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Although considerable attention has been given to the role of market speculation in recent price volatility, many energy experts say demand is rising and oil supplies are increasingly constrained, which puts upward pressure on oil and, consequently, gas prices. Political unrest in the Middle East, a recovering global economy, and revived demand in the emerging markets have all contributed to rising oil prices. U.S. gas prices in the spring of 2011 were more than $4 in some places and heading toward the record highs of 2008, when gas rose to nearly $5 per gallon. The U.S. Energy Information Administration (EIA) estimates that in 2011, gas prices will cost the average consumer at least $825 more than in 2010. The U.S. debate over protecting consumers against high gasoline prices has largely focused on increasing domestic supplies or finding ways to reduce consumer demand, but there is also concern about balancing these against environmental and economic issues.
Components of Gasoline Price
The EIA, an arm of the U.S. Department of Energy, breaks the price of retail gasoline into four components: the cost of crude oil; the cost of refining and fuel-blending; federal and state taxes; and distribution and marketing expenses.
- Crude oil: This is the raw material used to make commercial-grade gasoline, known in much of the world as petrol. The cost of crude oil accounts for the largest percentage of what U.S. consumers pay for gas at the pump. On average, about 51 percent of every dollar spent on retail gasoline went to crude suppliers in much of the last decade, according to the EIA. In 2008, when gas and oil prices were at their highest, crude represented an average of 75 percent of U.S. gas prices and currently hovers at around 70 percent (PDF), according to April 2011 analysis from oil industry advocate the American Petroleum Institute (API). "You cannot decouple gas prices from crude prices," says one API analyst. "If you want to help the consumer at the pump, you have to make sure crude prices don't rise too much." According to the EIA, a $1 change in crude prices corresponds roughly to a 5-cent change in wholesale gasoline prices.
- Refining: The process of turning crude oil into products for consumer use accounts for about 7 percent of the retail price of gasoline, on national average.* In the United States, refining requirements in different regions can affect gas prices. California, for instance, has the highest air quality rules, including stricter requirements for ethanol fuel-blending and sulfur content. Thus, gas prices in the West Coast region, dependent on California refineries, are significantly higher than the national average. Refining capacity can also have a price effect, as was the case in 2005 when Hurricane Katrina knocked out 20 percent of refining capacity in the Gulf region, which caused gas prices to increase.
- Taxes: The percentage of every dollar spent on gasoline that goes to federal or state governments has decreased in recent years. According to the EIA, taxes currently account for about 14 percent of the retail price Americans pay for gas, though this number is a national average and percentages vary significantly from state to state.* The national average, including a federal tax of 18.5 cents per gallon, is 49.5 cents, but some states' gas taxes go as high as nearly 70 cents (PDF).
- Distribution and marketing: The combined prices of purchasing and transporting gasoline from refineries to gas stations (often via intermediary distribution points) and the costs of operating the stations account for about 10 percent of the retail price of gasoline, according to EIA data.
Oil Supply and Demand
While U.S. consumption has fallen slightly in the last five years, China, the world's second largest consumer of oil, and countries such as India and Brazil are seeing a marked increase in oil demand (PDF). Some experts say these emerging markets have played a major role in the volatility in crude prices, which in the last few years have fluctuated widely, going as high as $145 per barrel in mid-2008 before dropping to $30 and then rising again to above $100 in 2011. "As long as the emerging economies, especially the big ones, keep growing, the demand for oil will keep growing," said CFR's Michael Spence in March 2011. "So, the kind of situation we saw before the cri9sis in 2006 through 2008, when there was a big spike in commodity prices, could return."
Demand also has outpaced new oil investment, leading to a tightening of global production capacity. For the last few decades, Saudi Arabia, the only country with notable spare production, has attempted to act as a price buffer by raising or lowering its production in response to the market, but in recent years the country has had less room to act (Reuters). Smaller margins of spare production capacity mean any potential disruptions in the oil supply have a marked effect. In 2011, the supply of oil in the Middle East became a significant concern and caused oil prices to increase as countries in the region including Libya, one of the world's top twenty oil producers, became embroiled in an ongoing pro-democracy movement. In the short term, the uprising known as the Arab Spring has instilled a new sense of insecurity (TIME) in oil markets. In the longer term, what happens in the Middle East could have serious implications for oil supplies.
"If future oil demand has any hope of being met, significant investment must take place to develop Middle East and North African oil reserves," writes Paul Stevens, a senior fellow at Britain's Chatham House, noting that political uncertainty could reduce interest future investment by international oil companies. "This could mean that an impending oil supply crunch, with crucial implications for oil price levels, could come sooner rather than later."
Some experts say that high oil prices are here to stay. "The age of cheap oil is over, though policy action could bring lower international prices (PDF) than would otherwise be the case," International Energy Agency head Fatih Birol said in March 2011. However, CFR Adjunct Senior Fellow Atul Arya cautions against predicting permanently higher oil prices. "We can't say with confidence that prices will stay high," he says, noting that historically, prices have bottomed out with new production coming online and the softening of demand due to high oil prices and other economic factors.
Factoring in Ethanol
The EIA expects ethanol-blended fuel, currently 10 percent per volume in a gallon of gasoline (E10), to account for nearly 10 percent of U.S. consumption in 2011. A 2008 Energy Department study estimated that, on average, ethanol-blending (PDF) saved the U.S. consumer anywhere from 20 cents per gallon to as much as 35 cents per gallon that year. A more recent ethanol industry report argues that in 2011, gas prices have been at least 12 cents lower than expected, thanks to the fuel additive.
But effects on prices, especially going forward, remain a topic of political debate. Some critics of corn-based ethanol, such as the environmental group Natural Resources Defense Council, argue that the 45 cent per gallon federal tax credit for blending masks the true price effect, and that the Renewable Fuel Standard, which mandates an increasing use of ethanol-blending--from nine billion gallons in 2008 to 36 billion gallons by 2022--is enough to incentivize production. Corn, a major ethanol feedstock, is also subject to commodities market fluctuations and production problems (PDF) that could increase ethanol prices. Thanks to low global corn stocks, ethanol prices are at a two-year high, though still lower per gallon than crude. Still, others argue that because of its heavy reliance on corn, ethanol is in competition with food, driving up food prices, especially for the world's hungriest.
Policies to Ease Gas Prices
U.S. policymakers have implemented a number of initiatives to either increase U.S. production of oil or lower consumption, but many of these take years to have an effect and thus have had limited impact on consumers in the short term. And though lawmakers in the last decade have brought oil companies to task for high prices, oil executives claim they are just as much at the mercy of market forces as consumers.
"No one person, organization, or industry can 'set' the price for crude oil," Marvin E. Odum, head of Shell Oil Company, told the Senate Finance Committee on May 12, 2011. "Stated simply, oil is a global commodity. And oil companies are price takers, not price makers." Some analysts note that though gross oil industry profits seems large, the industry's profit margin (which takes in the cost of oil production) ranks 114 out of 215 industries--making on average a little over 6.5 cents for every dollar.
Still, the Obama administration and Democrats in Congress already have renewed attempts to end $4 billion in annual oil company subsidies, but it is unclear whether it will affect prices (ProPublica). On May 14, President Obama also announced new plans to aid new domestic drilling, including leasing new parts of the Gulf of Mexico and Alaska, and encouraging drilling on unused energy leases on land and offshore.
Increasing domestic drilling, proponents say, will reduce U.S. dependence on foreign oil as well as encourage lower oil prices by increasing supply. Shale oil advocates estimate production using hydraulic fracking (inserting liquids into a well to push out trapped oil) could yield as much as two million barrels a day by 2015 (AP)--more than what is currently produced offshore in the Gulf of Mexico. Similarly, there is intense interest in boosting conventional offshore and deepwater production--which some argue could yield an additional two million barrels in the next five years.
However, such endeavors face challenges. Some projects will require oil prices to stay high to justify new investment and will take years to bring up to scale. And environmental issues such as water use and quality concerns, as well as greenhouse gas intensity, could slow development or raise costs through environmental compliance. For example, shale gas production--which also uses fracking--is under fire for water pollution concerns, and U.S. offshore production and leasing has slowed after the Obama administration imposed new environmental regulations following the four-month Deepwater oil spill in 2010.
Other analysts say the United States does not hold enough oil to make a significant impact. "In 2009, the U.S. produced about 7 percent of what was produced in the entire world, so increasing the oil production in the U.S. is not going to make much of a difference in world markets and world prices," EIA analyst Phyllis Martin told the Huffington Post.
Instead, many experts contend that reducing consumption through demand-reduction policies is the biggest buffer against high gas prices. Overall, CFR's Arya says that what should be communicated to consumers by policymakers is that the world is already "thinking about what's next" when it comes to dealing with oil dependence.
The United States is already implementing new corporate average fuel economy standards, and consumers have moved toward purchasing more fuel-efficient cars. This Scientific American article explores demand-reduction policies, including increased use of biofuels and alternative-fueled vehicles, and attaching new crude oil or gas taxes.
Unlike API, which favors reducing current gas taxes to help the U.S. consumer, some experts see a massive increase in gas taxes--in effect raising prices even further--as the simplest way to deter consumption. The United States pays the lowest fuel tax and thus lower fuel prices than any other industrialized nation (PDF) and less than some emerging-market countries, such as China.
*Editor's Note: The original version incorrectly stated that refining was 22 percent of gas prices and that taxes were 18 percent.
