Crude Reality: Gas Prices Rocket Because They Can

This story is part of a special series that explores energy issues. For more, visit The Great Energy Challenge.

It didn't take long for turmoil in North Africa and the Middle East to produce pain at gasoline pumps in the United States. And in the weeks ahead, the forecasters say, it's going to get worse.

Government energy analysts predict U.S. consumers will pay an average $3.71 per gallon during the upcoming summer driving season, 48 cents more than they projected just one month ago. Gas prices are rising everywhere, but the shock is not as great in other countries where consumers already pay high prices because of substantial taxes. In the United Kingdom, for instance, the price is about $8 per gallon. But in the United States, the projected increase likely means that summer vacation drives will cost fully 36 percent more than they did last year.

And the Consumer Federation of America (CFA) sees the market veering into an even sharper incline: "Given where prices are today, this year Americans will pay higher gasoline prices, on an inflation-adjusted basis, than at any time in U.S. history," says Mark Cooper, CFA's research director. That would put the price beyond the record of $4.17 per gallon set in early July 2008.

Consumers can be forgiven for their disbelief at the market's lightning-fast reaction to events that—while certainly historic—have not actually caused any real shortage of oil. But on the crude futures markets, where oil is bought and sold, a majority of traders are betting that the wave of rebellion in North Africa and the Middle East eventually will curtail petroleum supplies.

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The sequence of business transactions that takes place after moves in the futures market virtually ensures two equally maddening outcomes for consumers: Gas prices go up fast, and go down slowly.

Turbo-Charged Climb

"We like to say they rise like a rocket and fall like a feather," says Troy Green, national spokesman for the auto club AAA. While drivers are often quick to focus their outrage on the seller at the front line of this supply chain—the gas station owner—such ire would be misplaced, say those who monitor the market with consumers in mind.

"Truth be told, gas station owners make more money selling you 12 ounces of coffee than selling you 12 gallons of gasoline," says Green. "They are just using gas to get you in to buy doughnuts, coffee, and other things inside with a much larger profit margin." Green says data showed that during the 2008 gas price run-up, some retail stations were making 1 or 2 cents net profit per gallon—much less than 1 percent.

Numerous government investigations of gas price gouging, often mandated by Congress, have followed earlier gas price run-ups. But rather than turning up illegal market manipulation, investigators found only businesses responding as expected to market conditions.

Cooper argues that the choke point in the market is midstream between the oil fields and the retail stations—at the refineries, where there's little competition, and where a small number of players can dictate the price. The number of refineries operating in the United States has been cut in half in the past 30 years, from 301 in 1982 to 148 in 2010. While total capacity, which fell for some years, is now about the same as it was in the early 1980s—17.5 million barrels per day—it means fewer players in the market. "The price is controlled by refiners," Cooper says.

Retailers need to adjust their prices quickly when the wholesale charge increases. But the prices are "sticky downward," says Cooper. Because the service stations are operating at such a low margin, "They may decide not to bring down the retail prices as quickly for a couple days or several days," after the wholesale price drops, says Green. But what can push the price down is competition on the street: "On one side of the road there's one price, and other side, there's a guy who's selling it for 2 cents lower," says Green.

But for now, the price is going in the other direction—up 35 cents from February 20 to March 8, according to AAA's nationwide survey. The only time that the United States ever saw a faster run-up was after Hurricane Katrina took a direct hit on the nation's most important production and refining center. (That was a 42-cent hike in 12 days.)

More Pain in Store

And the current surge is not over. The U.S. Energy Information Administration predicts that pump prices will have to rise at least 10 cents more per gallon to fully reflect what has already happened in the crude oil market. That is true even though the U.S. benchmark for crude oil, called West Texas Intermediate, has fallen slightly to reflect large U.S. inventories of gasoline. That's because the refiners buy half of their crude from the world market, and the Brent benchmark—a better indicator of the global price—continues to rise in response to the bloodshed in Libya and unrest in neighboring nations.

(Related: "Oil Markets Churn Over Egypt's Potential as Gateway for Revolt")

Cooper maintains that the only response to the mounting gas prices that can make a difference is to reduce demand. U.S. oil consumption did fall slightly after the 2008 price peak and subsequent recession. But it has been climbing recently as the economy has recovered.

Cooper notes that despite presidential pledges to end petroleum addiction dating back to Richard Nixon, the United States still uses a quarter of the world's oil. "They have all failed, Democrats or Republicans alike," he said. But Cooper said he believes that the new automobile fuel economy standards under the Obama administration, which would require the car fleet to reach a 35.5 mile per gallon average by 2016, could have a real impact. So could decisions by individual consumers to cut consumption.

"The most important thing you can do in the short term is to make a long-term commitment to use less gasoline," Cooper says.

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