Source: The Milwaukee Journal Sentinel Publication date: 2000-06-25

Refiners' troubles increased gasoline prices

By AVRUM D. LANK

of the Journal Sentinel staff

Sunday, June 25, 2000

Politicians smiling over the recent break in gasoline prices in the Chicago and Milwaukee areas should be careful about claiming credit. It is quite possible they are walking into a bigger problem.

To understand why, reject the idea that some evil villain was masterminding the entire situation, and instead analyze it through the discipline of the market.

That discipline says that gas prices rose and fell because individual players reacted to a series of interrelated events, all the time trying to maximize their own advantage.

As gas prices rose higher, politicians joined the game. But they are as much in sway of market forces as any of the rest of the players.

A good place to start a market analysis of what happened is with the increase in crude oil prices engineered earlier this year by OPEC.

At the same time, the refineries had to change over to production of a new type of reformulated gasoline, mandated by the Environmental Protection Agency to clean the air in Milwaukee, Chicago and other parts of the nation. Most of the United States, including large parts of Wisconsin and Illinois, continued to use traditional unleaded fuel.

In addition, in Milwaukee and Chicago, the new fuel is mixed with ethanol, an alcohol made from corn, to meet the EPA requirements. Thanks to an unexpected court decision, the refineries had to pay a royalty to use a patented process to do the mixing.

The refineries had to decide how much of each type of gas to make from their ever more expensive crude oil.

To avoid paying the royalty, many oil companies apparently chose to make more of the traditional unleaded gasoline and less of the new blend needed in Milwaukee and Chicago.

Adding to the difficulties were some problems with pipelines bringing gasoline to Milwaukee and Chicago just as the changeover to the new blend was to take place June 1.

The EPA said that, considering production costs, at the pumps in Chicago and Milwaukee the new blend should be no more than 10 cents a gallon more expensive then traditional unleaded.

That is fine as the theory of some government bureaucrat, but in the real world retail prices have only a small relationship to costs of production. Rather, producers will charge as much as the public will pay.

In this case, it meant that the difference between the pump price of the traditional unleaded and the new blend became as much as 30 cents a gallon in Wisconsin.

The reason, from a market perspective, is obvious -- the refineries made too much of the traditional unleaded and not enough of the new blend.

That forced up the price of the new blend while depressing it for the traditional gas, widening the price gap between them.

Into this gap charged a phalanx of politicians, sensing a chance to make points with an electorate that believes it has the same right to cheap gasoline that it does to free speech.

Republicans blamed the EPA for requiring the new blend and the Clinton administration in general for failing to bring successful pressure on OPEC to increase production or open new oil fields in Alaska.

Democrats blamed the oil companies for artificially pumping up prices and started an investigation aimed at finding collusion, a task most experts say will be as difficult as finding 50-cent-a- gallon gasoline.

All of this political heat was felt by the oil companies.

So they switched some production from the traditional unleaded to the new blend.

The result was predictable -- as supplies of the new blend rose in Chicago and Milwaukee, prices fell, although not back to where they started.

In large part, that is because of the increase in crude that pumped up prices of all types of gasoline.

But there is a flip side. As less of the traditional unleaded is made, its price will rise.

Eventually, the refineries will find the right production mixture of traditional and new blend gasoline to maximize their revenue.

When that happens, the gap in price between the two types probably will stand at around the dime a gallon the EPA predicted.

That will make people in Chicago and Milwaukee happy with their pump prices, at least in comparison with where they were a week ago.

But it will upset folks elsewhere, as their gasoline prices rise even more than crude has pushed them up already.

As there are more people in areas using traditional unleaded than the new blend, that just makes the problem bigger.

It will be entertaining to see how the politicians react then.

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-- Martin Thompson (mthom1927@aol.com), June 25, 2000