June 20, 2007
By: Daniel Duffy, Principal Analyst
You asked for background information on (1) the relationship between crude oil prices and retail gasoline prices, especially in the spring of 2007, and (2) recent federal and state proposals intended to lower the retail price of gasoline.
The cost of crude oil is the largest component cost of gasoline. Because its price generally fluctuates more than the other components costs (taxes, refining costs, and distribution costs), changes in crude oil's cost generally accounts for changes in the price of gasoline, all other factors remaining equal.
Although the crude oil and gasoline markets are intertwined, there are occasions when changes in one market are not reflected in comparable changes in the other. In the spring of 2007, the price of a barrel of crude oil held steady for a time and then rose. During the same time, the price of gasoline rose steadily. The changed factor was refinery utilization. Because of refinery outages and scheduled maintenance, refineries were not operating at their normal capacity. This reduced the supply of gasoline and prices rose.
There were three types of proposals intended to reduce the price of gasoline in Connecticut in the 2007 legislative session. Two would have changed taxes. The first would have suspended collection of the state 25¢ per gallon excise tax during the summer driving season. The second would have delayed a scheduled increase in the petroleum products gross earnings tax. The third proposal was intended to change how gasoline is marketed by outlawing zone pricing. Suppliers that use zone pricing partially base the price to retailers based on the retailer's location. Supporters of the ban say that zone pricing is used to increase prices in high-cost areas of the state. Opponents claim that zone pricing is used to lower prices in highly-competitive areas of the state and near the borders of states with lower taxes.
There are many proposals in Congress intended to lower gasoline prices. Some would suspend collection of the federal excise tax. Some seek to lower prices by decreasing demand. Among these, some would raise the mileage standards (known as the CAFE standards) for vehicles built in the United States and apply the standards to more types of vehicles. Some would seek to increase the supply of gasoline by increasing the supply of crude oil; these would allow drilling in the Arctic National Wildlife Refuge and build refineries on closed military bases. There are also proposals to create a strategic gasoline reserve similar to the strategic petroleum reserve.
CRUDE OIL AND GASOLINE PRICES
The price of crude oil is set by global supply and demand, particularly in the main refining centers: Singapore, northwest Europe, and the U.S. Gulf Coast (Oil Market Basics: A Primer on Oil Markets Combined with Hotlinks to Oil Price and Volume Data Available on the Internet, (undated), Energy Information Agency, U.S. Department of Energy, http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/full_contents.htm). It describes oil supply, from exploration and drilling for oil to the impact of technology on prospecting and increasing recovery from known oil fields to the countries where oil is produced. The primer then discusses the demand for oil with a strong emphasis on U.S. consumption by sector, product, and region. It also addresses trade flows among global and U.S. regions. After discussing refining and why stocks of oil are important, it reviews pricing.
The discussions on supply, demand, refining, trade, and stocks describe the oil market and how it is interconnected among all parts of the globe. The region-by-region supply and demand patterns interact with each other to establish a price level. Anything that disrupts the supply or demand in one part of the globe affects the prices in all parts. Demand surges, refinery outages, supply cutbacks can all cause prices to increase. Some increases are temporary, called price spikes, while others reflect longer-lasting market changes.
There are different types of transactions in oil markets: by contract (the form under which most oil changes hands), spot transactions (cargo-by-cargo), and futures contracts (for delivery by a specified date). The spot market price is the first signal about changes in the supply and demand balance. Rising prices mean that supply is short. Prices are also affected by the level of stored supply, discussed in the primer's section on stocks.
The primer states that, on a pre-tax basis, the cost of crude oil is the most important determinant of all petroleum product prices, including gasoline. As a result, their prices tend to reflect the price of crude oil, if all other things are equal.
The cost to produce and deliver gasoline includes the refiner's cost of acquiring the crude oil, marketing and distributing costs, the retail station's costs, and federal and state taxes (A Primer on Gasoline Prices, May, 2006, Energy Information Agency, U.S. Department of Energy, http://www.eia.doe.gov/bookshelf/brochures/gasolinepricesprimer/eia1_2005primerM.html). A consumer's price reflects all of these costs as well as the profits of all of the businesses in the supply chain. Prices fluctuate due to many factors, including the competitiveness of the local market, seasonal demand, world events, and refinery disruptions. The primer states that in 2005:
● crude oil comprised 53% of the cost of a regular gallon of gasoline,
● federal and state taxes comprised 19% (based on a national average of state taxes),
● refining costs comprised 19%, and
● distribution, marketing, and retailer costs and profits comprise 9%.
RECENT PRICES OF CRUDE OIL AND GASOLINE
Chart 1 displays the weekly prices of crude oil and gasoline from the beginning of June 2006 to June 2007. Months are marked with black vertical lines. The red line (square data points) displays gasoline prices and the dark blue line (round data points) displays oil prices. Gasoline prices per gallon are stated on the left side of the chart, crude oil prices per barrel on the right. The price curves show that, as a general pattern, retail gasoline prices reflect the changes in the crude oil prices. But there was a difference beginning in the fall of 2006 when the retail price of gasoline dropped more than the price of oil and again in the spring of 2007 when the price of gasoline increased rapidly when the price of oil did not. Data was taken from the price history spreadsheets on the EIA website.
Chart 1: Weekly Crude Oil and Retail Gasoline Prices
The EIA also publishes a weekly paper, This Week in Petroleum. The June 6, 2007 edition discusses both retail gasoline prices to the utilization rates of refineries. In the spring of 2004 and 2005, refinery utilization rates were near-capacity, about 95%. This wasn't true in the spring of 2007. Refinery outages and maintenance kept utilization rates down to about 90% of capacity. As a result, gasoline inventories remained low and the tight supply at the start of the driving season affected its price.
There were several proposals in the Connecticut General Assembly this year intended to reduce the retail price of gasoline. For example, several would have suspended the collection of the 25¢ per gallon excise tax on gasoline during the summer driving season. These would have reduced a retailer's cost of acquiring gasoline by that amount. Some would have also required retailers to pass along the savings to consumers. There was also a proposal to delay a scheduled increase in the petroleum gross receipts tax, which is scheduled to increase from 6.3% to 7% on July 1, 2007.
Finally, there was a proposal to eliminate zone pricing in the gasoline industry. Suppliers that engage in this practice will use a station's location as one of the factors in determining the price that a retailer will pay for gasoline. Critics of the practice state that this drives up the cost in certain areas and that banning it will lower retailers' costs, and possibly consumer prices, in those areas. Supporters of the practice say that it is used to lower prices in highly-competitive areas or in areas close to neighboring states that have lower gasoline taxes.
There are proposals in dozens of bills pending in Congress intended to reduce the price of gasoline. As in Connecticut, some would suspend collection of an excise tax for the summer driving season.
Some are intended to reduce the demand for gasoline, which would thereby reduce its price, if all other factors remain equal. There are several to raise the CAFE (Corporate Average Fuel Economy) standards. The CAFE standards set fuel economy standards for a manufacturer's fleet of vehicles, as measured in accordance with Environmental Protection Agency standards. The federal government first required motor vehicle manufacturers to meet CAFE standards in 1975 in response to the 1973-74 Arab oil embargo. There are proposals to both raise the minimum standard and to apply them to additional types of vehicles.
Another indirect approach to price reduction is to increase the supply of gasoline. There are proposals to allow drilling in the Arctic National Wildlife Refuge and to encourage the construction of additional refining capacity by using closed military bases as the location of new refineries. Another would establish a strategic gasoline and fuel reserve, similar to the strategic petroleum reserve. The gasoline reserve would be used to reduce price spikes caused by a regional or national supply shortage. Another proposal would authorize releases from the strategic petroleum reserve in response to a reduction in supply that caused a significant increase in the price of petroleum products.