Gasoline Prices in the US - Essay Example

Recently, the attention of media has been devoted to increased gasoline prices, larger profits of oil companies and merges of the oil market leaders. Increased gasoline prices have a huge impact on the economy because of the heavy reliance in motor vehicles in developed countries. For example, each additional ten cents per gallon adds as much as $14 billion to American gasoline expenses. In order to understand the importance of gasoline for the national economy, it is essential to look at the market and what factors are affecting the price of gasoline. Increased fuel prices forces American society to find alternative energy sources and motivates the government to invest more into research and development of the cars with less fuel consumption and improving efficiency of the refinery sector. Crude oil prices have the major impact on gasoline prices. Other factors include refinery capacity in the country, gasoline inventories maintained by refiners which is going downward, regulatory environment (national air quality standards), and the structure of the gasoline market. It is important to note that mergers lead to anticompetitive effects because more power is given to merged companies who are able to increase prices above competitive level. The first wave of mergers has started in 1990s in US when several competing with each other companies have merged. More than 2,500 mergers have occurred at that time - since 2000 only 8 mergers have occurred involving different market segments (exploration, production, and transportation) (Energy Markets: Factors Contributing to Higher Gasoline Prices, 1). Refining capacity in the United States is not expanding at the same rate as demand for the gasoline. The American average refinery capacity is 92 percent - as the result, there is no room to expand production (Energy Markets: Factors Contributing to Higher Gasoline Prices, 1). In addition, gasoline industry has adopted just-in-time delivery technique in order to reduce the costs. However, this initiative has led to significant decrease in petroleum inventories in the US. Regulatory factors such as air quality standards require states to adopt the use of the special blends such as boutique fuels. Such blending adds cost to gasoline with the expenses being passed to consumers. Experts attribute higher prices to the expending demand (particularly for the electricity production) while supply is not expanding at the same rate. The balance of demand and supply is especially affected if demand or supply changes unexpectedly. For example, the prices went up at the end of year 2005 when two hurricanes hit the Gulf Coast region (Natural Gas: Factors Affecting Prices and Potential Impacts on Consumers, 1). As it was noted above, the domestic refineries are already working at their full capacity and the fact that the gasoline is imported leads to the shortage of supply. According to market structure principles, the shortage of supply results in increased cost - people will buy gasoline despite of the price they pay. In 2004 the United States citizens have consumed approximately 20.5 million barrels per day of crude oil accounting for as much as 25 percent of global production. Half of this crude oil was used for the production of gasoline. Data from the Energy Information Administration indicate that the capacity of American refineries is approximately 16.5 million barrels per day. Even though the refineries are upgraded, the majority of them have been built over 25 years ago. By year 2020 the demand for gasoline is projected to increase by 20 percent and the country will not be able to satisfy the domestic demand. As Karen Matusic has noted, since May 2005 the demand for gasoline has increased by 3.3 percent while the price increased by 35 percent. From supply side, she continues, those refineries that has been destroyed by hurricanes are operating now and the capacity utilization rate rose to 91.7 percent (Matusic, 1). Despite of the increased capacity, the price for gasoline is not decreasing, as it was expected, partially because of increasing demand. Consumers are aware of the impact higher fuel prices have on the economy. According to the survey conducted in Texas, "gas prices above $2 were causing citizens economic hardship and that they were making changes in their spending to offset the higher prices. Sixty-four percent of the survey respondents indicated that they had reduced their amount of driving. The higher fuel prices were also impacting their lifestyles with 53 percent cutting back on the times they dine out and 45 percent not going to see as many movies. This means there's opportunities for them to do other closer-to-home activities like gardening" (Kuack, 1). Americans consumer the quarter of all global consumptions and the increased fuel prices force people to find a more efficient way to consume gasoline, especially in cars. For example, the gas mileage of vehicles has been improved, however, Americans travel 25 percent more miles than 20 years ago. Interestingly, the average energy and transportation usage has not decreased as the percent of household income. This is an important fact from standpoint of economy - fuel has price-inelastic demand in the short run. Consumers will use the fuel despite of the cost, however, it will impact other spending (CIBC World Markets Inc., 1). The changes in consumer spending are affecting many industries: rising gasoline prices force car owners to adjust travel plans, buy fuel efficient vehicles and tighten their budgets. The car producers have to take this into account and shift production to small vehicles, while producers of premium-level products lose in sales because people are not able to afford these products. According to the findings of survey conducted by Consumer Reports National Research Center, the majority of respondents expect fuel prices to be even higher in the year. Over the past five years, the gasoline prices have increased by 250 percent and the average annual gasoline bill has increased by $1,000. Interestingly, the consumers report little flexibility to reduce community related driving and are prepared for higher bills through adjusting their lifestyles in several ways (Drivers feel pressure at the pumps, 1): Driving less (42 percent) Changing vocational plans (39 percent) Spending less money on entertainment (38 percent) Driving more smoothly to increase fuel mileage (38 percent) Spending less on essentials like food and healthcare (36 percent) Very few, however, would switch to alternative transportation such as bicycle or public transit. In addition, people tend to shop around for better prices and chose less-known petroleum blends. All of these shifts in consumer preferences put pressure on retailers who are forced to reduce the prices. Americans are especially vulnerable to the fuel price increases, taking into account that the real average weekly earning is falling for non-supervisory and production workers (Bajaj, 1). Food retailers are impacted by fuel prices as well - the profits have slowed down because "rising fuel prices were curbing consumers' appetite for its goods and driving up the company's expenses" (Bajaj, 1). The airfares have also increased by 7 percent from July 2004. If to look at the situation in general, every one cent increase in the price of gasoline costs consumers additional $1.4 billion. It means that higher gasoline prices result in the reduction of Gross Domestic Product. As Lyle Gramley, a former governor of the Federal Reserve Board says, "that's money that will not be spent on other goods such as televisions, toasters or refrigerators. "Until very recently, we've seen virtually no reaction of the economy and particularly no reaction to consumer spending at all to the rise in energy prices," say Mr. Gramley. "The March data on consumer spending, however, suggests that it's now beginning. And I think that if oil prices stay up in the $50 a barrel range, it's going to take a significant toll on consumer spending. Are we going to have a recession Most certainly not. This is an economy that has strong fundamentals. It will keep growing, but it will grow more slowly than it has been recently" (Westpheling, 1). Increasing fuel prices have snowball effect and will eventually lead to the slowdown of American economy. For example, the majority of goods bought in the country are delivered by trucks and the price of delivery is increasing due to the increased price for fuel, as the result, the prices in stores go up, companies have to reduce the number of employees and are unable to expand. Thus, the higher prices for fuel lead to the higher costs for products and services, leading to inflation and higher interests rates. If the interest rates increase, home mortgage rate and credit card interest rates will also increase. In conclusion, the increased price for fuel has enormous impact on American economy and influences almost all major economic areas starting with the lifestyle changes and ending with the overall economic slowdown. Technological progress has the potential to stabilize the fuel cost through innovative refinery developments, blending of brands and increased efficiency of fuel. People are changing the way they live, they have to spend more funds on gasoline and as the result, they spend less on essential products such as food and clothing. American is the motor nation and people drive more cars than anywhere else. Domestic supplies of fuel are not enough to meet the demand and the costs are increasing. Moreover, the global trend of mergers leads to the monopolistic market structure when the market leaders are able to set the price as high as they wish and consumers will have no other option as to accept it. Some of the analysts believe that American society is not impacted by increased fuel prices to the same extend as less developed countries, however, the recent surveys and polls indicate that even insignificant gasoline price increase leads to changes in lifestyle and lowers GDP. Word Count: 1617 Works Cited Bajaj, Vikas. Fuel Costs Drive Consumer Prices Slightly Higher in July. New York Times 16 Aug 2005. 3 July 2006 http://www.nytimes.com/2005/08/16/business/16cnd-econ.htmlex=1281844800&en=bf7ef923bd9f6a82&ei=5088&partner=rssnyt&emc=rss CIBC World Markets Inc. Occasional Report #51. Feb. 2005. 3 July 2006 Drivers feel pressure at the pumps. COnsumerReports.com, May 2006. 3 July 2006 Energy Markets: Factors Contributing to Higher Gasoline Prices. Feb. 2006. 3 July 2006 Kuack, David. "Higher fuel prices impact lifestyles". Branch-Smith Publishing, 2004. 3 July 2006 Matusic, Karen. American Petroleum Institute. Jun. 2006. 3 July 2006 Natural Gas: Factors Affecting Prices and Potential Impacts on Consumers. Feb. 2006. 3 July 2006 Westpheling, Paul. Oil Prices and the U.S. Economy. New York Jewish Times. 3 July 2006 < http://nyjtimes.com/Stories/2005/OilPrices&TheUSEconomy.htm> Read More