Why Do Gas Prices Rise in Summer?

AgMRC Renewable Energy Newsletter
February 2010

Cole Gustafson
Professor, Biofuel Economics
Co-Director, BioEnergy and Products Innovation Center
Department of Agriculture and Applied Economics
North Dakota State University
cole.gustafson@ndsu.edu

I am writing this article as North Dakota enjoys a reprieve from the record cold weather of early January. Gas prices have risen during the past few weeks to around $2.69 per gallon in Fargo. While national oil prices are dropping under $78 a barrel, it is possible that gasoline and diesel prices will moderate as we approach spring. As spring and summer appear on the horizon, we normally expect gasoline prices to increase. Interestingly, the reason why they increase might surprise you.

Traditionally, gasoline prices rise in the summer because more people travel and take longer vacations. Economists refer to this as increased demand, which leads to higher prices if suppliers only produce a fixed quantity of gasoline. This used to be partially true, but people are now more mobile in general, take vacations throughout the year and fly to destinations rather than drive. Therefore, the miles people travel during the year is relatively stable. The “people traveling more” argument isn’t as important a factor as it used to be.

What is a more important reason is environmental regulation. Since 1990 under the Clean Air Act, the Environmental Protection Agency (EPA) has required the use of reformulated gasoline blends during April through September in major metropolitan cities. This fuel costs more to produce, so it leads to higher gas prices during the summer months. The EPA has estimated the impact to be 2 to 4 cents per gallon. However, this only partially explains the summertime increase.

In addition, the reformulated fuel sold during the summer months doesn’t provide purchasers with the same mileage as winter blends. Therefore, more fuel has to be purchased to drive the same miles. This increase in quantity of fuel purchased also leads to higher prevailing market prices.

Economists also found that petroleum companies have more market power during the summer because of this environmental regulation. Rather than have a single summertime blend, each major city has a unique formulation tailored to mitigating its individual air pollution problem. These unique blends make it difficult to ship fuel from surplus to deficit areas, which would moderate price spikes. Consequently, petroleum companies have more regional monopoly power during the summer months than in winter.

Finally, engineering studies have found that it is quite costly for petroleum refiners to switch from one seasonal blend to another. In addition to reconfiguring their production plants, refiners also need additional storage to segregate both blends and prevent comingling. The investment cost of this additional equipment places even greater pressure on summer blend prices.

I recently attended a national economics conference where three independent studies concluded that, while refineries have dutifully complied with the Clean Air Act and provided reformulated fuels during the summer months, the policy has not resulted in cleaner air. The policy does not specifically direct how refiners must lower volatile organic compounds, so the refiners select the most inexpensive way, which does little to improve air quality. Consequently, consumers are bearing the cost of the environmental policy without deriving any appreciable benefit.

Sources

NDSU Agriculture Communication, Cole Gustafson, (701) 231-7096, cole.gustafson@ndsu.edu

Rich Mattern, (701) 231-6136, richard.mattern@ndsu.edu