In 2004, the United States consumed about 20.5 million barrels per day of crude oil accounting for roughly 25 percent of world oil production. A great deal of the crude oil consumed in this country goes into production of gasoline and, as a nation, we use about 45 percent of all gasoline produced in the world. California alone presently consumes almost 44 million gallons of gasoline per day. To put this in perspective, in 1997 (the last year for which we found available data for international comparisons), only the rest of the United States and Japan consumed more gasoline than California. Products made from crude oil—petroleum products, including gasoline— have been instrumental in the development of our modern lifestyle. In particular, gasoline, diesel, and jet fuel have provided the nation with affordable fuel for automobiles, trucks, airplanes and other forms of public and goods transportation. Together, these fuels account for over 98 percent of the U.S. transportation sector’s fuel consumption. In addition, petroleum products are used as raw materials in manufacturing and industry; for heating homes and businesses; and, in small amounts, for generating electric power. Gasoline use alone constitutes about 44 percent of our consumption of petroleum products in the United States, so when gasoline prices rise, as they have in recent months, the effects are felt throughout the country, increasing the costs of producing and delivering basic retail goods and making it more expensive to commute to work. It is often the case that prices of other petroleum products also increase at the same time and for the same reasons that gasoline prices rise. For example, today’s high gasoline prices are mirrored by high jet fuel prices, which have put pressure on airline companies, some of which are currently in the midst of financial difficulties. Gasoline prices vary a great deal over time. For example, in the 10-year period April 1995 through April 2005, the national average price for a gallon of regular grade gasoline has been as low as $0.89 and as high as $2.25 without adjusting for inflation. In addition, gasoline prices vary by location and, in recent years, California has consistently had among the highest prices in the nation. The future path of gasoline prices is difficult to predict, but it is clear that the use of petroleum products worldwide is going to increase for the near term and maybe beyond. Some analysts have predicted much higher crude oil prices—and as a result, higher prices of petroleum products—while others expect prices to moderate as producers respond to high prices by producing more crude oil and consumers respond by conserving more, and investing in more energy-efficient cars and other products. In either case, the price of gasoline will continue to be an important part of the household budgets of Americans for the foreseeable future and therefore, it is important to understand how prices are determined so that consumers can make wise choices. Crude oil prices feed directly into the price of gasoline, because crude oil is the primary raw material from which gasoline is produced. For example, according to our analysis of EIA data, crude oil accounted for about 48 percent of the price of a gallon of gasoline on average in 2004 in the United States. When crude oil prices rise, as they have in recent months, refiners find their cost of producing gasoline also rises, and in general, these higher costs are passed on to consumers in the form of higher gasoline prices at the pump. Figure 2 illustrates the importance of crude oil in the price of gasoline. The figure also shows that taxes, refining, and distribution and marketing also play important roles. Because of the prominent role of crude oil as a raw material of gasoline production, in order to understand what determines gasoline prices it is necessary to examine how crude oil prices are set. Overall, the price of crude oil is determined by the balance between world demand and supply. A major cause of rising crude oil prices in recent months has been rapid growth in world demand, without a similar growth in available supplies. In particular, the economy of China has grown rapidly in recent years, leading to increases in their demand for crude oil. In contrast, oil production capacity has grown more slowly, leading to a reduction in the surplus capacity—the amount of crude oil that is left in the ground, but could be extracted on short notice in the event of a supply shortfall. EIA has stated that the world’s surplus crude oil production capacity has fallen to about one million barrels per day, or just over one percent of the world’s current daily consumption, making the balance between world demand and supply of crude oil very tight. This tight balance between world crude oil demand and supply means that any significant supply disruptions will likely cause prices to rise. For example, a workers’ strike in Nigeria’s oil sector in October 2004 forced world crude oil prices to record highs (Nigeria is the world’s seventh largest oil producer, supplying an average 2.5 million barrels per day in 2004). Another important factor affecting crude oil prices is the behavior of the Organization of Petroleum Exporting Countries (OPEC)—members of which include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela. OPEC members produce almost 40 percent of the world’s crude oil and control almost 70 percent of the world’s proven oil reserves. In the recent past and on numerous other occasions, OPEC members have collectively agreed to restrict production of crude oil in order to increase world prices for that commodity. In addition to the cost of crude oil, gasoline prices are influenced by a variety of other factors, including refining capacity constraints, low inventories, unexpected refinery or pipeline outages, environmental and other regulations, and mergers and market power in the oil industry. First, domestic refining capacity, has not kept pace with growing demand for gasoline. As demand has grown faster than domestic refining capacity, the United States has imported larger and larger volumes of gasoline and other petroleum products from refiners in Europe, Canada, and other countries. EIA officials told us that, in general, this increase in imports has reflected the availability of gasoline from foreign sources at lower cost than building and operating additional refining capacity in the United States would entail. However, the American Petroleum Institute (API) has recently reported that capacity utilization has been high in the U.S. refinery sector. Capacity has typically averaged over 90 percent, and has recently increased to 92 percent—much higher than the rate in many other industries, which API reports are more typically operating at around 80 percent of capacity. As a result, domestic refineries have little room to expand production in the event of a temporary supply shortfall. Further, the fact that imported gasoline comes from farther away than domestically produced gasoline means that when supply disruptions occur in the United States, it might take longer to get replacement gasoline than if we had excess refining capacity in the United States, and this could cause gasoline prices to rise and stay high until these new supplies can reach the market. Gasoline prices may also be affected by unexpected refinery outages or accidents that significantly disrupt the delivery of gasoline supply. For example, in a recent report, we found that unexpected refinery outages had been a factor in a number of prices spikes in California in the 1990s. More recently, the tragic explosion and subsequent fire at a BP refinery in Houston, that killed 15 people, temporarily shut down about 3 percent of the nation’s refining capacity. While we have not analyzed the potential impact on gasoline prices of this specific event, similar events in the past have caused temporary increases in prices until alternative sources of supply can be brought to market. Pipeline disruptions can have a similar effect, as was seen when Arizona’s Kinder Morgan pipeline broke in July 2003 and average gasoline prices jumped 56 cents in a month in Arizona. In addition, tanker spills, and other similar events can all have an impact on gasoline prices at various points in time because they cause interruption in the supply of crude oil or petroleum products, such as gasoline. The level of gasoline inventories can also play an important role in determining gasoline prices over time because inventories represent the most accessible and available source of supply in the event of a production shortfall or increase in demand. Similar to trends in other industries, the level of inventories of gasoline has been falling for a number of years. In part, this reflects a trend in business to more closely balance production with demand in order to reduce the cost of holding large inventories. However, reduced inventories may contribute to increased price volatility, because when unexpected supply disruptions or increases in demand occur, there are lower stocks of readily available gasoline to draw from. This puts upward pressure on gasoline prices until new supplies can be refined and delivered domestically, or imported from abroad. Regulatory steps to reduce air pollution have also influenced gasoline markets and consequently have influenced gasoline prices. For example, since the 1990 amendments to the Clean Air Act, the use of various blends of cleaner-burning gasoline—so-called “boutique fuels—has grown. A number of reports by government agencies, academics, and private entities have concluded that the proliferation of these special gasoline blends has put stress on the gasoline supply infrastructure and may have led to increased price volatility because areas that use special blends cannot as easily find suitable replacement gasoline in the event of a local supply disruption. However, these special gasoline blends provide environmental and health benefits because they reduce emissions of a number of pollutants. GAO is currently working on a report on special gasoline blends that will look at these issues and discuss the effects of these special blends on emissions and on the supply system. Finally, we recently reported that industry mergers increased market concentration and in some cases caused higher wholesale gasoline prices in the United States from the mid-1990s through 2000. Overall, the report found that the mergers led to price increases averaging about 2 cents per gallon on average.