U.S. oil production is up, so why are gas prices so high?

ByWendy Koch, USA TODAY
April 21, 2012, 7:26 AM

— -- Given America's new oil rush, it would seem the best of times for gas prices. But with $4-per-gallon sticker shock, it might feel like the worst of times.

How can this be?

The question is all the more perplexing, because the United States is not only producing more crude oil but also using less of it. As a result, net oil imports have dropped a third since 2005.

With such good fortune, America's soaring pump prices seem to defy the laws of supply and demand — except for one fact: It's increasingly not just about us.

U.S. gas prices are largely determined by global crude oil prices, which depend on a widening and shifting array of factors half a world away: economic sanctions on Iran; deepwater drilling off Brazil; spare oil capacity in Saudi Arabia; auto use in China; less nuclear power in Japan.

So oil rigs may be hopping in North Dakota, but what happens in the Strait of Hormuz will likely have more impact on prices at the local gas station — even though the U.S. doesn't import a single gallon from Iran.

"The market for oil is global," says Neelesh Nerurkar of the Congressional Research Service, the research arm of Congress, who co-wrote a paper on 2012's rising gas prices. He says although the U.S. imported almost no oil from Libya, unrest there last year cut the world's crude oil supply and thus drove up gas prices here.

"It's frustrating to everybody," says Howard Gruenspecht, acting administrator of the U.S. Energy Information Administration, referring to the U.S.' limited ability to control its own gas prices despite its oil boom. His agency says the U.S. increased production of oil and petroleum products about 20% since 2008, but the amount was only 11% of the world's supply last year and 53% of what the nation used.

Federal laws do not generally allow crude oil that's produced in the U.S. to be exported but permit the export of refined products that come from it — such as gasoline, diesel and jet fuel. Last year, for the first time since 1949, the U.S. became a net exporter of these products. Most gasoline exports go from Gulf Coast refineries to Latin America, where demand is booming.

"They're not keeping it just for us," President Obama said this month about U.S. oil companies, noting they sell on the international market. As a result, he said, "We can't just drill our way out of this problem."

He argued the only true solution to high gas prices is independence from fossil fuels, adding: "I don't want our kids to be held hostage to events on the other side of the world."

His likely GOP presidential opponent, former Massachusetts governor Mitt Romney, partly blames Obama for gas prices, saying he should do more to expand U.S. oil production and pipeline capacity. When Obama was running for president in 2008, he partly blamed then-president George Bush for that year's surge in gas prices.

"The reality is that presidents have very little to do with near-term fluctuations in gasoline prices," Frank Verrastro, director of the energy program at the Center for Strategic and International Studies, told a U.S. Senate panel last month.

Here's a look at five factors that do:

1. Global crude oil price increases.

Crude oil accounted for nearly three-quarters, or 72%, of the retail cost of a gallon of gasoline in February, according to the most recent data from the U.S. Energy Information Administration, the analytical arm of the Department of Energy. Refining costs/profits accounted for 12%, federal/state taxes for 11% and distribution/marketing for 5%.

Crude oil prices reflect the cost of production, which has become more challenging as easy-to-access reserves dwindle.

"Oil companies are turning to increasingly costly-to-produce oil," says Michael T. Klare, author of The Race For What's Left: The Global Scramble for the World's Last Resources. He points to tar sands in Canada, deepwater reserves off Brazil or so-called tight oil that's extracted from shale formations by hydraulic fracturing in the U.S.

Klare says oil prices also reflect both the world's current supply and demand as well as expectations about the future. "People are bidding against each other and driving up the price," he says, noting buyers pay now for delivery later, so they often hedge their bets to account for a potential loss in supply.

2. Iran and other geopolitical uncertainties.

What's causing the most heartburn now is Iran, one of the world's top five oil producers (along with Saudi Arabia, Russia, the U.S. and China).

"This year, the dominant factor in pushing up world oil prices — and thus gasoline prices in the United States — is geopolitics — specifically, rising tension over Iran," Daniel Yergin, chairman of the IHS CERA division, formerly known as Cambridge Energy Research Associates, recently told a Senate panel.

Because of concern that Iran is developing nuclear weapons that could strike Israel, the U.S. and the European Union have imposed economic sanctions against it and are considering tougher measures. Iran has threatened to "close" the 6-mile-wide Strait of Hormuz, a major oil thoroughfare, but has also agreed to talks with six major world powers, including the U.S.

Other uncertainties focus on civil unrest in Yemen and Syria and discord between Sudan and South Sudan.

3. Limited spare capacity.

These countries worry the oil industry, even though they're not major oil producers, because there's limited global cushion to cover a loss in production should their conflicts spread or deepen.

Right now, Saudi Arabia holds almost all the world's spare capacity in crude oil production — estimated at about 2 million barrels a day, which is low historically and less than Iran's daily exports.

"We're on a cusp, a balancing point," says Martin Tallett of EnSys Energy, an industry consulting firm. He says less than 4 million barrels-per-day of spare capacity is problematic, because even small changes in supply or demand can swing prices. "We're in a period of quite high uncertainty."

The U.S. also has 696 million barrels in its Strategic Petroleum Reserve, designed as an emergency stockpile, but its prior releases lowered gas prices only temporarily. The reserve can satisfy a tiny fraction of the world's oil demand, estimated at 89 million barrels-per-day this year.

4. Rising worldwide demand.

Oil consumption in the U.S. has fallen 10% since 2005, back to 1998 levels, as Americans drive less and use more fuel-efficient cars and equipment.

That's not the case worldwide. From 2008 to 2011, oil demand grew by 3.2 million barrels per day from just four countries — Brazil, India, China and Saudi Arabia — and isn't expected to slow much this year, according to U.S. Senate testimony by Paul Horsnell, head of commodities research for Barclays.

Japan's demand for oil has also increased since a massive earthquake and tsunami in March 2011 caused partial meltdowns at its Fukushima Dai-ichi nuclear power plant. Of its 54 nuclear reactors, only one is now operational.

"Demand is rising worldwide, even if it's not in the United States, and supply is not keeping pace," Klare says.

5. Refinery closures/production costs.

Higher demand could trigger particularly higher gas prices along the East Coast where several oil refineries have closed in recent years, making the region dependent on gasoline imports. Refinery outages on the West Coast have recently pushed up prices there.

Unlike refineries on the Gulf Coast, which are sophisticated and have great export opportunities, those on the East Coast tend to be less flexible in the crudes they can refine and face more global competition.

Sunoco closed its Marcus Hook, Pa., refinery in December and may close (or sell) its Philadelphia one this year, while ConocoPhillips shuttered its Trainer, Pa., refinery last September. These three facilities account for half of the Northeast's refining capacity.

Another issue is pipeline capacity, which also varies nationwide and contributes to the regional differences in gas prices. Verrastro, an energy analyst, says expanding capacity with the Oklahoma-to-Texas half of the proposed Keystone pipeline could temporarily hike gas prices in the Rocky Mountain area by relieving the current glut of oil that has depressed gas prices there.

Where are gas prices headed? Some industry analysts say prices have already peaked this year. Gruenspecht's EIA predicted April 10 that regular-grade gas prices will average $3.95 a gallon through September and could peak at $4.01 in May. It forecasts slightly lower gas prices next year of $3.73 a gallon.

"Our outlook is for prices staying fairly high," Gruenspecht says, adding: "but there's a fair range of uncertainty around that."

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