Gas Prices

Why Does Gas Cost So Much?

By REX ROY

"Why does my gas cost so much?"

It's a valid question, especially when gas prices fluctuate overnight for no apparent reason and TV news talking heads focus on it with the same energy as the latest Paris Hilton scandal. A reasonable person has a right to wonder what's going on.

I quickly realized that I didn't know why we pay what we pay for a gallon of 87 octane. This prompted me to do a little research. After reading this story, you'll have a much better understanding of how and why gas prices change, and what the future holds.

The Billion-Dollar Equation
Many factors contribute to the price of a gallon of gas. The good news is that, in general terms, the equation is simple. These are the four main components that determine the gas prices you and I pay:

Crude Oil + Refining Process + Retail Sales/Distribution + Taxes = Gas Price

These components, however, don't contribute equally to the gas prices at the pump. Here's a look at each component and its role in the retail pump price:

Crude oil -- 57%

Finding the crude oil
Getting the crude oil out of the ground
Transporting the crude oil to the refinery
Maintaining a reserve capacity of crude oil
Profit

Refining the crude oil into gasoline -- 18%

Producing special blends of gasoline to meet local clean air government regulations
Transporting the gasoline to the gas station
Profit

Selling the gasoline at a station -- 11%

Operational costs
Marketing costs
Profit

Taxes, federal and state -- 20%

Understanding Gas Price Swings
Knowing the basic components of gas prices is a good start that makes understanding price swings easier. The two largest components of oil production are the most volatile. Many variables can interrupt the flow of crude oil and the refining process. Most gas price hikes happen in the wake of some kind of disruption in these two areas.

Hurricane Katrina provided a textbook example of this. It wiped out major drilling operations and refineries on the Gulf Coast. Gas prices shot up because the balance between supply and demand changed. Katrina's wrath caused a significant drop in gasoline production, but demand stayed constant, resulting in higher gas prices in the U.S. and across the globe.

In the months after Katrina, as the wells in the Gulf of Mexico and the huge refineries along the Gulf Coast came back on line, gas prices came down because supply increased to meet demand. Gas prices then moderated globally.

While Katrina was an obvious reason for a gas price swing, other factors are harder to identify. If you live in a major metropolitan area affected by the Clean Act, look for mild gas price swings heading into this fall. This is when refineries serving your geographic area have to change their fuel blending process to produce the government-mandated "boutique" gasolines that help reduce vehicle emissions over the colder winter months. These changeovers temporarily reduce supplies, causing modest and short-lived price increases. As soon as the refineries are back up to capacity after the blend shift, prices edge back down. Maintenance at refineries and on oil pipelines can also temporarily reduce supplies, causing localized price jumps.

What's Happening Now With Gas Prices
Obviously, gas prices are generally higher than they used to be. If you were driving back in the 1960s, you were used to gas prices of about 25 cents a gallon. Adjusted for inflation, that works out to be about $1.63 per gallon today. However, adjusted for inflation, gas prices between 1984-2001 were even lower. Today, we're definitely paying more than we used to, with the national average around $3.00 per gallon. So what other factors are causing gas prices to rise?

According to a report by BP Oil, worldwide demand for crude grew by 0.7 percent from 2005 to 2006, a rate that equates to almost 253 million barrels per year. Of some 60 countries surveyed by BP, demand was up in nearly 40 countries, while demand was flat or down in the other 20. For the record, United States oil consumption decreased in 2006 to below the levels of 2004.

Against this reality of increased demand, especially from developing countries with huge populations such as China (demand up 6.7 percent in 2006), oil production has been fairly flat. Between the jump in demand and flat production, gas prices have risen.

Several less obvious reasons are also behind jacked-up gas prices:

The crude oil that has been "the easiest to get" has already been pumped from the ground. Oil companies have to work harder to obtain oil they pump out today, and that costs more.
The quality of crude oil available now is generally lower, making it more expensive to refine than the more desirable "light sweet" crude that was more widely available in years past.
Supply uncertainty due to political issues in countries such as Nigeria, Iran, Iraq, and Venezuela, which in turn creates market nervousness. This tends to drive up prices from other oil producing countries because these suppliers can guarantee an uninterrupted supply. Some place the premium at $10 per barrel, but it's nearly impossible to quantify.

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Taxes drive gas prices up further
As noted above, state and federal gasoline taxes account for about 20 percent of the cost at the pump. (Earlier this year, it was only 13 percent.) This 20-percent figure equates to a national average of about 60 cents per gallon. As you can understand, states with percentage-based sales tax make considerably more on each gallon as gas prices rise (6 percent of $3 is twice as much as 6 percent on $1.50).

While paying nearly 60 cents per gallon in taxes is not great news, compared to many countries, we get off easy. The country of Turkey levies nearly a $5 per gallon tax on each gallon of fuel (this really seems like a "fine"). Norway, even with its huge oil industry, taxes its gasoline buyers about $4 per gallon. However, some countries enjoy little if any taxation. Most of these same countries also enjoy huge oil reserves and refining capabilities that have been "nationalized" by their governments. In Iran, gas is only 33 cents a gallon, while Venezuelans do even better, with gas as little as 17 cents per gallon. The trade-off, of course, is living under a totalitarian government.

Is raising fuel taxes further the right thing to do to encourage alternative energy sources?
No. Raising taxes will cause a non-market driven decrease in oil consumption. This decrease in demand will drive down the world price of oil, making it tougher for alternative energy sources to gain market share. Until alternative sources of energy are profitable to produce on an even playing field compared to gasoline, they won't get to market on a large scale. Many energy experts do not support raising taxes because of this economic reality.

What about higher mandated fuel economy standards?
Robert Lutz, GM's vice chairman of product development, believes "if fuel efficiency is the goal, making it impossible for consumers to buy full-size trucks and SUVs because of mandated fuel economy standards won't help. This will hurt the economy and decrease the demand for fuel, causing lower prices, thereby increasing demand (for fuel)."

Bob gets it. His point is that Americans should drive what they want until they decide the price of fuel is so important that it makes them choose a more efficient vehicle. If one assumes that gas prices will remain high, these elevated gas prices will encourage alternate energy development. Legislating larger vehicles out of existence isn't the answer. Hey Washington, are you listening?

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Where will gas prices go?
Because articles on the Internet literally live forever, I'm not going to stick my neck out with a prediction and perhaps look stupid in the future. Deferring to predictions made by the Energy Information Administration, the long-term outlook is good, with crude oil prices dropping from their current $80-90 per barrel to around $50. If their predictions from 2005 hold true (and their estimate is already proving to be optimistic), we should begin to see gas prices come down by 2009.

We'll see. (See future projections)

Are you still shaking your head about high gas prices? Do you think other factors are at play that affect your price at the pump? Take a look at some other theories Rex Roy explored about gas prices and share your views as well.

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15 comments

King Dlw 12:02:14 AM Aug 06 2008

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The version of the 100mpg carb I heard was the oil companies had the mechanic killed they say he had proven it can work and be mass produced, they say he was a regular family man one day he left home and his wife never saw him and again.......and all his specs and blueprints were never found.

Wagonmaster39 03:46:10 PM Feb 24 2008

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Rex Roy must be a college graduate majoring in basket weaving and just introduced to the new math. First of all , the text breakdown on the price of gas , the percentages total 106%, while the bar graph totals 100%, changing the taxes from 20% to 14%. So just as an example, say crude is $100.00 a barrell, and a barrell being 50 gallon, that makes crude to be $2.00 gallon, therefore the total cost of fuel must be $3.51 per gallon based on the 14% tax, where he gets the 20% tax, who knows. I have been buying 87 octane for $2.99 at Murphy's and even cheaper in the past.

Cat4684 11:36:28 AM Feb 24 2008

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The 100mpg carburator was developed by a mechanic in the US. Ford bought the rights to it, but their engineers could not make it work on a mass production scale, so they dropped it.Last I heard of it.

Bassfishing06 11:26:53 AM Feb 24 2008

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How many of the people owning stock in the oil comapny's are the ones fussing the most? Were you happy to see your stock prices going up? How many Americans own this stock? Face it THE PROBLEM IS FACING YOU. THE RICH GET RICHER AND THE POOR GET POORER.
Nakita Kruschev said when I was a young man that the United Stated would be taken over without ever firing a shot...the fall of the "US EMPIRE" is happening right now due to greed and moralistic values. Wake up Americans before it is too late!!

Daverwelch 11:06:24 AM Feb 24 2008

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So where does the excessive profits fit in. According to this article there doesn't seem to be any. The oil companies are raping us. How many gallons do they produce? How much profit is there per gallon. At 12 Billion Dollars a quarter, if they sell 12 Billion gallons, then that is an extra $ 1.00 per gallon. That is why I am headed for Biodiesel. www.biodiesel.org My next truck will be diesel, so I can switch to Biodiesel for my truck and heating oil. Save the enviroment, save my wallet, reduce consumption, and put the oil companies out of business. What's not to like

Frankeklund801 10:05:05 AM Feb 24 2008

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Pogo said we have met the enemy and he is us. Lower mpg standards should be required.
Better driving habits , knock off the jack rabbit starts and over the speed limit driving.Lower highway speed limits not higher.

Frankeklund801 10:05:05 AM Feb 24 2008

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Gdhominick 08:36:02 AM Feb 24 2008

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Largest oil company profits ever. Highest gas prices. Everything travels by truck or auto,and the service industry can't raise prices because of so many people out of work= less profit. BUSH AND HIS OIL FRIENDS HAVE DESTROYED THE ECONOMY! Largest oil company profits ever.

Catpete7 08:18:12 AM Feb 24 2008

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to RNe2571491..........in regard to your "100 mile per gal. carb. ".........wake up stupid it is a scientific fact that you can only get so much energy out of a gal. of gas......... hate to rain on your parade but 100 mpg's ain't never gonna happen. that hogwash has been going aroung since i was a kid as well........only saps buy into it

Dave3275 05:14:08 AM Feb 21 2008

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they wanna give 100 dollar tips instead of 50 dollar tips when OPEC goes an eat STEAKS with our money. BUSH an his daddy are getting rich before he leaves office. THEY ARE OIL PEOPLE!. im from MIDLAND TEXAS an i remember the BUSHES there an the way they ran MIDLANDS oil PRODUCTIONS an PURCHASES. NOW hes in the WHITE HOUSE RUNNING..... need i say more.

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