Winston Churchill once said that Russia was "a riddle wrapped in a mystery inside an enigma." ExxonMobil, ChevronTexaco and the other big oil companies work hard to make the true dynamics behind high gasoline prices at least as mysterious as Russia.

When California gas prices shot up 41 cents a gallon in August - costing California consumers an extra $16 million a day - most people felt like they were being gouged, but they couldn't quite figure out how or why. Now that prices are slowly falling, consumer outrage is fading. But experts predict California and the country will suffer more price shocks in the near future, with the spike price edging ever higher.

"I don't know why gas prices shot up in August," says Dennis Shepard, president of Varicorp, a concrete pumping company with 14 trucks that consume a steady stream of fuel. "I have been so busy I haven't had time to check. I do know that gas prices are hurting my business model. When my father, Bruce, and I started the business two years ago, fuel costs were 3 percent of our total costs. That has gone up to 6 percent and it is eating right into our profit margin."

Shepard, a bright guy with an MBA from UC Irvine's Graduate School of Management, is not alone in his uncertainty about the causes of recent gas price shocks. Even people in the oil and gasoline business are confused.

"I just know what you do, what you read in the papers," says Moe Baghai, general manager of Newport Center Chevron when asked the reason for the August spike. "A pipeline that broke in Arizona had something to do with it, and the price of crude. I think it was mainly the price of crude."

"I don't know why gas went up so much in August," says Parker, chairman of Kilmont Energy, a Newport Beach firm that invests in and owns oil and natural gas fields. "You can postulate various factors. OPEC has a dominating influence. They can turn the tap on or off whenever they chose and drive up the price of crude.

"Regulatory and environmental restrictions on expanding refineries or building new refineries play into it, too."

It is no coincidence that the factors cited by Orange County businessmen are the main ones big oil companies use as excuses for high gasoline prices. They have effectively sold the public their party line.

Slick stories The party line is that rising crude oil costs, refinery disruptions, pipeline breaks, power outages and complex market forces limit supply and drive up corporate costs, forcing price hikes like the ones in August and March. And it's true that market forces affecting oil and gas prices are complex. Interplay between the price of oil and gasoline futures on the New York Mercantile Exchange (NYMEX) and economic reports, political events and natural disasters create a thick smoke screen behind which wholesale and retail prices are manipulated.

What's not true is that any of these events significantly raised oil company costs in 2003. On the contrary, rising retail gasoline prices have enriched the big oil companies enormously, more than doubling their margins and resulting in the largest quarterly corporate profits in the history of the world.

In the fourth quarter of 2000, ExxonMobil made front-page news when it recorded the largest quarterly profit ever: $5.12 billion. In the first quarter of this year, during the anxious months leading up to the Iraq war, the company blew that record out of the water, racking up more than $7 billion in pure profit.

"It is difficult to understand why the price has gone up so steeply," Geoff Sundstrom, an AAA spokesman based in Florida, said in February. "No oil tankers have been sunk; refineries are operating; oil is flowing. We are not trying to be harsh on the industry, but we feel the big increase after the State of the Union address seemed to be based on fear and speculation."

During the first half of 2003, Royal Dutch Shell's profits nearly doubled, from $4.5 billion to $8.2 billion. ChevronTexaco's net profit more than tripled, from $1.1 billion to $3.5 billion.

And the oil companies make more profit in California than anywhere else in the country. According to the California Energy Commission, California businesses "pay an annual premium of $638 million for gasoline each year compared with the rest of the country."

"When do you cry foul?" says Shephard. "At the rate we are going, it will be $3 a gallon next year. At a certain point, it just becomes plain dishonest."

Reporting on his ongoing investigation into high gas prices in the state, Attorney General Bill Lockyer announced in September that "California oil refiners' price markup between the barrel and the gas pump increased 152 percent from January 2003 to March 2003, with virtually all of the rise representing profit."

According to the attorney general, the price Californians paid for a gallon of regular unleaded gas increased by 57 cents during the first three months of 2003, rising from $1.58 to a then-record high of $2.15. Refiners' costs increased minimally, if at all, during that period.

"These numbers raise legitimate questions about whether this state's drivers and businesses are getting gouged," says Lockyer. "No possible cause [for the price increases] should stand above suspicion."

Tapping the truth ChevronTexaco, created when San Ramon-based oil giant Chevron bought Texaco for $44 billion in 2001, is the only major oil company with headquarters in California. All other major U.S. oil companies are headquartered in Texas where gas prices are - what a surprise - 40 cents cheaper than in California. ChevronTexaco declined to answer questions about high gas prices for this article. Instead the company e-mailed me a press release identifying the usual suspects, and referred me to Anita Mangels, a spokesperson for the Western States Petroleum Association (WSTA), a trade group that represents companies involved in petroleum exploration, production, refining, transportation and marketing.

"Rising crude oil prices are the main reason gas prices go up," Mangels said when I asked her about the August spike. "Crude oil prices nearly doubled in 2002."

Her explanation matched information in the article sent by ChevronTexaco: "The greatest single factor affecting the rise and fall of gasoline prices is the cost of crude oil."

But there is compelling evidence that discounts the company line. According to the Energy Information Administration, Brent crude, a standard industry benchmark, went up less than 50 percent in 2002, from $19.42 to $28.33 a barrel. That sounds like a lot, but crude oil makes up only about a third of the cost of a gallon of gas. The rest goes to taxes, refinery and marketing costs and profit margins. So the impact of the 50 percent rise is diluted. In any case, the cost of crude did not come close to doubling.

More to the point, in 2003, the cost of Brent crude dropped 4 percent, from $31.18 to $29.89, while the cost of regular gasoline in Los Angeles went up by 40 percent. So crude oil wasn't the bogeyman (see chart below).

When I told Mangels that she had exaggerated the 2002 rise in crude oil costs, and that crude oil had actually fallen in price in 2003 while gasoline went up 40 percent, she changed the subject.

"Well, you have to realize there are a lot of other factors that affect the price," she said. "There were problems at several western refineries and there was a pipeline that broke in Arizona."

The pipeline that broke in Arizona. It has become the Holy Grail of oil company apologists this fall. This is what happened: On Aug. 8, a pipeline that carries gasoline from refineries in El Paso, Texas to Phoenix, Ariz. ruptured, cutting off 30 percent of the city's fuel supply for much of August. California refineries that normally supply that market sent some extra gas to Arizona to help make up the difference.

Mangels claimed that the extra transportation costs drove up the price of gas in California.

In fact, since gasoline refined and sold in California didn't log any extra miles between refinery and pump, there were no additional costs.

Oil companies also said the diversion caused a "shortage," pushing up the price of gasoline. Gasoline inventories in the state did fall by about 15 percent. Yet every gas station I saw was open and stocked with gasoline. There were no long, 1970s-style lines at the pump. And Fred Rozell, director of retail pricing at the Oil Price Information Service (OPIS), says that the Arizona pipeline break did not impact gas prices on the NYMEX where benchmark values are set.

So the pipeline break provided seemingly logical cover, not actual cause, for jacking up California's gas prices. It was another case of the big oil companies maximizing their profits at the expense of consumers in an imperfectly competitive market.

Mangels changed the subject, again. "It's very important to remember that the refineries don't set the retail gas price." In fact, ChevronTexaco, ExxonMobil and the other big oil companies that control California's market sell 14 billion gallons of gasoline each year at company-owned and operated filling stations where they set the price, plain and simple. They sell most of the rest of their gasoline through branded stations (Exxon, Mobil, Texaco, etc.) leased by franchisees who are locked into long-term contracts that require them to pay whatever price the parent oil company sets. Since the businessmen who operate the franchise outlets have to have a certain minimal margin to survive, the refineries in effect set the retail price at those stations, too.

Reminded of these inconvenient facts, Mangels sidestepped once more and said that the franchisees had entered into the contracts willingly, and that they receive many benefits from their association with the big oil companies.

Rocket and feather One feature of high gas prices that especially frustrates consumers is the "rocket and feather phenomenon," in which retail prices shoot up when crude oil costs are rising or there is word of a pipeline break, but float downward very slowly when the pipeline is fixed or crude prices fall.

"The price is going back down now, but very slowly," says Baghai. "Not the way it went up. It goes down 1 or 2 cents every few days, but it was jumping up 5 cents every day. It went up that high, that fast.

"It didn't used to be that way. I have been in the business for 15 years, and it used to be that when crude prices went up it didn't affect retail prices for a month or so. They won't be refining the crude they buy today until next month, so it should take awhile for a cost increase to impact the local market. But the impact is immediate now. They send us an e-mail and from that point on any gas we get is at the higher price. We have nothing to say about it.

"To be honest, I think it is greed. That is the bottom line. It is the greed of the oil companies, especially in Southern California."

John Felmy, chief economist for the American Petroleum Institute, which represents big oil companies, says prices go down slowly because it takes time to work the higher-priced gas out of the system. But that explanation raises an obvious question: Why doesn't it take time for the higher-priced gasoline to work its way into the system?

"The last couple of seasons, the oil companies have kept the price up, somehow, some way," says Baghai. "They find a reason to keep it up."

People often blame filling station owners for high prices, but price shocks hurt gas stations, too.

"When prices shoot up, people hold back," Baghai says. "They buy a cheaper grade or they just stop buying. That is how it hurts our profits. We are a high-volume station, selling 200,000 gallons a month and making most of our

profits from gasoline. We lost 10 percent of our profits, easily, when gas went up in August."

Baghai sets his own pump prices, based on what ChevronTexaco charges him. He aims to maintain a steady margin but he has to take other factors into account. If business is slow, he may keep prices lower to encourage consumption, even though it reduces his margin. Other times, he may leave prices high temporarily after his price has fallen in order to make up for profit lost when prices jumped.

Ultimately, higher prices charged by oil companies get passed on to businessmen such as Rob Ukropina, founder and president of Overnite Express in Irvine.

"Fast up, slow down doesn't make any sense to me," Ukropina says. "It complicates things for us in our business. We have 105 trucks on the road, making 1,200 pickups and 4,000 deliveries between 9 p.m. and 9 a.m. every day, and fuel accounts for about 7 1/2 percent of our overall costs. So when the price spikes we feel it."

Like UPS and other delivery companies, Overnite has imposed a fuel surcharge to protect its profits. "We change the rate every three months," Ukropina says. "Right now it is at 3.5 percent. Gas prices go up and down during the quarter and hopefully it averages out. It is not a profit maker, but it helps us recover higher fuel costs.

"We have to be careful when we adjust the surcharge because we don't want to look like the oil companies. We don't want to look like we are gouging our customers. We want to avoid the 'feather pattern.'"

In the end, higher gasoline costs get passed to consumers, who end up paying more for delivery service, taxi rides and all kinds of goods carried to market by gas and diesel-burning trucks.

"The problem is you begin to accept the constant increases as part of the cost of doing business without really focusing on it," says Shepard. "It reminds me of something my dad uses as an example. He says if you put a frog in a pan of cold water and gradually turn up the heat, the frog won't jump out. He gets used to the heat, degree by degree, and ends up getting boiled alive.

"Right now, I feel like that frog with the water around me starting to bubble a little bit. They've got me."

California crisis Californians routinely pay the highest gas prices in the nation (see chart on page 34). Oil companies say this is due to high state taxes, the high cost of making California's low-polluting gasoline and to supply limitations due to environmental and regulatory restrictions on refinery expansion. Those factors have some impact but, according to the attorney general's May 2000 "Report on Gasoline Pricing in California," the state's higher prices are mainly due to an anti-competitive environment created in large part by the big oil companies themselves.

Over the past few decades, independent refineries, gasoline wholesalers and service stations have been squeezed out of the California market as the big oil companies have consolidated and become more vertically integrated, owning everything from the oil fields to the corner gas station where you fill up (see "A Less Competitive Market," page 36).

In 1980, there were 67 gasoline refineries in California, and Californians paid the same price at the pump as the rest of the nation. Today there are eight refineries in the state, with the seven largest refineries controlling 97 percent of the market. In contrast, the six largest refineries in Texas control less than 60 percent of that state's refining capacity.

Independent retailers are dying out, too. In 2000, Attorney General Lockyer reported that "independent marketers of gasoline account for less than an estimated 10 percent of gasoline sales in California. This is in sharp contrast with many other large states. For example, independent marketers account for more than 50 percent of retail gas outlets in Texas," where gasoline is much cheaper.

The big, vertically integrated oil companies have greatest control over prices at company-owned and operated gas stations. The California Service Station and Automotive Repair Association (CSSARA) claims the big oil companies are systematically forcing their franchisees out of business in order to get control of their stations by raising rents and charging unfair prices.

Franchisees are independent businessmen who lease their stations from the oil companies and are locked into long-term contracts requiring them to buy company-branded gas at the non-negotiable price the oil companies demand at any given moment.

Refineries sell gas to unaffiliated stations at what is called the "rack rate;" they sell the same gas to their franchisees at a "dealer tank wagon" rate that is 10 to 20 cents a gallon higher. The higher rate includes the cost of delivery, but CSSARA and others say that transport costs often don't justify the price difference.

CSSARA says the oil companies target specific stations they want to take over, charging those franchises higher prices than they do other franchises in the same area in order to put them under.

Claims of predatory pricing were substantiated in 2002 when ExxonMobil lost its appeal of a $2.2 million judgment won by 51 franchisees who claimed they were being overcharged.

"These days, they have more company-operated stores," says Baghai. "That is why they can control pricing more easily. They own more stations. They just bought two new ones around here, including the one on Jamboree across from the airport."

When I asked the manager of the airport Chevron station

about company pricing policies, he told me he wasn't allowed to answer questions.

I demand an investigation Every time the price of gas spikes, someone somewhere launches an investigation. But the investigators never seem to find out very much. Launched like lions, the probes end like lambs, quiet and unnoticed.

Oil companies are quick to point out that, even after all the investigations, they have not been found guilty of illegal price-fixing.

"Some people have suggested that the oil companies hold back some of the gasoline supply to drive up prices, but I have never heard of a case where that has been proven," says Parker of Kilmont Energy.

And yet, more investigations are continually launched. Some may just be window dressing, politicians appeasing an outraged public. But the link between high prices and windfall profits is so direct that suspicion springs eternal.

A USA TODAY/CNN/Gallup poll taken in early September found that 63 percent of Americans think oil companies are charging unnecessarily high prices.

Outrage and investigations are surprisingly bipartisan. The Bush Administration is known for its close ties to big oil, yet Bush's very own secretary of energy, Spencer Abraham, recently launched a federal inquiry into high gas prices.

Speaking before the House Energy and Commerce Committee on Sept 3, Abraham said that the August price spikes "struck me as being unusually large. We will hopefully get some insight on whether this was really a market reaction only or if other factors were involved."

If illegal behavior is found, the information will be turned over to the Justice Department or the Federal Trade Commission. Drew Malcomb, a spokesman for the Department of Energy, says the results of the inquiry will be made public before Thanksgiving.

Here in California, Lt. Gov. Cruz Bustamante lashed out at the oil companies. "Californians are being gouged, and under current laws we are powerless to do anything about it," he said in late August. "The oil companies explain their behavior the same way Enron did. They say it was someone else's fault . . . what they never say is that their profit margin in California is the highest in the nation."

Bustamante, Lockyer and other California politicians have called for legislation to fix the flaws in California's energy market and make it more competitive.

In September, Lockyer said policy makers should consider creating a strategic fuel reserve and adopting measures to better import refined gasoline, via pipelines or other means. More imports would increase the supply of gasoline not controlled by California refiners, helping to create a true free market in which gas prices would more nearly reflect actual market conditions.

Others want legislation to prohibit oil companies from owning retail outlets and laws to give franchisees the right to buy branded gasoline on the open market at more competitive rates instead of being locked into company store contracts.

The oil companies say the current system is best and that legislation will only drive prices higher.

Sixteen other states have passed petroleum marketing laws that forbid predatory pricing and limit market control by integrated oil companies. In all those states, gasoline is cheaper than it is in California. OCM