EIA study concludes that changes at U.S. refineries are not responsible for increasing premium-to-regular gasoline retail price spread
Between 2010 and 2017, the U.S. average retail price difference between premium gasoline and regular gasoline doubled, from approximately $0.25 per gallon (gal) to $0.50/gal (Figure 1). However, in the 15 years before that period, from 1995 and 2010, the U.S. average premium to regular price spread increased $0.05/gal. The more recent price spread may be the result of a change in U.S. refinery operations or retail gasoline pricing dynamics.
The U.S Energy Information Administration (EIA) commissioned Baker & O’Brien, Inc. to conduct a two part study, Analysis of Octane Costs, to examine the possible changes in U.S. refinery operations that would result in the increasing price differential between premium gasoline and regular retail gasoline prices since 2010. Baker & O’Brien’s analysis concludes that the increasing premium-to-regular gasoline retail price spread is not the result of a change in the cost to produce higher octane gasoline at U.S. refineries.
Gasoline has many different attributes and specifications. Of those specifications, a gasoline’s octane rating, which measures the fuel’s ability to withstand compression without pre-igniting, is what separates different grades of gasoline at the retail level. In the United States, the price difference between regular gasoline with an octane rating, or Anti-Knock Index (AKI), of 87, and premium gasoline with an AKI of 91 has been increasing.
The increasing spread between premium gasoline and regular gasoline has occurred in all Petroleum Administration for Defense Districts (PADD) across the country—though to varying degrees. The gasoline price spread between premium and regular gasoline is largest in the Midwest (PADD 2) with an average difference of $0.56/gal in 2017, up $0.34/gal from 2010. The price difference between premium and regular gasoline on the West Coast (PADD 5) grew the least, up $0.08/gal, from $0.23/gal in 2010 to $0.31/gal in 2017 (Figure 2).
EIA retained Baker & O’Brien to analyze the factors and conditions resulting in the increasing price spread between premium and regular gasoline. The opinions and findings in this report are based on Baker & O'Brien's experience, expertise, skill, research, analysis, and related work to date.
In Phase 1 of the study, Baker & O’Brien’s analysis concludes that the increasing premium-to-regular gasoline retail price spread is not the result of a change in the cost to produce higher octane gasoline at U.S. refineries.
Baker & O’Brien’s analysis centered on reformer units at U.S. refineries. Reformer units convert low-octane naphtha into the high-octane gasoline blendstock reformate. Reformer units are one of the primary determinants in the incremental costs of producing octane.
Because U.S. production of mostly light-sweet crude oil from shale formations has increased since 2010, domestic refineries have increased the share of light-sweet domestic crude oil they process. Many of the light-sweet shale crude oils yield larger portions of naphtha and other low-octane gasoline blendstocks when processed at refineries. As a result, U.S. refinery net production of naphthas and lighter oils has increased since 2012.
The increased supply of naphtha has, in turn, decreased the cost of feedstocks (naphtha) for reformer units at U.S. refineries. With lower feedstock costs, U.S. refiners have increased reformer throughputs and slightly increased reformer severity, converting the surplus naphtha supplies into high-octane gasoline components.
Baker & O’Brien’s analysis found that the increased supply of high octane components from increased reformer throughputs and severity caused the spread between regular gasoline and premium gasoline at the wholesale (spot) level to narrow. Excluding a few brief periods of higher octane spreads as a result of temporary conditions, such as refinery outages, a narrowing spot market spread between regular and premium gasoline prices started in 2013 and has continued through the study period. A narrowing price spread between regular gasoline and premium gasoline in the spot market, or the first point of sale after being produced in a refinery, indicates decreasing costs of producing octane at U.S. refineries, not increasing.
Further analysis of regular gasoline and premium gasoline prices at the rack, or distribution terminal level just before delivery to retail stations, also failed to find any significant change since 2010 to account for the increasing regular-to-premium retail gasoline price spread.
Baker & O’Brien also analyzed changes in demand, or consumption, patterns that may explain the increasing regular-to-premium retail gasoline price spread. Baker & O’Brien concludes that no major shifts in U.S. gasoline consumption have occurred, and consumption shifts were unlikely to have been significant contributing factors in the increasing premium-to-regular retail gasoline price differential. Baker & O’Brien also concludes that changing engine design trends to more car models requiring premium gasoline or higher octane gasoline does not appear to have been a significant contributing factor in the premium-to-regular retail gasoline price differential.
This study is not an examination of pricing dynamics of retail motor gasoline markets. However, Baker & O’Brien identified two factors not included in the scope of this study but could be contributing to a widening regular-to-premium gasoline retail price spread.
One factor could be different asymmetrical price movement tendencies between regular gasoline and premium gasoline prices. The theory is a variation on the rockets and feathers hypothesis (Bacon, 1991) of asymmetric petroleum product pricing, where regular prices and premium gasoline prices both increase at similar speeds, but premium prices fall slower than regular gasoline prices.
A second possible contributing factor is the search and adjustment cost theory, which contends that the consumer could have less price transparency for premium gasoline prices compared with regular gasoline prices. Less price transparency leads to higher search costs to discover the most competitive premium gasoline prices compared to regular gasoline.
In Phase 2, Baker & O’Brien analyzed whether or not the U.S. domestic refining industry would be capable of meeting higher octane demand if the octane requirements for retail gasoline increased. The scenario assumes that, beginning with model year 2023, all light-duty vehicles in the United States will require a minimum 95 research octane number (RON) gasoline. Baker & O’Brien concluded that, in 2022, no significant changes in refinery configuration or throughput would be required to meet the minimum 95 RON gasoline requirement. Furthermore, Baker & O’Brien found that existing U.S. refineries would be able to supply the increased octane requirements in 2027 with minor operational adjustments combined with a projected decline in U.S. gasoline consumption based on EIA’s 2018 Annual Energy Outlook.
U.S. average regular gasoline and diesel prices decrease
The U.S. average regular gasoline retail price decreased more than 7 cents from last week to $2.54 per gallon on November 26, 2018, up less than 1 cent from the same time last year. Midwest prices fell more than 10 cents to $2.31 per gallon, Gulf Coast prices decreased more than 9 cents to $2.22 per gallon, East Coast prices fell nearly 6 cents to $2.50 per gallon, West Coast prices decreased 4 cents to $3.31 per gallon, and Rocky Mountain prices fell more than 3 cents to $2.80 per gallon.
The U.S. average diesel fuel price decreased more than 2 cents from last week to $3.26 per gallon on November 26, 2018, 34 cents per gallon higher than a year ago. Midwest prices fell more than 3 cents to $3.19 per gallon, West Coast prices decreased nearly 3 cents to $3.74 per gallon, Rocky Mountain prices fell more than 2 cents to $3.34 per gallon, East Coast prices fell nearly 2 cents to $3.28 per gallon, and Gulf Coast prices decreased 1 cent to $3.04 per gallon.
Propane/propylene inventories decline
U.S. propane/propylene stocks decreased by 0.6 million barrels last week to 81.1 million barrels as of November 23, 2018, 2.5 million barrels (3.0%) lower than the five-year (2013-2017) average inventory level for this same time of year. Midwest inventories decreased by 0.6 million barrels and Gulf Coast inventories decreased by 0.5 million barrels. East Coast inventories increased by 0.3 million barrels and Rocky Mountain/West Coast inventories increased by 0.1 million barrels. Propylene non-fuel-use inventories represented 5.1% of total propane/propylene inventories.
Residential heating oil prices decrease, propane prices remain flat
As of November 26, 2018, residential heating oil prices averaged $3.27 per gallon, 4 cents per gallon less than last week’s price but almost 43 cents per gallon higher than last year’s price at this time. The average wholesale heating oil price for this week averaged $2.05 per gallon, nearly 14 cents per gallon less than last week but 1 cent per gallon higher than a year ago.
Residential propane prices averaged $2.42 per gallon, less than 1 cent per gallon lower than last week and more than 1 cent per gallon lower than a year ago. Wholesale propane prices averaged $0.86 per gallon, almost 5 cents per gallon less than last week and 26 cents per gallon lower than a year ago.
