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Page Outline:

1. Basic Facts
2. Oil Import Graph
3. Price of Crude Oil Determines Gas Prices
4. Gas Prices
5. What Determines the Price of Crude Oil?
6. Gallons Per x Miles vs Miles Per Gallon?
7. Strategic Petroleum Reserve
8. Will Drilling for More Oil Help?
9. What Is Washington Doing?
10. Sources

Basic Facts

The following information comes from the USEIA.¹

• Currently, the US domestically produces 5 million barrels and imports nearly 10 million barrels of crude oil every day.
• Of the 10 million barrels imported, about 5 million are purchased from OPEC.
• Every day, US automobile drivers consume over 9 million barrels of gasoline.
• 70% of US oil is used for transportation.
• There are 42 gallons of crude oil in one barrel
• According to the US Department of Energy, 99% of the fuel used to run America’s cars and trucks comes from crude oil. In addition to its importance in the transportation sector, oil is also responsible for meeting nearly 40% of America’s total energy demands.
• In 1989, crude oil sold for $15 a barrel. In 2004, crude oil had only risen to $45 a barrel. In June of 2008, the price per barrel was a few cents shy of $140.

Oil Import Graph

The information in the graph above comes from the USEIA. ²

Price of Crude Oil Determines Gas Prices

Although some individuals blame America’s refineries (currently operating at 84 to 85% capacity) for the high price of gasoline, according to the US Energy Information Administration, if U.S. refinery utilization increased, gasoline prices might decrease some, but probably not by much. The following quote comes from the USEIA.³

Refiners purchase that crude oil and sell product at wholesale prices. The wholesale gasoline price spread (the difference between spot gasoline and crude oil price), where refiners operate, has narrowed, indicating plenty of gasoline supply has been available to meet demand

The chart below illustrates the costs that go into to each gallon of gas. Accounting for over 70% of the price of gasoline, it is evident that the price of crude oil plays the greatest role in determining what Americans pay at the pump. The data used in the graph below was can be found at the Energy Information Administration website.

Gas Prices

Graph created using USDE data.
⁴

What Determines the Price of Crude Oil?

The price of crude oil is a result of a variety of factors: international politics, wars, terrorism, supply and demand, speculation – just to name a few. According to some economists, commodity speculation may have played an important role in driving the cost of oil to record highs in recent years. In 2008, for instance, the US witnessed a rapid increase in speculation as investors shifted their investments from real estate and stocks to commodities. These investors purchased nearly as much oil as the industrializing nation of China. This massive increase in commodity trading, according to some economists and academics, resulted in higher than usual demand and forced the price of crude oil to skyrocket. According to the economist from Arizona State University in the video below, the price of a barrel of oil in 2008 would probably have been around $80 (as opposed to $140+) if commodity speculation had not dramatically increased.⁵

Video Source: Horizon⁶
Watch This Video For One Explanation of Why Gasoline Prices Are So High

Gallons Per x Miles vs Miles Per Gallon

The following paragraph about a study done on fuel efficiency is an excerpt from an article on a Duke University’s webpage.

“People presented with a series of car choices in which fuel efficiency was defined in miles per gallon were not able to easily identify the choice that would result in the greatest gains in fuel efficiency.

For example, most people ranked an improvement from 34 to 50 mpg as saving more gas over 10,000 miles than an improvement from 18 to 28 mpg, even though the latter saves twice as much gas. (Going from 34 to 50 mpg saves 94 gallons; but from 18 to 28 mpg saves 198 gallons).

These mistaken impressions were corrected, however, when participants were presented with fuel efficiency expressed in gallons used per 100 miles rather than mpg. Viewed this way, 18 mpg becomes 5.5 gallons per 100 miles, and 28 mpg is 3.6 gallons per 100 miles — an $8 difference today.

‘The reality that few people appreciate is that improving fuel efficiency from 10 to 20 mpg is actually a more significant savings than improving from 25 to 50 mpg for the same distance of driving,’ Larrick said.

Soll noted that replacing a large vehicle that gets 10 mpg with one that gets 20 mpg reduces gas use per 100 miles from 10 gallons to five, a 5-gallon savings. Replacing a small vehicle that gets 25 mpg with one that gets 50 mpg reduces gas use per 100 miles from 4 gallons to 2, a saving of only 2 gallons.

‘Miles per gallon is misleading and can play tricks on our intuitions,’ Soll said.”⁷

Video Source: Duke University ⁸
Video Explanation of Duke Fuel Efficiency Study

Strategic Petroleum Reserve

Created after the oil embargo of 1973-74, the Strategic Petroleum Reserve is currently filled to its maximum capacity of 700 million barrels. Stored in salt caverns along the Gulf Coast, this oil is America’s only immediate safety net in case of a dramatic drop in foreign oil imports.

If a crisis occurred and oil imports were shut off completely, the 700 million barrels of oil could only meet America’s demand for the next 58 days.

Presently, the SPR serves as a relief reserve in times of natural disasters. In 2005, Hurricane Katrina shut down 25% of America’s domestic crude oil production in the Gulf of Mexico. In response to this immense shortage, President George W. Bush authorized the Department of Energy to sell oil from the reserve to fill the gap in domestic production. In all, 11 million barrels of oil from the SPR were sold to five companies on September 14, 2005 to help meet the country’s incessant demand in the wake of Hurricane Katrina.⁹

Will Drilling For More Oil Help?

Offshore Drilling

In its explanation of the potential benefits and drawbacks of offshore drilling, the U.S. Energy Information Administration, states that,

“annual crude oil production in 2030 is projected to be 7 percent higher—2.4 million barrels per day in the OCS access case compared with 2.2 million barrels per day in the reference case.¹⁰

Although drilling off the coast of the United States will increase domestic oil production and decrease dependence on foreign oil, by 7 percent at best, it will not, according to the EIA, result in a drop of the prices at your local gas stations. In a 2007 report, the EIA states that,

“Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant”¹¹

Drilling In Alaska – Arctic National Wildlife Refuge (ANWR)

According to an EIA report released in May 2008, drilling in the Arctic National Wildlife Refuge would,

“. . . have its largest oil price reduction impacts as follows: a reduction in low-sulfur, light (LSL) crude oil18 prices of $0.41 per barrel (2006 dollars) in 2026 in the low oil resource case, $0.75 per barrel in 2025 in the mean oil resource case, and $1.44 per barrel in 2027 in the high oil resource case. Assuming that world oil markets continue to work as they do today, the Organization of Petroleum Exporting Countries (OPEC) could neutralize any potential price impact of ANWR oil production by reducing its oil exports by an equal amount. . .”¹²

According to this report, drilling in Alaska would, at best, result in a decrease of the price of a barrel of crude oil by $1.44 in 2027. Even if this happened, however, the report states that OPEC could “neutralize” the drop in price by decreasing its own exports. The benefit of drilling in Alaska, therefore, is not a reduction in the price of oil – or a drop in prices at the gas pumps – but a reduction in dependence on foreign oil.

The report goes on to say that if drilling is allowed in ANWR, the United States will spend $202 billion (7 percent) less on foreign oil between the years of 2018 and 2030.¹³

Furthermore,

“. . . the opening of ANWR to Federal oil and natural gas leasing improves the U.S. balance of trade by $135 to $327 billion during the 2018 through 2030 time-frame, based on the world oil prices projected in the AEO2008 reference case. . . “¹⁴

Thus, according to the Environmental Information Administration’s data, drilling in the ANWR province of Alaska will result in benefits to the US economy – the increasing of profits of the US oil companies selling the Alaskan oil – and will decrease US dependency on foreign oil. The main drawback is that drilling in ANWR will not, to any great extent, reduce the amount of money Americans pay for their gasoline.

What Is Washington Doing?

Windfall Profits Tax Proposal
On June 10, 2008, Senate Republicans blocked a proposal by Democrats known as the “Windfall Profit Tax”. According to Time magazine,

“the windfall profits bill would have imposed a 25 percent tax on profits over what would be determined ‘reasonable’ when compared to profits several years ago. The oil companies could have avoided the tax if they invested the money in alternative energy projects or refinery expansion. It also would have rescinded oil company tax breaks — worth $17 billion over the next 10 years — with the revenue to be used for tax incentives to producers of wind, solar and other alternative energy sources as well as for energy conservation. The legislation also would:

• Require traders to put up more collateral in the energy futures markets and open the way for federal regulation of traders who are based in the United States but use foreign trading platforms. The measures are designed to reduce market speculation.

• Make oil and gas price gouging a federal crime, with stiff penalties of up to $5 million during a presidentially declared energy emergency.

• Authorize the Justice Department to bring charges of price fixing against countries that belong to the OPEC oil cartel.”¹⁵

In response to criticism, one Republican Senator, Pete Domenici of New Mexico, explained that raising taxes on the domestic oil industry would increase America’s reliance on imported oil. Many Republican Senators have suggested opening up Alaskan territory to oil drilling as a potential solution to high gasoline prices and as a way to reduce national dependence on foreign oil. Critics of Alaskan drilling, however, contend that opening up areas of Alaska to oil exploration and production will not increase domestic production enough to offset foreign oil dependency by any substantial amount and may have detrimental affects on the environment.¹⁶

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