Switch to ethanol drives up gas price

As the state zooms past $2 a gallon, refiners get a bigger slice of the pie.

By Dale Kasler -- Bee Staff Writer
Published 2:15 a.m. PST Wednesday, March 12, 2003

The switch to ethanol is helping drive the state's gasoline prices to record levels -- and contributing to an enormous price premium between California and the rest of the nation.

As Sacramento's average gas price hit a stratospheric $2.09 a gallon Tuesday, or 39 cents higher than the national average, analysts said the conversion to the corn-based additive ethanol is taking on increasing importance.

Until lately, higher gas prices were caused mainly by the threat of war and the impact that had on worldwide crude oil prices. California's prices were going up at about the same rate as the nation's.

But in the last few weeks, California gas production has been hamstrung by a variety of issues, notably the first-ever rollout of ethanol-based fuel for the summer driving season, analysts said.

"Anytime a new blend of gasoline rolls out in a market, you usually have some stops and starts," said Mary Welge, senior editor at the Oil Price Information Service. "It's a challenge for refiners; they're struggling."

The latest increases have swollen refiners' coffers and sparked fresh charges of price-gouging by some elected officials -- charges the industry denies. Industry experts said it's unclear if anyone's manipulating the market.

But what's striking is that California gas prices have left the rest of the country in the dust.

California's gas prices are traditionally about 20 cents a gallon higher than the U.S. average, due in part to the specialty blends of gas required to meet the state's strict clean-air standards.

But in recent weeks, the California price premium has exploded: Californians are now paying 40 cents a gallon more than the U.S. average, according to the latest survey Tuesday by AAA of Northern California.

In the past month, the U.S. price has risen 9 cents; in Sacramento it shot up 31 cents, AAA said.

AAA said the California average is $2.10, while the California Energy Commission pegged it at $2.08. The current Sacramento and California prices are both records, the AAA said.

The market is so tight that relatively minor hiccups in supply are becoming magnified. Several refineries have shut one or more of their production units for planned maintenance, said fuels analyst Gordon Schremp of the Energy Commission.

That wouldn't be a big deal normally, but a few are taking longer than expected to return to production, he said.

Plus, one day last week, spot market prices shot up 17 cents in part because two oil tankers were late with their deliveries, according to David Hackett of the Irvine-based consulting firm Stillwater Associates.

Refinery production is bouncing back; it went up 8 percent last week, according to Energy Commission data released Tuesday. But "we're not yet out of the woods," said commission spokesman Rob Schlichting. "It's still a tight market."

The ethanol issue stems from Gov. Gray Davis' decision to phase out the fuel additive MTBE by the end of 2003 because of fears of MTBE's impact on groundwater. The Bush administration, in a decision that some analysts believed was aimed at currying political favor with Midwest farmers, essentially ordered California to replace MTBE with ethanol.

Several analysts had warned that the switch would lead to spot shortages; when several Midwestern cities converted to ethanol in 2000, gas prices temporarily soared as high as $2.75.

Although the California deadline is almost a year away, the major refiners already have begun converting to ethanol, which puts an immediate strain on supply. That's because ethanol takes up less volume in a gallon of gas than MTBE does, requiring refiners to pour more gas into the mixture to make up the difference.

And brewing gas for summer creates additional issues. Because gas in summer heat behaves differently -- and pollutes differently -- refiners are required to use a specialized, costlier blend for summer use.

That's been true for years. Now the phase-in of ethanol is complicating the production of that trickier summertime gas. Refiners are having to grapple with the formula for the new base fuel, known as CARBOB, which is blended with ethanol. The acronym stands for California Air Resources Board Oxygenate Blendstock.

"Several of the refiners are having trouble making the new flavor," Hackett said.

An independent West Coast wholesale trader, who requested anonymity, said he's heard of at least two refiners brewing up batches of fuel that didn't meet specifications.

It wasn't clear how long prices would stay high. It took several weeks for prices to subside after ethanol was introduced to the Midwest in 2000. But in California's case, there still could be upward pressure on prices because of the expected war.

Refiners insist they're adjusting to the new ethanol recipe.

"We knew going in that making the summer blend was going to be more challenging," said Cameron Smyth, spokesman for Shell Oil Products US. "However, Shell has not had any significant difficulties."

As prices rise, refineries are taking a much bigger bite out of motorists' wallets than before. Refiners' average costs and profits now take 55 cents out of every gallon, up from 28 cents in mid-January, according to estimates by the California Energy Commission.

Sen. Barbara Boxer, D-Calif., last week called for a General Accounting Office investigation into the refiners' conduct, charging that they've been sitting on supplies to jack up profits.

The petroleum industry denied it's engaging in price gouging or holding back production. Yes, refiners are charging more, but that's mostly a reflection of higher costs, not an increase in profits, said policy analyst John Felmy of the American Petroleum Institute.

Still, economists say these are heady days for refiners. "There's no question about it, the refiners are making a lot more money than they were at the beginning of the year," said Severin Borenstein, director of the University of California Energy Institute.

Borenstein said there's nothing wrong with a refiner benefiting because a rival is having trouble keeping supplies up. That's how markets work.

What's troubling, he said, is that a relatively few refiners control the lion's share of California's gasoline market and have the ability to withhold supply and drive up profits without worrying that someone will take their customers away.

"Is this all just a supply shortage, or are some refiners figuring out they can make more money producing less gasoline?" he said.

The answer is uncertain, he said. Oil industry spokesmen said no one is holding back on production.

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	Sources: AAA of Northern California; California Energy Commission Sacramento Bee / Olivia Nguyen

	Sources: AAA of Northern California; California Energy Commission Sacramento Bee / Olivia Nguyen