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How Will the War on Terrorism Affect Fuel Prices?

Watch Out for Price Volatility as the War Enters Its Later Phases

November 2001, by Mike Antich - Also by this author

It look less than an hour-and-a-half after the terrorist attacks of Sept. 11 before reports began to surface of price gouging by gasoline stations in California, Illinois, Indiana, Michigan, North Dakota, and Oklahoma. Some stations were charging as much as $5 a gallon before the stale attorney generals stepped in and threatened to sue for consumer fraud. But this was not a glimpse of things to come.

As of this writing, the events of Sept. 11 and the subsequent retaliation in Afghanistan have actually contributed to a decrease in fuel demand. Presently, there is an oversupply of aviation fuel, the supply of gasoline is higher than last year’s stock levels, and the pre-existing slowdown in the U.S. economy has lowered overall demand for fuel by industrial users.

However, it is the probability of expanded U.S./coalition military operations and potential counter-strikes by terrorists that threaten to increase pricing volatility over the next few years, especially if the war expands in its later phases to Iraq or other oil-producing countries identified as supporting terrorist activities. This has a probability of disrupting the flow of oil, which will impact the U.S., since currently more than half of our daily petroleum supply is imported. In addition, large-scale military activities beyond Afghanistan for sustained periods would divert fuel supplies away from consumer use. This would add a new demand element for oil supplies as the U.S. and coalition militaries consume higher-than-normal quantities of fuel.

There is precedent for making these statements. From 1973 to 2001 there have been live major escalations of gasoline prices - all but one the result of wars. They were the Arab oil embargo in 1973 following the Mideast war of that year, the Iranian revolution in 1978, the Iran and Iraq war in 1980, and the Gulf War in 1990. The fifth run-up in prices occurred in 1999 following the simultaneous OPEC production cuts and the increased demand for fuel from Asian economies recovering from recession.

Although the U.S. Department of Energy has not increased the supply of oil for the Strategic Petroleum Reserve, which currently holds 564 million barrels of oil in four sites in Texas and Louisiana, oil analysts do not regard this as a sign of near-term fuel stability. Rather they view it as a manifestation of bureaucratic delay and uncertainty. Congressional initiatives are underway to increase the number of barrels in the Reserve, which, short-term, would represent another new demand element for oil supplies.

The Near-Term Concern is Refining Constraints

What complicates matters are the pre-existing weaknesses in our fueling infrastructure. Regulations and public pressure are such that it has been impossible to build an all-new refinery in the U.S. since mid-’70s. This has resulted in limited refining capacity, especially for the production of reformulated gasoline, which has increased the frequency of spot shortages. For instance, California fuel prices are volatile because there are few sources of its unique blend of gasoline outside the stale. California refineries need to be running at near full capacity in order to meet the state’s fuel demands. If more than one of its refineries experiences downtime at the same time, California’s gasoline supply becomes very light and prices soar, as when a fire occurred at a Tosco refinery in the Los Angeles area in April 2001. Another example of our limited refining capacity occurred in the Midwest in the summer of 2001. One of the key factors that led to the run-up in gas prices, which lopped $2 per gallon, was that the Midwest uses ethanol reformulated gasoline. Few refineries outside the Midwest produce this reformulation, making the Midwest vulnerable to price spikes when supply problems occur, especially during the summer when inventories are at their lowest.

However, not all fleets will be affected equally by pricing volatility. Retail gasoline prices lend to be higher in certain states than others. For instance, the least-expensive gas prices are usually in Atlanta because Georgia has the lowest taxes on gasoline in the country. In addition, your proximity to oil supplies also influences retail prices. For example, the areas farthest from the Gulf Coast (the source of nearly half of the gasoline produced in the U.S.) lend to have higher prices than those that are closer. Plus, if you operate vehicles in areas where reformulated gas is mandated, the cost, on average, is 3 to 5 cents more per gallon than conventional gasoline.

Roller Coaster-like Volatility

Secretary of Defense Donald Rumsfeld has described our current political/military situation as being analogous to a game of billiards. He said, “When you hit a cue ball it is difficult to predict how the other balls will careen.” Although there is no predicting how fuel prices will careen in the future, my assessment is that all the necessary ingredients are in place for us to experience a recurring roller coaster-like volatility of peaks and valleys in the price of fuel.

Let’s hope that I’m wrong.

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