Gas gouging primer

...the demand for gasoline is what economists call inelastic, which means that people cannot quickly reduce their consumption when prices rise sharply, abrupt supply shortages lead to steep price increases without any immediate decline in sales.

The most common reason for such increases in gasoline prices is a steep increase in the price of crude oil. But crude oil prices are set in global markets, and even the biggest American or European oil companies are modest players compared with state-controlled oil companies in the Persian Gulf, Russia and Latin America.

Even the mighty Organization of the Petroleum Exporting Countries, which defines itself as a competition-limiting cartel, has only a limited grip on world oil prices. OPEC countries watched helplessly as oil prices plunged in the early 1980s and remained mired below $20 a barrel for most years (excluding the time of the Persian Gulf War in 1991) through the mid-1990s.

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The Federal Trade Commission has been skeptical about accusations of price-gouging on gasoline prices. In 2004, the agency studied price changes in gasoline from 1991 through late 2003. It concluded that about 85 percent of the price variability — both up and down — reflected changes in crude oil prices.

To be sure, this year is different. ...gasoline prices are slightly higher than they were a year ago.

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INDUSTRY executives say the anomaly reflects a temporary drop-off in refinery activity, partly because of scheduled maintenance and partly because of unscheduled interruptions. On top of that come ethanol prices, which have soared, because refiners now blend a small percentage of ethanol into standard gasoline.

The broader issue is that refinery capacity has not kept up with American demand for gasoline. Oil companies, caught with vast amounts of excess refining capacity in the early 1980s, systematically reduced capacity during the long lean years when energy prices and profit margins were the pity of Wall Street.

In theory, the allure of fat profits will attract heavy investment in more refinery capacity. And John Felmy, chief economist at the American Petroleum Institute, told reporters last week that oil companies have indeed been investing heavily in recent years.

But Congress could face an entirely new quandary in its desire to expand the use of renewable fuels. President Bush has called for producing 35 billion gallons a year of alternative fuels — from cellulosic ethanol to coal-based diesel — by 2017. Congressional Democrats might be even more aggressive.

If that’s the plan, will oil companies want to invest in more refineries? “You’ve got to ask whether the demand will be there,” Mr. Felmy said.