If you can’t join em, beat ’em: The day that Gasoline went Clean, and got Whacked. Part II

In 1970, an oil company launched the first major ad campaign around environmental benefits of a new fuel formulation.

Then, a radical shift in gasoline pricing occurred just as those remarkable ads went off the air.

What were lessons that industry learned about alternative fuels? How might it be still impacting us today? 

The Digest investigates. Part 2, today.

Part I of our story is here.

The change since 1970

While it could be coincidence, the price of gasoline relative to the cost of a barrel of crude oil has been falling sharply since it reached a 25-year high in 1970.

Back in 1970, a gallon of gasoline averaged $0.36 at retail and a barrel of crude oil averaged $1.80, according to the Energy Information Administration. Given that roughly 19 gallons of gasoline are produced from each barrel (the remainder being diesel, kerosene, petrochemical feedstocks, waxes, etc), the gasoline component of the barrel was worth around $7.11 at retail.

(Note to readers: Refiners get the wholesale price, not the retail price — the latter includes a retail mark-up, and taxes. We’ve focused this article around retail prices because they are more comprehensively available from EIA, and are sufficient to demonstrate a price trend. But take this into account, and try not to get hung up on a specific “value in a barrel”, please).

Starting in 1971, the relationship of gasoline prices to crude oil prices began to change dramatically. Though the first oil shock would not come until October 1973, the value of the gasoline (at retail) was down to 287% of the value of the barrel by 1972, and 198% in 1973.

By 1986, after the fading of the 1970s oil shocks, the value of the gasoline was down to 117%, at retail, of the value of the barrel. By 2013, it had fallen to 76 percent.

Gasoline at $18.25 a gallon?

(Note to readers: The Digest is, if you hadn’t noticed, not a peer-reviewed journal with articles written by teams of PhDs, where every possible variable (e.g. oil crises, changes in taxation, changes in retail markups, recession, oil booms, etc) has been controlled for. This column is based upon simple charts comparing retail gasoline prices to crude oil prices, drawn from public sources. So we’ll draw conclusions with that in mind, and you might do so also.)

One thing is clear. The relationship between retail gasoline prices and the value of crude oil began to change dramatically — starting in 1971, not with an oil crisis. And has continued to change despite war, energy shortages, energy booms, prosperity, or economic setback.

It would be fair to say that, if gasoline at retail was priced so that it has the same relationship to crude oil prices today, as in 1970, the average retail gasoline price last year would have been $18.25 per gallon.

It would also be fair to say that, if that were the case, we would be having a completely different national discussion about alternative fuels and fuel-efficient vehicles, today.

The problem of bundles

So, here’s the temptation. You might take the view that gasoline is increasingly subsidized by the rest of the customers for the barrel. Or, by the profits available in upstream oil exploration that creates the barrels of crude in the first place.

If so, we run into the problem of bundles. You might remember the battle between Netscape and Microsoft back in the 1990s, when Netscape had completed one of the most astonishing IPOs in history because of its initial success with the Netscape Navigator web browser. In 1996, Navigator cost $49 per license (though you could get a free version, bundled with some internet service provider contracts).  Subsequently Microsoft incorporated its own Internet Explorer web browser as an included element in each copy of the Windows operating system.

So, you could buy Navigator, or simply use IE for free. Microsoft ran into a lot of legal flak for its bundling strategy, but ultimately Netscape was effectively put out of business as a commercial concern.

Could one raise the same concerns about renewable fuels and fuel-efficient vehicles? That they are being priced out of the market because the competitive product is part of a bundle, where the competitor has other ways to extract profit and can sell gasoline at a fraction of what it used to, compared to the price of the barrel.

There’s evidence to be considered here, that supports that line of thinking. But evidence is not proof.

Over in the world of ethanol

Interestingly, some supporting evidence comes from the renewable fuels side of the equation. Field corn provides a comparable example, because growers of field corn also invest substantially in ethanol-production assets. So we have a case where the same grower is invested in upstream feedstocks and also in refining and marketing.

In the case of corn ethanol, we also see rising feedstock prices over time, and the fuel representing less and less of the value of the bushel.

In 2005, the year that the Energy Policy Act was signed in the wake of President Bush’s “addicted to oil” speech, the retail price of E85 fuel (adjusted upwards to represent a gallon of gasoline equivalent, to account for the lower energy value of ethanol) was $1.85, and there was $3.30 in fuel, at retail value, per bushel of corn

(Note to readers: we incrementally adjusted the ethanol yield per bushel from 2.7 to 2.9 between 2000 and 2013 to take into account new technology that improved yield per bushel.)  

That’s 177% of average cost that year for a bushel of corn, which was $1.86. By 2013, though fuel prices have increased and there was $8.48 in retail fuel value per bushel, E85 had a total value of 138% of the bushel of corn.

(Note to readers: this isn’t a perfect comparison, either. For one, E85 contains 15% or more gasoline by volume. So, you might benefit from staying away from quoting these “values per bushel” as if they were spelled out in the Gospels.  But it illustrates a trend — the shift in value towards the upstream.)

The Bottom Line

Had the FTC not stepped in in the 1970s, in the name of protecting consumers from overly simplified ads addressing complex environmental opportunities — who knows what the oilcos might be doing now?

The oil majors certainly saw a sharp shift in demand towards cleaner fuels then — a green preference— and we’ve seen rapidly falling gasoline values since then. You may well conclude that, to an extent that could be debated until the end of time, consumers have been drugged by a cheap fuel policy that keeps oil exploration alive. Were gasoline to be priced in the same way today, relative to the price of a barrel of crude, as in 1970 — we might well be deploying affordable alternatives to $18.25 gasoline right now, if not long ago.

We also see more value shifting to upstream exploration, to the feedstocks. The money’s shifted from the pump to the barrel. If you were to draw a conclusion (gingerly) you might conclude that our economy is not addicted to oil, it is addicted to oil exploration. And part of that reason is that the going proved too tough to message effectively about transformative progress toward cleaner fuels, all those years ago.

A challenge that remains today.

Note for data hounds: We’ve appended our gasoline, crude oil, E85 and ethanol price data is here — the crude and gasoline numbers are included below.