PA Two-Dollar Bargain — Gasoline

By Dennis Schiffel
  • Monday, March 29, 2004

Despite the outcry over high gasoline prices, gasoline in the U.S. is a bargain, even at two dollars per gallon. How can this be? Let’s look at a few comparisons.

U.S. gasoline prices are the lowest of almost any developed industrial nation. In Europe and developed Asia, gasoline typically costs two or three times more per gallon. Surely, by comparison, we’ve a bargain price.

If you adjust for inflation, gasoline prices today are cheaper than they were 15 or 20 years ago. In 1981 the inflation-adjusted price of gasoline peaked at over $2.90 per gallon. In real dollars, today’s price is 30-40 percent less.

According to economists, more of a product is consumed when it is inexpensive. The U.S. has a higher per vehicle and per capita consumption of oil and gasoline than almost any other developed nation—evidence that gasoline is a bargain here. We consume more gasoline because it is relatively cheap.

Whenever the price of gas goes up, motorists become agitated. Oil companies are vilified. Collusion and price gouging are claimed. Politicians call for investigations. But the story of why gas prices go up is pretty clear.

Recently, the price of crude oil exceeded $38 per barrel. Expert observers of the oil business had expected a crude price in the mid-to-upper $20 per barrel range. Rising world demand, especially from China, exerts upward price pressure on products made from crude oil. The actions of OPEC oil producers have done the same.

Also, the cost of manufacturing gasoline has an upward bias. To run new and different blends of gasoline, manufacturers must modify their refineries. Smaller runs of “boutique” gasoline for particular markets are more costly per unit than longer runs. Changing from one blend to another requires “tweaking” the refinery. Smaller runs of boutique gasoline imply more tweaking and more costs. California, Nevada, Arizona, New York—among other states—require by law or regulation different blends of gasoline that by law cannot be interchanged.

Environmental requirements also drive up costs. They do so by requiring less polluting gasoline in motor vehicles and by requiring the refinery manufacturing process to be more environmentally friendly. These costs, which get passed along to motor fuel users, produce a good thing—a cleaner environment.

Allegations of collusion by oil companies, as the cause of price increases, doesn’t survive scrutiny. That argument isn’t heard when prices fall. The many state and federal investigations of the oil industry over the last 20 years find no such noncompetitive behavior. The assertions by some politicians and social activists to the contrary are repeatedly proven to be unfounded.

Oil prices and gasoline prices have and will fluctuate up and down. Indeed, the painful upward fluctuations in price may become more severe and more frequent. Why? Partly it would result from OPEC actions. Partly, it would result from the collision between a lack of refinery capacity and a market segmented by unique state-to-state boutique gasoline requirements. Refineries are very expensive to build, and getting permits to do so is a long and highly speculative undertaking. Thus, no new refineries have been built in the U.S. for many years, and none are likely to be built in the near term. Try building a refinery in California if you want to experience frustration. Some small refineries have been shut down because they cannot justify the capital necessary to meet new blending requirements for boutique gasoline and new environmental requirements.

California is a perfect illustration of the dilemma. In-state refinery capacity is limited. Very few non-California refineries make the gasoline required by the state. The ones that do are located as far away as Europe and the Caribbean and can only supply through ocean shipping. While California manufacturers try to match production with demand, the increasing demand for refined products with no increase in refineries creates the potential for periodic shortages and price spikes. In California, if a single major refinery experiences an extended production loss, prices will spike due to the low supplies of gasoline.

What’s the message in this collision of capacity limits and specialized blends? Gasoline prices will continue to be volatile, probably increasingly so.

So $2 per gallon is a bargain, if a somewhat painful one. Gasoline prices will fluctuate downward as well as up. So an even better bargain price is coming.

Conspiracy theories and villains are mostly made-up fantasies—often encouraged by those who wish to capitalize on public ire without examining the facts or offering constructive solutions.

Dennis Schiffel is a former senior associate at the National Science Foundation and a policy fellow of the Nevada Policy Research Institute.

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