Energy Markets: Understanding Current Gasoline Prices and	 
Potential Future Trends (09-MAY-05, GAO-05-675T).		 
                                                                 
Gasoline prices have increased dramatically in recent weeks and  
currently, California has the highest gasoline prices in the	 
nation. Consequently, consumers are expected to spend		 
significantly more on gasoline this year than last. Specifically,
EIA recently projected that, because of higher expected gasoline 
prices, the average American household will spend about $350 more
on gasoline in 2005 than they did in 2004. Understandably, the	 
public and the press have focused on these higher gasoline prices
and some have questioned why this is happening. Moreover, people 
are concerned about the future, with some analysts projecting	 
prices of crude oil--the primary raw material from which gasoline
is produced--to remain at current high levels or even increase.  
Other analysts expect prices to fall as new oil supplies are	 
developed and as consumers adjust to the current high prices and 
adopt more energy-efficient practices. This testimony, as	 
requested, address factors that help explain today's high	 
gasoline prices in the nation as a whole and specifically in	 
California. In addition, potential trends that may impact future 
prices of crude oil and gasoline are addressed. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-675T					        
    ACCNO:   A23700						        
  TITLE:     Energy Markets: Understanding Current Gasoline Prices and
Potential Future Trends 					 
     DATE:   05/09/2005 
  SUBJECT:   Cost analysis					 
	     Crude oil						 
	     Energy costs					 
	     Energy demand					 
	     Fuel prices					 
	     Gasoline						 
	     Prices and pricing 				 
	     Property and supply management			 
	     Economic analysis					 
	     Projections					 
	     California 					 

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GAO-05-675T

United States Government Accountability Office

GAO Testimony

Before the Committee on Government Reform, Subcommittee on Energy and
Resources

For Release on Delivery

Expected at 1:00 p.m. EDT ENERGY MARKETS

Monday, May 9, 2005

       Understanding Current Gasoline Prices and Potential Future Trends

Statement of Jim Wells, Director Natural Resources and Environment

GAO-05-675T

[IMG]

Mr. Chairman and Members of the Subcommittee:

I am pleased to participate in the Subcommittee's hearing to discuss
today's gasoline prices and the factors behind future trends in those
prices. Soaring retail gasoline prices have garnered much media attention
and generated much public anxiety, particularly in a state as dependent on
gasoline as California. According to data published by the American
Automobile Association, since a year ago, average national gasoline prices
have increased 23 percent to $2.20, with average prices in California
currently at $2.57 per gallon. In the Los Angeles area, prices have
increased 19 percent to $2.60 in the same period. According to the
Department of Energy's Energy Information Administration (EIA), which
compiles and analyzes energy statistics, higher expected gasoline prices
in 2005 will increase the average American household's spending on
gasoline by about $350 over 2004 expenditures. Nationally, each additional
ten cents per gallon of gasoline adds about $14 billion to America's
annual gasoline bill. Still, when adjusted for inflation, gasoline prices
are not at an all time high-the highest inflation adjusted prices occurred
in 1981 and were equivalent to a price of about $3.00 today. In addition,
U.S. consumers pay less for a gallon of gasoline than consumers in many
other industrialized nations, in large part because the United States
imposes much lower taxes on gasoline than these other countries.

The availability of relatively inexpensive gasoline has helped foster
economic growth and permitted a quality of life not widely available
across the globe. Large price increases, especially if sustained over a
long period, pose long term challenges to consumers. In this regard, some
recent analyses suggest that gasoline prices may stay at today's
relatively high level or even increase significantly in the future. For
example, some analysts have projected that the price of crude oil-the
primary raw material in the production of gasoline-while changing from
day-to-day, may remain in the vicinity of current levels for some time.
One analysts has even projected that oil may reach $105 per barrel in
coming years- almost double the current price. In contrast, others suggest
that crude oil prices-and therefore, gasoline prices-will 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 or read
in the newspapers about high oil company profits.

It is therefore essential to understand the market for gasoline. In this
context, you asked us to discuss (1) how gasoline prices are determined
nationally, (2) what factors cause California's prices to be consistently
among the nation's highest, and (3) some of the important factors that
will determine gasoline prices in the long run. You also requested that we
provide some graphical depiction of gasoline prices and other relevant
data and we include these in appendix 1 of this document.

To respond to your questions, we relied heavily on previous work on
gasoline prices and other aspects of the petroleum products industry and
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-when crude oil prices fluctuate, gasoline
prices generally follow a similar pattern. In recent months, crude oil
prices have risen significantly-from January 2004 to the present, the
price of West Texas Intermediate crude oil, a benchmark for international
oil prices, has risen by almost $20 per barrel, an increase of almost 60
percent. Over the same period, average gasoline prices rose nationally
from $1.49 to $2.20 per gallon, an increase of 48 percent. Explanations
for this large increase in crude oil and gasoline prices include rapid
growth of 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.

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 and Bureau of Labor
Statistics, Monthly Motor Gasoline Prices,
U.S. City Averages, Regular Gasoline.

o  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. It is important to
note that imports are not, in and of themselves a problem-frequently
imported goods are available at lower prices than domestically produced
goods. However, the American Petroleum Institute has recently reported
that U.S. 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. In addition,
refinery accidents and

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

other localized supply disruptions have at times caused price spikes
especially at the state or regional level. Recently, a tragic fire at a BP
refinery in Houston killed 15 people and temporarily shut down about 3
percent of the nation's refining capacity-while this event has not been
definitively linked to increased prices, such events in the past have, at
times, had major effects on prices.

o  The volume of inventories of gasoline, maintained by refiners or
marketers of gasoline, can also have an impact on prices. As with trends
in a number of other 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, which puts 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 and amendments,
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.

o  Gasoline prices in California, and in other West Coast states, have
consistently been among the highest in the nation and recent experience is
no different. For example, for the last week in April, when the national
average price for regular grade gasoline was $2.20, the California price
was $2.57. Explanations for why California's prices have been higher than
the national average include (1) California's unique gasoline blend, which
is cleaner burning and more expensive to produce than any of the other
commonly used gasoline blends; (2) a tight balance between supply and
demand in the West Coast, and the long distance to any viable sources of
replacement gasoline in the event of local supply disruptions; and (3)
California's higher level of gasoline taxes-California currently taxes a
gallon of gasoline at 30 cents per gallon more than the state with the
lowest taxes, Alaska.

o  Future gasoline prices will reflect world supply and demand balance. If
demand for oil and petroleum products continues to rise as it has in past

years-EIA projects that U.S. demand for crude oil will rise about 38
percent by the year 2025-then oil supply will have to expand significantly
to keep up. Currently, 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 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. As a result, new
production facilities will have to be built, and perhaps new oil deposits
will need to be developed, to meet rising demand for gasoline and other
petroleum products. In so doing, entities may encounter higher costs of
extracting and processing oil. 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. To the extent that
extraction and processing costs rise, the price of crude oil and the
petroleum products made from it will have to rise to make supplying it
economically viable. If, on the other hand, technological innovations
improve our ability to extract and process oil, this will increase the
available future supply and 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
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.

Background 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.1 California alone presently consumes almost 44
million gallons of gasoline per day. To put this in perspective, in 1997
(the last year for which we found available data for international
comparisons), only the rest of the United States and Japan consumed more
gasoline than California.

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, which have put pressure on airline companies, some of which are
currently in the midst of financial difficulties.

Gasoline prices vary a great deal over time. For example, in the 10-year
period April 1995 through April 2005, the national average price for a
gallon of regular grade gasoline has been as low as $0.89 and as high as
$2.25 without adjusting for inflation. In addition, gasoline prices vary
by location and, in recent years, California has consistently had among
the highest prices in the nation.

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 of petroleum
products-while

1The large percentage of total world gasoline production that is consumed
by the United States partly reflects the fact that diesel is a commonly
used fuel for cars in Europe, while U.S. cars 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.

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

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 part of the
household budgets of 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 feed directly into 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, crude oil accounted for
about 48 percent of the price of a gallon of gasoline on average in 2004
in the United States.2 When crude oil prices rise, as they have in recent
months, 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. 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

2EIA also lists taxes; refining costs and profits; and distribution and
retail marketing costs and profits as other components of gasoline prices.

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 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

Source: GAO analysis based on EIA data.

Because of the prominent role of crude oil as a raw material of gasoline
production, in order to understand what determines gasoline prices it is
necessary to examine 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 the
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. For example, a workers'
strike in Nigeria's oil sector in October 2004 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
production of crude oil in order to increase world prices for that
commodity.

In addition to the cost of crude oil, gasoline prices are influenced by a
variety of other factors, including 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 building and operating additional refining capacity in the
United States would entail. However, the American Petroleum Institute
(API) has recently reported that capacity utilization has been high in the
U.S. refinery sector. Capacity has typically averaged over 90 percent, and
has recently increased to 92 percent-much higher than the rate in many
other industries, which API reports are 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.
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.

Gasoline prices may also be affected by unexpected refinery outages or
accidents that significantly disrupt the delivery of gasoline supply. For
example, in a recent report, we found that unexpected refinery outages had
been a factor in a number of prices spikes in California in the 1990s.
More recently, the tragic explosion and subsequent fire at a BP refinery
in Houston, that killed 15 people, temporarily shut down about 3 percent
of the nation's refining capacity. While we have not analyzed the
potential impact on gasoline prices of this specific event, similar events
in the past have caused temporary increases in prices until alternative
sources of supply can be brought to market. Pipeline disruptions can have
a similar

effect, as was seen when Arizona's Kinder Morgan pipeline broke in July
2003 and average gasoline prices jumped 56 cents in a month in Arizona. In
addition, tanker spills, and other similar events can all have an impact
on gasoline prices at various points in time because they cause
interruption in the supply of crude oil or petroleum products, such as
gasoline.

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 inventories of gasoline 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 inventories. 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 to draw from. This puts upward pressure on gasoline prices until
new supplies can be refined and delivered domestically, or imported from
abroad.

Regulatory steps to reduce air pollution have also influenced gasoline
markets and consequently have influenced 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. A number
of reports by government agencies, academics, and private entities have
concluded that the proliferation of these special gasoline blends has put
stress on the gasoline supply infrastructure and may have 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. However, these special gasoline blends provide environmental
and health benefits because they reduce emissions of a number of
pollutants. GAO is currently working on a report on special gasoline
blends that will look at these issues and discuss the effects of these
special blends on emissions and on the supply system.

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 2000.4 Overall, the report

4Energy Markets: Effects of Mergers and Market Concentration in the U.S.
Petroleum Industry (GAO-04-96, May 2004).

California's Unique Gasoline and Isolation from Other Markets Contribute
to its Higher Gasoline Prices

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.

California, and the West Coast states more generally, have consistently
had among the highest gasoline prices in the nation. For example,
California's gasoline prices averaged about 21 cents more per gallon than
national gasoline prices over the last ten years. In addition, California
has at times had more volatile gasoline prices than the rest of the
country. For example, in an earlier report on California gasoline prices,
we noted that, while gasoline prices did not spike more frequently than in
the rest of the United States, California's gasoline price spikes were
generally higher.5

Many of the factors influencing gasoline prices nationwide have had an
even more dramatic effect on California prices. For example, California's
high gasoline prices have been attributed, in part, to its cleaner burning
gasoline. In response to air quality problems and in order to meet air
quality standards resulting from the Clean Air Act and amendments,
California adopted a unique blend of gasoline in 1996 that increased
refining costs and likely caused prices of gasoline in the state to rise.
California's blend of gasoline is unique in the United States and,
according to EPA models, is the cleanest burning of all the widely used
special gasoline blends in the country. This gasoline blend is also very
difficult to make, and those refineries that chose to make it had to
install expensive new equipment and refining processes in order to meet
the specifications of the gasoline. Some studies have suggested that the
current blend of California gasoline costs between 5 and 15 cents more per
gallon to make than conventional gasoline. It is likely that these costs
are passed on, at least in part, to consumers.

In addition, in recent years, California has developed a tight balance
between supply and demand, which has at times led to sharper or longer
price spikes when supply disruptions have occurred. Expansion of the

5GAO, Motor Fuels: California Gasoline Price Behavior, GAO/RCED-00-121
(Washington, D.C.: April 28, 2000).

gasoline supply infrastructure has not kept pace with growing demand, and
as a result, the California refinery system has run at near capacity. For
example, according to EIA testimony before the Congress, demand for
gasoline in California has grown at roughly two to four times production
capacity growth. California Energy Commission staff told us that the tight
supply and demand balance has led to large price movements in response to
even small supply disruptions, caused by refinery outages and other
events.

Moreover, supply disruptions may have a larger impact on California than
on other states. First of all, only a few refineries outside of the state
can produce California's special blend of gasoline. In addition, there are
no major pipelines connecting the state with other major refining areas.
Therefore, if supply is disrupted in California, gasoline must be brought
in from the few refineries outside the state that make California's blend
of gasoline-often from as far away as the Gulf Coast or beyond. And
because of the lack of pipeline access to the state, tankers and other
means must be used, and the process is slow. For example, we recently
reported that gasoline shipped into California by tanker from such places
as the Gulf Coast, the U.S. Virgin Islands, Europe, and Asia, can take
between 11 and 40 days and added 3 to 12 cents per gallon to the retail
price.

Another factor contributing to the prices Californians pay at the gasoline
pump is that residents of California pay comparatively higher gasoline
taxes than residents in many other states. For example, at about 57 cents
per gallon on average, California's total gasoline tax rate is among the
highest, behind only New York and Hawaii, and is 30 percent higher than
the national average of 44 cents per gallon, according to a November 2004
survey by the American Petroleum Institute.

In our recent report on oil industry mergers discussed earlier in this
testimony, we found that the highest price impact of mergers-over 7 cents
per gallon of gasoline-was in California. In addition, the California
Attorney General recently reported that California's gasoline industry is
more concentrated than that of the rest of the United States, with
California's six largest refiners controlling more than 90 percent of
refining capacity. The California Attorney General noted further, that
these six refiners in California control a majority of the terminal
facilities and 85 percent of the retail locations in the state. To the
extent that these factors lead to greater market power on the part of
refiners or gasoline marketers, prices may be higher as a result. However,
we have not analyzed this directly.

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. For the United States alone, EIA estimates
that oil consumption will increase by between 1.2 and 1.9 percent annually
through 2025 depending on assumptions about economic growth and other
factors. 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 similarly rapid increase in their demand for crude oil and
petroleum products. While these countries currently consume only a small
fraction of world crude oil, the pace of their demand growth could have
far reaching implications if recent trends continue. For example,
consumption of oil by China and India is currently far below that of the
United States, but is projected to grow at a more rapid rate. 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 U.S. is projected to grow at an annual rate of 1.5
percent over the same period.

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.6 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.7 In addition, the

6Even if new oil fields are developed in the Arctic National Wildlife
Refuge, by the time these fields reach their expected peak production of
876,000 barrels per day, according to EIA projections, U.S. demand at this
time would have increased by far more than this amount.

7We are currently working on a report on global oil reserves that will
address the constraints on global supply due to tapped oil reserves and
the difficulty in extraction.

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
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, which enabled them to
ultimately extract the oil more efficiently, thereby getting more out of a
given oil field. In addition, improvements in technology have enabled oil
companies to drill in multiple directions from a single platform, and also
to pin-point specific oil deposits more accurately, which has led to
increases in the supply of crude 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 more of
the more valuable components, such as gasoline, out of each barrel,
thereby increasing the supply of these components. Further technological
improvements that lower costs or increase supply of crude oil or refined
products would likely lead to lower prices for these commodities.

Similarly, 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 its use in fuel cells
produces 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, consumption of gasoline 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 passenger fleet. Future reductions in
demand for gasoline could be achieved if either by fuel efficiency
standards for cars and light trucks are increased, or 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 green house 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
crude oil and petroleum product prices in the future. Because crude oil is
a global commodity, the price we pay for it can be affected by any events
that 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. imports for oil-is currently experiencing
considerable social, economic, and political difficulties that have, in
the past, impacted oil production. In April 2002, the oil flow from
Venezuela was stemmed during 3 consecutive days of general strikes,
affecting oil production, refining, and exports. 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 crude oil prices in the future. 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,
oilproducing countries may wish to increase prices for their crude oil in
order to maintain their purchasing power in the face of a weakening
dollar. Secondly, because the dollars that these countries have
accumulated, and that they use, in part, to finance additional oil
exploration and extraction, are worth less, the costs these countries pay
to purchase technology and equipment from other countries whose currencies
have gained relative to the dollar will increase. These higher costs may
deter further expansion of oil production, leading to even higher oil
prices.8

Conclusions In closing, clearly none of the options for meeting the
nation's energy needs are without tradeoffs. Current U.S. energy supplies
remain highly dependent on fossil energy sources that are costly,
imported, potentially harmful to the environment, or some combination of
these three, while many renewable energy options are currently more costly
than traditional options. Striking a balance between efforts to boost
supplies from alternative energy sources and policies and technologies
focused on improved efficiency of petroleum burning vehicles or on overall
energy conservation present challenges as well as opportunities. How we
choose to meet the challenges and seize the opportunities will help
determine our quality of life and economic prosperity in the future.

What is true for the nation as a whole is even more dramatically so in
California. California is one of the most populous and steadily growing
states in the nation, and its need for gasoline, as well as other energy
sources, will grow. However, California's unique problems with respect to
developing the right amount and type of infrastructure necessary to ensure
a sufficient supply of gasoline, other petroleum products, or alternative

8Higher 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 and cause the dollar
to weaken further.

fuels must be resolved or viable alternatives developed if California is
to continue to enjoy the prosperity and high quality of life it is known
for.

We are currently studying the gasoline prices in particular, and the
petroleum industry more generally, including a primer on gasoline prices,
a forthcoming report on special gasoline blends, an analysis of the
viability of the Strategic Petroleum Reserve, an evaluation of world oil
reserves, and an assessment of U.S. contingency plans should oil imports
from a major oil producing country, such as Venezuela, be disrupted. With
this body of work, we will continue to provide Congress and the American
people the information needed to make informed decisions on energy that
will have far-reaching effects on our economy and our way of life.

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

For further information about this testimony, please contact me at (202)
512-3841 (or at [email protected] ). Godwin Agbara, Nancy Crothers, Randy
Jones, Mary Denigan-Macauley, Samantha Gross, Mark Metcalfe, Michelle
Munn, Melissa Arzaga Roye, and Frank Rusco made key contributions to this
testimony.

GAO Contacts and Staff Acknowledgments

                 Appendix: Selected Charts and Figures �

U.S. Retail Price of Gasoline (Not adjusted for inflation) Dollars per
gallon

                                      2.5

                                      2.0

                                      1.5

                                      1.0

                                      0.5

 0.0 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 20032004

Year

Source: GAO analysis of monthly data from the Bureau of Labor Statistics,
U.S. City Averages, Regular Gasoline.

U.S. Gasoline Consumption (1970-2004)

Barrels per day in millions 9.5

9.0

8.5

8.0

7.5

7.0

6.5

6.0

5.5

0

Year

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
                                   2002 2004

Source: GAO analysis of Annual data from the Energy Information
Administration, U.S. Department of Energy.

Refining Capacity and Number of Refineries (1970-2004)

Number of refineries 350 20

Barrels in millions per day

18 300

16

250 14

12 200 10

150 8

100 6

4

50 2

                                       00

Year

Number of refineries

Refining capacity Source: GAO analysis of Annual data from the Energy
Information Administration, U.S. Department of Energy.

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