Shelling out and driving on

Posted: May 26, 2007

High crude-oil prices, record worldwide demand, and a crunch in U.S. refinery capacity all draw blame for the sticker shock many Americans will feel this Memorial Day weekend as they stop for gas en route to the beach, mountains, or Grandma's house.

But economists and oil-industry experts say that another factor in the news this week may merit equal attention: that by some measures, today's $3-plus gasoline prices still aren't so high by historical standards - and aren't high enough, or haven't been high long enough, to put a major crimp in demand.

As of yesterday, U.S. drivers paid an average of $3.23 a gallon for regular gas, according to AAA's Daily Fuel Gauge Report.

By some accounts, this week's prices set a record for the so-called real price of gasoline - a price that compares past prices in current dollars, after adjustment for inflation. The old record had endured since March 1981, set during the Iran-Iraq war.

It still stands, the U.S. Energy Information Administration concluded Wednesday. The EIA said that in May 2007 dollars, the March 1981 price was $3.29 a gallon, still higher than today.

Such numbers matter for a simple reason, economists say. The gas station is one of those rare places that ordinary consumers directly encounter the commodities market, and the daily evidence it provides of the law of supply and demand.

"We're producing historically high, record amounts of gasoline," said Bill Day, a spokesman for Valero Energy Corp. "But demand is at record highs, too."

The result, in some cases, is historically high profits for refiners such as Valero, a San Antonio company that operates refineries in Paulsboro, N.J., and Delaware City, Del. Last month, Valero announced "the highest first-quarter profits in company history;" net income of $1.1 billion, up 30 percent from the same quarter in 2006.

Day said Valero's Philadelphia-area refineries had been operating with "no major outages." But in its earnings statement, Valero said it had benefited from problems elsewhere in the industry, which has been operating less efficiently this year than in recent years - a factor that boosts refiners' profit margins by limiting the supply of gas.

"The industry is affected by planned maintenance and unplanned outages that are occurring more often and taking longer to bring back online," Bill Klesse, Valero's chairman and chief executive officer, told investors.

Sunoco, the Philadelphia company that is the region's largest refiner, has apparently contributed to the tight market. Although a spokeswoman said Sunoco "doesn't comment on operations," its quarterly report disclosed some details.

Sunoco said its first-quarter net from ongoing operations was up 8 percent, to $85 million. But John G. Drosdick, Sunoco's chairman and chief executive officer, said the company's "results were significantly limited by the major turnaround and expansion work at our Philadelphia refinery," a $520 million project that he said cut first-quarter production by about nine million barrels.

Sunoco also lost a million barrels of output from a power outage that caused "an unplanned shutdown" at its Marcus Hook refinery.

Shawkat Hammoudeh, a Drexel University economist, said reduced production at U.S. refineries was a major factor in the recent run-up in prices at the pump.

"They've expanded the capacity of existing refineries, but no new refineries have been built since 1976," Hammoudeh said.

Ironically, one of the main reasons for the lack of new refineries, along with more stringent environmental regulations, is the low prices for gasoline that Americans have been paying since the early 1980s.

"Prices were too low to justify investment," Hammoudeh said.

He said that for about 20 years, until 2003, return on oil investment was about 6 percent, compared with average returns in stock market of 9 to 10 percent.

"When prices are too low for a long time, you pay for it in the future in terms of refinery bottlenecks," Hammoudeh said.

What happens next is unclear, say Hammoudeh and other industry watchers.

"We're not on the verge of the gas price apocalypse," said Tom Kloza, chief oil analyst at the Oil Price Information Service, a trade publication. But he said some regions may soon reach a "tipping point," where consumers will move to significantly reduce their oil consumption.

Mark Cooper, research director for the Consumer Federation of America, said most Americans "have a great deal of difficulty responding to price signals at the gas pump because of the way we build our cities" and the long-term investment that a car represents.

But he said higher gas prices are already behind the difficulties that U.S. automakers have faced in selling larger, high-gas-consumption vehicles.

"If you ask Detroit whether people are responding to price signals, they'd say they are getting killed."

Gas Production

U.S. refineries are using less of their capacity this month than in recent Mays.

Year Refinery


May 2002. . . 92.2%

May 2003. . . 95.2

May 2004. . . 95.2

May 2005. . . 94.1

May 2006. . . 90.3

May 2007. . . 89.9

*Average as a percentage of capacity.

SOURCE: U.S. Energy Information Administration.

Contact staff writer Jeff Gelles at 215-854-2776 or

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