DIRECTOR, PETROLEUM DIVISION
U.S. DEPARTMENT OF ENERGY
ENERGY INFORMATION ADMINISTRATION
COMMITTEE ON ENERGY AND COMMERCE
SUBCOMMITTEE ON ENERGY AND AIR QUALITY
U.S. HOUSE OF REPRESENTATIVES
MAY 15, 2001
Gasoline prices in 2001 surged during April and early May, rising nationally 31 cents per gallon to reach $1.71 on May 14. Some consumers have experienced even higher increases. Like last year, Midwest drivers have seen some of the largest increases. There is no single factor causing today's price surge. The root of the problem is the tight world crude oil market. This tight market brings low inventories and an increased potential for volatility. But the apparent increase in volatility seen recently is not only a function of the tight crude oil market's low inventories, but also of the loss of flexibility due to refinery capacity and distribution constraints brought about by growing demand and product proliferation.
We are passing through what usually is one of the tightest times of year for the gasoline market - when refineries finish maintenance as demand is increasing. Production has increased almost 650 MB/D since the end of March as refineries ramp up to full capacity. With no further major refinery problems, we may see prices peak sometime this month. Our latest forecast has monthly average prices peaking somewhere between about $1.65 and $1.75. However, we are projecting continued low inventories, which, along with the other factors mentioned, keeps us exposed to further volatility, particularly during summer when demand peaks.
Consumers are also seeing high natural gas prices. As was the case in petroleum, natural gas storage levels had been drawn down as demand exceeded production, and last summer, prices began rising. As demand surged during last winter's cold weather, prices spiked over concerns about adequate supply. Spot prices this summer are expected to average about $5.00 per million BTU's, or about twice what we experienced two summers ago. Next year we expect the storage situation to improve somewhat, and with that, we should see a dip in average gas prices. However, in the short term, increases in production and imports will be pressed to keep pace with growing demand brought about partially by new natural-gas fueled electric generation capacity.
Statement of John Cook
Director, Petroleum Division
U.S. Department of Energy
Energy Information Administration
Before the Committee on Energy and Commerce
Subcommittee on Energy and Air Quality
U.S. House of Representatives
May 15, 2001
Thank you for the opportunity to testify on the factors affecting gasoline and natural gas markets.
Nationally, gasoline prices averaged $1.71 on May 14, an increase of 31 cents per gallon over 7 weeks. (Figure 1) Some regions have experienced even higher increases. Again, Midwest consumers are seeing some of the largest increases in the country. Prices in the Midwest averaged $1.81, having increased 43 cents per gallon over the past 7 weeks. Most of the same factors that affected prices last year are again at work this year: tight crude oil markets resulting in low petroleum inventories; unique regional and seasonal products; high refinery capacity utilization; and dependence on distant supplies. When these factors come together as they did last year and this year, the potential increases for rapid price runups.
Low petroleum inventories set the stage for our current situation, as they did last year both for heating oil and for gasoline. These low inventories originate from the tight world crude oil supply/demand balance that has evolved since early 1999. Arguably, tightness in crude markets has been the key factor driving low inventories in recent years.
Actions taken by OPEC and several other crude oil exporting countries are largely responsible for the sharp increase in oil prices from the $10 levels seen in December 1998. OPEC dramatically reduced crude oil production in 1998 and early 1999, so much so, that, even after four production increases last year, world inventories remain at extremely low levels. Furthermore, up until the last several months, scarce crude supplies encouraged high near-term prices relative to those for future delivery. This situation, referred to as backwardation, discouraged inventory growth, and maximum refinery production. Thus, with low crude oil and product inventories, today little cushion exists to absorb changing conditions, setting the stage for volatility. Although world demand is projected to continue growing this year, OPEC's current plans imply even less production than last year, which will keep world inventories low and maintain crude oil prices close to $30 per barrel for the remainder of the year
Within the United States, gasoline inventories have been even lower this spring than they were last year. (Figure 2) As of May 4, U.S. gasoline inventories were about 4% below their seasonal 5-year average. Midwest inventories were even lower, ending the week almost 9% lower than their 5- year average, and 4% below last year's levels at this time. (Figure 3) Both conventional as well as RFG gasoline markets are tight this year. Such low gasoline inventories are partially a consequence of refineries focusing strongly on distillate production last winter, given that the United States entered the heating season with very low inventories.
Inventories are located near demand areas and act as a buffer for mismatches between demand and production or imports. As EIA has pointed out on numerous occasions, very low gasoline stocks, combined with a market short on crude oil, generates an environment ripe for price volatility, both during the spring and peak summer periods
Growing Number of Gasoline Types
Another factor is at work that adds to the potential for volatility when inventories are low - the growth in the number of distinct types of gasoline. Today's gasoline market is comprised of many types of gasoline that serve different regional markets to meet varying environmental requirements. While producing specialized products for only those areas with air quality problems is seen as an efficient means of cleaning the air, the increase in product types adds a level of complexity in production, distribution and storage of gasoline.
The result of this targeted approach to air quality has been to create gasoline market islands. The primary examples are California and the Chicago/Milwaukee areas, in which the required gasolines are unique, and only a limited number of refineries make the products. The inventories of gasoline used in these regions can be drawn down rapidly in response to unusually high demand or a supply problem at one of the few refineries producing the specialized products, or in one of the pipelines delivering the products. Prices for gasoline in these regions then surge. If other gasoline markets are not tight, the prices surges may be limited to the specialized gasoline regions, as we have seen historically in the case of California.
Refinery Capacity Constraints
Refinery capacity limitations have also become a factor affecting the U.S. gasoline market, especially during periods of low inventories. The summer of 1997 was the first time the U.S. refinery system was pushed to its practical operating limits for gasoline production and was unable to respond adequately to unusually high gasoline demand. (Figure 3) As a result, seasonally low inventories were rapidly depleted and prices surged. Since then, capacity has grown slightly more than demand, but the capacity situation is still tight during the summer.
With little inventory to absorb a supply/demand imbalance, and many refineries running at their practical limits, any supply problems such as refinery outages may not be resolved quickly. This factor increases the time that it takes to respond to a problem and thus increases the potential for price runups and extends the time that prices will remain high. Furthermore, even if the world petroleum market begins to see more supply at some point in the future, lack of excess refining capacity may impede the ability of the system to remedy low inventory problems quickly.
Dependence on Distant Supplies
If local inventories and local refineries cannot respond adequately to a temporary shortfall in supply, extra product may have to come from a long distance away. The cost, capacity and reliability of logistical systems, as well as travel time for movement of new supply, can all impact the total time needed for adequate supply levels to reach a market, and prices respond accordingly. For example, travel time alone can be 2 or 3 weeks for product to move from the Gulf Coast to the upper Midwest. Distance and lack of pipeline connections have always been a factor affecting California markets. Last year problems with the Explorer pipeline, which brings products from the Gulf Coast to the Midwest helped to propel prices upward.
This year we have already seen what can happen when low inventories combine with regional capacity limitations and unique gasoline requirements. First, in the Midwest, the shutdown of the Blue Island refinery created a level of concern about supply of RFG for Chicago and Milwaukee. The closure also created the need for more product volumes to move from the Gulf Coast to the Midwest. Economic incentives to build inventories were further eroded as Gulf Coast prices surged in response to strong demand not only from the Midwest and West Coast, but also from the East Coast, where refineries underwent extended maintenance. During April, with little inventory cushion in place, the transition from winter to summer grade reformulated gasoline in the Midwest required running tanks down to very low levels, removing even more inventories. Just as tanks were beginning to refill, Tosco's Wood River, Illinois refinery had a fire that reduced its ability to produce both conventional gasoline and reformulated gasoline for the Midwest.
While East Coast prices have not surged as much as in the Midwest, the East Coast has suffered from some fairly long refinery maintenance outages. In addition, several foreign refineries that sell reformulated gasoline streams to the East Coast have had extended outages. East Coast refiners seem to be returning to full operations, with EIA's weekly data showing large increases in East Coast gasoline production.
California frequently sees price surges due to its tight supply/demand balance, the unique nature of its gasoline, and its long distance from other supply sources. This spring has been no exception. In addition, some refineries could be subject to more outages than usual due to threat of electricity shortages.
We are passing through what usually is one of the tightest times of year for the gasoline market - when refineries wind up maintenance as demand is increasing seasonally. Production has increased almost 650 MB/D since the end of March as refineries ramp up to full capacity. The Wood River refinery should be fully operational shortly, and with no further major refinery problems, we may see prices peak sometime this month. Our latest forecast has monthly average prices peaking somewhere between about $1.65 and $1.75. However, we are projecting continued low inventories, which, along with the other factors mentioned, keeps us exposed to further volatility, particularly during summer when demand peaks.
In short, there is no single factor causing today's price surge. The root of the problem traces to still tight world crude oil markets. This tightness brings low inventories and an increased potential for volatility. But the apparent increase in volatility seen recently is not only a function of the tight crude oil market's low inventories, but also of the loss of flexibility due to refinery capacity and distribution constraints brought about by growing demand and product proliferation.
In concluding, I also wish to note that consumers are seeing high prices in other fuels as well. For example, natural gas prices, which for many years fluctuated around $2.00-$2.50 per million BTU's, hit $10 per million BTU in the Louisiana spot market this past winter. New York city gate prices went over $20 per million BTU's, and California prices rose even higher. As was the case in petroleum, natural gas storage levels had been drawn down as demand exceeded production, and prices began rising last summer. As demand surged during last winter's cold weather, prices spiked over concerns about adequate supply. Areas like New York were also impacted by constraints in pipeline distribution. Spot prices this summer are expected to average about $5.00 per million BTU's, or about twice what we experienced two summers ago. Next year we expect the storage situation to improve somewhat, and with that, we should see a dip in average gas prices. However, in the short term, increases in production and imports will be pressed to keep pace with growing demand brought about partially by new natural-gas fueled electric generation capacity.
This concludes my testimony.