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Blame game: Just who is the oil-price villain, anyway?

By Lee Davidson

Utah gasoline prices hit record highs in five of the past seven days. And whenever gasoline prices spike ? such as they do around every Memorial Day ? arguments erupt about who is to blame. Politicians often call for investigations, as President Bush did after big gas price hikes last month.

Ravell Call, Deseret Morning News Utah's refineries, including Beck Street's, produce more than a billion gallons of gasoline yearly. Some politicians blame big oil companies and their big profits for big price hikes. Oil companies, in turn, blame politicians or environmentalists who limit new refineries and exploration. Some blame greedy Middle Eastern producers. Some blame taxes. Some blame lack of competition from recent oil industry mergers. Some blame local retailers or refiners.

Government investigations through the years reached an interesting conclusion about which of them is really to blame.

The answer: all of them. It's akin to "Murder on the Orient Express" where everyone on a train helped stab the victim. Pick a favorite suspect as the culprit for high oil prices, and you are essentially at least partially correct.

Here is what government investigations and studies have said about some of the major potential price villains — just in time for holiday motorists to know where to hurl gripes.

First, the good news

Before looking at possible gas villains, it is important to note that Utah has among the lowest gasoline prices in the nation — up to 20 cents a gallon less than the national average at times in recent months, according to the Energy Information Administration data.

However, Utah gasoline prices finally pulled even with national averages on Thursday, as the state set record highs every day during the week.

Having gasoline that often is cheaper than the national average is good, since people in Utah bought about 1.4 billion gallons of gasoline last year and paid $2.2 billion for it (about $4,200 per licensed driver in the state), according to Deseret Morning News analysis of EIA data.

The main reason for that often-cheaper gas may lead residents to question why it is not even less expensive.

That reason is, in short: None of Utah's gasoline comes from the Middle East or other exotic places where wars or supply manipulation affect worldwide crude oil prices. Nor does it come from wells, refineries or delivery systems damaged by Hurricane Katrina.

In fact, Utah's five refineries produce more than a billion gallons of gasoline each year. Additionally, a pipeline from Wyoming refineries has a terminal in Woods Cross that supplies the equivalent of another refinery's worth of gasoline locally. That is enough to supply Utah's needs from Intermountain sources, said Lee J. Peacock, president of the Utah Petroleum Association.

About three-fourths of the crude oil that supplies local refineries comes from Utah and nearby states, and about 25 percent comes from tar sands in Alberta, Canada, Peacock says.

In comparison nationally, the EIA says 66 percent of the crude oil used nationwide in 2005 was imported from abroad.

Peacock says gasoline is cheap enough here that sometimes it is economical for distant distributors to send trucks here to haul it back. (A gasoline truck that crashed and exploded last month in Spanish Fork Canyon was doing that.)

Such long-distance shipping when gas is cheap here tends to increase local demand and prices — so Peacock said prices tend to even out nationally over time.
Commodity pricing

So why isn't Utah gasoline even cheaper if it doesn't come from the Middle East and was not directly affected by hurricane damage?
"Oil is a commodity. We (oil companies) don't set the price, but we respond to it. It's a complicated system," Peacock says.

Mark Lennihan, Associated PresstoTraders deal in New York. "The price is set in the market by traders who look at all types of things in setting the price of the commodity. Some of it is rational, and some of it is not, just like any other commodity," says Lee J. Peacock, president of the Utah Petroleum Association. "The price is set in the market by traders who look at all types of things in setting the price of the commodity. Some of it is rational, and some of it is not, just like any other commodity," from the price of gold to wheat futures, he says.

Those factors could include worry that potential war in the Middle East could limit production, making traders bid higher for other crude to ensure they have adequate future supplies. Concerns could come about continuing hurricane damage or increased demand for oil in places such as India and China.

Or, especially, traders may respond to production limitation by Third World suppliers.
An Energy Information Administration report on gasoline pricing says, for example, that "OPEC (the Organization of Petroleum Exporting Countries) has tried to keep world oil prices at its target level by setting an upper production limit on its members" to keep demand and prices high. It sees OPEC as one of the price villains.

It adds, "OPEC has the potential to influence oil prices worldwide because its members possess . . . about 40 percent of the world's production of crude oil and (hold) more than two-thirds of the world's estimated crude oil reserves."

The Federal Trade Commission in a 2005 investigation into gasoline prices said, "The world price of crude oil is the most important factor in the price of gasoline. Over the last 20 years, changes in (world) crude oil prices have explained 85 percent of the changes in the price of gasoline in the United States."

That includes rapid price increases in response to crude oil shortages caused by the Arab oil embargo in 1973, the Iranian revolution in 1978, the Iran-Iraq war in 1980 and the Persian Gulf war in 1990, plus the latest conflict in Iraq.

Most of the cost to produce a gallon of gasoline goes to cover commodity-priced crude oil. The EIA said in 2004 that 47 percent of the price of gasoline went to crude oil costs; 23 percent to taxes; 18 percent to refining costs and profits; and 12 percent to distribution and marketing.

Vehicles line up recently for gas in Salt Lake City. Utah gasoline has been up to 20 cents a gallon less than the national average in recent months.Local reaction
So why, when world crude prices go up, do local gas stations also raise prices of their gasoline — even though it was already purchased at a lower price and is sitting in their tanks? The reason is akin to imagining that if world gold prices rise, the resale value of a gold ring sitting in a jewelry box will rise with it.

"When the price of crude goes up, a refiner or retailer realizes that they are going to have to replace the fuel that is already in their tanks with fuel that is going to cost more. That's why the price can rise so quickly, because of the replacement cost factor," Peacock says.

John Hill, state director of the Utah Petroleum Marketers and Retailers Association, says customers still should not blame their local gas station owners for that.

"Generally, it's the major oil company raising the price of gasoline. For example, during Katrina in less than 24 hours, some (oil companies) raised prices three or four times — with a 42-cent-a-gallon change. In New Jersey, where law prevents retailers from raising gas more than once in 24 hours, many retailers closed their doors because they couldn't keep up with the increases from the oil companies," Hill said.

He added that local gas stations' margins are as small as 6 to 8 cents a gallon to cover costs and make a profit, so they must act quickly to stay abreast of changes that oil companies charge them. He said their margin stays about the same, no matter the price of gas — so major oil companies are the ones that profit from the higher prices.

Ravell Call, Deseret Morning NewsThree-fourths of the crude oil that supplies local refineries comes from Utah and nearby states. Adding to problems, he said, is that as gas prices rise, more so-called "drive-away" thefts occur, forcing local stations to keep prices high to cover costs and losses.

A 2002 probe into gas prices by the Senate Permanent Subcommittee on Investigations noted, "Neither wholesale nor retail prices for gasoline are established on a cost-plus-profit basis" but are based instead on reaction to market conditions.
'Big oil,' big profits

As prices have risen, big oil companies have made huge profits. For example, Chevron, ConocoPhillips and Exxon Mobil reported combined profits of $15.7 billion during just the first three months of this year.

Some say that makes them price villains — and has led to repeated calls for taxes on them to hold down windfall profits. But oil companies say those big profits are needed to reinvest in more oil exploration and production.

The 2002 Senate probe into gas pricing essentially called big oil companies a big price villain.

It said it found that big gas price hikes "result in large transfers of wealth from consumers to a few companies that refine and market gasoline. Over the course of a year, each 10-cent increase in the price of gasoline results in approximately an additional $10 billion in revenues to the oil companies."

But Peacock says those big profits are needed to find and develop future supplies, including locally in Utah.

"Unfortunately, our oil production has been declining since the mid-'80s in Utah, so we're nowhere near self-sufficient when it comes to oil production," Peacock says. But, "There has been somewhat of a resurgence of production in Utah with the high prices that have allowed additional exploration."

He adds, "We have picked all the low-hanging fruit in the U.S. All of the readily available, easy-to-find, easy-to-produce fields have, for the most part, been found and produced."

Douglas C. Pizac, Associated Press

Another well is drilled in May 2005 at the Wolverine Gas & Oil field south of Sigurd, Utah. Peacock says big profits "allow oil producers to be more aggressive to use more of the technological advances that have come into play in the last few years and explore for and produce more areas that are more technologically challenging."

That may include finally developing Utah's vast oil reserves from tar sands and oil shale. Developing them has been considered too expensive (although about 25 percent of local gasoline already comes from tar sands in Alberta).

Big oil also contends that its earnings are not out of line compared to other industries. An American Petroleum Institute statement to the Senate in March said,

"Over the last five years, the oil and natural gas industry's earnings average 5.8 cents compared to an average for all U.S. industry of 5.5 cents for every dollar of sales."

The cost of clean air

Cleaning up fuels over recent decades has meant cleaner air — but at a cost. So, not surprisingly, big oil points to environmental groups as a price villain, too.

The American Petroleum Institute sent a statement to the Senate Judiciary Committee in March outlining some of its reasons.

For example, it said that while the oil industry once "produced two types of gasoline — leaded and unleaded — it now has 17 formulations" because of varying clean air standards in different states at different times of the year, which increases refining and distribution costs.

That may not have as much effect in Utah. Peacock says, "To this point, Utah has not been subject to many of the same fuel blend requirements that have been prevalent in other parts of the country" because pollution was not as bad here.

He adds, "Up until a year ago, we were required in the winter to provide oxygenated fuel, which was mainly an ethanol blend, in Utah County. Because of improving air-quality circumstances, that requirement has been lifted."

Deseret Morning News graphic Still, tightening restrictions on fuel standards have an effect here as well as elsewhere. For example, beginning in June, new blends of ultra-low sulfur diesel fuel will be required all over the nation.

"The air-quality benefits of taking all that sulfur out of diesel are going to be significant for the county and Utah. The downside is that those upgrades in fuel specifications have required significant upgrades in plants and refineries," Peacock says. "Those costs are being incorporated into the price of fuel all over the country."

A similar development is phasing out the additive MTBE around the country because it is a potential groundwater contaminant. It once provided up to 10 percent of the volume of gasoline, and now it is being replaced with more expensive ethanol or gasoline, Peacock says.

Oil companies also contend that tough environmental regulations make it nearly impossible to build more refineries to increase fuel supplies — and they have responded by expanding existing refineries.

The American Petroleum Institute statement to the Senate says, "Twenty years ago, there were 200 refineries producing about 250 billion gallons of product. Today, there are just 148 making 330 billion gallons per year."

Sen. Orrin Hatch, R-Utah, who has pushed for tax benefits to encourage new or expanded refineries, has said that more than 200 refineries have closed in America since 1970, and no new ones have opened since then.

Exploration vs. environment

Oil companies complain that government red tape or bans also hinder where they can explore for oil.

For example, President Clinton in 1996 created the vast 1.9 million acre Grand Staircase-Escalante National Monument in Utah, preventing planned coal mining there, as well as potential oil and gas exploration. And Congress has fought for years about whether to allow drilling in Alaska's Arctic National Wildlife Refuge and blocked it so far.

Deseret Morning News graphic Expressing the view of both oil and natural gas companies, Questar President Keith Rattie told a congressional hearing in 2003, "We're not running out of of natural gas, and we're not running out of places to look for natural gas. However, we are running out of places where we are allowed to look for gas."

In response to such concerns, the Bush administration ordered a study in 2003. It found that only 15 percent of oil and 12 percent of natural gas beneath federal lands in the West is totally unavailable because it is in such places as national parks, wilderness areas and critical habitat for endangered species. About 60 percent of oil beneath public lands is in areas where it could be developed with normal permits — also meaning 40 percent is in difficult or impossible-to-develop areas.

Environmental groups argue that exploration into sensitive areas is not needed and would have minimal impact on gasoline prices. For example, The Wilderness Society argues that even 20 years down the road, when the Arctic wildlife refuge would be at peak production if drilling is allowed there, it would affect gas prices by only about a penny a gallon.

However, the Energy Information Agency estimates that at possible peak production in 2025, the Alaska refuge would significantly decrease U.S. dependence on foreign imports. Without the Arctic National Wildlife Refuge, it says America would import 68 percent of its oil. With that area in production, it would import 64 percent.

Cutting competition

Increased competition usually lowers prices. But big oil companies have made huge mergers in the past decade, reducing competition. Senate investigators, for example, say that is one big factor in higher gasoline prices today.

Deseret Morning News graphic Among the mergers:

• In 1998, British Petroleum (BP) merged with Amoco.

• In 1999, Exxon merged with Mobil.

• In 2000, BP/Amoco acquired ARCO.

• In 2001, Phillips announced a mergerwith Conoco, and Chevron (which had acquired Gulf in 1994) acquired Texaco.

Senate investigators said it found that companies "attempt to achieve and maintain a tight balance between supply and demand" to keep prices high and are more able to do so with the currently decreased competition from mergers.

For example, they said that in California, "Six refiners own or operate about 85 percent of the retail outlets in the state, which account for more than 90 percent of the retail gasoline sold in the state. As a result, the few large refiners in the state have the ability to affect the price of gasoline through their individual supply decisions."

Zone pricing

Senate investigators said they found another practice by big oil companies and their refiners designed to reduce competition — this time among local distributors, or gas station chains. It is called zone pricing.

"Most oil companies follow the practice of grouping their retail outlets into geographic or market zones and charging their branded dealers in different zones different prices for the same brand and grade of gasoline" from the same source, the Senate report says.

"Each oil company has its own zone system. The number of outlets in a zone, the shape of a zone and the number of zones in a particular area vary from zone to zone and company to company. In recent years, zone size has been shrinking; some zones now contain only one outlet," the report says.

Deseret Morning News graphic It notes, "Station dealers argue that the zone pricing policy is unfair, because it allows an oil company to charge gas stations in nearby geographical areas — sometimes on the same corner — different prices for the same gasoline."

It says zone pricing is designed in ways to "enable particular stations to be able to charge higher prices without losing too much volume to nearby competitors." It said consultants who design zones "believe they can determine how much prices can be raised at a particular station before consumers will drive to other nearby stations."

Gas station owners say a related practice is "redlining." A fact sheet from the Western Petroleum Marketers and Retailers Association says that is "the practice by refiners to prohibit jobbers (independent gas station chains or distributors) from selling the refiner's branded products in a certain area. In some instances, refiners restrict growth."

It protects an oil company's own brand of stations. But the gas station owners' association says, "Redlining and zone pricing hurt consumers by reducing competition through elimination or restriction of competitors."

Hill, with the Utah Petroleum Marketers and Retailers Association, said the practices have caused problems in Utah on occasion.

"For example, it was very noticeable a few years ago in the Rose Park area. An oil company had a set price on one side of the street where it was 'subsidizing' a station (that sold its brand), and on the other side of the street it was charging much more. Some small retailers were affected."

Peacock, however, said most differences in prices to local gas stations are based on the volume of what they buy. "It's like when Wal-Mart purchases in bulk and quantity so it gets a discount. . . . The same is true for large (gas) wholesalers or jobbers. They are able to buy in quantities that allow them to get a little better price."

Of note, when a motorist buys gasoline of a certain brand, it does not mean it was produced by that company's refineries. About one-third of stations in the country are "unbranded" and may sell gasoline of any brand.

The other two-thirds are "branded" but may not necessarily sell gasoline from that brand company's refineries. That's because gasoline from different refineries is often combined for shipment by pipeline, and companies with different brands in the same area may be purchasing gasoline at the same bulk terminal.

Competition or collusion?

Motorists often complain that gas stations seem to raise and lower prices together as if in collusion. Gas stations insist that no collusion exists, and in fact that price movement is because of fierce competition.

Hill said about 68 gas station chains exist in Utah, and they and independents operate about 900 individual retail locations. "There is a lot of competition on the street with, for example, Maverick, Costco, Smith's and Holiday keeping down the price as low as possible for the consumer."

Senate investigators said prices tend to go up and down together because most stations try to keep prices at a constant cost differential with one or more competitors. Refiners also do the same in competition with each other.

Senate investigators wrote, "Oil companies and station operators typically will survey the retail prices of nearby gasoline stations at least once a day" to come up with a balance that will help prevent losing too much business to lower-priced competitors or being overrun if their own prices are too low.

Peacock said, "It's easy for competitors to see what each other is charging because we post it in 3-foot-high lettering. So that increases competitiveness."

Scott Reed, an assistant Utah attorney general, said the state has never found any collusion between competitors or antitrust violations, and no pricing irregularities that could not be explained by normal, legal pricing pressures and practices.

He said the state had never researched price gouging — because it was not against any law until last year, when the Legislature passed a law (after possible gouging in southern Utah after flooding) prohibiting vendors from raising prices more than 10 percent above the average price during the previous 30 days during declared emergencies.

Also, Utah law bans stations from selling gasoline below cost to attract business for other items or to hurt competitors. That law is designed to prevent large chains from forcing others out of business to reduce competition. Utah law allows a station to sell below cost only to respond to a competitor who is managing to sell for less.

Seasonal hikes

Every Memorial Day — and every summer — prices rise as more motorists hit the road. Why?

"Our industry, like all industries, is based on supply and demand," Peacock says. "Demand always goes up in the spring. People drive more and are more active. That drives up the cost because supplies are restricted."

The increase in demand also comes, at least initially, when refineries are changing over from winter to summer blends of fuel, which also restricts supplies and therefore increases prices.

"All of the tanks have to be emptied completely before the new grades can be put into those tanks, and it causes some supply issues," Peacock says.

An Energy Information Administration study says, "Good weather and vacations cause U.S. summer gasoline demand to average about 5 percent higher than during the rest of the year. If crude oil prices remain unchanged, gasoline prices would typically increase by 10-20 cents from January to the summer."

Fuel taxes

Much of what consumers pay for gasoline goes for taxes. The federal government charges 18.4 cents a gallon. Utah charges an additional 24.5 cents — for a total of 42.9 cents a gallon in tax.

As of Jan. 24, Utah's gasoline taxes were 13th highest among the 50 states, according to the American Petroleum Institute.

The highest in the nation were in New York — where federal and state taxes are a combined 64.2 cents a gallon. The lowest were in Alaska, where combined taxes were only 26.4 cents a gallon.

"Motor fuel taxes have not been increased in Utah since 1997. At that time, we were in the upper tier of the tax range for state taxes, but since then . . . we have migrated down (as others rose) toward the middle of the pack," Peacock said.

The outlook

Everyone (except maybe some price villains) is hurt when the price of gasoline is high.

As a Senate Permanent Subcommittee on Investigations probe wrote, "Gasoline price increases can disrupt the entire U.S. economy. By increasing the cost of transportation, increases in the price of gasoline affect the costs of all goods and services."

High prices are expected to remain for the foreseeable future.

Energy Secretary Samuel Bodman said three weeks ago, "The suppliers have lost control of the market. Demand exceeds supply. . . . Clearly, we're going to have a number of years — two to three years — before suppliers are in a position to meet the needs of demands."

Still, the U.S. Energy Information Administration said last month that it does not believe prices for regular gasoline will average $3 a gallon for the year. Why?

"First, a larger-than-normal amount of refinery capacity is currently off line" because of damage from Hurricane Katrina. "Hopefully, as these refineries return to full operation, gasoline production should increase, thus adding much-needed supply."

It also said, "While geopolitical concerns are likely to remain for the time being, at some point, inventories may be built sufficiently to provide enough of a hedge for some refiners, which could help halt the rise in crude oil prices."

Blame game: Just who is the oil-price villain, anyway?

 

Lee Davidson is a staff writer of Deseret Morning News . Petroleumworld not necessarily share these views.

Editor's Note: Thisarticle was first publish in Deseret Morning News, Sunday, May 21, 2006 . Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld 05/21/ 06

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