Commentary

Riding Out the Gas Spike

By Peter Van Doren and Jerry Taylor
This article originally appeared on Foxnews.com on May 14, 2004.
With gasoline prices hovering around $2 a gallon, the blame game has begun and political partisans are looking to settle scores. As per usual, however, the political theatrics are drowning out the real but complicated story behind the price spike.

Rising crude oil prices explain some of the price increase. Since November, the price of West Texas crude has climbed $5.60 a barrel; translated into gasoline prices, that’s about 13 cents per gallon.

But gas prices have jumped by more than twice that — by 29 cents per gallon.

The crude-price increase is not the result of production cutbacks. Despite OPEC’s announced cuts, cartel production rose by about 1 million barrels a day since last year. Non-OPEC production is up another 1.5 million barrels a day.

But demand is increasing faster than production, particularly in China. Red-hot economic growth in Asia is driving the world crude market.

If we accept that about 13 cents of the price increase for a gallon of gas since November is because of surging demand for crude, that leaves 16 cents unaccounted for. Some of the price spike can be attributed to the temporary rise we see about this time every year, when refineries switch from making winter-time gas blends to more expensive but environmentally friendly summer blends.

Tight oil-refining capacity is also playing a role — not because environmentalists have shut the door on capacity expansions, but because demand for gasoline in the Far East is claiming almost all the previous unused capacity.

A tight market, however, means suppliers can charge more for gasoline. Profit margins in the refining sector are up, which means investment in new refining capacity will follow.

New environmental regulations, however, threaten to dampen the incentives to invest in new refining capacity for the American market. Of particular concern is a new federal rule that began to take effect this year requiring refineries to strip most of the sulfur out of gasoline (search). Retooling refineries to meet the new standard is a major one-time expense. Refineries in Europe and Japan have already done it to comply with similar regulatory standards. Many U.S. refineries will lay out the needed capital, but others are expected to simply close — and some already have.

Another Green hammer threatening the refining sector is the prohibition of MTBE (an oxygenate made from petroleum) that takes effect this year for gasoline sold in the California, New York and Connecticut markets.

The background: Federal law requires areas that are in violation of national clean air standards to use oxygenated fuel. Now that MTBE (search) is out of the picture, the only oxygenate left to those areas is ethanol (search). But ethanol costs more than MTBE-mixed fuel to make and transport; those costs will surely show up to some degree in gasoline prices this summer. Moreover, carving-up special gasoline regulations for different parts of the country increases the chance that unforeseen supply disruptions will send prices in those “island markets” soaring.

There’s little we can do about world crude prices — and little we should do about the new sulfur rules. But the federal oxygenated-fuel requirement is another matter.

Before computer-controlled fuel-injection cars came along, the oxygenate rule did indeed reduce pollution. But 20 years later, the rule serves no environmental purpose. Instead, it is simply a welfare program for the Midwestern corn-based ethanol industry.

New York Gov. George Pataki has asked the EPA for a waiver of the oxygenate rule, but the EPA has not acted on his request. Not only should the EPA provide the waiver, Congress should scrap the oxygenate rule altogether.

That having been said, there’s little else we can do but ride this price spike out. High prices will induce new supply faster than will governmental bureaucrats or politicians. There’s no conspiracy afoot — just the periodic gyrations of Mr. Supply and Ms. Demand on the economic dance floor. Getting in their way will only prolong and worsen the spike.

Peter Van Doren is editor of Regulation magazine, published by the Cato Institute. Jerry Taylor is Cato’s director of natural resource studies.