Gasoline prices have been extremely volatile for nearly two years, with three significant pricespikes focusing the attention of consumers and policy makers on the gas pump. With 2004 nationalaverage gasoline prices setting a record of $2.05 per gallon (/gal) in mid-May -- breaking the oldsummer 2003 record of $1.74/gal -- gasoline market developments have been viewed with concern,even with a year-end decline to $1.80/gal. Crude oil prices also rose sharply during 2004, brieflyexceeding $55 per barrel on the spot market. Despite a pullback, crude prices for 2004 remainedabove levels last seen when Kuwait was invaded during the 1990-1991 Gulf Crisis. By mid-May, the crude oil price increase to almost $42 per barrel accounted for as much as20 cents per gallon of a total increase at the pump of 43 cents since the end of 2003. Simply stated,pump prices are essentially determined by the supply of and demand for gasoline, although the costof crude figures into the equation. Other supply-side factors leading to high prices relate to the abilityof domestic refineries to meet growing gasoline demand. With no new domestic refinery built fora quarter century, the nation relies on imports for roughly 11% -- 1 million barrels per day (mbd) --of its 9 mbd gasoline needs. As U.S. gasoline specifications to meet clean air standards becometougher for all refiners to meet, the supply of foreign fuel available to U.S. importers is not alwaysimmediately available. In addition to meeting U.S. specifications, foreign supply difficulties includelong in-transit time, and the cost and availability of vessels suitable for refined product transporthave become tight. These factors have contributed to gasoline prices exceeding the observed increasein crude oil cost during much of 2004. As a consequence, while the increase in crude prices standsout, increased gasoline prices have a greater profile, drawing attention to the nation's energysituation. According to the American Automobile Association (AAA) daily survey of retail gasolineprices around the country, gasoline prices at the pump nationwide have exceeded previous records.Since the start of 2003, prices at the gas pump have fluctuated by as much as 55 cents per gallon, andreached peaks above $1.70 three times. Figure 1 shows pump prices for the United States as a wholeand California, where both price levels and peaks exceed the national averages -- a result of variouslocal conditions. California pump prices peaked in October at $2.45 for regular. Figure 1. Daily Prices per Gallon for California and Nationwide Retail Gasolineand for Crude Oil, Jan. 2003 - Dec. 2004 Sources: Retail gasoline prices: Oil Price Information Service, Daily Fuel Gauge Report online,sponsored by the American Automobile Association, http://www.fuelgaugereport.com . Spot oil prices: EIA, Weekly Petroleum Status Report , Table 14. http://www.eia.doe.gov/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/wpsr.html Also shown on Figure 1 are crude oil prices for the benchmark NYMEX traded crude oil,West Texas Intermediate (WTI, for delivery at Cushing, OK). This is often referred to as the "spotmarket" price; the weighted average cost of different types of crude used by refiners tracks theNYMEX price, although it generally averages less than this benchmark. Gasoline is manufacturedfrom crude oil, and this price series provides a baseline comparison between retail prices, wholesaleprices (excluding tax), and raw material cost. When gasoline prices peaked in May, crude oilaveraged more than $40 per barrel on the NYMEX, the equivalent of 95 cents per gallon, an increaseof about 19 cents from the December 2003 average of $32 per barrel. Crude oil prices fluctuatemarkedly on a daily basis, posing a difficulty in updating the figures cited here. While an oversimplification, every gallon of gasoline requires a gallon of crude added torefinery input. For much of the Figure 1 time frame, crude oil prices track national average pumpprices reasonably closely. But the peaks in gasoline prices -- spring, late summer 2003, and morerecently in May 2004 -- exceeded what could be attributed to increased crude costs. While crude oilprice increases are generally passed through to the gas pump on a penny-for-penny basis, and helpexplain much of the change in gasoline prices, the divergence between gasoline at the pump andcrude points toward changed gross margins in refining and marketing. This is due to the fundamentalsupply and demand situation for gasoline, relating specifically to an imbalance between the two thatis resolved by a change in price. The most recent price spike seen in Figure 1 -- taking place in fall2004 -- appears to coincide with an increase in crude prices. The coincidence here suggests that highgasoline prices seen in September and October 2004 may have been driven by crude cost push, ratherthan demand pull at the pump. Rising gasoline prices often elicit questions about the federal government's ability tointervene in the market and roll back price hikes. It must be kept in mind that gasoline prices are notcurrently regulated, and there is no statutory authority to do so. A period of price controls,accompanied by supply allocation requirements, was in effect from August 15, 1971, until January20, 1981. Those controls were often associated with shortages, resulting in episodes of long lines atgas pumps. In retrospect, it is not clear that the price controls resulted in retail prices that were lowerthan they might otherwise have been. As a result, the concept of government-mandated price controlsduring periods of rapid price increases has seen little support as a policy option since the 1970s. Figure 2 shows U.S. gasoline inventories during the past two years. The gray area highlightsthe normal operating range -- including seasonal fluctuations -- for gasoline stocks. The horizontalline across the bottom of the figure shows the "lower operational inventory," which the Departmentof Energy (DOE) places at 185 million barrels, the equivalent of about 20 days of nominal supply.That is the level at which sporadic physical shortages begin to appear around the nation. The 185million barrel figure can be thought of as the "fill" needed to keep the distribution system in normaloperation; it cannot be drawn upon to meet a demand increment at the pump. When there is virtuallyno extra supply to act as a price cushion, price spikes, spot shortages, and localized "run-outs" area possibility. Figure 2. U.S. Gasoline Inventories, January 2003 to Present Source: EIA, Weekly Petroleum Status Report , Figure 4. The most recent peak gasoline demand -- recorded in mid-summer 2003 -- was a four-weekaverage of about 9.4 mbd: gasoline demand consistently averaged about 9.0 mbd during 2004. Thedifference between stocks -- which have run between 200 and 215 million barrels during 2004 --and DOE's "minimum operating level" is between 15 and 30 million barrels, the equivalent ofroughly two or three days of supply available from refiners' stocks. Gasoline inventories have bounced between the upper and lower ranges of "normal" during2004. They were below the normal range when gasoline prices peaked in May. And, at the end of2004, they were above the normal range for this time of year, a factor likely contributing to theyear-end decline in pump prices. Generally, when crude oil stocks were below the seasonal norm, pump prices rose. Andwhen stocks were above the seasonal norm, prices fell. The ebb and flow of gasoline stocks during2004 -- a period of noteworthy gasoline price volatility -- reflects a balance between gasolineinventories, seasonal driving demand, and the crude available to make more at U.S. refineries as wellas the supply of imports. U.S. refineries cannot currently manufacture all the gasoline called for by the nation'smotorists. (1) About 11%is imported either as finished, ready-to-market gasoline or as blending components that can be mixedinto the gasoline pool. Thus, two sets of gasoline supply figures should be watched; the "productssupplied" series compiled by EIA, and "new gasoline supply," the combination of imports of finishedgasoline, gasoline blending components, and net U.S. refinery production of gasoline. The "productssupplied" data show gasoline flowing to consumers from inventory. "New supply" data show theamount of newly available gasoline -- be it produced or imported -- that may flow into inventoriesor directly to the pump. Figure 3 shows gasoline supplied to U.S. markets since the start of 2003. These data consistof domestic refinery production, (2) imports of finished gasoline that meets U.S. specifications, as wellas a significant amount -- between 300,000 and 500,000 barrels per day -- of blending componentsfrom refineries abroad. Figure 3. Gasoline Production and Imports, Jan. 2002 - Dec. 2004 Source: Finished Imported Gasoline: EIA, Petroleum Supply Monthly , Table 54. BlendComponents: EIA, Weekly Petroleum Status Report , Table 9. U.S. Net Refinery Production:see text of report. These imported blending components lend a complexity to tabulating the data on gasolineproduction. EIA includes the blending components in its series on refinery production, even thoughthey are not produced in U.S. refineries. Blending components are added to gasoline supplies atrefineries and terminals. They appear in the EIA data collected from refiners and terminal operatorsas if they were the same as output from U.S. refineries' manufacturing process, whereas they areactually imported.