After staying relatively stable and inexpensive during most of the 1990s, gasoline prices have had a rocky time since 2000. In May of 2000 and 2001, average prices reached $1.70 per gallon, and motorists in parts of California and the upper Midwest experienced, for the first time ever, prices hitting $2.00 and above. When adjusted for inflation, these prices were not records (see “The Trend is Down,” CR, May 2001). Still, $2.00 per gallon was a regrettable milestone – and a signal to many that this decade may not be as friendly to motorists as the last. And thus far in 2002, we’ve seen national average prices shoot up from $1.10 per gallon in January to $1.40 as of this writing. The Department of Energy’s Energy Information Administration (EIA) predicts the average price will reach $1.46 per gallon this summer.<?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />

 

Contrary to much hyperbole about oil company conspiracies, changes in gas prices are largely related to changes in the cost of producing gasoline. Unfortunately, these cost factors are likely to cause further price increases in the years ahead.

 

Background

 

According to the EIA, the four cost components of gasoline prices are crude oil, taxes, refining, and distribution and marketing. The largest component is the cost of crude oil, the raw material from which gasoline is refined. It is responsible for approximately 40% of the price of gasoline. Next in importance are federal, state, and local taxes, which add about one-third to the price. Federal gasoline taxes amount to 18.4 cents per gallon, and state (and in some cases local) taxes add a comparable amount. The rest of the price for a fill-up is the cost and profit associated with the many steps from refining the oil into gasoline to distributing it to the many thousands of gas stations where it is sold to motorists.

 

Recent Fluctuations

 

Though gasoline taxes constitute a substantial part of the price of gasoline, they have remained steady for several years, and thus are not behind the recent fluctuations. Legislators, both at the federal and state level, have refrained from responding to recent price increases with gasoline tax cuts. Instead, it is the fluctuating cost of crude oil, and the federal regulations that raise the cost of refining and distributing gasoline, that are the main reasons behind the recent price increases.

 

The gasoline price rise since the beginning of the year was caused mainly by increasing crude oil costs. The cost of a barrel (42 gallons) of crude oil – from which a variety of products, including 20 gallons of gasoline, are made – has risen from under $20 in January to the mid- and upper-20s in March and April. This increase was caused by several factors, including Organization of Petroleum Exporting Countries’ production limits and political instability in the Middle East and Venezuela – both major sources of crude oil. In addition to supply constraints, overall global demand for oil is currently strong, adding further to the pressure on prices.

 

The price jumps in many parts of the country during the late spring and early summer of 2000 and 2001 can be traced to another component of gasoline prices: the cost of refining the crude oil into gasoline and of distributing the product. Those costs are heavily influenced by federal regulations. Prior to 1990, the composition of motor fuels was not heavily regulated by the government, and prices were not substantially influenced by the need to design fuels to meet federal requirements. All that changed with the 1990 amendments to the Clean Air Act, which contain extensive motor fuel regulations. Costlier specialized blends, such as reformulated gasoline (RFG), were mandated for areas whose air quality had not reached the standards required by law, and conventional gasoline was also subject to several requirements. A tough new round of RFG requirements took effect in the spring of 2000, just prior to the first wave of recent price run-ups. In addition to federal regulations, some state motor fuel requirements have also been imposed. The large number of these distinct fuel types now in use has greatly complicated petroleum logistics and added to refining and distribution costs.

 

The pattern of price spikes in May of 2000 and 2001 is a reflection of this costly regulatory burden. Indeed, the timing and locations of the greatest gasoline price increases match almost exactly with the timing and location of the most burdensome regulations. The late-spring-to-early-summer time frame coincides with the costly and logistically difficult transition away from winter fuel specifications to the more stringent summer requirements. And the locations of the sharpest increases – California and the upper Midwest – are the two parts of the country with the most challenging fuel standards. Both areas also have barely adequate refining capacity to make these specialized blends, in part because of Environmental Protection Agency regulations that discourage construction of new refineries and expansion of existing ones.

 

Future Gasoline Prices

 

Though few predict skyrocketing gasoline prices in the years ahead, the general trend will likely be higher. The EIA predicts slightly increasing crude oil prices through 2020. A small part of the this projected increase is a result of a projected continuing decline of domestic oil production, especially now that the Senate has voted not to allow drilling on Alaska’s Arctic National Wildlife Refuge (ANWR). The ANWR would not have provided enough oil to reduce substantially either the global price or America’s dependence on foreign sources, but it would have provided additional reliable supplies in the decades ahead.

 

The regulatory burden is also likely to increase. The Clinton Administration promulgated several costly gasoline regulations scheduled to take effect in the years to come. In addition, the pending energy bill mandates that a certain amount of ethanol be added to gasoline. Since ethanol costs more than an equivalent amount of gasoline, this mandate, if enacted, is certain to increase the cost to consumers.

 

The Environmental Case For Ethanol

 

The ethanol mandate is intended as a substitute for the more common additive, methyl tertiary-butyl ether (MTBE), which the National Research Council concluded “has little impact on improving ozone air quality and has some disadvantages.” MTBE has caused some concerns about groundwater contamination, and several states are planning to ban it.

 

The same National Research Council study that found little air quality benefit from MTBE use was equally negative about ethanol. Ethanol-containing fuels tend to evaporate readily, and evaporative emissions, along with combustion exhaust, contribute to air pollution.

 

In addition, ethanol creates more pollution in its production than does gasoline. The process of making ethanol, from the growing of the corn to distilling it into fuel-grade liquid, involves many energy-intensive steps. Several studies have shown that making ethanol takes nearly as much energy (if not more) than is derived from its combustion. As a result, each gallon of ethanol has already caused more emissions, as compared to a gallon of gasoline, before it ever enters your gas tank.

 

Ethanol has also been touted as a domestic fuel source, and thus a means to reduce our dependence on foreign oil. But, as a Congressional Research Service study recently noted, “if the energy used in ethanol production is petroleum-based, than ethanol would do nothing to contribute to national security.” The ethanol industry, despite its eagerness to impose its product on others, often prefers cheaper fossil fuels for its own operations.

 

If the environmental argument for ethanol is weak, the economic argument is even worse. One might ask how a fuel that requires nearly as much energy to make as it provides would be economically viable. The answer is: it isn’t; ethanol costs about twice as much as gasoline. Even preferential tax treatment has not significantly expanded its use.

 

In sum, the reasons for the recent behavior of gasoline prices are well known. Unfortunately, these factors – especially if the ethanol mandate is passed – will likely continue to exert upward pressure on prices at the pump in the years ahead.