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Global thirst, fears keep gas prices high

By Manav Tanneeru
CNN

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The price of gasoline has soared well above $3 a gallon in some parts of the country.

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(CNN) -- An interconnected set of domestic and international factors have pushed gas prices steadily higher over the past few years, and an almost unquenchable global demand for energy may keep them there for at least the short term, industry observers say.

The average price for self-service regular was hovering near $3 a gallon as the summer of 2006 got under way, according to a national survey of gas prices.

That's double the price in 2000 and more than 50 percent higher than two years ago, even when adjusted for inflation, government statistics show.

The retail price of gasoline is based on the price of crude oil, the cost of refining that crude into usable energy, distribution and marketing costs, and taxes.

Of those components, the price of crude makes up about half the price of gas. In 2000 and 2001, crude prices ranged from $20 to $30 a barrel. Prices for much of 2006 have hovered between $55 and $65 a barrel, surging above $73 in early June.

The price of oil soared in the early 1970s when Arab nations cut off oil sales to the United States and other Western countries to protest the West's support of Israel in the 1973 Arab-Israeli war. The Nixon administration's response to the crisis included price controls.

President Reagan lifted price controls on oil in 1981 in reaction to another crisis sparked by the Iranian revolution in 1979. Since then, gasoline prices have been based purely on the laws of supply and demand.

A rise in global demand

The price of crude oil rose steadily over the last few years for several reasons, the most important of which is the global demand for oil, according to Doug MacIntyre, senior oil market analyst at the U.S. Energy Information Administration.

"It's almost impossible for a country these days to grow substantially economically without dramatically increasing their oil demand," he said.

In particular, the economies of countries like China and India, which have large populations, have been expanding rapidly over the last few years, and their need for energy has been growing correspondingly.

"Their citizens are starting to be consumers. They're starting to buy cars and white goods, all of which consume energy," said Lawrence Eagles, who heads the oil markets division at the Paris-based International Energy Agency.

Some countries in the Middle East, a region which holds a significant amount of the world's oil reserves, also have booming economies, and their governments have had to rethink the way they handle their oil supplies, Eagles said.

Consequently, the model of Middle Eastern countries being the providers of oil and the Western countries largely being the consumers has changed, adding another wrinkle to the traditional supply and demand equation that determines oil and gas prices.

Geopolitics and supply headaches

As demand for crude oil has risen, several supply disruptions have caused bottlenecks. Rebel activity in Nigeria has cut out about a half-million barrels from the world's supply, and the war in Iraq -- where insurgents have targeted pipelines -- has reduced production there to below pre-war levels, Eagles said.

The nationalization of oil companies in Venezuela, increasing governmental control of the industry in Russia, and the continued wrangling with Iran over nuclear weapons also have led to concerns over future supplies.

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Hurricanes Katrina and Rita wreaked havoc on refineries along the U.S. Gulf Coast in 2005.

The result has been weekly or even daily fluctuations in gasoline prices, as well as the overall rise in consumer prices across the board over the past several years.

Meanwhile, American production of crude oil also has gotten more expensive because the easiest places to drill have mostly gone dry, said Rob Schlichting, a spokesman for the California Energy Commission.

"It looks like we may be coming to the end of cheap oil. The really easy-to-pump product has been pretty much pulled out of the ground unless we have some new finds," he said. "More often, we're going to offshore areas like the Gulf of Mexico, which are more expensive to drill in."

Meanwhile, spare production capacity, or the ability to produce oil fairly immediately to respond to a sudden rise in demand, has been curtailed over the last 20 years because of the increased demand.

"In 2002, we estimate there were probably about 5.5 million barrels a day or so of spare crude oil production that was being used," EIA's MacIntyre said. "Now that's closer to 1 million barrels a day."

Spare production capacity exists largely within the countries that make up the Organization of the Petroleum Exporting Countries, more commonly known as OPEC.

"The importance of [spare production capacity] is that OPEC could use that as a cushion to respond to events or unexpected developments to keep prices moderated. The Gulf War in late 1990 and 1991 was a great example of where that was done," Eagles said.

"The oil market is very susceptible to events, and when you had a lot of spare capacity in the system, it tended to attenuate the effects of an event," he added. "But now you've got events with no spare capacity."

The cost of refining crude oil in the United States also has risen over the past year, and experts cite two major reasons -- the devastation wreaked on oil refineries along the Gulf Coast by Hurricanes Rita and Katrina in 2005, and the congressionally mandated shift toward producing more environmentally sound blends of gasoline.

"The hurricanes last year had a pretty devastating effect on America's oil production," Schlichting said. "I think 15 to 20 percent of that oil production is still offline today."

Congress passed legislation in 2005 that phased out the use of methyl tertiary butyl ether, or MTBE, an additive used in the production of gasoline. The additive has been linked to water pollution and is being replaced by ethanol, which is more expensive than MTBE.

"They say it adds about seven cents a gallon or so to the cost here in California," Schlichting said.

Toward the future

Industry experts agree the easiest solution to the problems caused by high gasoline prices is a decline in demand, but that's difficult to foresee with continued growth in countries like China and India, which still have large sectors of the economy that have not fully modernized.

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Shopping for fuel-efficient cars may be among the simplest long-term solutions to high gas prices.

Additionally, the growth in demand for gasoline in the United States has slowed only marginally in this era of high prices, MacIntyre said.

"Every year, a typical demand growth would be one-half to 2 percent. We have gas prices up close to $3 or even above $3 in much of the country, and we now expect to see demand growing by one-half to 1 percent," he said. "It is lower, but it's still growing."

An economic recession could lower demand, but "that doesn't seem to be anywhere in the offing either," said Kevin Lindemer of Global Insight, an economic research and forecasting company. "The world economy is willing to pay for oil at this price."

Nor is a recession something that's entirely palatable to either consumers or governments.

"If you're looking for a short-term reduction in oil prices, one thing that might cause prices to come down is a convincing reduction in the risk that people see in [geopolitical events] like Iran," he said.

Such events have a psychological effect on the industry, which can have an impact on the market, the IEA's Eagles said.

When prices are high in a normal market, companies use surplus oil stocks to drive prices down.

But in this market, executives and traders -- speculating that prices may go even higher because of global events -- are actually buying more stocks to burnish their surplus. That, in turn, is raising prices.

Some long-term solutions are the simplest, like conservation and efficient use of energy.

"People have gotten away from the message of the 1970s and 1980s in regards to fuel efficiency, and now it's coming back," Schlichting said.

Additionally, improvements in infrastructure -- ports, pipelines and storage facilities -- could reduce some of the cost because they would make it easier and cheaper to import fuels, he said.

The best sources of relief, some experts say, are alternatives to petroleum like compressed gas, ethanol, propane or possibly the extraction of oil from tar sands, a process that wasn't economically feasible when oil prices were lower.

Until either the global thirst for oil lessens or geopolitical events affecting oil supply are mitigated, the price for a barrel of oil will probably remain above $45, Lindemer said.

As a consequence, gasoline prices may not return to the $1 or $2 range common just a few years ago.

"At least for this driving season," he said, "we need to get our mind around $3 a gallon."

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