Better Get Used to Gas-Price Spikes

When oil prices failed to fall after the Iraq war, refiners that were waiting for cheaper crude were caught unprepared and undersupplied

By Christopher Palmeri

Ladies and gentlemen, start your engines. The American Automobile Assn. is predicting the busiest Labor Day driving weekend ever, with a record 28.2 million people hitting the road. Why not? The stock market is up. Flying has become such a hassle. And we all deserve a little time at the beach or lake after a rough year.

Better have your credit card handy when you go to fill up your tank, though. The price of gasoline surged a remarkable 12 cents per gallon nationally from Aug. 18 to Aug. 25. That's the largest weekly jump ever. The average price of regular unleaded now stands at $1.74 per gallon, the highest on record, unadjusted for inflation.

What's behind these soaring gasoline prices? There's no simple answer. Chalk it up to a convergence of factors, from world events to goings-on at your regional refinery. And intermittent price spikes look likely for the foreseeable future.


  The first step in analyzing gas prices is to look at the price of crude oil, which accounts for about half of gasoline's cost. After hitting a low of $10 a barrel in 1998 due to a sharp slowdown in Asian demand and the resumption of exports from Iraq, OPEC clamped down oil-production restrictions on member nations.

The cartel set a price range for crude of between $22 and $28 a barrel and has been much more aggressive than in the past about adhering to its production quotas. Yet, at $32 a barrel today, crude is well above that range, because of several unpleasant events earlier this year that cut back production, which has yet to be fully restored: civil unrest in Nigeria, an oil worker's strike in Venezuela, and the Iraq war.

A local angle is also behind popping gas prices. No new gasoline refinery has been built in the U.S. in decades. The industry blames "NIMBY-ism", as in everybody wants a new refinery but "not-in-my-backyard." Refiners were forced to invest billions of dollars in new technology in the past 10 years, both to make their plants less polluting and to produce new blends of cleaner-burning gasoline. But those investments didn't translate into any additional profit. Result: Refining has been a low-return business for much of the last decade, and no oil companies want to invest in new plants and equipment.


  Fed up with the lousy profits, the refining industry has been on a consolidation spree in recent years. Since 1997 alone, the market share of the nation's 10 largest refiners has climbed from 50% to 80%. Only 58 companies engage in refining today, vs. 189 two decades ago.

Refiners have also learned to be lean. Inventories of crude oil and refined product have crept down each year. "Everyone wants to be like Michael Dell," says Tom Kloza, senior oil analyst at the Oil Price Information Service, referring to the computer maker lauded for his just-in-time manufacturing techniques.

Of course, part of the reason for the refining industry's low inventories also has to do with price at the pump. With crude prices high earlier in the year and the futures market expecting them to fall when Iraqi production came back, refiners were reluctant to stock up on oil they might be able to buy more cheaply later in the summer. That left supplies of crude and gasoline tight at the start of the summer driving season.


  No doubt about it, Americans live behind the wheel. As a nation, they logged 1.6 trillion miles on the road in 2000, up 14% from 1990. Truck traffic was up 42% in the same period. This rising demand puts tremendous strain on a refining system running increasing tighter. The average refinery in the U.S. now runs at 92% of capacity, up from 78% in 1985.

When U.S. gasoline demand peaks in the summer, other countries have historically come to the rescue. Earlier this summer, gasoline imports hit a record 1 million barrels per day, as the still weak European economies sent their excess gasoline across the Atlantic. Meanwhile, a rainy May and June diluted demand, further easing any supply crunch.

Those mitigating factors began to shift in July, however. Gasoline demand rose with the better weather, hitting a record 9.4 million barrels per day in mid-August. Then some unexpected things happened. A major pipeline in Arizona ruptured, depriving the state of one-third of its fuel and sucking gasoline supplies delivered by truck from neighboring states. The pipeline still isn't fully functional. The electrical blackout, meanwhile, knocked out service to several refineries in the Midwest. And a couple refineries in California also experienced unplanned outages.


  So price run-ups like the current one may be a regular occurrence for a while. And some spikes may be even worse than this one, according to a new report from the Rand Corp. think tank. "The big issue is that the industry is running much closer to the margin," says D.J. Peterson, the lead author of the report. "Whenever there's a shortfall, there's little slack in the system to deliver extra supply."

Here's some short-term good news, however. Analysts say the current price crunch should ease after Labor Day. Production should be back up at refineries, as drive-time demand decreases.

New Jersey native Brian Kiefer recently packed his family of six into their minivan for a Labor Day week drive to Hilton Head, S.C. Kiefer says he had to fill up the tank twice on the way down at $40 a pop. But now, sipping a Corona beer at his condo on the beach, he has no regrets. "We're loving life," he says. No gas spike is likely to stop Americans from enjoying a well-earned Labor Day.

Palmeri covers the oil-refinery industry for BusinessWeek from Los Angeles

Edited by Douglas Harbrecht

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