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Seven Factors that Control Gasoline Prices

By Edited Oct 25, 2015 5 7

Owwww! It Hurts!

Pain at the Pump
Credit: pippalou / morguefile.com

It almost hurts to pump gasoline when the price starts to climb.

It seems that everyone grumbles about gasoline prices, especially when they go up. In case you haven't noticed, gas is a weird market: for one, is there anything else whose price is advertised on street corners? Groceries don’t routinely do that for cereal or eggs, and clothing stores don’t do it for socks; but every station posts its prices in letters two feet tall. What makes the prices rise and fall, seemingly without reason? Many people think Big Oil controls the pump price, but that's not quite true. Let's take a look at what variables influence the price of gasoline.

1: Crude Prices

The Source...
Credit: pennywise / morguefile.com

A pumpjack sucking a few barrels of oil per day out of a reservoir deep underground.

According to the U S Energy Information Administration (EIA), two-thirds of gasoline's price is the cost of crude oil[1]. Crude prices vary depending on the quality, but markets use two reference prices: West Texas Intermediate (WTI) and North Sea Brent (Brent). Today, a 42-gallon barrel of WTI trades for about $94 and Brent sells for $102 (you can see crude prices in real time on-line[2]). If a barrel sells for $100, then the crude oil used to make a gallon of gasoline costs $2.38 all by itself.

Why is this stuff so expensive? Because it's not easy to find and get out of the ground. Contrary to some belief, there are no underground rivers and lakes just waiting for a "straw."  Exploration companies invest hundreds of millions, even billions of dollars, to find petroleum reserves. A well drilled in the deep Gulf of Mexico might cost $150 million, and there’s a chance the well won’t find enough to pay for itself. In 2011, ExxonMobil was spending about $100 million every single day[3] looking for new reserves – more than $3.5 billion that year. That number doesn’t include production costs; it's just the cost of finding new supplies. So: still think that an oil company's $100 million in profits in a quarter is a rip-off?

2: Pipelines and Tankers

Big, Expensive Boats
Credit: Peter Kaminski / flickr.comA

An oil tanker passes under the Golden Gate Bridge.

Your product is at the surface: now what? Well, it has to be refined because cars, planes and furnaces don’t burn crude. Large refineries like the ones on the U S Gulf Coast can process hundreds of thousands of barrels per day, pumped by thousands of wells – wells that may be thousands of miles away. To get crude oil  to refineries, companies must use networks of pipelines on land, and tankers on water.

You probably didn’t know that the oil refined at a Shell refinery comes from a pipeline company, not (necessarily) from a Shell well. Refiners buy crude on the basis of its physical and chemical properties, not based on where it comes from or who pumped it.

It's pretty obvious that a floating tanker is expensive, but so are pipelines: a reference cost is about $1 million per mile; not to mention terminals, pumping stations and the maintenance to keep everything operating safely. Those are all part of what the EIA estimates[1] accounts for 8% of the cost of an average gallon of gas.

3: Refining

Refineries Make Gasoline (and Lots of Other Products) from Crude Oil
Credit: ljmacphee / flickr.com

This huge complex is an average-sized refinery.

A refinery is a huge complex, often spreading over several square miles. Refining uses heat and chemistry to "break" crude oil into different products. Not just gasoline, either: the list is long, and includes diesel, jet fuel, heating oil, kerosene, lubricants, and feedstocks for all kinds of products from drugs to plastics to cosmetics.

Because they’re big and complex, refineries are expensive: BP recently sold  a Houston-area refinery to Marathon Petroleum for about $600 million[4]. That’s only the plant: the cost of refining also includes labor, maintenance and chemicals; and a refinery has to burn part of its own output to run the equipment that processes crude. The EIA estimates[1] that refining accounts for another 8% of the cost of a gallon of gasoline.

4: Transporting Gasoline

A Tanker Truck Filled with Gasoline
Credit: gvgoebel / flickr.com

The last step in the journey to your local station is a tank truck filled with gasoline.

Refined gasoline does no one any  good sitting at the refinery: it has to get to a filling station so we can pump it into our tanks. From a refinery, finished products go through pipelines to terminals across the country. At the terminal, gasoline is pumped into tanker trucks that ferry it out to the corner store. And then we buy it

The EIA estimates[1] that this distribution network, plus marketing (things like TV and newspaper advertising and stickers on NASCAR jumpsuits) adds about 11% to the cost of a gallon of gas.

5: Taxes

Nothing is Certain, Except...
Credit: drewgstephens / flickr.com

Taxes take a bite out of your wallet; more (or less) depending on where you live.

Oh, yes, there’s taxes. On average, Americans pay 49¢ per gallon in combined federal and state taxes. Federal tax accounts for 18.4¢ while state taxes range from 8¢ per gallon in Alaska to almost 50¢ per gallon in Connecticut and New York[5].

If you add up the costs of crude oil, pipelines, refining, and transportation, that's 96% of the pre-tax cost of a gallon of gasoline. So no, the corner market is not making a huge profit off of your gasoline purchase (those cigarettes are another matter...). The four costs plus taxes account for the basic price of a gallon of gasoline; the profit margin at most stations is just a few cents per gallon.

Prices at nearby stations will differ due to different gasoline quality (for instance, proprietary additives) and different costs of doing business: property taxes, cost of land and building, insurance, etc. And, of course, some stations charge more because they’re in “convenient” locations, such as near city centers and airports.

6: Crude Oil Volatility

Crude Oil Price Swings
Credit: U S Energy Information Administration

Five-year chart of world crude prices.

Refining, transportation, marketing and taxes are the sorts of costs that change slowly. Why, then do pump prices keep rising and falling? The answer is good old supply and demand, which influences the costs at two key points. The first is crude oil prices[6].

Oil companies don’t get to set the price of their product, because oil is traded on a global market. The global price of oil is affected by many factors, most of which can be lumped together under supply, demand or both. When traders believe that the supply of crude oil is increasing faster than demand, crude oil prices start to fall. Crude oil prices will fall when the economy looks bad, because that means demand is going to decrease. Crude oil prices will rise if the Organization of Petroleum Exporting Countries (OPEC) tightens production quotas, because that means the supply will decrease. Wars, political upheaval, major weather events, even major new discoveries can push and pull world crude oil prices in different directions.

Remember, crude oil prices account for about two-thirds of gasoline prices, so changes in the global price will be magnified at your local station.

7: Gasoline Price Volatility

National Gas Prices Average vs. Crude Oil Price
Credit: GasBuddy.com

The national average pump price (blue) plotted against the average crude oil price (red).

Though crude oil is a global market, gasoline is a regional and at times, local market. As the chart shows, the price of gas is related to the crude oil price, but there can be variations. Local supply and demand also control the wholesale price of gasoline as buyers for retail chains bid on gasoline deliveries for their stations; usually several weeks or months in the future. If traders believe that supplies will decrease or demand will increase, the bid price rises. Some common reasons this might cause wholesale gasoline prices to rise include:

  • Decrease in supply when refineries shut down for maintenance or to change their formulation; for instance from “winter gasoline” to “summer gasoline” or to increase gasoline production and decrease heating oil output.
  • Decreased supply when a refinery goes offline because of weather, such as hurricane Katrina; or an event like the August, 2012, fire at a Chevron refinery in Richmond, California.
  • Increased demand when the economy improves
  • Increased demand during the summer vacation season.

Wholesale gasoline prices may fall because of:

  • Increased supply when refineries expand or reopen.
  • Increased supply when regioal crude oil supplies expand.
  • Decreased demand when the economy falters.
  • Decreased demand when the summer driving season ends.

End of the Pipeline

The Neighborhood Gas Station
Credit: xandert / morguefile.com

An ordinary Shell station in someone's neighborhood.

Some Take-Aways for You

Some facts you may not know about oil companies and gasoline:

 

  • Big Oil owns very few of the stations with familiar names. Most stations are locally-owned franchises.
  • The gasoline sold in an BP station probably didn’t come from an BP refinery, and it almost certainly didn’t come from an BP well.
  • The gasoline sold in your nearby Hess station probably came out of the same pipeline and from the same refinery as the gas sold at your local Safeway store. It’s the additives that make brands different, and they’re added while the gasoline is in the tank truck.
  • Gas stations don’t make much money on a gallon of gas; usually 7-10¢ gross profit per gallon (gross, not net). That's why they'd like you to come inside for a soft drink or a candy bar - that's where the profits are.
  • There is some profit made at every step along the way in getting gasoline into your tank.
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Comments

Jun 1, 2013 8:18pm
MrRooibos
Very interesting article, but isn't there also a certain amount of panic that plays a role in gas prices? For example unrest in Afghanistan would cause oil prices to rise even though oil and Afghanistan have little to do with one another.
Jun 3, 2013 5:53am
2labz
This comment has been deleted.
Jun 3, 2013 7:28am
2labz
Since Afghanistan has little or nothing to do with oil, unrest in that country (which has been an ongoing state for 20 centuries and therefore isn't news) would probably have a negligible effect on world crude prices. About the only effects it might have would be due to increased demand: wars consume immense quantities of hydrocarbons.

Unrest in Libya (the entire Arab Spring, in fact) did cause an increase in world oil prices. That's because Libya is a net oil exporter - the country ranks about 30th among oil exporting countries; Egypt and Algeria are also exporters. Prices also started climbing a year or two ago when Iran was doing some saber-rattling about closing the Straits of Hormuz. Both of those are events that could conceivably restrict supply; so the situation again becomes a question of supply and demand. Restrict supply or increase demand; prices go up. Decrease demand or increase supply; prices go down.

In fact, it's more subtle: if the crude oil market "thinks" that supply will decrease or demand will increase, the price will rise. Right now, it looks as though the Syrian civil war will spread into Lebanon. That still wouldn't have much effect, but if it looks like the war will spread east into Iraq, then the markets will get nervous and prices will probably climb.
Jun 8, 2013 1:43am
egdcltd
Jun 8, 2013 3:03pm
2labz
@egdcltd Yeah, that's very much based on a philosophical difference, I think. To we yanks, cars often serve as a proxy for our "personal power." As such, many refuse to give them up to use public transportation and don't want to pay the additional taxes to fund transit projects they'd "never" ride. Then, too, the population density in much of the US is not conducive to public transportation.

The federal portion of that tax hasn't changed in something like 20 years, and studies by civil engineers sat that our infrastructure is suffering because of it. We've had a couple of major bridges collapse in the past decade - one of them just last month - and there aren't many plans to build new ones or upgrade the old ones. It's enough to make you scared to cross bridges sometimes.
Jun 8, 2013 3:36pm
Marlando
Hi--First of all extremely well done article. However, your article did not serve to give any more empathy for the tyrants of the oil companies. Granted I have not kept up any research for years but I do recall the 1972 oil crunch which was a mere ploy to raise gas prices and I am aware of the price manipulating by the Arabian-American Oil Corporation and their influence on US "good-old-boy" government. As for the argument that gas prices today are no higher than they were 50 years ago according to inflation doesn't impress me at all since inflation itself is a fantasy calculation made by economists. The robber barons of the oil industry has their hands on world banking with heavy investments in all kinds of enterprises making them obvious gluttons in a hungry world. Nevertheless, I truly enjoyed your article and found it to be smart and informative. 2 BIG THUMBS and a rating from me.
Jun 8, 2013 3:36pm
Marlando
Hi--First of all extremely well done article. However, your article did not serve to give any more empathy for the tyrants of the oil companies. Granted I have not kept up any research for years but I do recall the 1972 oil crunch which was a mere ploy to raise gas prices and I am aware of the price manipulating by the Arabian-American Oil Corporation and their influence on US "good-old-boy" government. As for the argument that gas prices today are no higher than they were 50 years ago according to inflation doesn't impress me at all since inflation itself is a fantasy calculation made by economists. The robber barons of the oil industry has their hands on world banking with heavy investments in all kinds of enterprises making them obvious gluttons in a hungry world. Nevertheless, I truly enjoyed your article and found it to be smart and informative. 2 BIG THUMBS and a rating from me.
Jun 9, 2013 3:09am
2labz
This comment has been deleted.
Jun 9, 2013 3:23am
2labz
The "1972 oil crunch" is more commonly known as the "Arab Oil Embargo." The Organization of Petroleum Exporting Countries (OPEC) arbitrarily decreased the supply, thereby driving up world oil prices. Your theory, however, collapses in view of the subse

{insert observation: could there be a touchier commenting interface?}

subsequent collapse of oil prices in 1983, which resulted in near-destruction of the industry. I don't know about other people, but if I were going to manipulate prices I wouldn't arrange to have such low profits that my company went out of business.

As for inflation being a "fantasy calculation": I remember gasoline prices in 1972. I also remember that I was working a full-time job making $2.40/hour (slightly more than $4,000 per year) and that a pay phone call cost ten cents and you could buy a Milky Way bar for a nickel. These days if you can find a pay phone, the call costs ten times as much and a Milky Way bar costs somewhere between 90 cents and a buck and a quarter. You could buy a new car for less than $2500, about the cost of repairs from a minor collision today. Is there a different name for that phenomenon?
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Bibliography

  1. "Gasoline and Diesel Fuel Update - Energy Information Administration." Gasoline and Diesel Fuel Update. 31/05/2013 <Web >
  2. "Crude Oil and Commodity Prices." Crude Oil and Commodity Prices. 31/05/2013 <Web >
  3. "OilPrice.com - Exxon’s $100 Million a Day Exploration Budget Pays Off." Exxon’s $100 Million a Day Exploration Budget Pays Off. 31/05/2013 <Web >
  4. "Bloomberg News | BP Sells Texas Refinery to Marathon for $598 Million." BP Sells Texas Refinery to Marathon for $598 Million. 31/05/2013 <Web >
  5. "American Petroleum Institute | State Motor Fuel Taxes 2013." State Motor Fuel Taxes 2013. 31/05/2013 <Web >
  6. "American Petroleum Institute | What's Up With Fuel Prices?." What's Up With Fuel Prices?. 31/05/2013 <Web >

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