Why is the Fed so worried about inflation?

Why are the oil refinery earnings down and the stock prices falling? I thought we had a shortage of refineries here. Are they being restricted from raising their prices at the pump?
— Mary S. Milwaukee, Wisc.

We may have a shortage of refineries when gas is cheap, but higher pump prices have begun to have the kind of impact you would expect: people are figuring out how to get more out of every gallon of gasoline. Some are switching to higher mileage cars. Others are taking public transportation if they can. Still others are combining trips and skipping the Sunday drive.

As a result, the total number of miles driven — even as the driving population increased — was flat last year (after falling 1 percent in 2006.) So the strong demand that was putting pressure on pump prices earlier in the decade is easing.

Supplies, on the other hand, are in better shape than they’ve been in years. While there may have been no new refineries built in the U.S. 30 years, the ones that are up and running have been gradually increasing production during that period — by squeezing a little more capacity every year with new technology and equipment. The industry has also gotten past some fairly serious supply interruptions over the past few years caused mainly by those nasty hurricanes in 2005 and the switch to ultra-low sulfur diesel last year.

Gas dealers and wholesalers are also getting more product from overseas; imports of gasoline and diesel have risen by about a third over the past five years, according to the Energy Dept.

There’s also more ethanol production coming online — which tends to increase the overall supply of motor fuel and keep prices from rising further. But the total amount of ethanol produced is still a small fraction of the total gasoline consumed. The market for ethanol is also limited because — except for use as a gasoline additive — it’s not available in most parts of the country.

Meanwhile, gasoline refiners have been paying top dollar for oil as the price of crude has risen to $100 a barrel. If demand at the pump is soft (as it usually is this time of year compared to summer) and the cost of crude for making gasoline goes up, that puts a squeeze on refiner’s profit margins.

All of which means that profit margins for gasoline refiners have been falling — and may have further to go. Eitan Bernstein, who follows the industry for Friedman, Billings, Ramsey, recently estimated that refiners this year, on average, will make about $14 per barrel of crude they refine — down from $17.50 last year. (That’s still not a bad profit: Bernstein figures their margins were $10.44 a barrel in 2004.)

Since profit margins have come down, so have the share prices of refiners’ stocks — about a third from their July, 2007 peak. But stay tuned. A lot can happen between now and this summer, when demand — and refiner stock prices — typically rise.

Until that happens, you probably won’t hear much about gasoline prices or oil industry profits. Gas prices are big news when they’re on the way up, as are industry profits. But few readers (or news editors, for that matter) pay much attention to them when they’re falling.

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