Gasoline price spikes spark US political firestorm

Indeed, the government-industry advisory group National Petroleum Council, EIA, and other analysts warn darkly that this year's gasoline price spike is a harbinger of things to come, as even more-stringent EPA specifications loom for US refiners.

Firestorm rages

Even as gasoline prices in the upper Midwest eased last week, the political firestorm continued to grow.

In the latest developments:

• Gore urged FTC to hold public hearings during its investigation of high gasoline prices in the Chicago-Milwaukee area. Gore reminded a Chicago audience that, on May 30, he first called for an FTC investigation into possible "price-gouging, collusion, or anticompetitive practices by the oil industry." He said open hearings-as opposed to the usual behind-closed-doors FTC investigations-would give the public access to all testimony. A preliminary report by FTC is due the third week of July. The presidential aspirant also used the opportunity to stump for the third part of his national energy policy proposal, a mass transit initiative to encourage investments in light rail systems, buses, and high-speed trains. The first two parts, disclosed earlier last month, focused on reducing energy use and government support for alternate energy (OGJ, Newsletter, July 3, 2000, p. 7).
• Richardson told Congress last week that "hopefully, we've turned the corner" on high gasoline prices in the upper Midwest. He said pump prices had dropped 7-12¢/gal in the preceding week, ending an 8-week rise. Richardson told the House international relations committee hearing that gasoline "prices are still unacceptably high." He said there is an "unexplained price differential" of 30-40¢/gal between standard and reformulated gasolines in the Chicago-Milwaukee area. Richardson also noted that DOE thinks the causes are higher demand, low supplies, problems making reformulated gasoline (RFG), and pipeline restrictions: "The main question is why there is such a high price differential between regular gasoline and RFG. The refiners have some explaining to do."
• Four Republican senators have proposed that the federal government consider suspending the 18.4¢/gal federal gasoline tax for 150 days (see Watching Government, p. 28). In Indiana, Gov. Frank O'Bannon declared an energy emergency and suspended the state's 10¢/gal gasoline tax for 60 days late last month. The action will cost the state $11 million.
• Sen. Frank Murkowski (R-Alas.) filed a bill that would allow individuals and families to deduct federal, state, and local gasoline taxes for the rest of the year from their 2000 federal income taxes. He said the measure would amount to nearly a $200 rebate for families in western states. Murkowski noted that, until 1978, taxpayers who itemized deductions could deduct their gasoline taxes.
• Sen. Rod Grams (R-Minn.) last week called for Richardson's resignation. He said Richardson has "demonstrated a dangerous ineptitude to follow through on the steps Congress has outlined for the department, such as improving security at our national laboratories, developing a strong energy policy that ensures the US is not entirely dependent on foreign sources of energy, and ensuring that DOE take responsibility for its promise to create a nuclear waste storage facility."

RFG ethanol waiver

On the eve of the weekend preceding the 4th of July-one of the busiest holiday travel periods in the US-EPA proposed a rule that will relax evaporative emissions limits for summertime RFG containing ethanol. EPA says the action will make it easier for refiners to use ethanol in RFG and still maintain the air-quality benefits of the RFG program. RFG has a minimum oxygen content requirement that makes it necessary for refiners to blend an oxygenate into gasoline. The oxygenate used in 87% of US RFG is methyl tertiary butyl ether.

EPA says use of ethanol, more so than other oxygenates, reduces vehicle carbon monoxide emissions. However, the additive has higher volatility, increasing evaporative emissions.

"Normally, for cleaner-burning gasoline with ethanol to meet pollution-reduction standards, an adjustment must be made to the gasoline," said EPA. "That adjustment involves reducing the evaporative property of gasoline to accommodate ethanol, since ethanol can make gasoline evaporate more readily, which leads to an increase in air pollution.

"EPA's proposed adjustment allows refiners to slightly increase the evaporative property of gasoline in exchange for the carbon monoxide reductions derived from using ethanol. This adjustment will maintain the overall air quality benefits of the program," EPA said, without elaboration.

Details of the rule were not available on EPA's website, and the agency could not be reached for comment at presstime.

Ethanol production receives a 54¢/gal tax subsidy from the US government.

EPA is accepting comment on the proposed rule for 60 days. It is also accepting comment on a proposal made by Illinois requesting that the state be allowed to revert to selling gasoline that meets Phase 1 summertime RFG standards until EPA grants a "carbon monoxide credit" in the state for gasoline containing ethanol.

Explanations

Oil companies and associations have sought to explain to Congress why gasoline prices have soared in the Chicago-Milwaukee area. Oil industry representatives testified at House commerce and judiciary committee hearings that also heard from government officials and consumer groups.

American Petroleum Institute Pres. Red Cavaney said gasoline prices needed to be examined in perspective: "The average retail price of gasoline reached $1.22/gal in 1999. This is the second lowest average annual pump price [in inflation-adjusted 2000 dollars] of the entire 81-year history of recorded pump prices. Average prices in 1998 were lowest. Prices started rising in March 1999 and continued to increase into 2000, reaching $1.71 in June."

Motor gasoline prices have declined sharply since 1981, said Cavaney, "when real pump prices reached a high of $2.53 [in 2000 dollars]. So the real cost of gasoline to consumers today remains below its 1981 peak. The decline can be attributed largely to lower crude costs, but manufacturing, distribution, and marketing costs are lower as well. Only taxes have increased."

Cavaney said the combined costs to manufacture, distribute, and market gasoline fell from an average of 69¢/gal in 1981 to 54¢/gal in June 2000, while during the same period, taxes rose from an average of 31¢ to 44.2¢.

Unocal patent

Another factor in the market squeeze, Cavaney said, is that the Unocal Corp. patent infringement case has created uncertainty and risk for companies making RFG.

In the case, a federal court upheld a Unocal patent, awarding a 5.75¢/gal royalty against other refiners in California because the gasoline they produce in order to comply with California Air Resources Board standards matches a gasoline formula Unocal patented before the CARB standards were implemented (OGJ, May 1, 2000, p. 35).

Cavaney said, "Refiners, importers, and blenders have publicly indicated that they may avoid possible infringement of the patents by making less RFG, and RFG imports have declined."

Late last month, four members of the House of Representatives filed a bill to waive Unocal's patent and permit the Department of Justice to license RFG patents. They said their bill would allow owners of the patents to receive reasonable fees but would now allow them to deny licenses.

William Ichord, a Unocal vice-president, said, "Unocal's patents are not a barrier to the manufacture and sale of RFG, and there is certainly no reason to think they have been a factor in the rising price of gasoline sold in the Midwest or anywhere else."

He noted the company is not collecting any royalties, and if it were, the impact on gasoline prices would be less than 2¢/gal.

"Furthermore," said Ichord, "we believe that our patented formulations may offer refiners a more cost-effective way to produce RFG that meets federal air quality standards. If that is the case, then refiners might reduce the relative cost of manufacturing RFG by licensing our patents and using our formulations."

Ichord said, "Unocal is once again repeating its offer to discuss license terms for use of its patented gasoline formulations with all interested parties. The final decision is up to the nation's refiners, blenders, and importers."

Transport limitations

Jerry Thompson, a Citgo Petroleum Corp. vice-president, said, "The US pipeline and distribution system was designed to handle a half-dozen grades of gasoline. Today, it has to cope with more than three dozen grades of 'boutique' gasolines (Fig. 1).

"Keep in mind that no refinery can manufacture all of these fuels, so they have to be shipped all over the country to where they are needed. Each of these fuels has to be kept separate from the time they are manufactured.

"Our nation can no longer substitute fuels from areas of abundant supply into areas of insufficient supply because they are literally different fuels," Thompson continued. "A patchwork of fuels has unintentionally constrained manufacturers' ability to refine and supply gasoline to the marketplace.

"The result," he said, "is that situations that previously could have been corrected very quickly take much longer for the system to correct. This longer correction time creates shortages, which in turn create price spikes."

Thompson said the problem is that "this nation's only energy policy is driven by [EPA]. In reality, it's not a policy at all but a patchwork quilt of regulations and requirements that has been added to every year since the Clean Air Act was passed in 1970.

"This hodgepodge of regulations fails to take into consideration the American people's needs or the refiners' ability to produce and distribute this increasingly complex range of products."

Pipeline problem

J. Louis Frank, president of Marathon Ashland Petroleum LLC, noted that US Midwest refineries can supply only about 75% of the region's demand. The rest, about 1 million b/d, comes via pipeline.

He said, "In March, one of these critical pipeline systems, the Explorer Pipeline, experienced a line failure followed by a 6-day outage, which resulted in a shortfall of about 8 million bbl of products to the Midwest.

"Explorer was repaired and returned to service, but part of the system must operate at a reduced capacity pending completion of safety tests. As a result, the region continues to suffer a shortfall of up to 50,000 b/d of pipeline deliveries."

Frank said, more recently, Wolverine Pipeline, which carries about 34% of Michigan's petroleum needs from Chicago, experienced a release that resulted in a 9-day interruption of supply to that area. It has returned to service, but it, too, is running at reduced capacity.

Frank urged the Department of Transportation to facilitate the full operation of both pipelines as quickly as possible.

EIA testimony

While Richardson was pointing fingers at oil companies, an agency that reports to him and is charged with energy sector data gathering and analysis suggested that the industry's explanations were on the mark.

John Cook, director of EIA's petroleum division, testified June 29 before the Senate committee on governmental affairs that a number of factors have combined to create this situation: tight crude oil markets, which resulted in low crude oil and product stocks and high crude oil prices; some pipeline and refinery supply problems; and a difficult transition to summer-grade Phase II RFG.

"Crude oil continues to be a large factor in explaining the price increases over year-ago levels," Cook said. "West Texas Intermediate crude oil price has risen from a low point in December 1998 of under $11/bbl to $34 recently. While $34 is far from the inflation-adjusted $70/bbl historical high seen in 1981, the change has been rapid. Rapid changes can impact consumers more initially than absolute levels, since individuals and organizations generally budget and plan for small changes from recent history. From a year ago [in] June, crude price increases have contributed about 33¢/gal to the increase in the price of gasoline."

While OPEC has been increasing supply, Cook noted, early data indicate a more-typical seasonal stock-building pattern: "But stock levels are still very low, and a normal stock-build will not help the gasoline market much this summer."

Cook also testified that the speed of the crude oil price hike oustripped those of product prices, putting a squeeze on refining margins.

"In June 1999, the difference between wholesale gasoline prices and WTI averaged less than 6¢/gal, vs. the more-typical 10-12¢/gal seen at this time of year.

"But low crude oil and product stocks in 2000 have now increased product prices relative to crude oil. Where the differences between gasoline wholesale prices and crude oil prices were low last year, they are high now at about 20¢/gal, 14¢ higher than in June last year."

In other words, the low level of gasoline inventories probably adds another 10¢/gal to the price of gasoline over what would typically be expected this time of year. But some regions have experienced much higher price increases over year-ago June levels than the 47¢ increase stemming from crude oil and low stocks.

"EIA has been pointing out that with low stocks and a market short on crude oil, the gasoline market is likely to see increased volatility this summer. The Midwest was our first incident. Several pipeline and refinery problems caused stocks to fall to 13% below their 5-year average at the end of May. Prices in the Midwest were bid up rapidly as concern over supply adequacy grew for both conventional gasoline and reformulated gasoline. But reformulated gasoline in the Chicago and Milwaukee areas drew most of the attention initially, as these prices increased more than 30¢/gal over conventional pricesellipsethe Midwest RFG price increases appeared to be similar to price surges we are used to seeing in California since the start of their RFG program."

There are several reasons why the Midwest RFG prices responded so strongly to the supply problems, Cook noted:

• The Midwest RFG market is small (13% of Midwest gasoline), which limits nearby supply options.
• This was the first year of Phase II RFG, and some refiners had difficulty making the transition from winter to summer-grade gasoline. In the Midwest, ethanol is used to make RFG, which requires a unique blend of other components in the gasoline with very low vapor pressure. In several cases, refiners had to bring gasoline components in from other refineries to meet the new gasoline specifications.
• Finally, different refineries in the Midwest produced different amounts of RFG than in prior years, causing distribution system adjustments. In isolated markets like the RFG market in the Midwest or the California gasoline market with its geographic isolation and unique gasoline, supply problems cannot be resolved as quickly as in broader markets.

"Today, the US refinery system has little excess capacity, and the growth in the number of distinct gasoline types that must be delivered to different locations increases the potential for temporary supply disruptions and increased volatility," Cook said.

He also pointed out that wholesale and retail prices in the Midwest began to decline in recent weeks, indicating that supplies have been increasing relative to demand.

"Wholesale prices indicate that we could see further declines, if no more pipeline or refinery problems occur. Retail prices normally lag wholesale prices, both when wholesale prices increase as well as when they decline, so, without further supply problems, we can expect retail prices to fall further.

"While the first hurdle of the transition from winter to summer-grade gasoline is behind us, we may experience more volatility before the summer is over. Consumers are not expected to cut back much on their consumption. As we enter the high gasoline-demand season, refiners will be pushed to just meet demand. With low stocks and refineries operating at high utilizations, any supply disruptions could trigger another price run-up," Cook said.

Analyst's view

A Houston analyst focused on the specific role the state of RFG inventories has played in the price drama.

An analysis by Petral Worldwide Inc. (PWI) focused on RFG production rates from refineries in the Midwest and Gulf Coast and RFG inventories in the Midwest.

PWI says its review of EIA statistics indicates that, nationwide, US RFG inventories have been steady at 40-45 million bbl and are in line with 1999 inventories. Based on total US RFG demand of 2.4-2.5 million b/d, RFG inventories are equal to 17.5 days of supply.

Midwest markets, on the other hand, have only 2 million bbl of RFG inventory compared with demand of 300,000 b/d, says PWI. RFG inventories in the region are equal to only about 6 days' supply.

"Effectively, RFG markets in the Midwest have very little usable inventory and rely nearly exclusively on daily RFG production from local refineries and from refineries in the Gulf Coast [region]."

EIA statistics indicate that RFG production from refineries in both the Midwest and Gulf Coast declined by 50,000-60,000 b/d beginning in mid-May.

"Gulf Coast refineries are the primary swing supply sources of RFG for the Midwest and the East Coast," said PWI. "Since Midwest markets have virtually no spare RFG inventory, the decline in Gulf Coast RFG production quickly created supply shortages in the Midwest markets.

"This analysis shows that EPA was unprepared for RFG supply problems in the Midwest," the firm concludes. "The decline in refinery RFG production is directly related to EPA's insistence that stricter RFG regulations be implemented as scheduled on June 1. Furthermore, EPA officials denied all applications for temporary waivers to stricter RFG regulations."

API responds

API late last month rejected the charge that anticompetitive behavior by oil companies is behind sharp gasoline price increases in the Milwaukee and Chicago areas (OGJ Online, June 20, 2000).

Cavaney said, "Claims to the contrary are misleading the American consumer. Those allegations do a disservice to the American taxpayer by encouraging competing investigations that focus attention and resources away from solving very real regulatory problems.

"During times of volatility in gasoline markets, it is not unusual for investigations of our industry to be launched. Our record of being exonerated by those investigations is spotless. Time and again, our industry has been cleared of any wrongdoing in these matters, and we are confident that this investigation will have the same results."

He said, "The current situation is brought about by uncoordinated, competing regulations that have reduced refinery and distribution flexibility, raising costs and negatively impacting service to the American consumer. The American public would be well-served by government addressing these matters."

Cavaney also responded to the administration's attempt to tie the rebound in oil industry profitability from the doldrums of 1998 and early 1999 to the price spike.

Gore charged, "Oil company profits have increased by nearly 500% in the first part of this year. These enormous and unreasonable profits suggest that big oil is gouging American consumers."

Cavaney replied, "Last year, industry was in the depths of economic straits" with oil prices at record low levels.

NPC warning

The National Petroleum Council has warned that EPA is mandating too many fuels changes simultaneously for the nation's refining industry to meet them efficiently.

NPC-the US energy secretary's oil and gas industry advisory panel-late last month issued a report on the refining industry's ability to meet new fuels specifications.

NPC said, "The timing and size of the necessary refinery and distribution investments to reduce sulfur in gasoline and diesel, eliminate methyl tertiary butyl ether, and make other product specification changes such as reducing toxic emissions from vehicles are unprecedented in the petroleum industry.

"Large investments will be required at essentially all domestic refineries and many product terminals. These capital requirements are expected to affect the viability of US refiners."

The number of US refiners has fallen steadily since World War II, except during a period of price controls in the 1970s, notes NPC. "Recent shutdown history has included a range of sizes, configurations, and geographies." Meanwhile, the average refinery size has increased.

"The NPC expects that individual refinery shutdowns will likely continue to occur in the future," the report concluded.

Refiners' view

That view was echoed by the National Petrochemical & Refiners Association, which represents almost all US refiners.

Bob Slaughter, NPRA general counsel, said, "The refining industry has been coping with difficult times. According to the [NPC], the refining industry's return on invested capital over the past 10 years averaged 4%. During much of the same period, refiners were called upon to invest about $20 billion in environmentally related expenditures.

"The outlook for the next 10 years is for continued difficulties. Refiners will face a blizzard of regulatory initiatives over the next 10 years. These environmental initiatives are largely uncoordinated and, if history is any guide, their impact on energy supplies will be ignored or downplayed.

"They also are very expensive," said Slaughter. "The gasoline sulfur reduction program will cost the refining industry $8 billion, according to the NPC. Diesel sulfur reduction, if done in conformity with EPA's proposal, will cost around $10 billion. And the cost of responding to methyl tertiary butyl ether-related problems will take the combined total above $20 billion.

"And these are just three programs facing the industry."