Engineering News

OUTLOOK: Paying The Price
January 15, 2009

One phrase common in the American lexicon in recent years has been "price gouging." During the recent oil and gas bubble, pundits and politicians regularly ascribed the practice to the refining industry. A review of government data suggests that the rhetoric ignored market realities.

To be sure, the extraordinarily high fuel prices that motorists paid until the latter half of 2008 were a shock to consumers. With oil peaking at approximately $147 in July 2008 and gas and diesel pump prices in some areas surpassing $4.00 and $5.00 a gallon, respectively, the days of paying less than $2.00 a gallon for fuel seemed a distant memory. Industries particularly sensitive to fuel prices, such as airlines and trucking, also struggled to cope in this environment. For instance, many within these industries employed the unpopular tactic of levying surcharges on customers to mitigate the impact of dramatically higher fuel costs.

Although much of the attention in public discourse was rightfully paid to the tribulations of consumers, absent from much of the discussion were the difficulties that refiners were experiencing. Far from "gouging" the consumer, refiners were simply coping with an environment in which demand for their products was declining yet the cost of their key raw material -- crude oil -- was skyrocketing. Demand fell as Americans changed their driving habits to adapt to high fuel prices. The cost of acquiring crude oil to process rapidly rose to an unprecedented level in 2008. Considering this latter point is a particularly worthwhile exercise because the cost of crude oil often accounts for at least 50 percent of the retail price of gasoline or diesel.

According to a preliminary estimate from the U.S. Department of Energy's Energy Information Administration (EIA), the average 2008 crude oil acquisition cost for U.S. refiners likely had risen to $95.07 a barrel as of Dec. 9. In contrast, the average crude oil acquisition cost for the previous year was a significantly lower $69.08. The crude oil acquisition cost, in this case a composite figure that considers both domestically produced oil and imports, was for many years less than one-half of the 2007 figure. As the graph below illustrates, the growth in average crude oil acquisition costs since approximately 2004 has been unprecedented in the context of the past four decades.

Annual US Crude

SOURCE: U.S. Dept. of Energy, Energy Information Administration

The world crude oil price, along with the crude oil acquisition cost, did decline steadily through the latter half of 2008 and into January 2009. With retail prices hovering below $2.00 a gallon for gasoline and holding at approximately $2.30 a gallon for diesel in the first weeks of January, the pain at the pump for consumers has diminished dramatically since the middle of 2008. In fact, as the chart below shows, the retail price for gasoline is closing in on the January 2004 level. Retail diesel prices, though still higher than they were four years ago, are less than one-half as high as they were last summer.

US Retail Gas

SOURCE: U.S. Dept. of Energy, Energy Information Administration

It is also noteworthy that the pattern of retail gasoline and diesel prices since 2004 follows that of the average crude oil acquisition cost. The chart below illustrates this trend.

Gas Diesel Comparison

SOURCE: U.S. Dept. of Energy, Energy Information Administration

Comparing retail gasoline and diesel prices with the refiner crude oil acquisition cost provides evidence refuting claims of price gouging. Instead, it validates the position that refiners were simply passing along higher raw materials costs to the consumer -- a reality that exists in myriad manufacturing sectors.

Source: U.S. Department of Energy, Energy Information Administration

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