnote 4]
Overall, the report found that the mergers led to price increases
averaging about 2 cents per gallon on average. For conventional
gasoline, the predominant type used in the country, the change in the
wholesale price, due to specific mergers, ranged from a decrease of
about 1 cent per gallon--due to efficiency gains associated with the
merger--to an increase of about 5 cents per gallon--attributed to
increased market power after the merger. For special blends of
gasoline, wholesale prices increased by from between 1 and 7 cents per
gallon, depending on location.
California's Unique Gasoline and Isolation from Other Markets
Contribute to its Higher Gasoline Prices:
California, and the West Coast states more generally, have consistently
had among the highest gasoline prices in the nation. For example,
California's gasoline prices averaged about 21 cents more per gallon
than national gasoline prices over the last ten years. In addition,
California has at times had more volatile gasoline prices than the rest
of the country. For example, in an earlier report on California
gasoline prices, we noted that, while gasoline prices did not spike
more frequently than in the rest of the United States, California's
gasoline price spikes were generally higher.[Footnote 5]
Many of the factors influencing gasoline prices nationwide have had an
even more dramatic effect on California prices. For example,
California's high gasoline prices have been attributed, in part, to its
cleaner burning gasoline. In response to air quality problems and in
order to meet air quality standards resulting from the Clean Air Act
and amendments, California adopted a unique blend of gasoline in 1996
that increased refining costs and likely caused prices of gasoline in
the state to rise. California's blend of gasoline is unique in the
United States and, according to EPA models, is the cleanest burning of
all the widely used special gasoline blends in the country. This
gasoline blend is also very difficult to make, and those refineries
that chose to make it had to install expensive new equipment and
refining processes in order to meet the specifications of the gasoline.
Some studies have suggested that the current blend of California
gasoline costs between 5 and 15 cents more per gallon to make than
conventional gasoline. It is likely that these costs are passed on, at
least in part, to consumers.
In addition, in recent years, California has developed a tight balance
between supply and demand, which has at times led to sharper or longer
price spikes when supply disruptions have occurred. Expansion of the
gasoline supply infrastructure has not kept pace with growing demand,
and as a result, the California refinery system has run at near
capacity. For example, according to EIA testimony before the Congress,
demand for gasoline in California has grown at roughly two to four
times production capacity growth. California Energy Commission staff
told us that the tight supply and demand balance has led to large price
movements in response to even small supply disruptions, caused by
refinery outages and other events.
Moreover, supply disruptions may have a larger impact on California
than on other states. First of all, only a few refineries outside of
the state can produce California's special blend of gasoline. In
addition, there are no major pipelines connecting the state with other
major refining areas. Therefore, if supply is disrupted in California,
gasoline must be brought in from the few refineries outside the state
that make California's blend of gasoline--often from as far away as the
Gulf Coast or beyond. And because of the lack of pipeline access to the
state, tankers and other means must be used, and the process is slow.
For example, we recently reported that gasoline shipped into California
by tanker from such places as the Gulf Coast, the U.S. Virgin Islands,
Europe, and Asia, can take between 11 and 40 days and added 3 to 12
cents per gallon to the retail price.
Another factor contributing to the prices Californians pay at the
gasoline pump is that residents of California pay comparatively higher
gasoline taxes than residents in many other states. For example, at
about 57 cents per gallon on average, California's total gasoline tax
rate is among the highest, behind only New York and Hawaii, and is 30
percent higher than the national average of 44 cents per gallon,
according to a November 2004 survey by the American Petroleum
Institute.
In our recent report on oil industry mergers discussed earlier in this
testimony, we found that the highest price impact of mergers--over 7
cents per gallon of gasoline--was in California. In addition, the
California Attorney General recently reported that California's
gasoline industry is more concentrated than that of the rest of the
United States, with California's six largest refiners controlling more
than 90 percent of refining capacity. The California Attorney General
noted further, that these six refiners in California control a majority
of the terminal facilities and 85 percent of the retail locations in
the state. To the extent that these factors lead to greater market
power on the part of refiners or gasoline marketers, prices may be
higher as a result. However, we have not analyzed this directly.
Future Oil and Gasoline Prices Will Reflect Supply/Demand Balance, but
Technological Change and Conservation Will Also Play a Role:
Looking into the future, daunting challenges lie ahead in finding,
developing, and providing sufficient quantities of oil to meet
projected global demand. For example, according to EIA, world oil
demand is expected to grow to nearly 103 million barrels per day in
2025 under low growth assumptions, and may reach as high as 142 million
barrels per day in 2025--increases of between 25 and 71 percent, from
the 2004 consumption level of 83 million barrels per day. For the
United States alone, EIA estimates that oil consumption will increase
by between 1.2 and 1.9 percent annually through 2025 depending on
assumptions about economic growth and other factors. Looking further
ahead, the rapid pace of economic growth in China and India, two of the
world's most populous and fastest growing countries, may lead to a
similarly rapid increase in their demand for crude oil and petroleum
products. While these countries currently consume only a small fraction
of world crude oil, the pace of their demand growth could have far
reaching implications if recent trends continue. For example,
consumption of oil by China and India is currently far below that of
the United States, but is projected to grow at a more rapid rate. EIA's
medium-growth projections estimate that oil consumption for China and
India will each grow by about 4 percent annually through 2025, while
consumption in the U.S. is projected to grow at an annual rate of 1.5
percent over the same period.
To meet the rising demand for gasoline and other petroleum products,
new oil deposits will likely be developed and new production facilities
built. Currently, many of the world's known and easily accessible crude
oil deposits have already been developed, and many of these are
experiencing declining volumes as fields become depleted. For example,
the existing oil fields in California and Alaska have long since
reached their peak production, necessitating an increasing volume of
imported crude oil to West Coast refineries.[Footnote 6] Developing new
oil deposits may be more costly than in the past, which could put
upward pressure on crude oil prices and the prices of petroleum
products derived from it. For example, some large potential new
sources, such as oil shales, tar sands, and deep-water oil wells,
require different and more costly extraction methods than are typically
needed to extract oil from existing fields.[Footnote 7] In addition,
the remaining oil in the ground may be heavier and more difficult to
refine, necessitating investment in additional refinery processes to
make gasoline and other petroleum products out of this oil. If
developing, extracting, and refining new sources of crude oil are more
costly than extracting and refining oil from existing fields, crude oil
and petroleum product prices will rise to make these activities
economically feasible.
On the other hand, technological advances in oil exploration,
extraction, and refining could mitigate future price increases. In the
past, advances in seismic technology significantly improved the ability
of oil exploration companies to map oil deposits, which enabled them to
ultimately extract the oil more efficiently, thereby getting more out
of a given oil field. In addition, improvements in technology have
enabled oil companies to drill in multiple directions from a single
platform, and also to pin-point specific oil deposits more accurately,
which has led to increases in the supply of crude oil. Further,
refining advances over the years have also enabled U.S. refiners to
increase the yield of gasoline from a given barrel of oil--while the
total volume of petroleum products has remained relatively constant,
refiners have been able to get more of the more valuable components,
such as gasoline, out of each barrel, thereby increasing the supply of
these components. Further technological improvements that lower costs
or increase supply of crude oil or refined products would likely lead
to lower prices for these commodities.
Similarly, innovations that reduce the costs of alternative sources of
energy could also reduce the demand for crude oil and petroleum
products, and thereby ease price pressures. For example, hydrogen is
the simplest element and most plentiful gas in the universe and its use
in fuel cells produces almost no pollution. In addition, hydrogen fuel
cell cars are expected to be roughly three times more fuel-efficient
than cars powered by typical internal combustion engines. Currently,
enormous technical problems stand in the way of converting America's
fleet of automobiles from gasoline to hydrogen, including how to
produce, store, and distribute the flammable gas safely and
efficiently, and how to build hydrogen cars that people can afford and
will want to buy. However, there are federal and state initiatives
under way as well as many private efforts to solve these technical
problems, and if they can be solved in an economical way in the future,
the implications for gasoline use could be profound.
Greater conservation or improved fuel efficiency could also reduce
future demand for crude oil and petroleum products, thereby leading to
lower prices. The amount of oil and petroleum products we will consume
in the future is, ultimately, a matter of choice. Reducing our
consumption of gasoline by driving smaller, more fuel-efficient cars--
as occurred in the 1980s in response to high gasoline prices--would
reduce future demand for gasoline and put downward pressure on prices.
For example, the National Academies of Science recently reported that
if fuel-efficiency standards for cars and light trucks had been raised
by an additional 15 percent in 2000, consumption of gasoline in the
year 2015 would be 10 billion gallons lower than it is expected to be
under current standards. The Congress established fuel economy
standards for passenger cars and light trucks in 1975 with the passage
of the Energy Policy and Conservation Act. While these standards have
led to increased fuel efficiency for cars and light trucks, in recent
years, the switch to light trucks has eroded gains in the overall fuel
efficiency of the passenger fleet. Future reductions in demand for
gasoline could be achieved if either by fuel efficiency standards for
cars and light trucks are increased, or consumers switch to driving
smaller or more fuel-efficient cars.
The effect of future environmental regulations and international
initiatives on oil and petroleum products prices is uncertain. On one
hand, regulations that increase the cost or otherwise limit the
building of refining and storage capacity may put pressure on prices in
some localities. For example, the California Energy Commission told us
the lack of storage capacity for imported crude oil and petroleum
products may be a severe problem in the future, potentially leading to
supply disruptions and price volatility. Alternatively, international
efforts to reduce the generation of green house gas emissions could
cause reductions in the demand for crude oil and petroleum products
through the development and use of more fuel-efficient processes and as
cleaner, lower-emissions fuels are developed and used.
Moreover, geopolitical factors will likely continue to have an impact
on crude oil and petroleum product prices in the future. Because crude
oil is a global commodity, the price we pay for it can be affected by
any events that affect world demand or supply. For example, Venezuela-
-which produces around 2.6 million barrels of crude oil per day, and
which supplies about 12 percent of total U.S. imports for oil--is
currently experiencing considerable social, economic, and political
difficulties that have, in the past, impacted oil production. In April
2002, the oil flow from Venezuela was stemmed during 3 consecutive days
of general strikes, affecting oil production, refining, and exports.
Finally, instability in the Middle East, and particularly the Persian
Gulf, has in the past, caused major disruptions in oil supplies, such
as occurred toward the end of the first Gulf War, when Kuwaiti oil
wells were destroyed by Iraq.
Finally, the value of the U.S. dollar on open currency markets could
also affect crude oil prices in the future. For example, because crude
oil is typically denominated in U.S. dollars, the payments that oil-
producing countries receive for their oil are also denominated in U.S.
dollars. As a result, a weak U.S. dollar decreases the value of the oil
sold at a given price. Some analysts have recently reported in the
popular press that this devaluation can influence long-term prices in
two ways. First, oil-producing countries may wish to increase prices
for their crude oil in order to maintain their purchasing power in the
face of a weakening dollar. Secondly, because the dollars that these
countries have accumulated, and that they use, in part, to finance
additional oil exploration and extraction, are worth less, the costs
these countries pay to purchase technology and equipment from other
countries whose currencies have gained relative to the dollar will
increase. These higher costs may deter further expansion of oil
production, leading to even higher oil prices.[Footnote 8]
Conclusions:
In closing, clearly none of the options for meeting the nation's energy
needs are without tradeoffs. Current U.S. energy supplies remain highly
dependent on fossil energy sources that are costly, imported,
potentially harmful to the environment, or some combination of these
three, while many renewable energy options are currently more costly
than traditional options. Striking a balance between efforts to boost
supplies from alternative energy sources and policies and technologies
focused on improved efficiency of petroleum burning vehicles or on
overall energy conservation present challenges as well as
opportunities. How we choose to meet the challenges and seize the
opportunities will help determine our quality of life and economic
prosperity in the future.
What is true for the nation as a whole is even more dramatically so in
California. California is one of the most populous and steadily growing
states in the nation, and its need for gasoline, as well as other
energy sources, will grow. However, California's unique problems with
respect to developing the right amount and type of infrastructure
necessary to ensure a sufficient supply of gasoline, other petroleum
products, or alternative fuels must be resolved or viable alternatives
developed if California is to continue to enjoy the prosperity and high
quality of life it is known for.
We are currently studying the gasoline prices in particular, and the
petroleum industry more generally, including a primer on gasoline
prices, a forthcoming report on special gasoline blends, an analysis of
the viability of the Strategic Petroleum Reserve, an evaluation of
world oil reserves, and an assessment of U.S. contingency plans should
oil imports from a major oil producing country, such as Venezuela, be
disrupted. With this body of work, we will continue to provide Congress
and the American people the information needed to make informed
decisions on energy that will have far-reaching effects on our economy
and our way of life.
Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions you or the other Members of the Subcommittee
may have at this time.
GAO Contacts and Staff Acknowledgments:
For further information about this testimony, please contact me at
(202) 512-3841 (or at wellsj@gao.gov ). Godwin Agbara, Nancy Crothers,
Randy Jones, Mary Denigan-Macauley, Samantha Gross, Mark Metcalfe,
Michelle Munn, Melissa Arzaga Roye, and Frank Rusco made key
contributions to this testimony.
[End of section]
Appendix I: Selected Charts and Figures:
Figure 3: U.S. Retail Price of Gasoline (Not adjusted for inflation):
[See PDF for image]
[End of figure]
Figure 4: U.S. Gasoline Consumption (1970-2004):
[See PDF for image]
[End of figure]
Figure 5: Refining Capacity and Number of Refineries (1970-2004):
[See PDF for image]
[End of figure]
[End of section]
FOOTNOTES
[1] The large percentage of total world gasoline production that is
consumed by the United States partly reflects the fact that diesel is a
commonly used fuel for cars in Europe, while U.S. cars primarily run on
gasoline. If all motor vehicle fuels were accounted for, the United
States' share of these fuels would be smaller than its share of
gasoline. However, we do not have the data to present this more
comprehensive measure.
[2] EIA also lists taxes; refining costs and profits; and distribution
and retail marketing costs and profits as other components of gasoline
prices.
[3] The latter two categories, refining, and distribution and
marketing, includes costs associated with these activities as well as
profits. The figure is a snapshot of how much each component
contributes to the price of a gallon of gasoline, and the relative
proportions attributable to each component vary over time as crude oil
prices and other factors change.
[4] Energy Markets: Effects of Mergers and Market Concentration in the
U.S. Petroleum Industry (GAO-04-96, May 2004).
[5] GAO, Motor Fuels: California Gasoline Price Behavior, GAO/RCED-00-
121 (Washington, D.C.: April 28, 2000).
[6] Even if new oil fields are developed in the Arctic National
Wildlife Refuge, by the time these fields reach their expected peak
production of 876,000 barrels per day, according to EIA projections,
U.S. demand at this time would have increased by far more than this
amount.
[7] We are currently working on a report on global oil reserves that
will address the constraints on global supply due to tapped oil
reserves and the difficulty in extraction.
[8] Higher oil prices, because they increase the U.S. trade deficit,
may also contribute to the further devaluation of the dollar. Hence,
analysts have called this process a vicious cycle in which a weak
dollar drives up oil prices, which then feeds back into the trade
deficit and cause the dollar to weaken further.
