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Surprise! Domestic Production Can Lower Gas Prices After All.


The good folks at the Independent Petroleum Association of America — a trade group representing represents more than 6,000 independent oil and natural gas producers and service and supply companies across the U.S. – have put forth a new report discussing the relationship between domestic production and gasoline prices.

Their report reinforces what common sense would suggest: that while oil is traded on a global market, the pre-tax cost of gasoline is relatively cheaper when you are near the source and the refinery. Oil produced here in the United States has an easier time getting to a U.S. refinery – making it cheaper to produce than oil that has to be shipped here from overseas.

They begin by pointing out:

First of all, gasoline is not crude oil. Before crude oil becomes gasoline, it must undergo a series of transformations, which refineries play a crucial role. Although gasoline is not the only petroleum product that helps keep the U.S. economy running, it does account for nearly half of U.S. petroleum consumption (which is understandably why it receives the most attention in the media).  While petroleum products overall, including diesel fuel and jet fuel, make up 93 percent of energy used in U.S. transportation, gasoline alone accounts for more than 60 percent of U.S. transportation energy.

Here’s the key difference: domestic crude can be up to $20/barrel cheaper than imported crude oil.

American oil production has helped lower the price of many of our domestic crude streams in comparison to internationally-priced Brent and other imported grades. As a result, relatively abundant supplies in the mid-continent have in recent times put market prices for West Texas Intermediate (WTI) crude at some $10-$20/barrel cheaper than imported Brent crude.  As of mid-March, the difference was running at about $20/barrel. Further up the supply chain, Bakken crude itself was trading some $17-18 below WTI several weeks ago. Because of increased U.S. oil production, mid-continent refiners have seen lower costs for increased domestically-supplied inputs, while East Coast (and Caribbean) refiners have largely been faced with the higher cost of imported foreign crude oil.

They note that prices of the ingredient (crude oil) and the final product don’t always move in perfect symmetry. Examining prices between 2005 and 2007, they find, “EIA data show that the average crude oil price paid by refiners has more than doubled, rising the equivalent of $1.35 per gallon, while retail prices of gasoline have risen by about 50 percent, or about $1.10 per gallon. One has to be careful in one’s expectations of price symmetry between the raw material and the product.”

They point to three other factors that can make a big difference in what a customer pays when they fill up their tank:

Taxes on Gasoline Matter. On a much smaller but still significant scale, local taxes vary within the U.S. While the Federal excise tax is the same across the country at 18.4 cents/gallon for gasoline (and 24.4 cents/gallon for diesel), state and local taxes vary considerably. According to tax data compiled by the Energy Information Administration and other sources, taxes range from over 65 cents/gallon for New York, including Federal excise taxes, to 26.4 cents/gallon for Alaska. The national average is around 46 cents/gallon.

Burdensome Regulations Matter. Gasoline for sale in most major metropolitan areas is required by the EPA to meet tighter standards than gasoline sold in rural regions. Meeting these tighter standards can make that gasoline more costly to produce. Going further, California requires its own specific formulation of gasoline which must meet the most stringent requirements in the country. There are other various regional requirements, and by some counts, across the country there are at least 15 different gasoline formulations.

Infrastructure matters. Consumers geographically farther from the source of production are likely to pay more because of the higher cost of transportation and the need for more storage terminals to buffer fluctuations in shipments along the lengthy supply chain. Our piece on the dramatic rise of crude oil production in the Bakken in North Dakota highlighted the geographic distance between the location of ‘new’ production and where the major consuming areas are located, and requisite transportation infrastructure to move some of that crude oil beyond the mid-continent. The East Coast accounts for over 36 percent of U.S. gasoline consumption, but with relatively few refineries, the region only accounted for 7 percent of refinery runs in 2011. This may help explain why retail prices in the high-demand, refinery-poor Northeast, even after adjusting for differences in taxes, are higher than on the Gulf Coast, where roughly half of the nation’s refinery capacity operates. Also part of the mix is how certain refineries have been tailored with specific crudes in mind, resulting in differences in the products refined. East Coast refiners have traditionally targeted lighter, lower-sulfur crudes, while Gulf Coast refiners have more often focused on heavier and sourer crudes.

If the Northeastern states wanted cheaper gas, they could A) lower state gasoline taxes B) simplify the formulation requirements for gasoline sold within the state or C) build more refineries. (And all of you scoffed while driving down the New Jersey Turnpike. The Garden State has, by far, the cheapest gasoline in the region and the lowest taxes in the region.)

Tags: Gas Prices


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