Story taken from TIME Magazine May 13, 1996 Volume 147, No. 20


Politicians are jumping to intervene, but high prices may be the result of increasing demand


Pulling into his local Texaco station, Don McCullough, a Wolfeboro, New Hampshire, artist, blinked and looked again. The price for high-test gasoline had jumped overnight from $1.36 per gal. to $1.49. "I couldn't believe it," he says. Blame the steep increase on the Iraqis and a problem in a Philadelphia refinery, said the attendant.

Oh, no you don't!

We want to blame Big Oil. It has given us precious little to work with in the past couple of years, save the occasional assault on the environment. Indeed, the price of oil and gas just kept falling, as did industry profits. But Big Oil, the profitmongering version we love to lambaste, is back in form, courtesy of gasoline prices rising geyser-like to more than $2 per gal. in some places. "Gasoline prices are outrageous; my bill has gone up about $20 a month," complains Debra Davis, a San Francisco school-district employee, as she stares in dismay at prices at the pumps.

Now that's more like it.

All across the nation last week, gasoline prices--which have soared as much as 25 cents since February, to levels as high as $2.19 per gal. in California--were provoking a chorus of angry protests from motorists and truckers. Washington, particularly sensitive to voter discontent in a presidential-election year, made a response that was uncharacteristically swift and characteristically disproportionate. Senator Bob Dole, first off the mark, proposed in a letter to President Clinton that the 1993 federal gasoline-tax increase of 4.3 cents per gal. be repealed, an action that Speaker Newt Gingrich suggested Congress could accomplish by Memorial Day. Pointedly noting that there had been no Republican support for that 1993 tax increase, Dole declared on the Senate floor, "We believe, with the skyrocketing prices of gasoline, jet fuel and other fuels, that the most certain way to give consumers relief is to repeal the gas tax."

Of course, stimulating demand in a tight market, as the Republicans suggest, tends to raise prices and thus may not offer consumers any relief. In fact, it would relieve the Treasury of some $4.8 billion.

Not to be outdone, President Clinton last week ordered the sale of about 12 million bbl. of oil from the Strategic Petroleum Reserve. Though a sale totaling $277 million was mandated by Congress in the budget agreement two weeks ago, the Administration's move to do so last week was a dramatic gesture that officials hoped would dampen the upward price spiral. The President's order, said White House spokesman Mike McCurry, is a "precise, prudent and modest step, designed to move the market in the right direction."

Sure it is. Because Americans consume 17 million bbl. of oil daily, dumping 12 million bbl. on the market may be spitting in the ocean. And the reserve will thus sell for $21 per bbl. oil that was purchased for $27. That's some kind of deficit reduction.

Nowhere in this hydrocarbon hysteria did the notion arise that maybe gas prices are exactly where they ought to be. The price of any commodity is a means of balancing supply and demand, and right now the balance is going in favor of higher prices. In gasoline's case, demand has clearly been on the upswing. It used to be that Americans were happy with a full tank and an open road. Now they don't even need the road, given the growing passion for heavy sport-utility vehicles. "If there hadn't been this shift to larger vehicles," says John Lichtblau, chairman of the Petroleum Industry Research Foundation, "you would have seen a lower increase or perhaps a leveling off of demand."

These SUVs, as they are known in the industry, account for an astonishing 40% of automobile sales yet generally provide gas mileage of less than 20 m.p.g. "With a typical SUV like a Chevy Blazer," says Mike Morrissey, spokesman for the American Automobile Association, "gas and oil will cost 6.8 cents a mile, compared with 5.9 cents for a Ford Taurus and 4.5 cents for a Ford Escort."

Yet U.S. motorists don't seem very concerned with fuel economy. At Ford, a survey revealed that fuel economy ranks only 15th among the items considered by consumers today when purchasing a new vehicle. That attitude is reflected on the highways, where drivers of all types of vehicles are sacrificing fuel economy by taking full advantage of new, higher speed limits in many states. As a result of this national indulgence, industry experts estimate that third- and fourth-quarter consumption of gasoline this year will reach 8 million and 8.1 million bbl. a day, respectively, a 7.5% and 10% increase over last year.

The supply side has traveled in the opposite direction. Since 1981, the number of U.S. refineries has dropped steadily, although capacity has held at around 15 million bbl. a day since the mid-1980s. That seems like plenty, but refineries, like most industries, operate on a "just-in-time" inventory system, meaning they buy supplies of crude oil just before they need them, keeping barely adequate inventories of refined products on hand. The industry currently has 203.5 million bbl. of gasoline in storage, compared with 210.7 million bbl. at this time last year. Inventories of crude oil are even more depleted.

This just-not-in-time shortfall has been accelerated by apparently overoptimistic expectations that negotiations between the U.N. and Iraq would shortly bring a return to the marketplace of Iraqi oil--700,000 bbl. a day--which would lower oil prices. That hasn't happened, so refiners are buying higher-priced crude and passing along their increased costs to drivers.

Now throw in the weather. The exceptionally long and cold winter in the U.S. caused refiners to devote more of their capacity to meeting the greater demand for heating fuel. This, in turn, gave them little time to convert their production to meet the blossoming spring and summer demand for gasoline. In the week ending April 19, the American Petroleum Institute reported that gasoline production, hobbled by a series of accidents and closures of refineries, slipped more than 220,000 bbl. a day, to just under 7.3 million bbl. By Memorial Day, production will be about 320,000 bbl. a day lower than at the same time last year.

Although the explanation is plausible, the suddenness of the price jump still begs the issue of price gouging. Is Big Oil making a killing? Not exactly, says Michael Mayer, managing director and oil analyst for Schroder Wertheim. "The major oil companies' after-tax profit on refining and marketing has been between 1 cent and 2 cents a gal. on average over the past five quarters. It's certainly significantly higher than that in the past month, but that's a very fleeting phenomenon."

In April and May, the oil companies are likely to earn two to four times their average profit margins on refining and marketing. But on average, those margins have been paltry. Mayer says that in the five years ending in 1995, the oil companies have earned a rate of return on their "downstream" operations ranging from minus 1% to about 5%--nothing to brag about.

But with voters howling, both Republicans and Democrats pursued the price-gouging question. Serving notice on the oil industry, President Clinton instructed Energy Secretary Hazel O'Leary to report back within 45 days on "the factors that led to the run-up in prices." And Democratic Senators Christopher Dodd and Joseph Lieberman, both of Connecticut, asked the Justice Department to investigate. "When prices escalate this rapidly," said Lieberman, "you can either sit back and say, 'There go the oil companies again,' or you can investigate, which at a minimum lets them know that someone is looking."

Chances are that prices will drop before anyone starts probing, and it won't require passing any legislation in Congress. Consumers themselves are fully capable of knocking down the cost of gasoline by Memorial Day. They happen to be very good at it, given a little incentive--say, $2.19-per-gal. gasoline. A little bit of conservation, mixed with some smarter shopping, will do the job just fine, leaving the Democrats and Republicans all summer to bicker about something else.

--Reported by John Dickerson/Washington, Joseph R. Szczesny/ Detroit and Jane Van Tassel/New York