The Battle Over the Blame for Gas Prices
Firms Cite Supply Issues, Deny Abuse

By Steven Mufson
Washington Post Staff Writer
Friday, April 21, 2006

When Severin Borenstein drove by a Shell station in Orinda, Calif., yesterday morning, the price of unleaded gasoline was $2.99 a gallon. When he drove by five hours later, the price was $3.10 a gallon.

Borenstein has a better grasp of why that happened than most. He's a professor of business and public policy at the University of California at Berkeley and is director of the University of California Energy Institute.

"The oil side is one piece of this. The refining side is another piece of this," he said.

Oil prices are soaring, with the price of crude at more than $70 a barrel on world markets and 37 percent higher than a year ago. That works out to more than $1.7o a gallon, more than half the cost of a gallon of regular unleaded gasoline.

The next biggest chunk of the cost of a gallon of gasoline is the cost of refining, which is now about twice the average levels over the past five years. And that has sparked controversy over whether oil refiners have been gouging consumers by holding back on expanding capacity to gain more power over prices.

The oil companies deny those allegations, but what's not in dispute is what's happening at the gasoline pumps.

"What's going on is just a continued reflection of the worsening supply-and-demand balance, and when you get into a tight market, small changes can cause big price movements," said Borenstein, explaining the rising price of crude oil.

He added that the reasons for fatter refining margins were not so clear. "This is the time of year when that number always goes up, but it has gone up more than usual," Borenstein said. "What we're seeing is that refineries are making huge profits. We have not been building refineries, demand continues to grow, and supply is not keeping up with it."

For most consumers, the high prices have been a bit of a puzzle. When oil prices spiked last year, many of the reasons seemed temporary: hurricane damage in the Gulf of Mexico and unusually low inventories of crude oil and gasoline. This year, inventories have mostly been rising since January and hurricane season is still months away. (Yesterday, the American Petroleum Institute said crude oil inventories dipped slightly but still stood 6.7 percent higher than the year before while gasoline stocks fell to 4 percent below the level a year earlier.)

In the absence of a clear explanation, members of Congress have jumped into the fray. "These major oil companies have hooked their hose up to the pocketbooks of American citizens and are sucking money from ordinary Americans into the treasury of the giant oil companies," said Sen. Byron L. Dorgan (D-N.D.), a member of both the Senate Commerce and Energy committees. Sen. Charles E. Schumer (D-N.Y.) on Tuesday called on the Federal Trade Commission to make sure the major oil companies weren't intentionally keeping refinery capacity offline to jack up prices. He cited a 5-percentage-point decline in refinery utilization rates.

But the American Petroleum Institute responded sharply. "Any charge that oil companies are intentionally driving up prices ignores the very obvious fact that refinery capacity has been lower because the industry is still in the process of recovering from the extensive damage caused by Hurricanes Katrina and Rita last summer," the API said in a statement. "It is a fact that three refineries remain closed since the hurricanes. The combined capacity of those refineries is 804,000 barrels per day -- or about 5 percent of U.S. refinery capacity, the same amount Senator Schumer mentions."

One indication of the Gulf of Mexico refinery problems was the price of gasoline, which is usually cheaper there than on the East Coast. Currently, the price of gasoline is running about 15 cents a gallon more in the Gulf region.

Major refiners say that the shortage of capacity in their industry has been years in the making and, because of the long time it takes to build refineries, will also be years in the fixing. For years, it was a low-margin, capital-intensive business. Investors shunned refining companies, and many refineries were put up for sale at relatively cheap prices or closed.

"The curves have crossed, and [profit] margins have improved," said Bruce Smith, chairman and chief executive of Tesoro Corp., a large independent refiner. "Only by improving margins do people have enough to invest in new facilities."

This year, however, billions of dollars of investments in refineries will be channeled into improving the quality of petroleum products to meet new environmental standards, companies say, cutting the sulfur content.

U.S. refining capacity today is about 16 million barrels a day, about the same as it was in 1983, but the refineries run at much higher utilization rates.

To the extent that new cash is flowing into the energy business, much of it is flowing to commodity markets from investors, not oil companies. Oil consultant Philip K. Verleger estimates that $60 billion in cash has flowed into oil commodity markets over the past two years, contributing to the climb in prices. When expectations of future price increases hit a certain level, they can create a momentum of their own.

There is little sign that the forces driving crude oil prices higher will ease in the coming weeks or months. Those forces have been tangible as well as psychological: Supply disruptions in Nigeria that have lowered output there by half a million barrels a day; anxiety about the U.S. face-off with Iran over inspections of nuclear facilities and the talk of military action against Iran, which exports almost 2.5 million barrels a day; prolonged repairs to Gulf of Mexico production facilities damaged by hurricanes last year; and U.S. consumer demand that continues to run strong in seeming defiance of rising prices.

Yesterday, Shell Oil Co. announced that it would resume production slightly sooner than expected on its Mars platform in the Gulf of Mexico, providing a rare bit of solace to oil markets. Marvin Odom, Shell's executive vice president for exploration and production, said in an interview that the platform, damaged by Hurricane Katrina, would begin production in the second half of May and reach its full 140,000-barrel-a-day capacity by the end of June.

During the hurricane, the platform's 1,000-ton rig fell on the platform substructure, its derrick toppled over and sank, and its two pipelines were hit by the anchor of a mobile drilling rig that was drifting in the 175 mph winds and 80-foot waves.

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