Gas prices spiraling - NO SLOWDOWN IN SIGHT: WAR FEARS, LOW INVENTORIES, HIGHER PROFITS ARE FACTORS

www.bayarea.com Posted on Thu, Feb. 27, 2003 By David A. Sylvester Mercury News

Soaring gas prices in the Bay Area -- averaging $2 a gallon in San Jose -- could go even higher after crude oil hit its highest price in 12 years Wednesday amid tightening supply and fears of war.

Crude oil surged to $37.70 a barrel in the New York markets, a price not seen since October 1990, when Iraq occupied Kuwait at the start of the Persian Gulf War. At the same time, the federal Energy Department reported oil inventories fell last week to the third-lowest level in at least 19 years.

That's pushing gas prices higher and, unfortunately, relief is not in sight.

Among the reasons prices are rising: fears of the loss of Iraq's oil during a U.S.-led attack; the unusually low inventories and tight supplies after a strike blocked oil from Venezuela; and higher profit margins among refiners and oil dealers.

Bay Area motorists are paying anywhere from an average of $2 for a gallon of regular in San Jose, to $2.12 in San Francisco, only pennies away from the highest prices last year. That's higher than both the state and national averages.

In California, some state refineries have cut production while they change equipment to produce the blend of gasoline used during the hot months of summer. The California Energy Commission reports that this conversion is temporarily tightening supplies in the state, making the cleaner-burning gas used here more expensive than normal.

But the biggest reason for the higher prices remains the threat of a war. Iraq sits atop the world's second-largest oil reserves, and serious damage to its oil fields could destabilize world markets.

``Until something gets resolved about Iraq, we're likely to see prices stay this high,'' said Severin Borenstein, director of the University of California Energy Institute in Berkeley.

So far, the oil markets are following the same pattern they did during the gulf war. After Iraq invaded Kuwait in 1990, prices jumped sharply, to $41.15 a barrel. After U.S.-led forces expelled Iraq from Kuwait, prices fell dramatically.

Whether prices fall again depends on how the war against Iraq proceeds, observers say.

Norman Higby, energy consultant at WMP Forecasts in Menlo Park, predicts prices will drop again after the conflict and stay below their current levels for the foreseeable future.

If so, it would help keep the economy out of a recession.

Keitaro Matsuda, senior economist at the Union Bank of California, said he believes the economy is strong enough to take ``some negative shock'' from the oil price increase.

``The question is how high oil prices might get and how long this will last,'' he said.

In the past two months, dealers and refineries have increased their operating margins -- which include their costs and their profits. Margins for dealers of branded gasoline have doubled, from 9 cents a gallon at the beginning of the year to 18 cents a gallon in late February, according to the California Energy Commission. For brand refineries, the margin rose from 27 cents a gallon at the beginning of the year to 36 cents in late February.

Dennis DeCota, executive director for the California Service Station and Automotive Repair Association, representing brand and independent gas stations, said margins are higher because stations are selling less gasoline.

``As a dealer's volume goes down, he has to increase his margin to stay in business and pay his rent to the oil company,'' DeCota said.

However, UC's Borenstein worries that the state is vulnerable to profiteering during gas shortages.

``The big question is: Is this a tight supply market or is this some sellers driving up prices? I don't know the answer. It's very hard to separate the two.''

Of all the reasons for higher prices, one possible cause has not apparently had much effect. Some oil analysts worried that prices might rise this year as California substitutes ethanol for an additive called MBTE in gasoline to reduce pollution. But so far, the change has not added to the price increases because ethanol is more plentiful than previously expected and cheaper than gas, said Rob Schlichting, energy commission spokesman.

Instead, California's relatively higher gas prices reflect the more refined type of gas used to meet stringent air quality controls.

``California gas tends to be more expensive because it has to go through a more expensive refining process,'' said Chris Kelley, spokesman for the American Petroleum Institute in Washington, D.C.

Contact David A. Sylvester at dsylvester@sjmercury.com or (408) 920-5019.