Why Gas Costs So Much in Oil-Rich Alaska

Alaska produces more oil than any other state in the country except for Texas. Alaska has higher gasoline prices than any other state in the country, period. Alaskans are flummoxed and mad. A few state legislators are talking about regulating fuel prices. You don't often hear calls for more government regulation in the land of Sarah Palin.

Alaska's situation raises intriguing questions about the economics of oil and gasoline. When gasoline prices are perceived to be too high, such questions regularly come up, sometimes with an accusatory flavor garnished with mutterings about price gouging and oil industry conspiracies.

Let's compare two states - Alaska, which produces some 700,000 barrels of oil per day, and South Carolina, which produces no oil to speak of. In Anchorage, gasoline costs around $3.25 per gallon. In Charleston, gas costs about $2.50 per gallon.

Why the big difference? Why are fuel prices higher in a state where oil is plentiful than in a state that relies on outside suppliers for all its petroleum products? What does it cost to deliver a gallon of gasoline to customers at the pump? How are gasoline prices set?

There are four leading components of gasoline costs - crude oil, taxes, refining, and distribution and marketing.

Start with crude oil, which accounted for about half the cost of gasoline, on average, between 2000 and 2008, according to the U.S. Energy Information Administration.

Very important to remember - crude oil prices are set in a global market. Anything that happens anywhere in the world that affects supply or demand will show up in the cost of crude oil. If a sizzling Chinese economy boosts oil demand, or if turmoil in the Niger River Delta reduces supply, or if Wall Street speculators bid up the price of oil futures, look for the cost of crude to go up.

Don't forget OPEC. The Organization of Petroleum Exporting Countries is a cartel made up of 14 countries, whose oil ministers meet periodically to manipulate supply and control prices, collusive behavior that would land U.S. executives in the hoosegow.

Consumers should have a few grains of salt handy when U.S. politicians claim that the answer to high gasoline prices is all-out domestic oil production, environmental stewardship be damned. The "Drill, Baby, Drill" lobby seldom mentions that new U.S. oil wouldn't be priced in a national market. It would enter a global pool, which serves worldwide demand totaling more than four times U.S. consumption and is subject to market influences over which the U.S. has little control.

If crude were priced in a national market, an extra million barrels per day from the Arctic National Wildlife Refuge, for example, would likely make a significant difference in moving crude oil prices. In the global pool, which is where Arctic refuge oil actually would be priced, it would have much less pricing influence.

A 2008 analysis by the Energy Information Administration bears this out. The EIA estimated that in a best-case scenario, oil production from the Arctic National Wildlife Refuge would reduce oil prices by, at best, $1.44 per barrel by 2027. Oil today is running at more than $80 per barrel.

The next largest component of gasoline costs is local, state, and federal taxes, which accounted for an average of about one-fourth of gasoline's cost between 2000 and 2008. The federal gasoline tax is 18.4 cents per gallon. State gas taxes vary, but they don't explain the dramatic difference between Alaska and South Carolina gasoline prices. South Carolinians pay 16.8 cents per gallon in state gas taxes. Alaskans pay only 8 cents.

Refining, distribution, and marketing account for the remaining one-fourth of gasoline costs. These are the points in the gasoline food chain that explain the price difference between Alaska and South Carolina. It's all about market forces. Proximity to refineries, pipelines, and bulk storage terminals influences gasoline prices. At the retail level, prices are influenced by dealer costs, traffic patterns, and dealer supply sources.

South Carolina receives gasoline via two competing pipelines from the Gulf Coast, where 37 percent of gasoline produced in the U.S. originates. The Port of Charleston also receives shipments by tanker and barge. When hurricane-linked gasoline shortages panicked much of the Southeast in 2008, Charleston had few supply problems, thanks to the port.

In Alaska, competition in refining and distributing gasoline is limited. Two refineries, which are small as such industrial beasts go, produce most of the gasoline used in the Great Land. Incidentally, it might surprise Alaskans proud of their state's oil industry to learn that the larger of the two refineries buys a significant fraction of its crude oil feedstock from foreign suppliers.

A 2009 report from the state attorney general's office characterized Alaska's gasoline market as an oligopoly, whose members have significantly more pricing power than merchants in more competitive markets. The state's gasoline market is too small and remote to attract outside suppliers that could stir up more competition for Alaska's retail fuel dollars.

As the state AG's report observed: "We do not live in a cost-plus society. Sellers are not required to price their goods and services based on what it costs to acquire them, plus a 'reasonable' profit. Instead, sellers can and do price their goods according to market conditions."

Nothing personal, oil executives might say. It's just business, in Alaska, South Carolina, and everywhere else

Something for drivers everywhere to remember the next time gasoline prices shoot up.