Studying how gas prices change - They shoot up, but flutter down

www.sfgate.com Verne Kopytoff, Chronicle Staff Writer Sunday, March 16, 2003

Don't hold your breath for gasoline to get cheaper if and when oil prices tumble from near their 12-year highs.

Costs at the pump may rise like a rocket, but they fall more like a feather.

At least that's the view of some economists who have found a curious disparity in gas prices. Sudden spikes at the pump because of higher oil costs are usually followed by leisurely declines, their research shows.

"Firms are pretty quick to raise gas prices," said Severin Borenstein, director of the Energy Institute at UC Berkeley and co-author of one of the studies. "They try to hold onto them even when crude prices go down, until customers force them down by shopping around."

Borenstein and his co-authors found that a rise in oil prices is fully passed on to drivers in two to four weeks. But declines in oil prices take six to eight weeks to reach the pump.

For example, California's gas prices rose roughly in step with oil prices in the winter of 2000. But the pattern changed substantially when prices began to decline.

Oil dropped sharply during March. Gas prices, following the usual lag of up to a month behind oil, also began to drop, but far more gently, over two months instead of one.

A couple of somewhat similar examples occurred later in 2000.

It's too soon to say whether the current gas spike will follow the rocket and feathers theory. That will become evident only after oil prices decline significantly.

Gas prices have become a burning issue for drivers now that a gallon of regular unleaded has soared to record highs across the Bay Area. As of Friday, a gallon of unleaded averaged $2.27 in San Francisco, up 71 cents from a year ago, according to the AAA of Northern California.

The increase in oil costs is partly to blame amid tensions over Iraq and a worker strike in Venezuela. But local issues are also a factor.

In California, refiners are switching from making their winter blend of fuel to a summer blend, which causes less smog in hot weather. Production usually drops during these annual adjustments.

In addition, the state's refineries are changing from the smog-reducing fuel additive MTBE to ethanol. The retooling and the inherent properties of the new fuel blend add some extra costs.

At such times, consumers tend to suspect that they are being gouged. Indeed,

oil companies such as ChevronTexaco, based in San Ramon, usually have bigger profits when crude prices jump.

But the reason for prolonged high gas prices is complex, defying simplistic accusations of collusion. Researchers disagree on whether the rocket/feathers phenomenon exists at all and on whether anyone actually profits much.

It's unclear who first suspected that gas and oil prices sometimes get out of whack. What is certain is that a forest of trees has been felled on the topic by researchers who have looked at every step in the petroleum supply chain over a range of different periods.

Borenstein's study -- which used the Gulf War era of 1990 and 1991 as a model -- reveals a market that is out of kilter. And because of the imbalance, consumers end up paying a few cents more for a gallon of gas during periods associated with falling oil prices than they otherwise would.

Who's responsible? Borenstein said the price disparity arises between the time service stations buy gas from wholesalers and when they sell it to consumers. The service station owners, many of whom operate independently, resist lowering prices for the short run simply because they can, Borenstein said.

What allows this temporary latitude is that consumers don't immediately know where to find cheaper gas. Furthermore, drivers are confused by the frequency of changing gas prices.

"The retailers aren't absolutely competitive," Borenstein said. "It costs drivers money and time to shop around, so they don't do it."

Contributing to high fuel costs is the wholesale spot market for gas. Spot prices take up to two weeks to catch up with declines in oil, Borenstein said.

But he added that such a lag isn't unusual. Spot prices are equally slow to rise when oil gets more expensive, he found.

Eventually, gas prices catch up with the falling cost of crude oil, Borenstein said. The entire cycle then repeats itself during the next price spike.

Gas is not the only commodity whose prices sometimes become unbalanced when rising rather than falling. Others with similar tendencies include oranges, some fresh vegetables and some meats, according to various studies.

But John Felmy, an economist for the American Petroleum Institute, an oil industry trade association, disputed that gas prices fall within that category.

He said many researchers have in fact failed to find a lag in gas prices, or at least lags that have a financial impact on consumers.

Despite what consumers may think, the oil industry is not engaging in price gouging, Felmy said. Drivers, he said, are simply confused because they pay more attention to rising prices than declining prices.

"Prices going up generate such a visceral reaction in people," Felmy said. "Prices going down are a different story."

Felmy's more benign views of gas prices are corroborated by other independent sources. Among them are researchers from Texas A&M University, the Federal Reserve Bank in St. Louis and the Energy Information Administration, an arm of the Department of Energy.

All of them have found that fuel prices move in concert with oil or other parts of the petroleum food chain. The links in the chain sometimes do get tangled, some of them said. But it all evens out in the end, they say.

"It seems to wash out," said Michael Burdette, a senior analyst for the Energy Information Administration.

Borenstein agrees, to a point. He said that service stations make only modest amounts of money from the rocket and feathers phenomenon, not a bundle.

Service stations don't make as much money during spikes in gas prices, Borenstein said, but they recover those profits -- and a little more -- by cutting prices slowly when their supplies become cheaper.

In any case, Borenstein said the effect of temporarily higher gas prices on drivers is relatively minor. He said a typical driver spends only a couple of extra dollars because of unbalanced prices as a spike runs its course.

"In the grand scheme of things, this isn't a big deal," Borenstein said. "The fact that gasoline prices go down a little less than they go up doesn't cost that much money."

He said he's more concerned about limited competition among California's oil refiners, of which there are only seven major players.

Borenstein also said another problem for Californians is that these refiners are capable of producing only just enough to satisfy demand. If a few of the refineries are shut down because of an accident or maintenance, prices can skyrocket.

E-mail Verne Kopytoff at vkopytoff@sfchronicle.com.