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College of Food, Agricultural, and Environmental Sciences


Economist: Demand, Not Supply Driving High Fuel Prices

March 8, 2006

COLUMBUS, Ohio -- Strong global demand rather than a shortage of supply stateside is what is driving the high costs of gasoline, says an Ohio State University Extension economist.


Matthew Roberts, an assistant professor with the Department of Agricultural, Environmental, and Development Economics with the College of Food, Agricultural, and Environmental Sciences, said the popular notion of constrained refining capacity as the cause of high fuel prices is misplaced.

"We can easily look at the futures market and get a good idea of the money being made by refiners. What we have seen over the last five years hasn't been a significant shift in refining margins. If we truly had a shortage of refining capacity and it was having an effect on our energy prices, then refineries would be making lots of money. We'd see the difference between the cost of the input and the cost of the output increasing," said Roberts. "Instead, with a few exceptions, we've seen that refining margin holding steady or declining. Refining margins are at their lowest point in five years, so there actually appears to be a refining capacity surplus in the market. "

Roberts contends that global demand for energy driven by strong economic growth is the fundamental issue driving the energy market.

"Part of the energy demand is coming from China, which is using the energy not for driving cars, but for microgeneration of electricity. Here in the states, Americans' consumption habits of fuel have not changed dramatically in response to higher fuel prices. And so this country's gasoline demands are increasing," said Roberts. "Additionally, global economic growth is on track to be over 4 percent, which is very strong economic growth. Strong economic growth means strong oil demand."

Add to demand the supply fears generated from such issues as instability in the Middle East and Iran's nuclear production aspirations, and global oil flow becomes tighter.

So what does this mean for American consumers? Right now, not much, but things could change this summer.

"Until we get to $3 a gallon on gasoline, American consumers don't really seem to care about the price," said Roberts. "But this summer certain regions of the country may see $3 a gallon of gas or higher. The issue will have less to do with whether or not there's enough gasoline, but whether or not there is enough fuel of the right specification at the right place at the right time. There are a lot of worries this scenario might happen."

One scenario that might cause those higher prices is government regulations that require dramatic reductions in sulfur content in gasoline and diesel starting this summer.

"Right now, ultra-low sulfur fuels represent less than 1 percent of all the fuel being produced. This number needs to rise to 70 percent or 80 percent by this summer," said Roberts. "Refineries will have to be taken off-line to make the adjustments so they can meet those targets. When you are not producing fuel and living off the inventories we have, that's going to cause prices to rise."

Also, refineries across the United States are phasing out fuel additive MTBE (methyl tertiary butyl either) and replacing it with ethanol. Analysts speculate this phase-out, which California is expected to complete this year, will stretch the country's gas supply.

Farmers or other small business owners who store fuel on-site should take note, said Roberts.

"The take away point of this whole situation is that for those who have fuel storage, I would be filling it to the max right now," said Roberts. "It would probably be wise to fill fuel storage for use through June, and if you have any additional capacity, to fill up all tanks at this point."

U.S. consumers are already seeing a taste of what might come in a few short months. According to the Department of Energy, average retail gas prices have risen nearly 8 cents from the previous two weeks, and Roberts said the prices are likely to continue to climb well into April.

"We are entering into the refinery maintenance season, where the units are taken off-line to be repaired, modified, or upgraded. Some refineries went off-line March 2," said Roberts. "More refineries will continue to go off-line, and as that happens, we'll see the price of gas continue to increase."


Candace Pollock
Matthew Roberts