Understanding Variations in the Price of
Gas
The
retail price of a gallon of gasoline has four major components:
- The cost of crude oil,
- Refining costs and environmental
requirements,
- Distribution costs, and
- Taxes.
The
two largest components of the price are the cost of crude oil and
the added taxes--which account for 43 percent and 28 percent of the
retail price, respectively. (See Chart 1.) The major reason for the
increase in gasoline prices over the past year has been the rise in
crude oil prices set by the Organization of Petroleum Exporting
Countries (OPEC). Because OPEC,
which floundered after the 1986 collapse of oil prices, regained
production discipline and restricted production in 1999, the demand
for oil has outstripped supply and driven up prices.
The
resulting low inventory levels of both crude oil and refined
gasoline have significantly affected prices. But as noted above,
the degree to which prices rose also has been affected by refining
costs, U.S. environmental regulations, and distribution
problems.
Crude Oil Costs
and Inventories. The price of a barrel of crude oil makes
up the largest portion of the retail price of a gallon of gasoline.
As prices increased in 1999, the crude oil share of the retail
price rose from 37 percent to 43 percent. The most recent gasoline
price increases are due in part to the cuts OPEC made in crude oil
production in 1999. In addition, higher demand from recovering
Asian economies increased competitive bidding for crude oil
supplies and helped to drive up the prices.
Crude oil and imported gasoline prices
also vary by location. For example, according to the Energy
Information Administration, in June 2000, the spot price (without
taxes) for imported conventional regular gasoline varied from 96
cents per gallon in the Gulf Coast District to $1.01 per gallon in
Los Angeles.
U.S.
inventories of crude oil have fallen sharply since the beginning of
1999. The stock of crude oil is currently 20 million barrels under
the normal range for the summer months, which represents only a
two-day supply for refineries. The expected
growth in demand this year, though small by historical standards,
should keep inventory levels lean and prevent prices from falling
rapidly for the remainder of the year, unless crude oil production
increases significantly.
Refining
Costs. On average, the cost of refining crude oil accounts
for around 20 percent of the price of a gallon of gasoline, an
increase from its 13 percent share in 1999. Refinery costs include
crude oil processing and oxygenate additives, reformulating
gasoline, shipping and storage, oil-spill fees, advertising, the
purchase of gasoline to cover shortages, and profits. As an
official of the Energy Information Administration recently told the
Senate Committee on Energy and Natural Resources, "the U.S.
refinery system has little excess capacity, and continuing growth
in the number of distinct gasoline types that must be delivered to
different locations increases the potential for temporary
disruptions and increased volatility."
U.S.
refineries are currently running at a 97.4 percent utilization
rate, up from 93.8 percent a year ago, and Midwest refinery
utilization rates are around 99 percent. There is little margin for
error given these utilization rates. Unexpected refinery outages,
which occur more often at high utilization rates, can have a
significant impact on regional prices in the short run,
particularly with today's low gasoline inventories. The refining
industry also suggests that burdensome Clean Air Act requirements
tied to upgrading or building new refineries slow its ability to
move rapidly to respond to such situations. In fact, the
nation's newest major oil refinery was constructed nearly 25 years
ago.
Environmental
Requirements and Reformulated Gas. Some areas of the
country are required to use specially refined gasoline to meet more
stringent air pollution requirements. The 1990 Clean Air Act
Amendments mandate the sale of reformulated gasoline in 10
metropolitan areas: Baltimore, Chicago, Hartford (Connecticut),
Houston, Los Angeles, Milwaukee, New York City, Philadelphia,
Sacramento, and San Diego.
About 30 percent of the gasoline sold in
the United States is reformulated. On June 1, 2000, new federal
requirements for Phase II of the reformulated fuel program took
effect, making it more difficult and costly to make reformulated
gas, especially with ethanol. The EPA estimates that the cost of
the Phase II requirements will add 5 cents to 8 cents to the price
of a gallon of gasoline, although it admits that "retail prices may
be higher and more changeable at the start of the Phase II
program." A recent
Congressional Research Service report found that 25 cents of the
recent gasoline price spike in the Chicago/Milwaukee area could be
attributed to the new federal environmental standards.
The
state of California implements its own reformulated gasoline
program with more stringent requirements than those issued by the
federal government. California's prices are more variable than
others, since there are relatively few supply sources for its
unique blend of gasoline outside the state. Moreover, California
refineries need to be running near their fullest capacities in
order to meet the state's fuel demands. If two or more of its
refineries experience operating difficulties at the same time,
California's gasoline supply becomes very tight and prices soar.
Supplies could be obtained from the Gulf
Coast and foreign refineries; however, California's substantial
distance from those refineries means that any unusual increase in
demand or reduction in supply will result in a large pricing
response in the market before the relief supplies can be delivered.
The farther away the necessary relief supplies are, the higher and
longer the price spike will be.
The
number of reformulated gasoline specifications also affects gas
prices. The American Petroleum Institute reports that the United
States has become a nation of boutique fuels. For example, 10
different types of reformulated gas are sold east of the Rocky
Mountains. The result is that
refiners and distributors have less flexibility to move supplies
around the nation to respond to local or regional shortages.
Moreover, the wide variety of gasoline
makes storage and distribution more difficult and increases the
potential for temporary supply disruptions. This spring, refiners
were forced to reduce inventories to near zero in order to change
over from winter grades of gasoline to summer grades. In addition,
the refining industry estimates that it will be required to comply
with at least a dozen major regulatory requirements over the next
10 years, including reductions in gasoline sulfur content and
on-road diesel sulfur and the phasing out and/or introduction of
certain oxygenates. This has the potential to complicate even
further the supply and distribution of gasoline.
Distribution
Costs. Distribution, marketing, and retail station costs
combine to make up 9 percent of the cost of a gallon of gasoline,
down from 14 percent in 1999. Most service station outlets are
independent dealers who are free to set their own prices. The price
on the pump reflects both the retailer's cost to purchase the
product and other costs incurred in operating the service station.
It also reflects local market conditions and factors such as the
desirability of the location and the marketing strategy of the
owner. Consumers in remote locations may face a trade-off between
higher local prices and the inconvenience of driving some distance
to find a lower priced alternative.
Areas farthest from the Gulf Coast--the
source of nearly half of the gasoline produced in the United States
and, thus, a major supplier for the rest of the country's gasoline
inventories--tend to have higher prices. The proximity of
refineries to crude oil supplies can even be a factor, as well as
the cost of shipping (by pipeline or waterborne) from the refinery
to market. Two oil pipelines serving the Midwest recently
experienced operational problems that disrupted supply and
contributed to recent price increases. The Congressional Research
Service estimates that 25 cents of the recent gasoline price spike
in the Midwest District could be attributed to distribution
problems.
Federal, State,
and Local Taxes. On average, federal, state, and local
taxes account for the second largest portion of retail gasoline
prices after the price of crude oil--41 cents per gallon, or 28
percent of the cost, as of May 2000. Federal taxes add
18.4 cents per gallon, while state taxes add an average of 22.6
cents. Local taxes add, on average, another 2 cents per gallon.
American motorists' annual gasoline tax bill adds up to a stunning
$53 billion per year--$22.6 billion in federal taxes and $30.1
billion in state taxes.
State gasoline excise taxes vary
considerably, from a low of 8 cents per gallon in Alaska to 34.7
cents per gallon in New York--a difference of 26.7 cents per
gallon. (See Table 2.) The 10 states with the lowest tax rates also
have regular gasoline prices that are below the national
average.
Most
state tax rates do not change very often; however, 10 states adjust
their tax rates on an annual, semiannual, or quarterly basis. Four
states--California, Nevada, Oklahoma, and Tennessee--have
provisions in their statutes that will increase the state motor
fuel tax rates if the federal tax rate is reduced.
Five
states also apply a sales tax on top of their excise tax. Together,
these states--California, Georgia, Hawaii, Michigan, and New
York--account for almost one-fifth of the motor fuel sold in the
United States. Worse, four of these states--California, Georgia,
Michigan, and New York--even tax the taxes on gasoline by applying
their sales tax to state and federal gasoline excise taxes.
A SHORT-TERM FIX: REDUCE THE FEDERAL
TAX
Because gas taxes represent the second
largest component of retail gas prices after the cost of crude oil,
cutting the federal gas tax would be one of the fairest, most
significant, and most sensible ways to reduce the price of a gallon
of gas in the short term to give American families much-needed
relief. In the long term, Congress and the President must develop a
coherent and workable energy policy that would restore and
guarantee the nation's energy independence.
A
number of bills (such as H.R. 3849, H.R. 3982, S. 2262, and S.
2285) have been introduced in the 106th Congress to cut, either
temporarily or permanently, the federal gas tax, which is one of
fastest growing federal taxes. The proposals range from permanently
cutting the 1993 increase in the gas tax of 4.3 cents (H.R. 3848
and H.R. 3982) to suspending the entire 18.4 cent federal tax for
up to 9 months (S. 2262 and S. 2285). On July 13, 2000, the Senate
voted (40 to 59) to defeat an amendment offered by Senators Spencer
Abraham (R-MI) and Peter G. Fitzgerald (R-IL) to suspend the entire
18.4 cent federal tax for 150 days.
Many
Members still defend the tax, claiming that reducing it would
result in lost revenue that otherwise could go to states and local
communities for planned highway projects. But Washington has a long
legacy of wasting billions of gas tax dollars on questionable
pork-barrel projects that include museums, historic train station
renovations, and parking garages. Citizens Against
Government Waste has identified $1 billion in transportation
pork-barrel spending in fiscal year 2000. And as the size of
the tax surplus continues to expand, such claims are increasingly
greeted by the public with considerable skepticism.
The Burden on Families and Businesses
As
noted above, Congress could suspend the federal tax on gasoline and
diesel fuel for just three months and save motorists $4.4 billion.
Most of America's consumable goods are carried to their local
destinations by the more than 7 million trucks--many owner-operated
by a head of a household--on America's roads today. Meanwhile, many
businesses are operating on profit margins of just 2 percent to 4
percent.
Small companies have been especially hurt
by the high gas taxes; those that consume 50,000 gallons of diesel
fuel per month spend an average of $40,000 more each month on fuel
than they did last year, just because of the increase in the price
of gas over the past year. The additional costs they incur from
these rising fuel prices are often added to the price of goods and
services. Reducing the cost of fuel by just 4.3 cents a gallon
would save small companies more than $2,000 each month.
If
the price of oil remains high for too long, the vibrant U.S.
economy will suffer. According to an analysis by The Heritage
Foundation's Center for Data Analysis, if the price of oil remains
at $30 per barrel for the remainder of the year, economic growth
would decrease over the next two years. High oil prices
without any tax relief would reduce real disposable income for an
average family of four by $1,324, decrease consumer spending by
$79.6 billion, and reduce the number of job opportunities by almost
500,000. Higher prices and slower economic growth would reduce
federal tax revenues by $12.4 billion over the next three fiscal
years.
States Act to Cut Gas Taxes
While Washington continues to debate the
issue of reducing gas taxes, some states already have taken action
to do just that. On July 1, Illinois suspended its sales tax on
gasoline for six months and Indiana suspended its gas tax for 60
days. Both of these states took action with an understanding that
their budget surpluses had made it hard to justify not providing
relief to lower-income Americans and those who make their living
driving. A number of other states, such as Michigan and Wisconsin,
are also considering temporary reductions in their gas taxes.
The
fact that states impose their own gas tax begs the questions:
Should not the states determine how much to tax gasoline use in
order to maintain infrastructure? Why should citizens be forced to
send more money through Washington only to have it cycle back to
their states and local communities for transportation projects?
Washington's penchant for wasting federal gas tax revenues on
unnecessary pork projects highlights the need for Americans to
demand that the federal government get out of the way and do what
is fair by giving control of federal highway programs back to
states and local communities.
CONCLUSION
Washington's failure to establish a
long-term domestic energy policy that guarantees and protects
America's energy independence is largely to blame for the high gas
prices Americans pay at the pump. In the long term, Congress and
the President must address the nation's dependence on foreign oil
that leaves the economy and national security vulnerable.
In
the short term, Washington has one important way to mitigate the
impact of high gas prices--reduce the federal gasoline tax. As the
surplus of tax overpayments in the Treasury continues to break
records, what better opportunity than now will Congress or the
President have to provide some much-needed relief to lower-income
Americans, the elderly, families, and those who make their living
driving?
Americans want good highways, and they want Washington to lower the
price of fuel. Maintaining the nation's highways is not dependent
on the federal gas tax. Cutting this tax--even temporarily--would
be a good and fair step that would immediately help Americans who
find it increasingly difficult to make ends meet.
D.
Mark Wilson is a former Research Fellow in, and Angela
Antonelli was the Director of, the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage
Foundation.
The authors would like
to thank Christopher Summers, Research Assistant at The Heritage
Foundation, for his contributions to this paper.