Overview

Gasoline prices have been on a roller coaster over the past year--raising the ire of motorists, pushing pump prices to the top of the political agenda, shocking Detroit with how rapidly buyers can change what they want--at least until prices come down again. In recent times, motorists have experienced some of the highest prices they have ever paid, only to see the prices fall back sharply. In 2005, after Hurricanes Katrina and Rita disrupted the vast energy complex of the Gulf of Mexico, regular unleaded prices hit $3.04 nationwide. Similar levels were touched in late July and early August 2006--as high as $3.00 per gallon--after war broke out in Lebanon and fears mounted about an imminent confrontation over Iran's nuclear program. But at this writing, they are down substantially, back to $2.22 per gallon, about where they were at the same time last year.

Why the roller coaster? More than anything else, it is because of what happens to crude oil prices. Of new importance since the previous edition of Gasoline and the American People is the shifting balance in the world oil market and the role of new consumers around the world.

In 2004 and 2005, during a time when US gasoline prices were rising, Asia consumed more oil than North America--for the first time ever. American motorists are being reminded more clearly than ever that their consumption of gasoline is part of a much bigger and growing global market--one in which stresses and imbalance caused by rising demand in Asia or natural disasters or political events in key crude oil producing areas translate into price increases at the pump.

In the meantime, what is happening at home in the relationship between Americans and gasoline, the energy source that fuels their personal mobility? This fourth edition of Gasoline and the American People explores the long-term trends that have defined that relationship and focuses in on what is new since the last edition, in 2001.

HOW MUCH DRIVING AND HOW MUCH GASOLINE?
People are driving more, and are using more gasoline. Mileage driven keeps increasing. In 1990 the average car was driven 10,277 miles. This rose to 12,375 miles in 2005--which means 20 percent growth over a decade and a half. People are spending more time behind the wheel and burning more gasoline--the result of longer commutes, the continuing expansion of the nation's suburbs and exurbs, and more and more use of the automobile for everyday chores. The average motorist used about 703 gallons in 2005--and drove 40 percent more miles than 25 years ago (from 9,723 to 13,657 miles per driver during this period).

For the most part, the nation's total gasoline consumption continues to go up year after year. It rose from 104 billion gallons in 1973 to 141.2 billion gallons in 2004 (see Figure O-1). This represented an annual average growth rate of 1.5 percent. But price counts.

When prices are low, fuel economy is low on the priorities of motorists. The opposite also holds true. There are clear indications that the growth in gasoline consumption has slowed down in response to higher prices. The year 2005 saw high gasoline prices. While total gasoline consumed still grew, the rate of growth was much lower than in a typical year. The number of miles driven by licensed drivers fell in 2005, the first such decline in 25 years. Demand grew ever so slightly in 2005--to 141.6 billion gallons--a growth rate of just 0.3 percent, well below the annual growth rate of 1.6 percent average from 1990 to 2004. The year 2006 shows a continued below trend rate of growth--during the first eleven months of the year demand grew 1.0 percent compared to the same period in 2005.

WHAT ARE AMERICANS DRIVING?
Americans are driving bigger, more powerful cars. For decades it was common to speak about Americans' "love affair with the automobile." In recent years, that love affair has grown more selective--honing in on "light trucks"--the generic term that includes sport utility vehicles (SUVs), minivans, and light pickup trucks. In 1975, the year that the corporate fuel efficiency standards were legislated, just 16 percent of all vehicles were light trucks, and thus that category hardly figured in the minds of legislators in the 1970s. By 2005, the share had risen to 41 percent! The change shows up even more dramatically in terms of new vehicle sales. From 1990 to 2004, the light truck share of all new vehicles sold grew uninterruptedly, peaking at 56 percent. But, then, preferences among consumers began changing. After the surges in gasoline prices in 2005 and 2006, new-car buyers started shopping once again for fuel efficiency. In 2005, the light truck share of total sales slipped to under 55 percent and has fallen even further thus far in 2006 to under 53 percent. Total sales of light trucks fell by 109,000 units in the first ten months of 2006 compared to the same period last year. Sales of full-size SUVs have been declining in recent years--there has been a shift toward smaller, more fuel efficient SUVs, adding to the woes of Detroit (see Figure O-2).

WHAT SHARE OF SPENDING?
All through the 1960s, gasoline and oil spending as a share of household budget fluctuated between 3.4 and 3.6 percent. On the back of the two oil shocks of the 1970s and early 1980s, it rose--reaching 5 percent by 1981--and then receded. It fell to its all-time lowest level in 1998, when just 2.1 percent of household spending went to gasoline and oil. That was a year when world oil prices collapsed. With rising world oil prices, it was back to an estimated 3.8 percent in 2006. Over the same period, the components of household spending have shifted. Between 1981 and 2005, food has generally declined, down from 19.8 percent to 13.9 percent. Most striking over the entire time period is the rapidly growing share of household spending that goes to medical care?from 11.2 percent in 1981 to 17.3 percent in 2005.

WHERE THEY BUY
The traditional gasoline station has not disappeared, but it is in retreat. Or rather it continues to morph into a site that mixes the dispensing of gasoline with sales of coffee, soft drinks, submarine sandwiches, and snacks. Out of a total of 223,118 outlets in 1977, just 11,900--or 5 percent--were convenience stores. The number of total outlets has declined since then to 167,476 (At the same time, the amount of gasoline pumped per station has risen by 73 percent). But of that total, some 109,400 are convenience stores--fully 65 percent of the total. In other words, convenience stores are where the majority of Americans purchase their gasoline. But now there is a third choice. Small in number--but growing--are the mass market outlets attached to the big discount stores. There were a mere 111 in 1997; today, there are 4,073. More are on the way.

WHERE GASOLINE IS MADE
Since the last report on Gasoline and the American People, the issue of refinery capacity has become prominent. But it is important to distinguish between the number of refineries and the number of barrels that can be produced. The number of refineries in the United States today is only half the number at the beginning of the 1980s. Much of that decline reflects the retirement of small, inefficient, "tea kettles." These were made economically attractive in the 1970s by the subsidies of the once-famous and now-forgotten "small refiner bias" that Congress enacted in that decade. Actual output from refineries declined in the early 1980s because of both the disappearance of the tea kettles and the rationalization of the industry after total petroleum demand went down. But in recent years refinery capacity has gone up significantly--from 15.3 million barrels per day (mbd) in 1996 to 17.4 mbd in 2006--about 13 percent. This growth is occurring on existing refinery sites. It is the result of capacity being added, debottlenecking of facilities, modernization, and environmental upgrades. It has been supported by $5 to $7 billion a year of investment in refineries. Cumulatively, this capacity expansion has had the same effect in terms of volume of refined products as building 17 average-sized new refineries in the country since 1996.

THE COST OF GASOLINE: THE BIG PICTURE
To compare prices over time, we need to use "real" prices--that is, adjust each year's price for inflation. In this edition of Gasoline and the American People, we are expressing prices in constant 2005 prices. The picture that emerges is very striking (see Figure O-3). Adjusted for inflation, the highest annual price for gasoline goes all the way back to 1918 during World War I when a "gasoline famine" was thought to portend an era of permanent shortage. The famine did not last. By the early 1930s gasoline was so plentiful that, in order to bring in customers, some stations gave away chickens as a premium. During the 1950s, while freeways and suburbs rolled out across the country, the price was generally above $2 a gallon in 2005 dollars. The 1960s was a period of low gasoline prices. That changed with the oil crises of the 1970s, with gasoline reaching $2.96 in 1981. The 1990s saw the lowest prices ever--in constant 2005 prices, regular unleaded was as low as $1.27 in 1998. In 2003, gasoline prices were still relatively low, although rising--averaging $1.69 in constant 2005 prices. That changed in 2004 and 2005, when gasoline prices surged to an average annual price of $1.94 and then $2.30 ($1.88 and $2.30 in nominal dollars, respectively). Thus far in 2006, through mid-November, prices in constant dollars have averaged $2.53 in real terms, and $2.61 in nominal dollar terms. Prices can also fluctuate a great deal over the year. In January 2006, they averaged $2.32 in nominal terms; the high point was early August, when they hit an average of $3.00; and by mid-November they had fallen as low as $2.22.

AND COMPARED WITH OTHERS?
Gasoline prices vary widely across national borders. In the United States, they are at the low end compared with many other nations. The reason is not the cost of crude oil, which trades at a world price, but because of tax policy. In the third quarter of 2006, US motorists were paying an average of $2.86 a gallon for regular unleaded. Mexico was a little cheaper--at $2.78 per gallon--while Canada was higher--at $3.49. Japan and India were virtually tied at $4.42 and $4.34, respectively. Of the countries surveyed here, China's prices were the lowest, at $2.21. The big spenders are the Western Europeans, where motorists spend more than double that in the United States--France at $6.20 a gallon; Germany, at $6.33; Italy, at $6.46; and Britain, at the top of the league, with $6.50 a gallon.

The disparity, as pointed out above, is not because of wide differences in crude oil prices around the world, but rather depends on how heavily governments choose to tax gasoline. In the United Sates, the gasoline tax (federal and state) is 39.4 cents a gallon--15 percent of the total cost of regular gasoline. In Canada, it is $1.06--30 percent of the cost. But in Western Europe, governments use gasoline stations as tax collecting offices for the national treasury. In Italy, the tax is $3.72, or 58 percent of the total; and in Britain, $4.19, or 64 percent. In the United States, there are at least two tax collectors (and sometimes localities add a third tax). The federal government takes 18.4 cents. The average state tax is 21 cents. The lowest tax state is Georgia--at 7.5 cents per gallon--as it was in the last edition of Gasoline and the American People. Last time, the top state taxer was Rhode Island, but now it is fourth from the top at 30 cents. Going up the ladder, the next is Washington state (31 cents), Pennsylvania (31.2 cents), and at the top Wisconsin at 32.9 cents.

WHAT MAKES UP THE PRICE?
During 2006, over half of the price in the United States--58 percent--was accounted for the by the price of crude oil itself. Refining costs--involving the transformation of crude oil into such products as gasoline, jet fuel, and heating oil--were 18 percent. Sales and marketing (that is, the gasoline station and getting the gasoline there) were 9 percent. The rest was federal and state tax--15 percent.

HOW EFFICIENT?
Automobiles today are a lot more efficient compared with those in the bellwether year of 1973--when the average car managed just 13.4 mpg). Legislation enacted in 1975 set a standard--27.5 mpg by 1985 for new cars on a fleet average for each manufacturer. The effects became clearly felt as new cars entered the driving fleet and old ones were retired. The fuel efficiency of the entire automobile fleet--new and old cars on the road--reached 22.1 mpg by 2001. Since then, however, the pace of fuel efficiency gains has slowed--flattening out at 22.2 mpg by 2005. The reason that the fleet average is lower than the mandated 27.5 mpg new car average is that actual road mileage under varying road conditions is roughly 15 percent lower than the EPA tests. Also, fuel efficiency tends to deteriorate as cars get older. Light trucks (SUVs, minivans, vans, and light pickup trucks) drive to a different drummer. The federal fleet average target for new light trucks is 21 mpg, having been slightly raised in 2005 with further increases to 22.2 mpg being required for the 2007 model year trucks. Older ones faced lower standards. The average for all light trucks on the road is currently 16.9 mpg as of 2005, less than the federal target for new light trucks. Since light trucks are a growing share of the vehicle fleet, they have pulled down the average for all vehicles to 19.8 mpg in 2005 (the last year for which complete data are available)--which reflects a drop from the peak of 20.2 mpg attained in 2001. The rise in the share of light trucks in the vehicle fleet is a result of changing preferences by consumers, who have over the years paid less attention to fuel efficiency and instead sought more size, power, and performance from their vehicles. Now it appears that interest in fuel efficiency has once again become important to automobile buyers. A new entrant are hybrids, which respond to a demand for higher fuel efficiency. Hybrid sales have risen steeply--to 211,000--during the first 10 months of 2006. But their share of the market is still very small--1.4 percent.

WHAT IS THE ROLE OF GASOLINE IMPORTS?
The United States imports over 10 mbd of crude oil--two-thirds of its total refinery crude input requirements. Domestic oil production supports about one third of total refinery crude input requirements. But when it comes to gasoline, imports are at a much lower level-- 1.15 mbd--or 12 percent of total gasoline consumption. They have been rising in recent years because US demand has been outpacing domestic gasoline supply. At the same time Europe--saddled with increasing surpluses of gasoline-refining capacity because of the switch to diesel cars--has pushed competitive barrels into the US market. Europe is the largest source of imports--443,000 barrels per day (bd). That is nearly 40 percent of the total. The next largest supplier of gasoline is Canada--175,000 bd, or 15 percent of the total.

WHO IS DRIVING?
The changing demographics of the United States, where 89 percent of the driving age is licensed, are also evident behind the wheel. The most striking change is the growth in the number of older drivers. There are now almost 29 million licensed drivers over the age of 65--14.5 percent of the total--compared to less than 16 million in 1980. Over the same period, the number of drivers aged 16 to 21 dropped from 18.8 to 15.8 million. As people get older, they tend to drive less. Since an increasing share of the US population will be entering middle age in the next five to ten years, the growth rate of miles driven per licensed driver is likely to slow, as it has in the recent past.

CARS AND PEOPLE
When it comes to cars, the United States is saturated--and then some. It has reached the unusual situation among all the countries of the world of having 1,148 registered personal vehicles (cars and light trucks) for every 1,000 licensed drivers (see Figure O-4). France and Britain follow with 702 and 700 cars, respectively, per thousand eligible drivers. Japan is also up there. Despite its small land size, Japan has some 608 cars per thousand eligible drivers. In other countries, the numbers fall away. Brazil has 137 per thousand eligible drivers. But even Brazil seems well supplied with cars when compared with China and India: India has just 11 cars per thousand eligible drivers and there are only 9 per thousand in China. That tells you something about what to expect for the future and where the growth will be!

CORN AND OIL
Ethanol is hot politically. It has garnered strong support not only from its traditional advocates--Midwest farmers and their elected representatives--but also now from some environmental activists on the East and West Coasts, US automakers, entrepreneurs, and from some national security specialists. For many years, ethanol was barely a drop in the nation's motor fuel pool.* In 1980, the United States consumed a grand total of 11,000 barrels of ethanol per day--such a small number as to almost escape statistical detection. In the past few years, powered by its new popularity, ethanol has really taken off. By 2006 demand had reached roughly 350,000 bd--which is nearly 4 percent of the total gasoline market by volume. (Ethanol has roughly two thirds the energy content as gasoline. Thus, this 350,000 barrels per day would be equivalent to the energy content of 233,000 barrels per day of conventional gasoline.) That is about the same absolute volume as in Brazil, but ethanol accounts for about 40 percent of Brazil's total passenger transportation fuel consumption because its market is so much smaller.

Reformulated gasoline requirements, congressional and state mandates, and significant tax incentives (currently a 51 cents per gallon tax credit)--all these suggest that ethanol is here to stay. But hurdles are set by food-versus-fuel tradeoffs and by the logistical challenges of shipping, handling and blending ethanol. Conventional ethanol from corn is currently not expected to exceed 10 percent by volume of total gasoline usage. The big uncertainty concerns the timing, cost-competitiveness, and feasibility on a large scale of what is called cellulosic ethanol--ethanol made from waste agricultural product or specially grown nonfood energy crops.

ASIA'S GROWING ROLE
One of the most striking changes since the last edition of Gasoline and the American People is the expansion of the larger world oil market outside the United States. For some time, the European motor fuel market has been largely comparable to the United States in terms of size, although Europeans use much more diesel fuel as opposed to gasoline than the United States (primarily because diesel has been priced lower than gasoline). What is new is the increasing impact of a rapidly growing Asian oil market.

Through the 1960s, the American motorist was insulated from market shifts and disruptions beyond US borders. That ended when large-scale imports started at the beginning of the 1970s. But today the United States is even more a part of the global market, as the nation currently meets 60 percent of its total net crude and refined products needs with imports. At the same time that US imports have been growing, the global market for oil products has been increasing rapidly in Asia and elsewhere. As a result, American motorists are now affected not only by possible disruptions in crude oil exporting regions, as has happened in the past, but also by the pace of demand growth in Asia and the Middle East.

This new reality became obvious in 2004, when world consumption surged by 3.1 mbd--a significant portion of which came from China and the rest of Asia. Over the previous ten years, world demand growth had averaged 1.2 mbd. This increase in 2004 was the "demand shock" that set crude oil--and gasoline--on a higher price path. It was as though two and a half years of global demand growth had been crammed into a single year. There were multiple reasons for this unanticipated surge--the best global economic performance in a decade, combined with strong economic growth in the United States and India. But the biggest single reason was China, where demand grew by an extraordinary 16 percent (though it has slowed since then). China's unprecedented rate of growth in oil consumption was, in turn, the result of not only growing consumption by its motorists but also of a shortage of electricity, which was partly solved by burning more oil instead of coal to produce electricity. Motorists in America would never have expected that the rising prices they faced at the pump would be the result, in part, of shortfalls of electricity production in China, blackouts and brownouts in most of its provinces, and bottlenecks in mining and transporting coal across that country. Yet that was exactly what happened.

The impact of the "China growth story"--annual economic growth of 9 or 10 percent or more--is evident on other commodity markets as well, all of which have experienced very large surges in price. Oil, for instance, is up 167 percent since 2000. But copper, lead, zinc, and nickel prices are up 370 percent. We introduce in this edition comparable global commodity prices to capture the broader trends.

The demand shock of 2004 led to a tighter oil market, which in turn made it more susceptible to supply disruptions. And that is what has transpired. The elements of the supply shock were many and varied: loss of a substantial part of Nigerian supply owing to violence in its Delta region, the troubles facing Iraqi oil production, declines in Venezuelan capacity, and the disruption of both Gulf Coast oil production and refinery activity as a result of last year's hurricanes. There was no massive disruption of the kind that occurred in 1973, with the Arab oil embargo, or in 1979, with the Iranian Revolution, or in 1990, when Iraq invaded Kuwait. However, when added together in a tight market, the cumulative effect of these smaller supply shocks was significant, driving oil prices up the next leg of the price increase. In July and August 2006, war in Lebanon, escalation of tensions over Iran's nuclear program, temporary disruption of half of Prudhoe Bay production in Alaska, plus fears of new hurricanes or other disruptions affecting US gasoline--all sent crude oil prices to the $78 level, and gasoline prices up with them.

The supply picture has improved since then, political tensions have eased (at least for the time being), and the feared hurricane disruptions did not occur. These constitute the major reasons why prices have come down so fast and why OPEC countries are implementing production quotas once more. It has again become clear that the American motorist is part of an expanding global market. This means that stresses in the world market can show up abruptly in prices at the gasoline pump--and then quickly recede. Other corners of the world may seem far away. But they are not when it comes to the world oil market and the flow of that vast pool of 85 mbd of oil that comprises that market. How much that recognition will affect the decisions of consumers when they buy new cars--in terms of emphasizing greater fuel efficiency or not--will have much to do with what happens to gasoline demand in the United States in the years ahead.

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