On April 25, Dr. John Cook, Petroleum Division Director in the Office of Oil and Gas, testified on West Coast gasoline prices before the Senate Subcommittee on Consumer Affairs , Foreign Commerce, and Tourism. This Subcommittee is under the jurisdiction of the Senate Committee on Commerce, Science and Transportation. Dr. Cook provided the Subcommittee with information on the current gasoline price situation as well as identified unique characteristics of the West Coast gasoline market that help make its gasoline prices generally higher than other regions of the United States.
West Coast Retail Gasoline Prices
Thank you, Mr. Chairman and members of the Committee for the opportunity to testify today.
As you know, gasoline prices have risen sharply in recent weeks, with prices for regular grades now up over 20 cents per gallon across the country, and additional increases likely to follow. While the largest increases have occurred in the Midwest and Gulf Coast regions, average prices on the West Coast are still the highest in the country at over $1.70 per gallon (Figure 1). Higher still, is regular grade reformulated gasoline (RFG) in California, which is averaging nearly $1.83 per gallon, with premium grades averaging over $2.02 per gallon. When gasoline prices reach these levels, consumers and policy makers demand to know the underlying causes. My testimony summarizes these factors, beginning with the drivers behind the West Coast's elevated prices.
Why West Coast Gasoline Is Often the Most Expensive in the Nation
Gasoline prices on the West Coast are usually the highest in the nation, largely due to several factors. First, the West Coast is geographically isolated, with petroleum markets typically self-sufficient. That is, usually gasoline demand is almost entirely supplied from West Coast refineries. When supplies get tight, it can take weeks for added supply to arrive from outside the region. To satisfy consumption, West Coast refineries operate at relatively high levels, especially during the peak summer season. When refinery or other distribution problem occur, West Coast markets tighten very quickly, causing prices to rise quickly. Since the entire West Coast market is interconnected, price pressures in one area often affect the whole region.
The second reason West Coast prices are typically higher is that California, which comprises the dominant share of the West Coast market, uses a unique type of reformulated gasoline. California RFG must conform to more stringent requirements than Federally-mandated RFG, making it more expensive to produce. With no short-term "complying" supply readily available, significant shifts in markets conditions can cause large price changes.
Still another, but often unrecognized factor, is that not only does California consume more gasoline than any other state, nearly 39 million gallons daily in 1999, but in recent years, demand has grown at a pace roughly 2 to 4 times its production capacity growth. These factors combine to put pressure on refineries to produce at near maximum rates. With the balance between supply and demand so fragile, any problems with infrastructure, whether refining or distribution, cause prices to increase substantially. An April 2000 General Accounting Office (GAO) report noted that while California had not experienced more price "spikes" than other regions, the increases experienced were larger. This finding is consistent with a system operating with a finely tuned balance between supply and demand, with little or no room for error.
Although California strongly influences gasoline market conditions for the entire West Coast, it can impact other regions of the country as well - especially this year. A problem in California can result in extra supplies of gasoline being purchased on the Gulf Coast for delivery to the West Coast. These marginal barrels add price pressure to the Gulf Coast, which supplies not only the Gulf region, but also the East Coast and the Midwest. With the gasoline balance very tight in these other regions, especially the Midwest, additional product demand from California can increase prices in areas East of the Rocky Mountains. In closing, I would like to focus briefly on the rest of the country.
Gasoline Prices Are High Across the Country
As stated earlier, prices are increasing dramatically across all regions of the country for a number of reasons.
First, crude oil prices remain relatively high, nearly triple what they were as recently as early 1999. The change in crude oil prices alone would explain about 35-45 cents per gallon of the increase in gasoline prices since then.
Equally important, gasoline inventories are currently very low in virtually every region of the country. EIA's preliminary estimates show stocks at the lowest end-March level since EIA began compiling these data in 1963. And, the situation has not improved in recent weeks, with mid-April levels significantly less than the past five-year average (Figure 2)
When inventories are this low, supplies immediately available to cover unexpected imbalances in supply and demand are minimal, thereby raising the risk of sharp price increases. Since U.S. refineries operate at very high utilization rates during the summer, absent adequate inventories, added supplies must come from other parts of the country, or even foreign sources. As such, even the perception of tightening conditions, such as rumored refinery problems, can precipitate price pressure through "precautionary buying".
In fact, while gasoline production has generally exceeded year-ago levels since the beginning of the year, extensive refinery maintenance this spring has somewhat limited recent production, resulting in a brief dip below year-ago levels during the second half of March. With demand resuming growth rates so far this year typical of the late 1990s, despite an apparent slowdown in the U.S. economy, an exceedingly tight gasoline balance has emerged, resulting in very low stocks and rapidly rising wholesale prices.
With spot prices rising 25 to 30 cents per gallon in almost all regions since mid March, retail prices have begun to respond accordingly, and further increases should be expected over the next several weeks.
In particular, the Midwest is especially tight again this year. Retail prices for conventional gasoline have risen 20 cents on average over the past 4 weeks, but RFG has risen over 40 cents per gallon, in part due to the pull on Gulf Coast clean products by California. Like California, parts of the Midwest also use a unique RFG, one blended with ethanol rather than MTBE. The unique nature of gasolines consumed in the Chicago and Milwaukee areas was one of the reasons Midwest gasoline prices temporarily rose above West Coast prices last summer when supplies were initially unable to meet demand at the start of the summer season. While not geographically isolated per se, the Chicago/Milwaukee market is partially dependent on distant Gulf Coast production. This combination, which effectively makes the Chicago/Milwaukee area an "RFG island", can result in very high prices, because significant distances are involved in acquiring a blend of RFG not produced by many refineries outside their market.
To conclude on a brighter note, retail prices may be nearing an early seasonal peak, barring further significant operating problems, as preliminary EIA data show that currently high prices have sparked an expected sharp increase in refinery production and imports over the last two weeks. Continued high supplies may yet stabilize inventories and weaken prices going forward into summer.
This concludes my testimony.