Gasoline Price Changes - Federal Trade Commission

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Price (Cents per Gallon Excluding Taxes) 250 200 150 100 50 0 1978 1979 Source: EIA, BEA THE DYNAMIC OF SUPPLY, DEMAND, AND COMPETITION Figure 3-2: U.S. Annual Average Nominal and Real Gasoline Prices, Excluding Taxes (1978-2004) Nominal Price Real Price (2004 Dollars) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Average U.S. retail prices, including taxes, 6 have been increasing since 2003, from an average of $1.56 in 2003 to an average of $2.04 in the first five months of 2005, but it is difficult to predict whether these increases represent the beginning of a longer term trend. $ To Meet Increased U.S. Demand for Gasoline, U.S. Refiners Have Taken Advantage of Economies of Scale and Adopted More Efficient Technologies and Business Strategies. U.S. refinery production meets more than 90 percent of U.S. demand for gasoline, on average. Between 1985 and 2004, U.S. refineries increased their total capacity to refine crude oil into various refined petroleum products by 7.8 percent, moving from 15.7 million barrels per day in 1985 to 16.9 million barrels per day as of May 2004. This increase – approximately one million barrels per day – is roughly equivalent to adding 10 average-sized refineries to industry supply. This increase occurred even though U.S. refiners did not build any new refineries during this time and, as refineries were closed, the number of overall refineries declined. Rather, they added this capacity through the expansion of existing refineries, enabling them to take advantage of economies of scale. All else equal, scale economies make larger refineries more efficient than small refineries. U.S. refiners also have adopted processing methods that broaden the range of crude oil that they can process and allow them to produce more refined product for each barrel of crude they process. In addition, they have lowered inventory holdings, thereby lowering inventory costs. Lower inventory holdings may, however, make an area more susceptible to short-term price spikes when there is a disruption in supply. EXECUTIVE SUMMARY ix
GASOLINE PRICE CHANGES: $ Increased Environmental Requirements Since 1992 Likely Have Raised the Retail Price of a Gallon of Gasoline by a Few Cents in Some Areas. Even though many U.S. refineries have become more efficient and have adopted processing methods that allow them to produce more refined product for each barrel of crude they process, some regulations likely have raised retail gasoline prices in some areas. For example, gasoline use is a major factor in air pollution in the United States. Under the Clean Air Act, the U.S. Environmental Protection Agency (EPA) requires various gasoline blends for particular geographic areas that have not met certain air quality standards. The air quality in the U.S. has improved due to the Clean Air Act. As with any regulatory program, however, costs come with the benefits. Environmental laws and regulations have required substantial and expensive refinery upgrades, particularly over the past 15 years. It costs more to produce cleaner gasoline than to produce conventional gasoline. Estimates of the increased costs of environmentally mandated gasoline range from $0.03 to $0.11 per gallon and affect some areas of the country more than others. $ Profits Play Necessary and Important Roles in a Well-Functioning Market Economy. Recent Oil Company Profits Are High but Have Varied Widely over Time, over Industry Segments, and Among Firms. Profits compensate owners of capital for the use of the funds they have invested in a firm. Profits also compensate firms for taking risks, such as the risks in the oil industry that war or terrorism may destroy crude production assets or that new environmental requirements may require substantial new refinery capital investments. EIA’s Financial Reporting System (FRS) tracks the financial performance of the 28 major energy producers currently operating in the U.S. In 2003, these firms had a return on capital employed of 12.8 percent as compared to the return on capital employed for the overall S&P Industrials, which was 10.0 percent. Between 1973 and 2003, the annual average return on equity for FRS companies was 12.6 percent, while it was 13.1 percent for the S&P Industrials. The rates of return on equity for FRS companies have varied widely over the years, ranging from 1.1 percent to 21.1 percent between 1974 and 2003. Returns on equity vary across firms as well. Crude oil exploration and production operations typically generate much higher returns than refining and marketing. In essence, companies with exploration and production operations now find themselves in a position analogous to that of a homeowner who bought a house in a popular area just before increased demand for housing caused real estate prices to escalate. Like the homeowner, crude oil producers can charge higher prices due to increased demand. If high prices and high profits are expected to continue, they may draw greater investments over time into the oil industry, in particular to crude exploration and production. Over the long run, such investments may elicit more crude supply, which could reduce high prices. x FEDERAL TRADE COMMISSION, JUNE 2005
Page 2: Federal Trade Commission DEBORAH PL
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THE DYNAMIC OF SUPPLY, DEMAND, AND
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CHAPTER 3. SUPPLY, DEMAND, AND COMP
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Year-over-year Percentage Change in
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Capacity (Million Barrels per Calen
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Endnotes THE DYNAMIC OF SUPPLY, DEM
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CHAPTER 4. SUPPLY, DEMAND, AND COMP
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Price Difference (Cents per Gallon)
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Millions of Barrels 1,500 1,250 1,0
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Millions of Barrels per Day 9 8 7 6
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CHAPTER 5. STATE AND LOCAL POLICIES
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Percentage of Customers Lost to 1%
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Retail Price (cents per gallon) 220
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Share (Percent) 80 70 60 50 40 30 2
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Price (Cents per Gallon) 200 190 18
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6. GAO, supra note 5, at 20. 7. Id.
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Herfindahl-Hirschman Index (HHI) Th
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Gasoline Price Changes - Federal Trade Commission

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