Simply stated,pump prices are essentially determined by the supply of and demand for gasoline, although the costof crude figures into the equation. Gasoline Prices

According to the American Automobile Association (AAA) daily survey of retail gasolineprices around the country, gasoline prices at the pump nationwide have exceeded previous records.Since the start of 2003, prices at the gas pump have fluctuated by as much as 55 cents per gallon, andreached peaks above $1.70 three times. Figure 1 shows pump prices for the United States as a wholeand California, where both price levels and peaks exceed the national averages -- a result of variouslocal conditions. California pump prices peaked in October at $2.45 for regular. The ebb and flow of gasoline stocks during2004 -- a period of noteworthy gasoline price volatility -- reflects a balance between gasolineinventories, seasonal driving demand, and the crude available to make more at U.S. refineries as wellas the supply of imports. These data consistof domestic refinery production, (2) imports of finished gasoline that meets U.S. specifications, as wellas a significant amount -- between 300,000 and 500,000 barrels per day -- of blending componentsfrom refineries abroad. Above-minimum gasoline inventory levels and increased gasoline availability maywell be a price stabilizing factor, having contributed to the decline of pump prices from theirall-time highs during the last part of 2004. This hasresulted in much higher prices in the United States. Other Factors Contributing to High Gasoline Prices

U.S. gasoline quality and composition regulations have created unusual fuel requirementsthat are not easily met by foreign refiners. In a nation where refinery capacity can only meet about90% of gasoline needs, calling for significant supplies from abroad, meeting U.S. product "specs"for imports can present a barrier to supplying market demand. In addition to U.S. requirements forreformulated gasoline, low sulfur requirements began in 2004. In addition to manufacturing challenges at U.S. refineries, two purely economic factors haveoperated to raise the cost of importing gasoline. Gasoline Prices and the Strategic Petroleum Reserve

The recent increase in the prices of crude oil and gasoline have prompted calls for use of theStrategic Petroleum Reserve (SPR). While a release of SPR oil may soften crude prices to some extent, it may be little reflected in localgasoline prices if demand for fuel remains high where refining capacity is tight. As suggested, this is likelier in some regions of the country than others. In sum, opinion appears divided on the effect that the Administration's current fill policy ishaving on crude price and product supply, as well as on the benefits that might be more thanshort-term if RIK oil is diverted to the markets, or a swap/exchange of SPR is held. Steadily growing gasoline demand, which has increased by 600,000 barrels perday since 1999, has risen from 8.4 mbd to 9.0 mbd for the whole of 2004. This has accounted forvirtually all the nation's increase in oil consumption.
Since late 2002, gasoline prices have been extremely volatile, with the national averagespiking above $1.70 three times. Most recently, the nationwide pump price for regular fuel set a newrecord as momentum carried it over $2.00 per gallon. Prices in some states -- reaching a high of$2.45 per gallon in California -- are much above the national average. In addition to the marketforces affecting pump prices in the United States, the Organization of Petroleum Exporting Countries(OPEC) announced a production cut effective in January 2005. At a minimum, this is likely tosupport crude prices; crude prices have significant impact on prices at the pump.
Apart from higher crude oil prices, gasoline prices are strongly influenced by the supply anddemand situation at the pump. Since 1999, the only growth in U.S. oil consumption has beenincreased gasoline demand, which has risen by 600,000 barrels per day to a current annual averageof 9.0 million barrels per day. While this might seem to be a relatively small amount, it has directlyincreased demand for imports of foreign gasoline, since U.S. refineries have not added capacity asgasoline demand has grown. Demand for imported gasoline now exceeds one million barrels per day.
In addition to the high demand for imported gasoline, the quality of gasoline sought fromforeign refiners has become a factor. As the specifications for environmentally acceptable fuel havebecome more stringent, the complexity of manufacturing "U.S. spec" gasoline has increased. Not allrefiners can economically make fuel that meets domestic requirements. U.S. gasoline marketersseeking imports must shop world markets for a scarce commodity; accordingly, prices are high.These high-priced incremental supplies play an important role in determining prices at the pump,because all gasoline tends to be priced by the market at the cost of the last units supplied.
Other factors contributing to the pump price situation include the state of gasoline and crudeoil inventories at U.S. refineries. Both are recovering from low levels. Gasoline inventories availablefor consumption amount to less than two days of supply. Crude oil stocks -- from which gasolineconsumed is replaced -- are still at low levels, although rebounding somewhat from last winter'srecord lows. Petroleum inventories are low because global oil supplies are tight, in part due to strongdemand, especially in Asia. OPEC production policy is a consideration as well.
As gasoline prices rise, so does interest in finding some sort of public policy remedy thatwould return lower and more stable prices. Among the options generally discussed are a release ofcrude from the Strategic Petroleum Reserve and the relaxation of Environmental Protection Agencyrules regarding gasoline composition. Both are controversial, with the wisdom and effectiveness ofeach challenged by some.
This report will be updated to reflect significant changes in the factors impacting gasolinemarkets and prices.