Owwww! It Hurts!
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
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. 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). 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 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
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 accounts for 8% of the cost of an average gallon of gas.
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. 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 that refining accounts for another 8% of the cost of a gallon of gasoline.
4: Transporting Gasoline
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 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.
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.
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
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.
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
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
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.