Crude Oil and Gasoline: The Illusion of Equality

by: James Picerno

The time has come to once and for all put to rest the notion that crude oil and gasoline are joined at the hip as commodities in solidarity.

Yes, there's a thin veil of truth to the myth, born of the fact that the latter is refined from the former. But for all practical purposes, it's prudent to consider each separately from the other. The reason: each is driven by a separate, and at times dissimilar, set of supply and demand factors.

Still, the two appear to share a commonality in pricing trend at times, promoting the illusion of equality. But as the news from Iran reminds, the danger in the conceit carries more than a little risk for clear thinking on energy matters.

The casual observer may wonder why Iran, home to 10% of the world's proven oil reserves, and second in global crude production, has started rationing gasoline, which has sparked riots and unrest in the country. In fact, there's no great mystery here.

Iran produces far more crude oil than it consumes domestically, thus its high level of exports. But, its domestic gasoline production falls well short of internal demand. The reason should be familiar to Americans, namely, a lack of investment in refineries to slake rising consumption.

In 2005, Iran imported roughly one-third of its domestic gasoline consumption of 400,000 barrels a day, according to the Energy Information Agency. In an odd twist of fate, Iran's reliance on foreign gasoline makes it the world's second-largest importer of the fuel, after the United States.

Adding to Iran's challenge in solving its gasoline shortage, is the fact that the state imposes price caps on the fuel, thereby insulating the population from the market price for a commodity that's set globally by the forces of supply and demand. The New York Times, via the Houston Chronicle, reported that as a result, Tehran buys foreign gasoline for $2 a gallon, and sells it domestically for $0.34 cents. In addition to the ill-advised policy of promoting consumption, while domestic production is, at best, static, state-subsidized gasoline plants the seeds for social strife for the day when market forces inevitably shatter the myth that energy's inexpensive.

The moral of the story is that access to large quantities of crude oil doesn't necessarily translate into energy security for the man on the street. That truism doesn't stop some, if not most Iranians, from letting expectations run away from the reality on the ground.

"There is no reason why we should pay the same price as people outside Iran do," Amir Aram, a carpenter in Tehran, told the Times. "We have all this oil beneath our feet, and have to wait for hours in line to get our ration."

Politicians in Washington would do well to study the current Iranian energy crisis, and recognize the distinction between the markets for crude oil and gasoline, and the separate, but independent challenges looming in each, for the United States. Yes, each commodity requires sober analysis, and planning. But however that unfolds, accepting that the two aren't interchangeable for policy-making is essential.

The U.S. could have all the inexpensive oil in the world, but that alone doesn't put gasoline in Joe Sixpack's SUV tank. We can, and should, have an intelligent national debate about the country's long-term energy strategy. (Hey, there's a first time for everything.) But no matter the path we take, the choice must flow from a firm grasp of the facts. This begins with understanding the supply and demand dynamic that is the U.S. gasoline market.

Fact number 1: According to the EIA, there were 149 operating refineries in the United States in 2006, which is down 50% from 1982.

Fact number 2: From 1982 and 2006, the capacity of the operating U.S. refineries has fallen by 3.7%.

Fact number 3: Between 1982 and 2006, motor gasoline consumption in the U.S. increased by 40%.

Fact number 4: Gasoline imports to the U.S. have climbed by 140% from 1982 to 2006.

On the surface, the above stats don't look all that different from the dynamic of crude oil, i.e., rising consumption, falling domestic production, and the increasing reliance on imports. The difference is that when it comes to oil, geology has imposed its reality on the United States. In sharp contrast, whatever awaits for gasoline in this country will come solely as a self-inflicted scenario, a fact that these days, Iran understands all too well.