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Traders dealing crude oil options on the floor of the New York Mercantile Exchange in April. Speculation is one factor in surging oil prices (AP Photo)

10 tough questions on oil and gas prices

ASK THIS | May 05, 2008

For starters, Joseph Davis asks: Why is Congress so passive on the lack of refining capacity? What about probes into price manipulation? The House passed a bill on price gouging; who’s holding it up in the Senate?

By Joseph A. Davis

Q. If Congress and the candidates are serious about reducing U.S. dependency on foreign oil, why would they passively accept little or no growth in U.S. refining capacity at a time when world refining capacity is growing?

Q. What has come of the various Congressional investigations, or calls for investigations, into possible manipulation of the domestic motor fuel market?

Q. What are the prospects for the House-passed bill (H.R. 1252) setting stiff penalties for gasoline price-gouging? Why has the Senate Commerce Committee taken no action on it? What Senators are holding it up?

Q. What are the root causes of soaring oil and gasoline prices? What will candidates and Congress do to address them?

Q. Why has U.S. refinery capacity not grown more and more quickly?

Q. What is the financial strategy that causes oil companies not to invest more in refinery capacity at a time when they are flush with profits and demand exceeds supply and is growing? How much, precisely, is industry currently investing in new or increased refinery capacity? What do stockholders think of this?

Q. How is the price of domestic wholesale and retail gasoline actually set? Is it really a free, open, and competitive market? Does the diminishing number of companies in the market – and the ownership of distribution and retail outlets by the refining companies – offer opportunity for anti-competitive practices?

Q. What is the credibility of industry claims that refiners are worried that demand for gasoline may drop disastrously as a result of the government push for more ethanol use? How does this square with historical demand growth and the current market signal of strongly and persistently rising prices?

Q. What is the credibility of the Federal Trade Commission's 2006 report [also click here] finding no manipulation or collusion among refiners in restricting supply or setting prices. Are those findings consistent with findings in the FTC's 2001 investigation?

Q. Has the Justice Department investigated the possibility of anti-competitive practices in the domestic motor fuel industry? What were the results? Did then-Attorney General Alberto Gonzales in 2006 shut down a Justice Department investigation sought by state Attorneys General?

 The price of gasoline at the pump is climbing steadily toward $4.00, the summer driving season is likely to make things worse, and some political leaders have again begun trying to convince the voters that they have solutions.

It may be a hard sell. A Kaiser Family Foundation poll done in April showed that voters were more worried about paying for gasoline (44%) than about getting a good-paying job (29%) or paying their rent or mortgage (19%). The survey of 2,003 U.S. adults was conducted April 3-13.

Gasoline prices are an issue, and probably a growing one, in the 2008 presidential and Congressional campaigns. John McCain and Hillary Clinton are pushing for a summer moratorium on the federal gasoline excise tax, while Barack Obama dismisses the idea as a "gimmick." President Bush says there is no "magic wand" he can wave, but in the same breath says the answer is to drill the Arctic National Wildlife Refuge -- and blames the Democrats for not letting him do it.

This week, the BP and Shell oil companies posted higher-than expected profits and saw share prices rise.

The climbing world price of oil and the soaring domestic price of gasoline are certainly related, but are actually two very separate phenomena governed by very different sets of causes. First: crude oil.

Crude oil prices

The world price of crude oil in April 2008 went above $120 per barrel. In March of 2007, it was below $60 per barrel.

The oil price can not be simply set by policy – OPEC policy, U.S. policy, oil-state policy, or corporate policy – although it can be influenced somewhat by all of the above. Crude oil and some petroleum products are bought and sold on a fairly free world market, cranky as it is. Also a bit simplistic for an understanding of today's market is the idea that oil companies are all affiliated with a single state (though in the case of nationalized oil companies, some are). Most big oil companies are multinationals, with scant loyalty to the interests of any single nation, and scant dependence on the wells of any one nation. The idea that U.S. companies can somehow solve our problem by producing more U.S. oil – thus saving us from a "dangerous dependence on foreign oil" – does not reflect the realities of the oil business. More so because much of the oil imported into the U.S. comes from countries who are (or used to be) our allies – like Mexico, Canada, Venezuela, the Virgin Islands, Colombia, U.K., Belgium, Brazil, Trinidad and Tobago,  and Norway – and who do not belong to OPEC, and whose product can often be shipped unthreatened by foreign politics or gunboats.

Twenty or thirty years ago, a rising oil price could be counted on to eventually bring more oil into the market. Not so today. The question is why, and we do not have to search too hard for answers. Here is a short, incomplete checklist of some big ones.

  • World demand is rising fast as economic development fuels the economies of emerging nations like China. 
  • Many of the easy-to-get oil reserves have already been tapped and extensively drained. Bringing more oil online may be more expensive today than 30 years ago, in many countries. We are running out of cheap, accessible oil. 
  • Military conflict, political instability, and national policy are preventing reserves from getting to market from many more countries than 30 years ago. The infrastructure in some of these countries would prevent them from getting oil to market even if they wanted to. The threat or fear of supply disruption, in other cases, is enough to drive prices up in a jittery market. Iraq, with some of the largest oil reserves of any nation, is a key and very relevant example. But we could also cite Nigeria, Venezuela, Algeria, Angola, Colombia, or Iran (from whom we import no oil). 
  • Speculation and currency-market shifts are a huge factor. As the dollar weakens vis-a-vis other currencies, the dollar price of oil goes up regardless of other factors. Oil-rich nations are reconsidering the long tradition of pricing oil in dollars – and this would only make things worse. As stock and real-estate prices tumble, investors seek to put more money into commodities like oil, and the buying pressure drives the oil price up. Pure speculation is also a factor, whether based on real economics or an illusory "bubble." Speculators may be betting that the world price of oil is headed upward on various timeframes. But they may also be betting that oil futures are a good hedge against geopolitical chaos.

The numbers say one thing clearly: we can not drill our way out of this pickle (which is essentially the oil policy embraced by the White House and some in Congress). We have already pumped and burned most of our U.S. oil. However you count them, U.S. proved and potential reserves are only a small fraction of the reserves left in North America, and an even tinier fraction of the substantial reserves left in nations like Saudi Arabia, Iran, Iraq, Kuwait, United Arab Emirates, Russia, etc.

The problem is not a dangerous U.S. dependence on foreign oil; the problem is a dangerous dependence on oil itself. If the oil price is headed upward permanently, then the best policy answers most likely involve learning to use what there is more efficiently – and diversifying our base of fuels, technologies, and energy sources.

Has the U.S. government done all it could to address and adapt to these realities? Hardly. The energy bill of 2005 spent far more to subsidize fossil and nuclear energy than it did to promote efficiency and alternatives, and it left existing subsidies for oil production largely untouched. The energy bill of 2007, while it did much finally to promote efficiency and alternatives, left green-energy incentives to expire and did not cut most existing subsides for oil and coal. Few argue that it will have much impact on the world price of oil or the domestic price of gasoline.

Gasoline prices

What impacts U.S. consumers and voters most directly is the price of gasoline and diesel fuel, not only because of what they pay at the pump but also because higher fuel costs raise the price of many consumer goods. Fuel price hikes can be a major drag on the whole economy.

Gas prices are most politically relevant because they are a sharp pain that voters will be feeling this summer and fall, before they vote. All three candidates (and even President Bush) seem to "get" this. But the summer holiday for the 18.4-cent federal excise tax on gasoline proposed by Clinton and McCain will not, in the view of the experts and the media, do much more than slightly numb the voters before their wallets are amputated. [For stories, here’s one from NPR; one from the New York Times, and one from Newsweek.]

With Democrats and Republicans both split on the gas tax holiday, the chances of it passing a narrowly-divided Congress in an election year seem close to nil. The biggest danger, from all three candidates' perspective, is that the public may conclude that they have proposed nothing serious or substantial to address gas prices. During the time since McCain proposed the gas-tax holiday, the price of gasoline has actually risen more than the 18.4 cents worth of tax relief it would offer, according to the Energy Information Administration.

That it will do nothing to solve the problem is a given that even McCain admits. The danger to candidates is that it will do nothing to get them elected. If Congress passed a tax holiday and the price of gas stayed flat (because of a rise in the underlying commodity price) or went up, the tactic could boomerang.

The price of gasoline at the end of April 2008, averaged over the whole U.S., was about $3.60 -- up about $0.63 from a year earlier. Even worse was the price of diesel, $4.17 -- up $1.36 from a year earlier.

As for crude oil prices, experts estimate that the cost of crude oil accounts for anywhere from 46 percent of the retail price of refined gasoline to 72 percent. Obviously, the numbers are fuzzy. The looseness of the linkage between wholesale oil and retail gasoline prices raises questions. Journalists might well ask whether oil companies, refiners, distributors, and retailers are taking advantage of the situation. But they rarely do ask.

While crude prices are a factor, most experts would agree that tightly limited U.S. refinery capacity is also a big factor in pushing domestic gasoline prices higher.

Less easy to answer: why is refinery capacity limited and what can be done about it?

Environmentalists and consumer advocates tend to argue that companies are colluding and dragging their feet on purpose -- since high gas and diesel prices help profits. Companies blame government regulations.

There are grounds for skepticism. Utility and gas transmission companies first blamed the California "energy crisis" of 2001 on clean air and market regulation, too. Few news media questioned this explanation. But it turned out to be totally untrue, and a cover for billions of dollars worth illegal market manipulation by companies like Enron.

The Nieman Watchdog has previously raised the question of whether there may be manipulation or collusion in the U.S. gasoline market. [Click here and here.]

Some numbers: In 1981, there were 324 refineries with a total capacity of 18.6 million barrels per day, according to the EIA. As of 2007, there were 149, with a capacity of 17.4 bpd.

It is no secret that the industry deliberately shut refineries to improve profits in recent decades. Industry says it is now building new capacity at existing plants – but despite rising prices and growing demand, refineries are again cutting back their capacity-building plans.

Posted by Ed Van Hoy
09/10/2008, 11:25 AM

Why are we paying a dollar more a gallon for gas than our local
distributor. They were found guilty once for price gouging.
Where is our high paid Gov.
watch dogs now? We live in Bristol VA. Gas is 3.65 a gallon
09-10-08.gas Market price today
2.62 a gallon

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