Every time lawmakers or regulators tighten specifications for gasoline or diesel fuel-and there have been many such times in the past 15 years-a guessing game begins over cost. Refiners estimate costs of compliance and project the effect on fuel price. Government officials proposing the new specification do likewise and project price effects usually much lower.
At this political stage, each side is making a case. And at this stage, neither side can know precisely what the price effect will be. Lawmakers and regulators don’t refine crude. They can’t know what the costs will be. Refiners can’t either. They can’t predict the innovations of processing and catalyst technology that will evolve to lower costs as new standards take effect. Neither side can predict market conditions.
The fact remains that nearly anything that toughens fuel standards also raises the costs of fuel manufacture. Sooner or later, the costs affect fuel price. Congress and the Bush administration proved with the Energy Policy Act of 2005 that they don’t understand this.
Handling costs
Refiners handle increased costs in one of two ways. If market conditions allow, they pass them along; if not, they suffer diminished profits, which in a market too soft to absorb new costs are likely already to be low. If the lowered profits last, refiners shutter uneconomic refineries. Eventually, the consequent capacity erosion limits product supply, amplifying price increases that accompany any later increase in demand.
The US has arrived at the crimped-supply, elevated-price position in a cycle roughly of this type. A flurry of laws and regulations in the 1990s greatly tightened fuel standards, beginning with the reformulation and oxygenation of gasoline. Toward the end of the decade, the Environmental Protection Agency lowered ceilings on the sulfur content of gasoline and diesel fuel and reinterpreted the New Source Review program in costly ways.
The toughened fuel standards, of course, have paid off richly with improved US air quality. The improvements justify much of the cost. But the costs-difficult as they are to measure-are real. Because refiners couldn’t recover them in the chronically oversupplied market of most of the 1990s, consumers didn’t feel the effects. For the same reason, however, refining capacity didn’t grow as fast as fuel demand.
There’s no way to say how much of today’s oil and diesel prices reflect yesterday’s cost hikes, which are overwhelmed in any case by high crude prices. But historic expenditures are clear. The American Petroleum Institute says the oil industry spent $47.4 billion during 1994-2003 to bring refineries into compliance with all environmental regulations. The total includes $15.9 billion in capital costs and $31.4 billion in operations and maintenance costs. The burden was not the only reason the number of US refineries by API’s count declined from 194 in 1990 to 144 at the end of 2004. But it was a strong one.
Now, even though capacity increases in surviving plants have mostly offset the 1990-2004 closures, there’s not enough refining capacity relative to product demand, which continues to rise. A market this tight readily compensates cost.
As long as these conditions-so unlike those of the 1990s-prevail, new costs will flow with relative ease to retail price. And new cost increases loom. Refiners are in the middle of a phased reduction in the sulfur content of gasoline. Next year they’ll begin meeting unnecessarily strict requirements for ultralow-sulfur diesel fuel. API estimates the sulfur requirements add 4.5¢/gal to the price of gasoline and will add 11.6¢/gal or more to the price of diesel.
Unjustified costs
Those costs, notwithstanding the diesel overkill, at least have an environmental justification. The same can’t be said about the new energy bill’s huge mandate for ethanol. The tax-subsidized material is costly to handle and contains less energy than gasoline. That the mandate will raise fuel costs is beyond dispute. Inevitably, consumers will pay.
In politics and news reports, attention to fuel prices is growing in the US. The price of crude properly gets most of the blame. But it must not obscure the influence of costs imposed by laws and regulations. More such effects lie just ahead. Consumers won’t like them. They shouldn’t. Some of the costs have no justification and never should have been imposed. ✦
