While inflation-adjusted gasoline prices may not reach the all-time record highs of 20 years ago, consumers are likely to chafe this summer over pump prices that are widely expected to surge beyond last year's spikes and reach numeric levels heretofore unfamiliar to U.S. drivers. Rising crude oil prices are usually the impetus to higher gasoline prices, since the cost of oil to refiners normally accounts for about 70% of the price of gasoline before taxes. However, so far this year soaring gasoline prices can hardly be blamed on higher crude costs or production strictures by OPEC. Though it cut its crude output by 1 million barrels per day in April, since then crude prices have been fairly stable against last year and record crude shipments have flooded U.S. ports. The high imports helped swell U.S. crude stockpiles more than 40 million barrels during the six weeks of April and early May, according to government and industry surveys. At nearly 322 million barrels on hand, "crude is in the middle of the five-year range," observes Michael Mayer, analyst with Prudential Securities. The single largest reason for the surge in gasoline prices and all the dire predictions is low refined product supply heading into the traditional start of the high-demand summer driving season. Despite record levels of gasoline production by refiners seeking to make the most of extremely high margins on gasoline, inventory surveys from industry and government both reveal spring gasoline stockpiles in the U.S. running well behind last year's low level. Though many refiners put plant operations on hold during the first quarter this year to complete delayed maintenance, refinery crude inputs reached the highest level ever for the quarter, up 3.5% from last year to 14.9 million barrels per day, according to the American Petroleum Institute. That kept domestic gasoline production at a strong 7.8- to 8 million barrels per day through the quarter, which nevertheless was unable to keep up with gasoline demand that averaged more than 8 million barrels per day. With the driving season only weeks away, refineries pushing operations near capacity have induced some large increases in gasoline inventory. By the first week of May, the API reported gasoline production at nearly 8.55 barrels per day-3% more than the same time last year. Meanwhile, imports of gasoline have also climbed significantly, according to the API. "However, gasoline inventories remain quite low," notes Mayer. With total stocks under 200 million barrels, the nation's gasoline supply remained in the bottom third of the five-year average inventory range, he says. "It is not a crude oil problem, it is a refinery problem," says a New York trader. "The trouble this year is finding a way of turning all the crude we have into the gasoline we need. That takes refineries and there aren't enough of them." The lack of gasoline in the U.S. is a problem of volume, says Jim Jordan, an analyst with Houston-based consultant DeWitt & Co. "It is extremely clear that the basic problem with gasoline is...one of a fixed supply system in a tight and growing market. We need new refineries with better processing units, but it takes at least two to three years to go through the process of design, permitting and construction." Refinery expansion work remains pretty thin, Jordan observes. Only 13 projects are currently under way that may eventually add as much as 1% to domestic gasoline output. "In the mean time, we must make do with what we have." Designer fuels And what we have is a melange of other factors that have also worked to restrict domestic gasoline volumes in recent years. The federal reformulated gasoline (RFG) mandate, which currently includes about a third of the nation's supply, requires four RFG formulas in different air pollution problem areas of the country among the traditional three grades of gasoline. These dozen fuel blends make it difficult or impossible to transfer product from region to region when local shortages surface. That problem manifested itself in headlines a year ago when pipeline trouble coincided with the introduction of EPA-mandated summertime Phase 2 RFG in some Midwest markets. A couple of pipeline breaks crimped gasoline shipments in and about the region, while refiners found they could not make as much of the low-vapor-pressure Phase 2 product, which sent Midwest gasoline prices soaring. The requirement for ethanol in gasoline in key markets Chicago and Milwaukee irritated the problem further, because refiners said the higher vapor pressure of ethanol made it even more difficult to blend the new RFG in those areas. The problem of summer RFG is again a heavy influence on gasoline prices this year. Although total gasoline inventories began to rise this month, RFG inventory and production continued to lag. "The gasoline deficit with last year is shrinking, but it's largely in regular finished gasoline," says a market analyst. "Reformulated supplies are falling further behind last year." RFG stocks in May were actually lower than in February At 39.82 million barrels in early May, national RFG stockpiles are nearly 3.3 million barrels behind last year's depleted level, according to the API. And regions that had trouble with supply last year report particularly pinched supplies again this year. In the first week of May, Midwest RFG stocks declined by nearly 500,000 barrels. Though the Bush administration has already announced it will relax fuel standards for ethanol-blended gasoline in Chicago and Milwaukee markets, wholesale and retail gasoline in the region are already the highest in the nation. To make matters worse for the region, Premcor shut its 80,000-barrel-per-day Blue Island, Illinois, refinery in February because the company was reluctant to make refinery upgrades that will be required by the government in coming years and was unable to sell the facility. The refinery was a producer of RFG for the Chicago market area. East Coast RFG, the basis for Nymex benchmark gasoline futures contracts, also reveals a disturbing deficit with last year's stock level. Eastern RFG stocks slipped 331,000 barrels in early May, down a whopping 3.58 million, or about 20%, from a year ago. Though the West Coast supply situation had improved markedly at press time, California refinery production could be threatened by the state's electricity crisis. California officials recently said San Francisco area refiners are on the list for inclusion in the state's rolling blackouts. The overall crimp in RFG products has produced a huge premium for RFG in U.S. markets over April, particularly for high-octane product. This has pushed RFG, recently running more than $1.08 per gallon on Gulf Coast spot markets, 12 to 15 cents per gallon above conventional unleaded product. At Chicago-area racks, wholesale RFG recently averaged 15 cents per gallon more than conventional. Why not more? But with such huge premiums, why are refiners not making more RFG? One answer is that it is expensive and hard to get blending components, particularly those that can add octane without boosting fuel vapor pressure. "That's why a blender would rather give up his wife than give up toluene," says one refining consultant. "It's getting harder to find, and they are moving to xylenes or a mix of xylene, and that has become costly too." Spot market prices for both additives recently climbed higher than $1.30 per gallon, up nearly 20 cents versus May 2000. MTBE is another gasoline component that analysts say has been costly to refiners and blenders this spring. Raging natural gas prices near the end of last year kept pressure on feedstock butane and methanol values, forcing many merchant MTBE-makers to reduce or eliminate output through December and January. Consequently, MTBE merchant producers slashed their January production to less than half of what it was the previous year, and overall U.S. MTBE production declined to the lowest level in more than half a decade. "Eighty to 85% of the RFG in this country requires MTBE," notes one fuel-market analyst. "Low MTBE inventory raised real questions about the ability of refiners to blend RFG and added to speculation that RFG would again be tight this summer." However, to say that the price of MTBE heavily influences gasoline is getting things turned around, insists DeWitt's Jordan. It is gasoline, instead, that exerts pressure on MTBE markets, because that is where MTBE draws its value. "So it is much more likely that rising MTBE prices are a symptom of constricted gasoline supply that is raising gasoline prices, rather than the other way around." In fact, MTBE production rebounded smartly in recent months. At the same time, MTBE Gulf Coast spot prices recently moved up into the $1.60-per-gallon range. Running more than 60 cents per gallon over conventional gasoline cash prices makes MTBE very expensive for blending, "but refiner demand is about as good as it's ever been," says Jordan. Despite significant constraints on production and rising demand, some market analysts see the worst-case scenarios and talk of $3-per-gallon retail prices as generally overblown. "With each weekly report, U.S. inventories to us seem to move closer to more comfortable levels," concludes Deutsche Banc Alex. Brown analyst Adam Sieminski.