Crude Oil Prices and Other Factors Affect Gasoline Prices

Crude oil prices are a major determinant of gasoline prices. As figure 1  shows, crude oil and gasoline prices have generally followed a similar path  over the past three decades and have risen considerably over the past few  years.
Also, as is the case for most goods and services, changes in the demand for  gasoline relative to changes in supply affect the price that consumers pay.   In other words, if the demand for gasoline increases faster than the ability  to supply it, the price of gasoline will most likely increase.  In 2006, the  United States consumed an average of 387 million gallons of gasoline per  day.  This consumption is 59 percent more than the 1970 average per day  consumption of 243 million gallons—an average increase of about 1.6  percent per year for the last 36 years. As we have shown in a previous  GAO report, most of the increased U.S. gasoline consumption over the last  two decades has been due to consumer preference for larger, less-fuel  efficient vehicles such as vans, pickups, and SUVs, which have become a  growing part of the automotive fleet.
Refining capacity and utilization rates also play a role in determining  gasoline prices. Refinery capacity in the United States has not expanded at  the same pace as demand for gasoline and other petroleum products in  recent years.  According to FTC, no new refinery still in operation has  been built in the U.S. since 1976.  As a result, existing U.S. refineries have  been running at very high rates of utilization averaging 92 percent since  the 1990s, compared to about an average of 78 percent in the 1980s.  Figure 2 shows that since 1970 utilization has been approaching the limits  of U.S. refining capacity. Although the average capacity of existing  refineries has increased, refiners have limited ability to increase  production as demand increases. While the lack of spare refinery capacity  may contribute to higher refinery margins, it also increases the  vulnerability of gasoline markets to short-term supply disruptions that  could result in price spikes for consumers at the pump.  Although  imported gasoline could mitigate short-term disruptions in domestic  supply, the fact that imported gasoline comes from farther away than  domestic supply means that when supply disruptions occur in the United  States it might take longer to get replacement gasoline than if we had  spare refining capacity in the United States.  This could mean that gasoline  prices remain high until the imported supplies can reach the market.
Further, gasoline inventories maintained by refiners or marketers of  gasoline can also have an impact on prices. As have a number of other  industries, the petroleum industry has adopted so-called “just-in-time”  delivery processes to reduce costs leading to a downward trend in the  level of gasoline inventories in the United States. For example, in the early  1980s U.S. oil companies held stocks of gasoline of about 40 days of  average U.S. consumption, while in 2006 these stocks had decreased to 23  days of consumption.  While lower costs of holding inventories may  reduce gasoline prices, lower levels of inventories may also cause prices to  be more volatile because when a supply disruption occurs, there are fewer  stocks of readily available gasoline to draw from, putting upward pressure  on prices.
Regulatory factors play a role as well. For example, in order to meet  national air quality standards under the Clean Air Act, as amended, many  states have adopted the use of special gasoline blends—so-called  “boutique fuels.” As we reported in a recent study, there is a general  consensus that higher costs associated with supplying special gasoline  blends contribute to higher gasoline prices, either because of more  frequent or more severe supply disruptions, or because higher costs are  likely passed on, at least in part, to consumers.  Furthermore, changes in  regulatory standards generally make it difficult for firms to arbitrage  across markets because gasoline produced according to one set of  specifications may not meet another area’s specifications.
Finally, market consolidation in the U.S. petroleum industry through  mergers can influence the prices of gasoline.  Mergers raise concerns  about potential anticompetitive effects because mergers could result in  greater market power for the merged companies, either through unilateral  actions of the merged companies or coordinated interaction with other  companies, potentially allowing them to increase and maintain prices  above competitive levels. On the other hand, mergers could also yield cost  savings and efficiency gains, which could be passed on to consumers  through lower prices. Ultimately, the impact depends on whether the  market power or the efficiency effects dominate.

	Mergers in the 1990s Increased Market Concentration and Led to Small But Significant Increases in Wholesale Gasoline Prices; However the Impact of More Recent Mergers is Unknown

During the 1990s, the U.S. petroleum industry experienced a wave of  mergers, acquisitions, and joint ventures, several of them between large oil  companies that had previously competed with each other for the sale of  petroleum products. More than 2,600 merger transactions occurred from  1991to 2000 involving all segments of the U.S. petroleum industry.  These  mergers contributed to increases in market concentration in the refining  and marketing segments of the U.S. petroleum industry.  Econometric  modeling we performed of eight mergers involving major integrated oil  companies that occurred in the 1990s showed that the majority resulted in  small but significant increases in wholesale gasoline prices. The effects of  some of the mergers were inconclusive, especially for boutique fuels sold  in the East Coast and Gulf Coast regions and in California. While we have  not performed modeling on mergers that occurred since 2000, and thus  cannot comment on any potential effect on wholesale gasoline prices at  this time, these mergers would further increase market concentration  nationwide since there are now fewer oil companies.
Some of the mergers involved large partially or fully vertically integrated  companies that previously competed with each other. For example, in  1998 British Petroleum (BP) and Amoco merged to form BPAmoco, which  later merged with ARCO, and in 1999 Exxon, the largest U.S. oil company  merged with Mobil, the second largest. Since 2000, we found that at least 8  large mergers have occurred. Some of these mergers have involved major  integrated oil companies, such as the Chevron-Texaco merger, announced  in 2000, to form ChevronTexaco, which went on to acquire Unocal in 2005.  In addition, Phillips and Tosco announced a merger in 2001 and the  resulting company, Phillips, then merged with Conoco to become  ConocoPhillips.
Independent oil companies have also been involved in mergers. For  example, Devon Energy and Ocean Energy, two independent oil  producers, announced a merger in 2003 to become the largest independent  oil and gas producer in the United States at that time.  Petroleum industry  officials and experts we contacted cited several reasons for the industry’s  wave of mergers since the 1990s, including increasing growth, diversifying  assets, and reducing costs. Economic literature indicates that enhancing  market power is also sometimes a motive for mergers, which could reduce  competition and lead to higher prices. Ultimately, these reasons mostly  relate to companies’ desire to maximize profits or stock values.
Proposed mergers in all industries are generally reviewed by federal  antitrust authorities—including the Federal Trade Commission (FTC) and  the Department of Justice (DOJ)—to assess the potential impact on  market competition and consumer prices. According to FTC officials, FTC  generally reviews proposed mergers involving the petroleum industry  because of the agency’s expertise in that industry. To help determine the  potential effect of a merger on market competition, FTC evaluates, among  other factors, how the merger would change the level of market  concentration. Conceptually, when market concentration is higher, the  market is less competitive and it is more likely that firms can exert control  over prices.
DOJ and FTC have jointly issued guidelines to measure market  concentration. The scale is divided into three separate categories:  unconcentrated, moderately concentrated, and highly concentrated. The  index of market concentration in refining increased all over the country  during the 1990s, and changed from moderately to highly concentrated on  the East Coast. In wholesale gasoline markets, market concentration  increased throughout the United States between 1994 and 2002.  Specifically, 46 states and the District of Columbia had moderately or  highly concentrated markets by 2002, compared to 27 in 1994.
To estimate the effect of mergers on wholesale gasoline prices, we  performed econometric modeling on eight mergers that occurred during  the 1990s: Ultramar Diamond Shamrock (UDS)-Total, Tosco-Unocal,  Marathon-Ashland, Shell-Texaco I (Equilon), Shell-Texaco II (Motiva), BP- Amoco, Exxon-Mobil, and Marathon Ashland Petroleum (MAP)-UDS.
For the seven mergers that we modeled for conventional gasoline, five led  to increased prices, especially the MAP-UDS and Exxon-Mobil mergers,  where the increases generally exceeded 2 cents per gallon, on average.
For the four mergers that we modeled for reformulated gasoline, two— Exxon-Mobil and Marathon-Ashland—led to increased prices of about 1  cent per gallon, on average. In contrast, the Shell-Texaco II (Motiva)  merger led to price decreases of less than one-half cent per gallon, on  average, for branded gasoline only.
For the two mergers—Tosco-Unocal and Shell-Texaco I (Equilon)—that  we modeled for gasoline used in California, known as California Air  Resources Board (CARB) gasoline, only the Tosco-Unocal merger led to  price increases. The increases were for branded gasoline only and were  about 7 cents per gallon, on average.
Our analysis shows that wholesale gasoline prices were also affected by  other factors included in the econometric models, including gasoline  inventories relative to demand, supply disruptions in some parts of the  Midwest and the West Coast, and refinery capacity utilization rates.

	Concluding Observations

Our past work has shown that, the price of crude oil is a major  determinant of gasoline prices along with changes in demand for gasoline.   Limited refinery capacity and the lack of spare capacity due to high  refinery capacity utilization rates, decreasing gasoline inventory levels and  the high cost and changes in regulatory standards also play important  roles. In addition, merger activity can influence gasoline prices. During the  1990s, mergers decreased the number of oil companies and refiners and  our findings suggest that these changes in the state of competition in the  industry caused wholesale prices to rise. The impact of more recent  mergers is unknown. While we have not performed modeling on mergers  that occurred since 2000, and thus cannot comment on any potential effect  on wholesale gasoline prices at this time, these mergers would further  increase market concentration nationwide since there are now fewer oil  companies.
We are currently in the process of studying the effects of the mergers that  have occurred since 2000 on gasoline prices as a follow up to our previous  report on mergers in the 1990s.  Also, we are working on a separate study  on issues related to petroleum inventories, refining, and fuel prices. With  these and other related work, we will continue to provide Congress the  information needed to make informed decisions on gasoline prices that  will have far-reaching effects on our economy and our way of life.
Mr. Chairman, this completes my prepared statement. I would be happy to  respond to any questions you or the other Members of the Committee may  have at this time.

	GAO Contacts and Staff Acknowledgments

For further information about this testimony, please contact me at (202)  512-2642 (mccoolt@gao.gov) or Mark Gaffigan at (202) 512-3841  (gaffiganm@gao.gov).  Godwin Agbara, John Karikari, Robert Marek, and  Mark Metcalfe made key contributions to this testimony.
This is a work of the U.S. government and is not subject to copyright protection in the  United States. It may be reproduced and distributed in its entirety without further  permission from GAO. However, because this work may contain copyrighted images or  other material, permission from the copyright holder may be necessary if you wish to  reproduce this material separately.

Summary:
Why GAO Did This Study

Few issues generate more attention and anxiety among American consumers than the price of gasoline. The most current upsurge in prices is no exception. According to data from the Energy Information Administration (EIA), the average retail price of regular unleaded gasoline in the United States has increased almost every week this year since January 29th and reached an all-time high of $3.10 the week of May 14th. Over this time period, the price has increase 94 cents per gallon and added about $20 billion to consumers' total gasoline bill, or about $146 for each passenger car in the United States. Given the importance of gasoline for the nation's economy, it is essential to understand the market for gasoline and the factors that influence gasoline prices. In this context, this testimony addresses the following questions: (1) what key factors affect the prices of gasoline and (2) what effects have mergers had on market concentration and wholesale gasoline prices? To address these questions, GAO relied on previous reports, including a 2004 GAO report on mergers in the U.S. petroleum industry, a 2005 GAO primer on gasoline prices and a 2006 testimony. GAO also collected updated data from EIA. This work was performed in accordance with generally accepted government auditing standards.

What GAO Found

The price of crude oil is a major determinant of gasoline prices. However, a number of other factors also affect gasoline prices including (1) increasing demand for gasoline; (2) refinery capacity in the United States that has not expanded at the same pace as the demand for gasoline; (3) a declining trend in gasoline inventories and (4) regulatory factors, such as national air quality standards, that have induced some states to switch to special gasoline blends. Consolidation in the petroleum industry plays a role in determining gasoline prices as well. For example, mergers raise concerns about potential anticompetitive effects because mergers could result in greater market power for the merged companies, potentially allowing them to increase and sustain prices above competitive levels; on the other hand, these mergers could lead to efficiency effects enabling the merged companies to lower prices. The 1990s saw a wave of merger activity in which over 2600 mergers occurred in all segments of the U.S. petroleum industry. This wave of mergers contributed to increases in market concentration in the refining and marketing segments of the U.S. petroleum industry. Econometric modeling that GAO performed on eight of these mergers showed that, after controlling for other factors including crude oil prices, the majority resulted in wholesale gasoline price increases--generally between about 1 and 7 cents per gallon. While these price increases seem small, they are not trivial because according to the Federal Trade Commission's (FTC) standards for merger review in the petroleum industry, a 1-cent increase is considered to be significant. Additional mergers occurring since 2000 are expected to increase the level of industry concentration further, and because GAO has not yet performed modeling on these mergers, we cannot comment on any potential effect on gasoline prices at this time. However, we are currently in the process of studying the effects of the mergers that have occurred since 2000 on gasoline prices as a follow up to our previous work on mergers in the 1990s. Also, we are working on a separate study on issues related to petroleum inventories, refining, and fuel prices.