In May 2008, average gas prices in the United States approached, and in some places passed,
$4.00 a gallon, shattering records. But this was nothing new to American consumers. May was a
month of records that broke one after another, and that came on the heels of months of rising
prices. And then the cycle continued, with prices eventually falling and then inching toward the
$4.00 mark again in 2011.
Gasoline is the bloodline that keeps America moving, and tracking gas prices can feel like a
roller coaster ride. They're down a little one month, up the next, and then they shoot up more
than 50 percent in a year. Plus, they're different depending on where you look. Other countries -and even other states and cities -- can have very different gas prices from your local Gas-N-Go.
To the average person, it probably seems as though there's little rhyme or reason to how gas
prices are determined. In this article, we will look at the forces that impact the price of gas at the
pump, and we'll find out where your gas money actually goes.
Americans have an insatiable thirst for gasoline. Just look at the amount of traffic on roads and
highways, and you'll see that a severe gas shortage would practically cripple the United States.
Americans drive nearly 3 trillion miles per year, according to the Motor and Equipment
Manufacturer's Association [source: MEMA]. That's about 820 trips from the sun to Pluto and
back.
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The United States consumes about 20 million barrels of oil products per day (bbl/d), according
to the Department of Energy [source: DOE]. Of that, almost half is used for motor gasoline. The
rest is used for distillate fuel oil, jet fuel, residual fuel and other oils. Each barrel of oil contains
42 gallons (159 L), which yields 19 to 20 gallons (75 L) of gasoline. So, in the United States,
something like 178 million gallons of gasoline is consumed every day.
Typically, the demand for gas spikes during the summer, when lots of people go on vacation.
Holidays like Memorial Day and the Fourth of July create logjams of tourist traffic during the
summer. This high demand usually translates into higher gasoline prices. Cleaner-burning
summer-grade fuels, which are more expensive to produce, can increase the price as well, but
prices don't always go up in summer. For instance, while gas prices soared 31 cents in April and
early May of 2001, reaching $1.71 per gallon (which seems inexpensive compared to today's
prices), prices actually declined during the 2001 summer.
In 2004, prices continued to rise past the end of the summer travel season for a variety of
reasons, including several hurricanes and an increase in the price of crude oil. And in 2005,
Hurricane Katrina (along with a sizable increase in crude oil prices) pushed prices to $3.07 per
gallon on September 5. Prices settled down somewhat in November and December of 2005. But
now the numbers are among the highest they've ever been, only recently dipping back below the
$4.00 mark after a month of average prices at $4.06 for a gallon of regular gas in July 2008
[source: EPA]. It seems the record high prices encouraged people to drive less, which in turn
drove down demand and subsequently, prices. As prices rose again in 2011, President Barack
Obama announced the formation of a task force to examine oil markets [source: Pace].
Price increases generally occur when the world crude-oil market tightens and lowers
inventories. We will discuss who controls the crude-oil market later. Also, growing demand can
sometimes outpace refinery capacity. In the spring, refineries perform maintenance, which can
place a pinch on the gasoline market. By the end of May, refineries are usually back to full
capacity.
In the next section, we'll look at where the money goes when you pay for gas.
Breakdown of Gas Prices
Photo by Mario Tama/Getty Images
Traders work in the crude oil options pit at the New York Mercantile Exchange, April 22, 2008.
Oil posted a then-record high of more than $118 following oil demand from China and supply
concerns from Russia and Nigeria.
When you pump $30 into your tank, that money is broken up into little pieces that get distributed
among several entities. Gas is just like any other consumer product: There's a supply chain and
several groups who are responsible for setting the price of the product. The media can sometimes
lead you to believe that the price of gas is based solely on the price of crude oil, but there are
actually many factors that determine what you pay at the pump. No matter how expensive gas
becomes, all of these entities have to get their slice of the pie. According to the U.S. Department
of Energy, here's an approximation of where each dollar you spend on gas goes:
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Taxes: 13 cents
Distribution and Marketing: 8 cents
Refining: 14 cents
Crude oil: 65 cents
[source: DOE]
This is what the average breakdown looked like in April 2011. Let's look at those components in
more detail.
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Crude oil - The biggest portion of the cost of gas goes to the crude-oil suppliers. This is
determined by the world's oil-exporting nations, particularly the Organization of the
Petroleum Exporting Countries (OPEC), which you will learn more about in the next
section. The amount of crude oil these countries produce determines the price of a barrel
of oil. Crude-oil prices averaged around $35 per barrel (1 barrel = 42 gallons or 158.99 L)
in 2004. And, after Hurricane Katrina, some prices were almost double that. In April
2008, crude-oil prices averaged around $104.74 per barrel. During that month, the price
of oil reached a record price of almost $120 a barrel [source: DOE]. By May 16, prices
had topped $117 per barrel [source: MarketWatch]. On May 22, markets in New York
and London reported prices past $135 per barreland, and on July 11, oil hit an all-time
high of $147 [source: Forbes, New York Sun]. Analysts speculated that everything from
investment in oil futures to increasing demand from countries like India and China
contributed to the spike in price.
Sometimes, gas prices go up even though there is plenty of crude oil on the market. It
depends on what kind of oil it is. Oil can be classified as heavy or light, and as sweet or
sour (no one actually tastes the oil, that's just what they call it). Light, sweet crude is
easier and cheaper to refine, but supplies have been running low. There's plenty of heavy,
sour crude available in the world, but refineries, particularly those in the U.S., have to
undergo costly retooling to handle it.
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Refining costs - The cost of refining diesel fuel can be considerably higher than the price
of refining regular gasoline. To learn more about oil refining, read How Oil Refining
Works.
Distribution and marketing - Crude oil is transported to refineries, and gasoline is
shipped from the refineries to distribution points and then to gas stations. The price of
transportation is passed along to the consumer. Marketing the brand of the oil
company is also added into the cost of the gasoline you buy.
Taxes - Federal and state governments each place excise taxes on gasoline. There may
also be some additional taxes, such as applicable state sales taxes, gross receipts taxes, oil
inspection fees, underground storage tank fees and other miscellaneous environmental
fees. Add that to the state excise taxes, and it can average 27.4 cents. It could be worse.
In Europe, gas prices are far higher than in America because taxes on gas are much
higher.
Station markup - Of course some of the money you spend at the pump does go to the
service station. While some consumers blame high prices on station markup, service
stations typically add on a few cents per gallon. There's no set standard for how much gas
stations add on to the price. Some may add just a couple of cents, while others may add
as much as a dime or more. However, some states have markup laws prohibiting stations
from charging less than a certain percentage over invoice from the wholesaler. These
laws are designed to protect small, individually-owned gas stations from being driven out
of business by large chains that can afford to slash prices at select locations.
Average U.S. Gasoline Prices
Year
Price Per Gallon
1980
1985
1990
1995
2000
2001
2002
2003
2004
2005
2006
2007
2008
$1.22
$1.96
$1.22
$1.21
$1.56
$1.53
$1.44
$1.64
$1.92
$2.34
$2.63
$2.85
$3.32
2009
$2.40
Source: U.S. Bureau of Labor Statistics Consumer Price Index (CPI). Average Price Data, Gasoline All Types.
Gas prices also vary from state to state for several reasons. Taxes are probably the biggest factor
in the different prices around the country. Additionally, competition among local gas stations
can drive prices down. Distance from the oil refineries can also affect prices -- stations closer to
the Gulf of Mexico, where many oil refineries are located, have lower gas prices due to lower
transportation costs. There are also some regional factors that can affect prices.
World events, wars and weather can also raise prices. Anything that affects any part of the
process, from the moment the oil is drilled, through refining and distribution to your car will
result in a change in price. Military conflicts in parts of the world with lots of oil supplies can
make it difficult for oil companies to drill and ship crude oil. Hurricanes have damaged offshore
drilling platforms, coastal refineries and shipping ports that receive oil tankers. If a tanker itself
is lost or damaged, or leaks its oil into the ocean, that will put a dent in the market as well.
Next, we'll look at why it's more expensive to buy gas in Milwaukee, Wis., than in many other
parts of the United States.
OPEC and Gas Prices Around the World
The single largest entity impacting the world's oil supplies is the Organization of the Petroleum Exporting
Countries (OPEC), a consortium of 13 countries: Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait,
Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.
Together, these 13 nations are responsible for 40 percent of the world's oil production and hold
the majority of the world's oil reserves, according to the Energy Information Administration
(EIA). [source: EIA]. When OPEC wants to raise the price of crude oil, it simply reduces
production. This causes gasoline prices to jump because of the short supply, but also because of
the possibility of future reductions. When oil production dips, gas companies get nervous. The
mere threat of oil reductions can raise gas prices.
In April 2001, OPEC decided to reduce its collective production by one million barrels per day.
This was at the same time that American consumers saw gas prices rise, hitting an average high
of $1.71 per gallon on May 14, 2001.
OPEC increased its production in June 2005, when it raised to 28 million barrels per day with an
increase of 500,000 barrels per day pending changes in oil prices. In September 2005, it made all
of its member countries' "spare output" available, an estimated 2 million barrels per day.
However, in November 2006, OPEC again reduced its rate of production by 1.7 million barrels
per day to keep the price from falling below $50 per barrel [Source: Joint Economic Committee
]. OPEC's production for the second quarter of 2008 was an average of 36.87 million barrels per
day [source: EIA].
Beyond OPEC, there are several other countries that contribute to the world's crude-oil supplies,
including the United States, Mexico, Canada, Equatorial Guinea, Russia and China. In April
2008, the United States imported approximately 1.8 million barrels of crude oil per day from
Canada [source: [Energy Information Administration]. OPEC tracks the oil production of these
nations and then adjusts its own production to maintain its desired barrel price.
Cause and Effect
Numerous forces can influence the price of gas at the pump, but fuel costs are only one part in
the vast web of global economics. Gas prices have an impact on other parts of the economy as
well. You're already aware of the immediate effects of rising prices - that feeling of stunned
disbelief as the numbers climb and climb while you fill your tank. There are secondary effects as
well. You might decide against a long road trip because the gas would cost too much. When it
comes time to buy a car, you might decide against a gas-guzzling SUV and find something with
better mileage instead.
Let's look at the big picture. Does a hike in gas prices lead to inflation in the overall economy? It
could, as long as the increase is a steady, long-term rise in prices. Expensive gas means it's
expensive to ship products by truck, expensive to drive long distances and expensive to fly in
airplanes. All those costs mean the cost of virtually any product you can think of will go up if gas
prices stay high.
However, economists don't look at gas prices as a leading indicator of inflation. The price of oil,
along with food costs, are far too volatile -- that is, they are easily influenced by things like
weather, labor strikes and wars. The costs swing up and down, depending on world events. To
watch for inflation, economists keep their eyes on the core Consumer Price Index, which is a
measure of the cost of certain goods, like DVD players, hotel rooms or college textbooks, which
stay more stable in the short term.