Energy Markets: Gasoline Price Trends (21-SEP-05, GAO-05-1047T). 
                                                                 
Soaring retail gasoline prices have garnered extensive media	 
attention and generated considerable public anxiety in recent	 
months, particularly in the aftermath of Hurricane Katrina.	 
Prices in many areas hit by the hurricane saw retail gasoline	 
prices increase to over $3.00 per gallon, and in one reported	 
case to almost $6.00 per gallon, with some gasoline stations	 
running out of gasoline entirely. The availability of relatively 
inexpensive gasoline over past decades has helped foster economic
growth and prosperity in the United States, so large price	 
increases, especially if sustained over a long period, pose	 
long-term challenges to the economy and consumers. This 	 
testimony, as requested, addresses factors that help explain how 
gasoline prices are determined and what key factors will likely  
influence trends in future gasoline prices.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-1047T					        
    ACCNO:   A37637						        
  TITLE:     Energy Markets: Gasoline Price Trends		      
     DATE:   09/21/2005 
  SUBJECT:   Cost analysis					 
	     Crude oil						 
	     Economic analysis					 
	     Fuel prices					 
	     Gasoline						 
	     Oil importing					 
	     Petroleum industry 				 
	     Petroleum prices					 
	     Petroleum products 				 
	     Petroleum refining facilities			 
	     Prices and pricing 				 

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GAO-05-1047T

United States Government Accountability Office

GAO Testimony

Before the Senate Committee on Commerce, Science, and Transportation

For Release on Delivery

Expected at 10:00 a.m. EDT ENERGY MARKETS

Wednesday, September 21, 2005

                             Gasoline Price Trends

Statement of Jim Wells, Director Natural Resources and Environment

GAO-05-1047T

September 21, 2005

ENERGY MARKETS

                             Gasoline Price Trends

[IMG]

  What GAO Found

Crude oil prices and gasoline prices are inherently linked, because crude
oil is the primary raw material from which gasoline and other petroleum
products are produced. In the past year, crude oil prices have risen
significantly-from August 31, 2004 to August 31, 2005, the price of West
Texas Intermediate crude oil, a benchmark for international oil prices,
rose by almost $27 per barrel, an increase of almost 64 percent. Over
about the same period, average retail prices for regular gasoline rose
nationally from $1.87 to $2.61 per gallon, an increase of about 40
percent. Major upward and downward movements of crude oil prices are
generally mirrored by movements in the same direction by gasoline prices.
However, based on recent events, at least in the short term, this
historical trend has not held, and retail prices have risen faster than
crude oil prices.

While crude oil is a fundamental determinant of gasoline prices, a number
of other factors also play a role in determining how gasoline prices vary
across different locations and over time. For example, refinery capacity
in the United States has, in recent years, not expanded at the same pace
as demand for gasoline and other petroleum products. During the same
period we have imported larger and larger volumes of gasoline from Europe,
Canada, and other countries. Further, the American Petroleum Institute has
recently reported that U.S. average refinery capacity utilization has
increased to 92 percent. As a result, domestic refineries have little room
to expand production in the event of a temporary supply shortfall.

Gasoline prices may also be affected by unexpected refinery outages or
accidents that significantly disrupt the delivery of gasoline supply. Most
recently, Hurricane Katrina hit the Gulf Coast, doing tremendous damage to
homes, businesses, and physical infrastructure, including roads;
electricity transmission lines; and oil producing, refining, and pipeline
facilities. Because the Gulf Coast refining region is a net exporter of
petroleum products to all other regions of the country, retail gasoline
prices in many parts of the nation rose dramatically. Average retail
gasoline prices increased 45 cents per gallon between August 29 and
September 5. The average price for a gallon of regular gasoline on
September 5 was $3.07, the highest nominal price ever.

Future gasoline prices will reflect the world supply and demand balance.
Globally, if demand for oil and petroleum products continues to rise,
supply will need to keep pace. The challenge is to boost supply and reduce
demand. We need to choose wisely and we need to act soon.

                 United States Government Accountability Office

Mr. Chairman and Members of the Committee:

I am pleased to participate in the Committee's hearing to discuss current
gasoline prices and the factors that will likely influence trends in those
prices. Soaring retail gasoline prices have garnered extensive media
attention and generated considerable public anxiety in recent months,
particularly in the aftermath of Hurricane Katrina. Prices in many areas
hit by the hurricane saw retail gasoline prices increase to over $3.00 per
gallon, and in one reported case to almost $6.00 per gallon, with some
gasoline stations running out of gasoline entirely. In addition, retail
gasoline prices have shot up in many areas of the country that were not
directly affected by the hurricane. It was not uncommon to see pump prices
rise not just daily, but multiple times in the same day. Overall, gasoline
prices have been significantly higher this year than last, costing
American consumers considerably. According to the Department of Energy's
Energy Information Administration (EIA), nationally, each additional ten
cents per gallon of gasoline adds about $14 billion to America's annual
gasoline bill.

The availability of relatively inexpensive gasoline over past decades has
helped foster economic growth and prosperity in the United States.
However, large price increases, especially if sustained over a long
period, pose long-term challenges to the economy and consumers.
Importantly, some recent analyses suggest that gasoline prices may stay at
today's relatively high level or even increase significantly in the
future. In contrast, others suggest that prices may fall as oil companies
invest in more crude oil producing capacity and as consumers respond to
higher prices by adopting more energy-efficient practices. Regardless of
what happens in the future, the impact of gasoline prices is felt in
virtually every sector of the U.S. economy and when prices increase
sharply, as they have in recent months, consumers feel it immediately and
are reminded every time they fill up their tanks.

It is therefore essential to understand the market for gasoline. In this
context, you asked us to discuss (1) how gasoline prices are determined
and (2) what key factors will likely influence trends in future gasoline
prices?

To respond to your questions, we relied heavily on the gasoline primer,
"Motor Fuels: Understanding the Factors That Influence the Retail Price of

Gasoline,"1 and 17 other GAO products on gasoline prices and other aspects
of the petroleum products industry. (See Related GAO Products at the end
of this testimony.) We also collected updated data from a number of
sources that we deemed reliable. This work was performed in accordance
with generally accepted government auditing standards.

In summary, our work has shown:

o  	Crude oil prices and gasoline prices are inherently linked, because
crude oil is the primary raw material from which gasoline and other
petroleum products are produced. In the past year, crude oil prices have
risen significantly-from August 31, 2004 to August 31, 2005, the price of
West Texas Intermediate crude oil, a benchmark for international oil
prices, rose by almost $27 per barrel, an increase of almost 64 percent.
Over about the same period, average retail prices for regular gasoline
rose nationally from $1.87 to $2.61 per gallon, an increase of about 40
percent. Explanations for the large increase in crude oil and gasoline
prices include the rapid growth in world demand for crude oil and
petroleum products, particularly in China and the rest of Asia;
instability in the Persian Gulf region (the source of a large proportion
of the world's oil reserves); and actions by the Organization of Petroleum
Exporting Countries (OPEC) to restrict the production of crude oil and
thereby increase its price on the world market. Figure one illustrates the
relationship between crude oil and gasoline prices over the past three
decades. The figure shows that major upward and downward movements of
crude oil prices are generally mirrored by movements in the same direction
by gasoline prices. However, based on recent events, at least in the short
term, this historical trend has not held, and retail prices have risen
faster than crude oil prices.

1GAO, Motor Fuels: Understanding the Factors That Influence the Retail
Price of Gasoline, GAO-05-525SP (Washington, D.C.: May 2, 2005).

Figure 1: Gasoline and Crude Oil Prices-1974-2004 (Not adjusted for
inflation)

Dollars per gallon

2.5

2.0

1.5

1.0

0.5

0.0

Year

Crude oil price Gasoline price

Source: GAO analysis of Energy Information Administration, Department of
Energy, Monthly Energy Review, Monthly Refiner Acquisition Cost of Crude
Oil, Composite and Bureau of Labor Statistics, Monthly Motor Gasoline
Prices, U.S. City Averages, Regular Gasoline.

o  	While the price and availability of crude oil is a fundamental
determinant of gasoline prices, a number of other factors also play a role
in determining how gasoline prices vary across different locations and
over time. For example, refinery capacity in the United States has not
expanded at the same pace as demand for gasoline and other petroleum
products in recent years. During the same period the United States has
imported larger and larger volumes of gasoline from Europe, Canada, and
other countries. The American Petroleum Institute has recently reported
that U.S. average refinery capacity utilization has increased to 92
percent. As a result, domestic refineries have little room to expand
production in the event of a temporary supply shortfall. Further, the fact
that imported gasoline comes from farther away than domestically produced
gasoline means that when supply disruptions occur in the United States, it
might take longer to get replacement gasoline than if we had excess
refining capacity in the United States, and this could cause gasoline
prices to rise and stay high until these new supplies can reach the
market.

o  	Gasoline inventories maintained by refiners or marketers of gasoline
can also have an impact on prices. As with trends in a number of other

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

industries, the petroleum products industry has seen a general downward
trend in the level of gasoline inventories in the United States. Lower
levels of inventories may cause prices to be more volatile because when a
supply disruption occurs, there are fewer stocks of readily available
gasoline to draw from, putting upward pressure on prices. Regulatory
factors also play a role. For example, in order to meet national air
quality standards under the Clean Air Act, as amended, many states have
adopted the use of special gasoline blends-so-called "Boutique Fuels."
Many experts have concluded that the proliferation of these special
gasoline blends has caused gasoline prices to rise and/or become more
volatile, especially in regions such as California that use unique blends
of gasoline, because the fuels have increased the complexity and costs
associated with supplying gasoline to all the different markets. Finally,
the structure of the gasoline market can play a role in determining
prices. For example, we recently reported that some mergers of oil
companies during the 1990s led to reduced competition among gasoline
suppliers and may have been responsible for an increase in gasoline prices
by as much as 2 cents per gallon on average, with boutique fuels
increasing from between 1 to 7 cents per gallon.

o  	Gasoline prices may also be affected by unexpected refinery outages or
accidents that significantly disrupt the delivery of gasoline supply. Most
recently, Hurricane Katrina hit the Gulf Coast, doing tremendous damage to
homes, businesses, and physical infrastructure, including roads;
electricity transmission lines; and oil producing, refining, and pipeline
facilities. The DOE reported on August 31, 2005 that as many as 2.3
million customers were without electricity in Louisiana, Mississippi,
Alabama, Florida, and Georgia. The DOE further reported that 21 refineries
in affected states were either shut down or operating at reduced capacity
in the aftermath of the hurricane. This amounted to a reduction of over 10
percent of the nation's total refining capacity. Two petroleum product
pipelines that serve the Midwest and East Coast from Gulf Coast refineries
were also out. In addition, the Minerals Management Service in the
Department of the Interior reported that as of September 1, 2005, over 90
percent of crude oil production in the Gulf of Mexico was out of
operation. Because the Gulf Coast refining region is a net exporter of
petroleum products to all other regions of the country, retail gasoline
prices in many parts of the nation rose dramatically. Average retail
gasoline prices increased 45 cents per gallon between August 29 and
September 5. The average price for a gallon of regular gasoline on
September 5 was $3.07, the highest nominal price ever. In addition,
gasoline stations faced large increases in wholesale gasoline prices, and
some even reported running out of gasoline. The spot price for wholesale
gasoline delivered to New York Harbor rose by about $0.78 per gallon

between August 26 and August 30. Gasoline supply is recovering in the wake
of the storm, however, and prices have begun to decrease. Between
September 5 and September 12, average gasoline prices decreased 11 cents
to $2.96 per gallon. Gasoline production increased dramatically over this
time, rising by more than 400,000 barrels per day as most of the
refineries shut down after the storm resumed production. Until production,
refining, and pipeline facilities are fully operating at normal levels,
prices are expected to continue to be higher in affected areas. Coming as
this has on the heels of a period of high crude oil prices and a tight
balance worldwide between petroleum demand and supply, the effects of the
hurricane illustrate the volatility of gasoline prices given the
vulnerability of the gasoline infrastructure to natural or other
disruptions.

o  	Future gasoline prices will reflect the world supply and demand
balance. If demand for oil and petroleum products continues to rise as it
has in past years, then oil supply will have to expand significantly to
keep up. The EIA projects that world demand for crude oil will rise by at
least 25 percent by the year 2025. However, world surplus crude oil
production capacity-the amount by which oil production can be increased in
the short run without installing more drilling equipment or developing new
oil fields-is currently very small. Moreover, many of the world's known
and easily accessible crude oil deposits have already been developed and
many of these are experiencing declining volumes as the fields become
depleted. Other new sources may be more expensive to develop. For example,
there are large stores of crude oil in tar sands and oil shale, or
potentially beneath deep water in the ocean, but these sources are more
costly to extract and process than many of the sources of oil that we have
already tapped. If developing, extracting, and refining new sources of
crude oil are more costly than extracting and refining oil from existing
fields, crude oil and petroleum product prices likely will rise to make
these activities economically feasible. If, on the other hand,
technological innovations improve the ability to extract and process oil,
this will increase the available future supply and may ease pressure on
petroleum product prices.

o  	Although demand for crude oil is projected to increase, it could fall
below current expectations if consumers choose more energy efficient
products or otherwise conserve more energy. Such a reduction in demand
could lead to lower-than-expected future prices. For example, in response
to high gasoline prices in the United States, in the 1980s many consumers
chose to switch to smaller or more fuel-efficient vehicles, which reduced
demand for gasoline. Environmental issues could also have an impact on
world crude oil and petroleum product prices. For example, international
efforts to reduce greenhouse emissions could cause reductions in demand

Background

for crude oil and petroleum products as more fuel-efficient processes are
adopted or as cleaner sources of energy are developed. Additional factors
that will likely influence future oil and gasoline prices include
geopolitical issues, such as the stability of the Middle East; the
valuation of the U.S. dollar in world currency markets; and the pace of
development of alternative energy supplies, such as hydrogen fuel cell
technology.

In 2004, the United States consumed about 20.5 million barrels per day of
crude oil accounting for roughly 25 percent of world oil production. A
great deal of the crude oil consumed in this country goes into production
of gasoline and, as a nation, we use about 45 percent of all gasoline
produced in the world.2 Products made from crude oil-petroleum products,
including gasoline-have been instrumental in the development of our modern
lifestyle. In particular, gasoline, diesel, and jet fuel have provided the
nation with affordable fuel for automobiles, trucks, airplanes and other
forms of public and goods transportation. Together, these fuels account
for over 98 percent of the U.S. transportation sector's fuel consumption.
In addition, petroleum products are used as raw materials in manufacturing
and industry; for heating homes and businesses; and, in small amounts, for
generating electric power. Gasoline use alone constitutes about 44 percent
of our consumption of petroleum products in the United States, so when
gasoline prices rise, as they have in recent months, the effects are felt
throughout the country, increasing the costs of producing and delivering
basic retail goods and making it more expensive to commute to work. It is
often the case that prices of other petroleum products also increase at
the same time and for the same reasons that gasoline prices rise. For
example, today's high gasoline prices are mirrored by high jet fuel
prices, creating financial pressure on airline companies, some of which
are currently in the midst of economic difficulties. Gasoline prices vary
a great deal over time. For example, in the period January 1, 1995 through
August 29, 2005, the national average price for a gallon of regular grade
gasoline has been as low as $1.10 and as high as $2.80 without adjusting
for inflation.

2The large percentage of total world gasoline production consumed by the
United States, in part, reflects the fact that diesel is a commonly used
fuel for cars in Europe, while automobiles in the United States primarily
run on gasoline. If all motor vehicle fuels were accounted for, the United
States' share of these fuels would be smaller than its share of gasoline.
However, we do not have the data to present this more comprehensive
measure.

The future path of gasoline prices is difficult to predict, but it is
clear that the use of petroleum products worldwide is going to increase
for the near term and maybe beyond. Some analysts have predicted much
higher crude oil prices-and as a result, higher prices for petroleum
products- while others expect prices to moderate as producers respond to
high prices by producing more crude oil and consumers respond by
conserving more, and investing in more energy-efficient cars and other
products. In either case, the price of gasoline will continue to be an
important factor affecting the household budgets of individual Americans
for the foreseeable future and therefore, it is important to understand
how prices are determined so that consumers can make wise choices.

Crude oil prices directly affect the price of gasoline, because crude oil
is the primary raw material from which gasoline is produced. For example,
according to our analysis of EIA data, in 2004 crude oil accounted for
about 48 percent of the price of a gallon of gasoline on average in the
United States. When crude oil prices rise, as they have over the past
year, refiners find their cost of producing gasoline also rises, and in
general, these higher costs are passed on to consumers in the form of
higher gasoline prices at the pump. However, based on recent events, at
least in the short term, this historical trend has not held, and retail
prices have risen faster than crude oil prices. Figure 2 illustrates the
importance of crude oil in the price of gasoline. The figure also shows
that taxes, refining, and distribution and marketing also play important
roles.3

  Gasoline Prices Are Determined by the Price of Crude Oil and a Number of Other
  Factors

3The latter two categories, refining and distribution and marketing,
includes costs associated with these activities as well as profits. The
figure is a snapshot of how much each component contributes to the price
of a gallon of gasoline, and how the relative proportions attributable to
each component vary over time as crude oil prices and other factors
change.

Figure 2: Elements in the Price of a Gallon of Gasoline (Average for 2004)

Crude oil

Taxes

Refining

Distribution and marketing

Sources: GAO analysis of EIA data; GAO (photo).

Because crude oil is the primary raw material used in the production of
gasoline, understanding what determines gasoline prices requires examining
how crude oil prices are set. Overall, the price of crude oil is
determined by the balance between world demand and supply. A major cause
of rising crude oil prices in recent months has been rapid growth in world
demand, without a similar growth in available supplies. In particular, the
economy of China has grown rapidly in recent years, leading to increases
in their demand for crude oil. In contrast, oil production capacity has
grown more slowly, leading to a reduction in surplus capacity-the amount
of crude oil that is left in the ground, but could be extracted on short
notice in the event of a supply shortfall. EIA has stated that the world's
surplus crude oil production capacity has fallen to about one million
barrels per day, or just over one percent of the world's current daily
consumption, making the balance between world demand and supply of crude
oil very tight. This tight balance between world crude oil demand and
supply means that any significant supply disruptions will likely cause
prices to rise. Such a disruption occurred in Nigeria in October 2004,
when a workers' strike in Nigeria's oil sector forced world crude oil
prices to record highs. (Nigeria is the world's seventh largest oil
producer, supplying an average 2.5 million barrels per day in 2004.)

Another important factor affecting crude oil prices is the behavior of the
Organization of Petroleum Exporting Countries (OPEC)-members of which
include Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar,

Saudi Arabia, United Arab Emirates, and Venezuela. OPEC members produce
almost 40 percent of the world's crude oil and control almost 70 percent
of the world's proven oil reserves. In the recent past and on numerous
other occasions, OPEC members have collectively agreed to restrict the
production of crude oil in order to increase world prices.

Turning now to the price of gasoline seen at the pump, it is important to
discuss the role of taxes. In the United States, on average, taxes
accounted for 23 percent of what consumers paid for a gallon of gasoline
in 2004, according to EIA's data. This percentage includes estimated
federal and average state taxes totaling 44 cents per gallon (see figure
3).4 Federal taxes accounted for 18.4 cents of this total, while state
taxes averaged 25.6 cents per gallon, although taxes vary among states.

 Figure 3: Estimated Federal and Average State Gasoline Taxes per Gallon (2004)

                              44 cents per gallon

                         Federal tax Average state tax

                Sources: GAO analysis of API data; GAO (photo).

4EIA uses tax data from the American Petroleum Institute (API) for its tax
analysis. According to API, these data include applicable state sales
taxes, gross receipts taxes, and other applicable fees but largely exclude
local taxes, which may average about 2 cents per gallon nationwide.

Differences in gasoline taxes across states help explain why gasoline
prices vary from place to place in the United States. In addition to
federal taxes that apply across the board, states and, in some cases,
local jurisdictions also impose taxes and other fees on gasoline that add
to the price. Figure 4 shows total state and federal gasoline taxes for
each of the 50 states and the District of Columbia, as of November 2004.
New York, Hawaii, and California have the highest total gasoline taxes,
while Alaska, Wyoming, and New Jersey have the lowest. While differences
in taxes affect the price of gasoline, there is no consistent relationship
between high taxes and high prices. For example, on March 7, 2005,
gasoline cost $1.91 per gallon in North Carolina and $1.98 per gallon in
Alaska, even though the taxes paid in North Carolina were almost 17 cents
per gallon higher.

Figure 4: Motor Gasoline Taxes as of November 2004

                                                                     New York
                                                                       Hawaii
                                                                   California
                                                                       Nevada
                                                                  Connecticut
                                                                    Wisconsin
                                                                 Rhode Island
                                                                      Florida
                                                                     Michigan
                                                                   Washington
                                                                     Illinois
                                                                      Montana
                                                                 Pennsylvania
                                                                        Maine
                                                                         Ohio
                                                                     Nebraska
                                                                      Indiana
                                                                West Virginia
                                                                       Kansas
                                                                        Idaho
                                                               North Carolina
                                                                         Utah
                                                                 South Dakota
                                                                       Oregon
                                                                Massachusetts
                                                                     Maryland
                                                                     Delaware
                                                                    Minnesota
                                                                     Colorado
                                                                      Alabama
                                                                     Arkansas
                                                                         Iowa
                                                                    Tennessee
                                                                 North Dakota
                                                                New Hampshire
                                                                      Vermont
                                                                        Texas
                                                                    Louisiana
                                                         District of Columbia
                                                                     Virginia
                                                                      Arizona
                                                                  Mississippi
                                                                   New Mexico
                                                                     Oklahoma
                                                                     Missouri
                                                               South Carolina
                                                                     Kentucky
                                                                      Georgia
                                                                   New Jersey
                                                                      Wyoming
                                                                       Alaska

0 102030405060

(Cents per gallon)

Source: GAO analysis of API data.

Note: According to API, these tax data include applicable state sales
taxes, gross receipts taxes, and other applicable fees but largely exclude
local taxes, which may average about 2 cents per gallon nationwide.

In addition to the cost of crude oil, taxes, refining, and distribution
and marketing costs, gasoline prices are influenced by a variety of other
factors. These include refining capacity constraints, low inventories,

unexpected refinery or pipeline outages, environmental and other
regulations, and mergers and market power in the oil industry.

First, domestic refining capacity has not kept pace with growing demand
for gasoline. As demand has grown faster than domestic refining capacity,
the United States has imported larger and larger volumes of gasoline and
other petroleum products from refiners in Europe, Canada, and other
countries. EIA officials told us that, in general, this increase in
imports has reflected the availability of gasoline from foreign sources at
lower cost than could be achieved by building and operating additional
refining capacity in the United States. However, the American Petroleum
Institute (API) has recently reported that capacity utilization has been
high in the U.S. refinery sector. Refining capacity has typically averaged
over 90 percent, and has recently increased to 92 percent-much higher than
the rate in many other industries that API reports as more typically
operating at around 80 percent of capacity. As a result, domestic
refineries have little room to expand production in the event of a
temporary supply shortfall. Furthermore, the fact that imported gasoline
comes from farther away than domestically produced gasoline means that
when supply disruptions occur in the United States, it might take longer
to get replacement gasoline than if we had excess refining capacity in the
United States, and this could cause gasoline prices to rise and stay high
until these new supplies can reach the market.

Second, the level of gasoline inventories can also play an important role
in determining gasoline prices over time because inventories represent the
most accessible and available source of supply in the event of a
production shortfall or increase in demand. Similar to trends in other
industries, the level of gasoline inventories has been falling for a
number of years. In part, this reflects a trend in business to more
closely balance production with demand in order to reduce the cost of
holding large reserves. However, reduced inventories may contribute to
increased price volatility, because when unexpected supply disruptions or
increases in demand occur, there are lower stocks of readily available
gasoline upon which to draw. This puts upward pressure on gasoline prices
until new supplies can be refined and delivered domestically, or imported
from abroad.

Third, gasoline prices may be affected by unexpected refinery outages or
accidents that significantly disrupt the delivery of gasoline supply. Most
recently, Hurricane Katrina hit the Gulf Coast, doing tremendous damage to
homes, businesses, and physical infrastructure, including roads;
electricity transmission lines; and oil producing, refining, and pipeline

facilities. The DOE reported on August 31, 2005 that as many as 2.3
million customers were without electricity in Louisiana, Mississippi,
Alabama, Florida, and Georgia. The DOE further reported that 21 refineries
in affected states were either shut down or operating at reduced capacity
in the aftermath of the hurricane. The refining capacity of the shutdown
refineries alone is equivalent to over 10 percent of the nation's total
refining capacity. Two petroleum product pipelines that serve the Midwest
and East Coast from Gulf Coast refineries were also out. The Minerals
Management Service of the Department of the Interior reported that as of
September 1, 2005, over 90 percent of crude oil production in the Gulf of
Mexico was out of operation. Because the Gulf Coast refining region is a
net exporter of petroleum products to all other regions of the country,
retail gasoline prices in many parts of the nation have risen
dramatically, with news reports that many locations have seen prices over
$3.00 per gallon, and in one reported case to almost $6.00 per gallon. In
addition, many gasoline stations have reported running out of stocks and
have faced large increases in wholesale gasoline prices-the spot price for
wholesale gasoline delivered to New York Harbor rose by about $0.78 per
gallon between August 26 and August 30. Until production, refining, and
pipeline facilities are back up and running at normal levels, prices are
expected to continue to be higher in affected areas. Coming as this has on
the heels of a period of high crude oil prices and a tight balance
worldwide between petroleum demand and supply, the effects of the
hurricane illustrate the volatility of gasoline prices given the
vulnerability of the gasoline infrastructure to natural or other
disruptions. Such disruptions also have the potential to adversely affect
the economy. For example, in 2004, the International Energy Agency
reported that a $10 increase in the world price of crude oil would lead to
at least a one half percent reduction in world GDP - equivalent to $255
billion - in the year following the price increase. The effects on
individual countries would vary depending on whether or not they are net
oil importers and on the level of energy intensity of their economies.

Fourth, regulatory steps to reduce air pollution have also influenced
gasoline markets and consequently have increased gasoline prices. For
example, since the 1990 amendments to the Clean Air Act, the use of
various blends of cleaner-burning gasoline-so-called "boutique fuels- has
grown as states have adopted the use of such fuels to meet national air
quality standards. The use of these special blends has provided
environmental and health benefits by reducing emissions of a number of
pollutants. However, the proliferation of these special gasoline blends
has also put stress on the gasoline supply infrastructure and has led to
increased price volatility because areas that use special blends cannot as

easily find suitable replacement gasoline in the event of a local supply
disruption.5

Finally, we recently reported that industry mergers increased market
concentration and in some cases caused higher wholesale gasoline prices in
the United States from the mid-1990s through 2000.6 Overall, the report
found that the mergers led to price increases averaging about 2 cents per
gallon on average. For conventional gasoline, the predominant type used in
the country, the change in the wholesale price, due to specific mergers,
ranged from a decrease of about 1 cent per gallon-due to efficiency gains
associated with the merger-to an increase of about 5 cents per gallon-
attributed to increased market power after the merger. For special blends
of gasoline, wholesale prices increased by from between 1 and 7 cents per
gallon, depending on location.

  Future Oil and Gasoline Prices Will Reflect Supply/Demand Balance, but
  Technological Change and Conservation Will Also Play a Role

Looking into the future, daunting challenges lie ahead in finding,
developing, and providing sufficient quantities of oil to meet projected
global demand. For example, according to EIA, world oil demand is expected
to grow to nearly 103 million barrels per day in 2025 under low growth
assumptions, and may reach as high as 142 million barrels per day in
2025-increases of between 25 and 71 percent from the 2004 consumption
level of 83 million barrels per day. Looking further ahead, the rapid pace
of economic growth in China and India, two of the world's most populous
and fastest growing countries, may lead to a rapid increase in their
demand for crude oil and petroleum products. While current consumption of
oil by China and India is far below that of the United States, it is
projected to grow at a far more rapid rate. Specifically, EIA's
medium-growth projections estimate that oil consumption for China and
India will each grow by about 4 percent annually through 2025, while
consumption in the United States is projected to grow at an annual rate of
1.5 percent over the same period.

5For more details see GAO,Gasoline Markets: Special Gasoline Blends Reduce
Emissions and Improve Air Quality, but Complicate Supply and Contribute to
Higher Prices, GAO05-421 (Washington, D.C.: June 17, 2005).

6GAO, Energy Markets: Effects of Mergers and Market Concentration in the
U.S. Petroleum Industry, GAO-04-96 (Washington, D.C.: May 17, 2004).

To meet the rising demand for gasoline and other petroleum products, new
oil deposits will likely be developed and new production facilities built.
Currently, many of the world's known and easily accessible crude oil
deposits have already been developed, and many of these are experiencing
declining volumes as fields become depleted. For example, the existing oil
fields in California and Alaska have long since reached their peak
production, necessitating an increasing volume of imported crude oil to
West Coast refineries. Developing new oil deposits may be more costly than
in the past, which could put upward pressure on crude oil prices and the
prices of petroleum products derived from it. For example, some large
potential new sources, such as oil shales, tar sands, and deep-water oil
wells, require different and more costly extraction methods than are
typically needed to extract oil from existing fields. In addition, the
remaining oil in the ground may be heavier and more difficult to refine,
necessitating investment in additional refinery processes to make gasoline
and other petroleum products out of this oil. If developing, extracting,
and refining new sources of crude oil are more costly than extracting and
refining oil from existing fields, crude oil and petroleum product prices
likely will rise to make these activities economically feasible.

On the other hand, technological advances in oil exploration, extraction,
and refining could mitigate future price increases. In the past, advances
in seismic technology significantly improved the ability of oil
exploration companies to map oil deposits, while improvements in drilling
technology have enabled oil companies to drill in multiple directions from
a single platform. Together, these advances have enabled companies to
identify and extract oil more efficiently, essentially increasing the
supply of oil. Further, refining advances over the years have also enabled
U.S. refiners to increase the yield of gasoline from a given barrel of
oil-while the total volume of petroleum products has remained relatively
constant, refiners have been able to get a greater proportion of the more
valuable components, such as gasoline, out of each barrel, thereby
increasing the supply of these components. Similar technological
improvements in the future that lower costs or increase supply of crude
oil or refined products would likely lead to lower prices for such
commodities.

Innovations that reduce the costs of alternative sources of energy could
also reduce the demand for crude oil and petroleum products, and thereby
ease price pressures. For example, hydrogen is the simplest element and
most plentiful gas in the universe and when used in fuel cells produce
almost no pollution. In addition, hydrogen fuel cell cars are expected to
be roughly three times more fuel-efficient than cars powered by typical

internal combustion engines. Currently, enormous technical problems stand
in the way of converting America's fleet of automobiles from gasoline to
hydrogen, including how to produce, store, and distribute the flammable
gas safely and efficiently, and how to build hydrogen cars that people can
afford and will want to buy. However, there are federal and state
initiatives under way as well as many private efforts to solve these
technical problems, and if they can be solved in an economical way in the
future, the implications for gasoline use could be profound.

Greater conservation or improved fuel efficiency could also reduce future
demand for crude oil and petroleum products, thereby leading to lower
prices. The amount of oil and petroleum products we will consume in the
future is, ultimately, a matter of choice. Reducing our consumption of
gasoline by driving smaller, more fuel-efficient cars-as occurred in the
1980s in response to high gasoline prices-would reduce future demand for
gasoline and put downward pressure on prices. For example, the National
Academies of Science recently reported that if fuel-efficiency standards
for cars and light trucks had been raised by an additional 15 percent in
2000, gasoline consumption in the year 2015 would be 10 billion gallons
lower than it is expected to be under current standards. The Congress
established fuel economy standards for passenger cars and light trucks in
1975 with the passage of the Energy Policy and Conservation Act. While
these standards have led to increased fuel efficiency for cars and light
trucks, in recent years, the switch to light trucks has eroded gains in
the overall fuel efficiency of the fleet of American passenger vehicles.
Future reductions in demand for gasoline could be achieved if either fuel
efficiency standards for cars and light trucks are increased, or if
consumers switch to driving smaller or more fuel-efficient cars.

The effect of future environmental regulations and international
initiatives on oil and petroleum products prices is uncertain. On one
hand, regulations that increase the cost or otherwise limit the building
of refining and storage capacity may put pressure on prices in some
localities. For example, the California Energy Commission told us the lack
of storage capacity for imported crude oil and petroleum products may be a
severe problem in the future, potentially leading to supply disruptions
and price volatility. Alternatively, international efforts to reduce the
generation of greenhouse gas emissions could cause reductions in the
demand for crude oil and petroleum products through the development and
use of more fuel-efficient processes and as cleaner, lower-emissions fuels
are developed and used.

Moreover, geopolitical factors will likely continue to have an impact on
the price of crude oil and petroleum product in the future. Because crude
oil is a global commodity, the price we pay for it can be affected by any
events that may affect world demand or supply. For example,
Venezuela-which produces around 2.6 million barrels of crude oil per day,
and which supplies about 12 percent of total U.S. oil imports-is currently
experiencing considerable social, economic, and political difficulties
that have, in the past, impacted oil production. Finally, instability in
the Middle East, and particularly the Persian Gulf, has in the past,
caused major disruptions in oil supplies, such as occurred toward the end
of the first Gulf War, when Kuwaiti oil wells were destroyed by Iraq.

Finally, the value of the U.S. dollar on open currency markets could also
affect future crude oil prices. For example, because crude oil is
typically denominated in U.S. dollars, the payments that oil-producing
countries receive for their oil are also denominated in U.S. dollars. As a
result, a weak U.S. dollar decreases the value of the oil sold at a given
price. Some analysts have recently reported in the popular press that this
devaluation can influence long-term prices in two ways. First,
oil-producing countries may wish to increase prices for their crude oil in
order to maintain their purchasing power in the face of a weakening U.S.
dollar. Secondly, because the dollars that these countries have
accumulated, which they use, in part, to finance additional oil
exploration and extraction, are worth less, the costs they pay to purchase
technology and equipment from other countries whose currencies have gained
relative to the dollar will increase. Such higher costs may deter further
expansion of oil production, leading to even higher oil prices.7

Conclusions 	In closing, the wide-ranging effects of Hurricane Katrina on
gasoline prices nationwide are a stark illustration of the
interconnectedness of our petroleum markets and reveal the vulnerability
of these markets to disruptions, natural or otherwise. Current U.S. energy
supplies remain highly dependent on fossil energy sources that are costly,
largely imported, and potentially harmful to the environment. No matter
what the price of petroleum is, alternative energy options seem always to
remain uneconomic. Striking a balance between efforts to boost petroleum

7Higher oil prices, because they increase the U.S. trade deficit, may also
contribute to the further devaluation of the dollar. Hence, analysts have
called this process a vicious cycle in which a weak dollar drives up oil
prices, which then feeds back into the trade deficit causing the dollar to
weaken further.

supply, provide incentives for developing of alternative energy sources,
develop policies and technologies focused on improving the fuel efficiency
of petroleum burning vehicles, and promote overall energy conservation,
presents challenges as well as opportunities. Clearly, all providers and
consumers of energy need to get serious about conserving energy. The
challenge is to boost supply and reduce demand. We need to choose wisely
and we need to act soon. How we choose to meet the challenges and seize
the opportunities will help determine our quality of life and economic
prosperity in the future.

We are currently studying the determinants of gasoline prices in
particular, and the petroleum industry more generally, including an
evaluation of world oil reserves; an assessment of the security of
maritime facilities for handling and transporting petroleum, natural gas,
and petroleum products; an analysis of the viability of the Strategic
Petroleum Reserve; and an assessment of the impacts of a potential
disruption of Venezuelan oil imports. With this body of work, we hope to
continue to provide Congress and the American people the information
needed to make informed decisions about energy that will have far-reaching
effects on our economy and our way of life.

  GAO Contacts and Staff Acknowledgments

Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions you or the other Members of the Committee may
have at this time.

Contact points for our Offices of Congressional Relations and Pulic
Affaris may be found on the last page of this statement. For further
information about this testimony, please contact Jim Wells at (202)
512-3841 (or at [email protected] ). Individuals who made key contributions
to this statement include Godwin Agbara, Byron Galloway, Dan Haas,
Michelle Munn, Melissa Arzaga Roye, and Frank Rusco.

Related GAO Products

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the Retail Price of Gasoline. GAO-05-525SP. Washington, D.C. May 2, 2005

Oil and Gas Development: Increased Permitting Activity Has Lessened BLM's
Ability to Meet Its Environmental Protection Responsibilities.

GAO-05-418. Washington, D.C. June 17, 2005.

Gasoline Markets: Special Gasoline Blends Reduce Emissions and Improve Air
Quality, But Complicate Supply and Contribute to Higher Prices.
GAO-05-421. Washington, D.C. June 17, 2005.

Energy Markets: Understanding Current Gasoline Prices and Potential Future
Trends. GAO-05-675T. Washington, D.C. May 9, 2005.

Energy Markets: Effects of Mergers and Market Concentration in the U.S.
Petroleum Industry. GAO-04-96. Washington, D.C. May 17, 2004.

Research and Development: Lessons Learned from Previous Research Could
Benefit Freedom CAR Initiative. GAO-02-810T. Washington, D.C.: June 6,
2002.

U.S. Ethanol Market: MTBE Ban in California. GAO-02-440R. Washington,
D.C.: February 27, 2002.

Motor Fuels: Gasoline Prices in the West Coast Market.
GAO-01608T.Washington, D.C.: April 25, 2001.

Motor Fuels: Gasoline Prices in Oregon. GAO-01-433R. Washington, D.C.:
February 23, 2001.

Petroleum and Ethanol Fuels: Tax Incentives and Related GAO Work.
RCED-00-301R. Washington, D.C.: September 25, 2000.

Cooperative Research: Results of U.S.-Industry Partnership to Develop a
New Generation of Vehicles. RCED-00-81. Washington, D.C.: March 30, 2000.

Alaskan North Slope Oil: Limited Effects of Lifting Export Ban on Oil and
Shipping Industries and Consumers. RCED-99-191. Washington, D.C.: July 1,
1999.

International Energy Agency: How the Agency Prepares Its World Oil Market
Statistics. RCED-99-142. Washington, D.C.: May 7, 1999.

Energy Security and Policy: Analysis of the Pricing of Crude Oil and
Petroleum Products. RCED-93-17. Washington, D.C.: March 19, 1993.

Energy Policy: Options to Reduce Environmental and Other Costs of Gasoline
Consumption. T-RCED-92-94. Washington, D.C.: September 17, 1992.

Energy Policy: Options to Reduce Environmental and Other Costs of Gasoline
Consumption. RCED-92-260. Washington, D.C.: September 17, 1992.

Alaskan Crude Oil Exports. T-RCED-90-59. Washington, D.C.: April 5, 1990.

Energy Security: An Overview of Changes in the World Oil Market.

RCED-88-170. Washington, D.C.: August 31, 1988.

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