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Next to the skyline of downtown Minneapolis, a gas station sign displays a price of $2.49 for regular unleaded gasoline.

As the price of a barrel of oil continues to soar, gas prices in the Twin Cities--including at this station on University Avenue near I-35W--rose accordingly.

Fuel for thought

By Andrew Bacskai

Published on August 10, 2005; updated August 17, 2005

Oil prices in the United States hit an all-time high on Monday, August 15, when the cost of a barrel climbed to $67. That, in turn, has led to gasoline prices at or near record highs in Minnesota and across the nation. Gas now averages $2.55 a gallon nationwide.

"We may be in for an era when we never again see a barrel of crude oil under $45," says Alfred Marcus, Carlson School of Management professor of strategic management and organization. As a result, he adds, consumers shouldn't expect escalating energy costs to recede back to the more pocketbook-friendly levels they've enjoyed for most of the past three decades. "I don't think we're going to see gasoline prices much below $1.85 per gallon for the next 15 years, and I'm being really safe on the low end. It likely will fluctuate between $1.85 and what I imagine could be up to $3.50 or even more."

Marcus and Akshay Rao, Carlson School professor of marketing and logistics, agree that ascending oil prices are being fueled by two main sources: dramatically increased demand, especially from such developing nations as China, India, and Brazil, and constrained refining capacity. "If people think the reason why energy prices are high right now is because we're running out of oil in the short term," Marcus says, "that is a mistaken impression. Rather, the capacity to refine oil is extraordinarily low."

"The price of oil is not fixed purely by supply and resources," Rao says. "It's also fixed by the supply chain--the entire process of converting raw crude to gasoline."

Rao explains that certain nations, chiefly China and India, are developing at about twice the rate of the United States. To nourish this growth, these countries need petroleum products such as gasoline to fuel cars and petrochemical products for industrial production. China consumed an average of one million additional barrels of oil a day in 2004, according to the Energy Information Administration, an independent agency within the U.S. Department of Energy.

"Here's the double-edged sword the United States faces from a geopolitical standpoint: we need those markets to purchase our products and to supply our economy," Rao says. "But when that development starts, it creates increased competition in the world market for scarce resources, such as oil."

So why not increase supply? Marcus says, "There are still large supplies in the ground--existing reserves that we know about and probably a lot of undiscovered reserves." However, extracting more oil from the earth won't immediately boost supply. Once acquired, crude oil is refined, a process in which it's converted into gasoline, diesel fuel, heating oil, jet fuel, and many other products. But the world's refineries already are running at full capacity; additional refining capacity is nowhere in sight, Marcus says.

"The price of oil is not fixed purely by supply and resources," Rao says. "It's also fixed by the supply chain--the entire process of converting raw crude to gasoline."

Absorbing the shock

Compounding the problem for American consumers is the fact that increased oil costs translate into more than just higher prices at the pump. "Gasoline is inflationary," Rao says. "If I raise the price of gas, this raises the price of the shipment of goods. It's amazing how many industries that affects--railroads and trucking are the primary victims. And then everything they carry has a price increase, from nuts and bolts to clothing to food to tractors and cars."

Marcus is optimistic about the American economy's ability to withstand the current fuel shock. Similar energy-price spikes in the 1970s ignited inflation and an economic downturn. Today, conversely, "we're much less dependent [on gasoline]," he says. "Cars are lighter. Buildings make less use of oil for heating purposes. Our industrial base is less manufacturing-intensive, so it makes less use of gasoline. We're more of a service-based economy and we don't use as much energy to make a unit of Gross Domestic Product as we did in the 1970s. So in that sense, we're in much better shape."

"I think we're also better off," he adds, "because there have been extraordinary advances in technology that the higher prices will spur. A lot of those technologies, [such as the hybrid car] are right there, right now--they're not futuristic."

Edited from Insights@Carlson School, July 2005, a publication by the Carlson School of Management.