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Pain at the Pump, Explained

Mon March 12, 2012 - National Edition
Lori Lovely

With fuel prices once again on the rise, there is a noticeable disparity in cost from one region to the next, leaving many consumers wondering why.

Several factors affect the price of gas everywhere, including demand, supply and supply disruptions, which, in turn, can be affected by events such as hurricanes and politics, distance from the supply source, competition and federal emissions standards – or even higher environmental standards in some regions, which require specific refining, distribution and storage, all of which add to the cost.

Environmental programs often require reformulated gasoline that contains additives to reduce pollutants. Approximately one-third of the gasoline sold in the United States is reformulated. This creates “gasoline market islands,” according to John Cook, director of the petroleum division of the Department of Energy’s Energy Information Administration. Because the clean-burning requirements in these islands are unique, few refineries can supply them, leading to the possibility of higher prices in certain markets, due to demand or the potential for supply interruptions.

Don’t Be Crude

Crude oil acquisition costs are the single biggest driver impacting gas prices, according to Tim Hess, analyst of the U.S. Energy Information Administration. Although the United States is the world’s third-largest producer of crude oil, it imported 13 million barrels of oil and petroleum products per day in July 2008.

Typically, the farther the point of purchase is from the source of the supply, the higher the cost. Sixty-two percent of the crude oil processed by U.S. refineries in 2010 was imported. About 26 percent of that was brought in by ocean tanker through the Gulf Coast.

The Midwest and the smaller Rocky Mountains market, which rely on inland crude mostly from Canada, enjoy lower gas prices than eastern regions that depend on more expensive coastal and imported crude. “Due to rapid growth of oil production, North Dakota is a new major production center in the U.S.,” Hess said.

However, because production came on so quickly, it has outpaced construction of infrastructure to transport it to other regions.

“There’s no pipeline from North Dakota or the Rockies to the west coast because there wasn’t sufficient production in the past to justify one,” Hess elaborated. Without a pipeline, it can be shipped only by rail or truck. But, he added, infrastructure is catching up.

Until it does, transportation constraints and increasing production have resulted in discounted crude in this region over the past year. While refineries paid $3 less per barrel than average prior to 2011, last year the difference rose to $14 per barrel. In November, the most recent month the EIA has provided data for, the difference was $16 per barrel. According to the EIA, East Coast refiners paid $22 more per barrel of crude than Midwest refiners in late 2011.

Lower crude oil costs in the Rockies resulted in lower gas prices. Gas prices in the Rocky Mountain region fell between Thanksgiving 2011 and the end of January 2012, while prices in other parts of the country rose.

“On January 30, 2012, average gasoline prices in the Rockies were 41 cents below the U.S. average, which was a record for the region since EIA began tracking regional retail price data in 1992,” EIA reported. Even after a “heavy September refinery maintenance schedule,” according to EIA, gross inputs to Rocky Mountain refineries were 4 percent above average during the last three months of 2011. The increase in refinery inputs has continued this year, averaging 10 percent above five-year averages in January 2012. This has kept inventory 12 percent higher than average.

In contrast, East Coast refinery inputs dipped 41 percent below average. The HOVENSA joint-venture refinery located in the U.S. Virgin Islands, a major source of product supply, was closed on January 18, Hess reported. A planned closure, it follows the idling of two other refineries in the Delaware Valley by Sunoco and ConocoPhillips. When Sunoco idles an additional refinery in the region by mid-2012, it will collectively cut up to 50 percent of refining capacity in the East Coast region.

“No refinery wants to close,” Hess said, explaining that idling a refinery only helps its competitors. “There’s an incentive not to shut down because they have long-term contracts that have to be filled. If they’re not operating, they have to buy crude from another refinery.”

However, because many of the less sophisticated East Coast refineries rely on heavier crude imported from Africa, they can’t produce quality product for the same cost.

Crude is classified as light or heavy, depending on its density. Gasoline and diesel fuel come from light crude, which is more expensive. As Hess pointed out, crude differs from region to region. “Each has its own characteristics and grade.” Proximity of a refinery to a higher grade of crude impacts costs.

Redrawing the Map

Shifts in regional crude acquisition costs are redrawing the U.S. refining map.

“The ingrained supply chain is being turned on its head,” Hess said. “It’s an interesting time.”

Because Midwest markets are pulling gasoline from the Gulf Coast, higher acquisition costs are driving the price of gasoline there, rather than Midwestern production costs. Meanwhile, in the Gulf Coast, refiners have been investing in increased conversion depth, allowing regional refineries to replace light crude with the less expensive heavy crudes. These upgrades, when completed, will affect the volume of light crude piped north.

In addition, the reversal and later expansion of the Seaway pipeline could result in significant volumes of light crude being shipped south from the Midwest to the Gulf Coast just when southern demand is down due to the local deep-conversion refinery expansions.

As Hess reiterated, it’s acquisition costs that affect the price of gas more than anything else.

“The local station isn’t really making a lot on gasoline; they make more on the candy bars they sell.”

According to the U.S. Department of Energy, out of every dollar spent on gas, only 65 cents is applied to the cost of crude oil. Fourteen percent goes to refining, 13 percent to state and local taxes and 8 percent to distribution and marketing.

Fluctuating acquisition costs and minimal margins are why local retailers are in constant contact with suppliers, Hess said.

“The local stations are responding to rapidly changing market prices, which are volatile right now because of the changes in the supply chain and the cost of acquisition.” The discrepancies in these aspects from region to region create micro-economies that result in the divergence of gas prices.

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