Gas Prices Ought to Be Lower

Gas Prices Ought to Be Lower

Thanks to a global economic slowdown, the price of oil has plunged 60%—to $40 a barrel from $96 in August 2014. Yet the price of gasoline across the U.S. has fallen by only 25% over the same period. What gives? Multiple and overlapping regulatory barriers prevent refiners from moving to alternative sources of crude and from entering markets to fill supply shortages. The result: a regulatory price premium in every gallon of gas.

Though commonly known as commodities, oil and refined fuels are increasingly design-specific products. That is, the price you pay at the pump for a gallon reflects local constraints, not merely the price of oil. No two refineries are designed identically, and no new world-scale refinery has been built in the U.S. since 1976. Meanwhile, the global oil market has grown more diverse, including heavier, unconventional tar sands and shale oils as well as relatively light and sweet benchmark crudes.

Some refineries are limited by the amount of asphalt they can accept in their crude, while others are limited by their capacity to remove sulfur. Only a handful of U.S. refiners have so far elected for the extensive upgrades and regulatory approvals needed to process large amounts of unconventional crude. Thus the regulatory burdens are leaving the American refinery fleet largely inflexible. That’s why crude-oil processing has become specific to the design details of each refinery.

Moreover, inflexibility in the U.S. refining fleet is compounded by barriers that Balkanize a national market for refined fuels. An example: On Aug. 9 the BP refinery in Whiting, Ind., was forced to run at 40% of capacity for more than two weeks due to an unplanned outage in one of three crude-distillation units. Already among the most expensive in the country, gasoline prices in nearby Chicago jumped almost $0.70, to $3.37 a gallon.

Meanwhile, 60 miles south in Kankakee, Ill., the price at the pump held steady at $2.65. Kankakee County sits right outside a zone that the Environmental Protection Agency deems “nonattainment,” which means that retail gasoline must be “reformulated” to minimize the potential for smog emissions. But not every gallon of gasoline is equally amenable to reformulation, which shrinks the pool of fuel available. These areas end up with higher prices as the remaining reformulated fuel is rationed among nonattainment zones.

This is exacerbated by the renewable-fuels mandate, which requires blending nearly all gasoline with ethanol. Ethanol, when mixed with gasoline, increases the tendency for the lightest molecules to evaporate and contribute to urban smog. Gasoline therefore has to be stripped of so-called light-ends, increasing refining costs while reducing the yield of marketable fuel.

A similar set of regulatory constraints is affecting the retail price of diesel. In 2007, the EPA lowered the sulfur limit for on-road diesel to 15 parts per million, and for the first time applied the previous specification of 500 parts per million to off-road diesel—railroad and marine fuels, for instance. The 15 parts per million ultralow sulfur diesel specification now applies to off-road diesel as well. Meeting the new specifications has left refiners with three options: use only the lightest and sweetest crudes, operate equipment harder and sacrifice yields, or invest to maintain capacity.

Much like ethanol, the mandated introduction of ultralow sulfur diesel has complicated the supply system. Sulfur in diesel contributes to what is called “lubricity,” or the ability of diesel to lubricate the parts it touches. The impact of removing sulfur is further compounded by mandates to blend biodiesel, a renewable fuel made from plant-based oils. Biodiesel also affects fuel lubricity and must be accounted for before it can be marketed and sold.

And so this regulatory patchwork builds a price premium into every gallon, essentially to compensate refiners for providing fuels that meet ever-increasing regulatory and production demands. The result: When oil prices rise, the rise is reflected in retail fuel prices. But when oil prices fall, the relief you feel at the pump is limited.

In the mid-1980s and ’90s, the cost of crude oil accounted for about 45% of the retail price of gasoline. By August 2004, when a barrel of oil first touched $40, only 40% of the cost of retail gasoline was attributable to oil. Today, oil accounts for a mere 35% of the retail price of gasoline. Simply breaking down such regulatory barriers would reduce gas prices by about $0.60 a gallon, saving consumers more than $250 billion every year. Given the global economy, U.S. consumers could use every penny.

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