No one needs to be told when gas prices are going up. The price of crude oil affects almost every aspect of our lives, and it's the major factor influencing gasoline prices.
According to the U.S. Energy Information Administration, one barrel of crude yields 45 gallons of petroleum-based products, including 19 gallons of gas and 10 gallons of diesel fuel. The rest is transformed into jet fuel, heating oil, lubricants, plastics and a wide variety of other products used in homes and industries. The supply and demand for all of these products will impact the price of gas, even though it represents less than half of the total usage. (Find out how this commodity's fluctuating price affects more than just how much you pay at the pump, see How Does Crude Oil Affect Gas Prices?)
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The price of gasoline is comprised of four components that can be influenced by a variety of factors. Assuming a price of $3.11 per gallon, here in an approximation of where your money goes, according to the department of energy in December of 2010:
- $2.11 – Crude oil production
- 44 cents – Taxes
- 25 cents – Marketing & distribution
- 31 cents – Refining
Since two-thirds of the cost is directly attributable to crude oil exploration and extraction, this is clearly the component to focus on when analyzing future gas prices.
Supply is driven by the rate of extraction of oil-producing countries, and is heavily influenced by the Organization of the Petroleum Exporting Countries (OPEC). Originally founded in Iraq in 1960, the original five countries have since expanded to the current 12: Iraq, Iran, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador and Angola.
OPEC exerts tremendous leverage in determining world crude prices. Total crude for the U.S. in October, 2010 consisted of 33% U.S. production, 36% OPEC imports and 41% imports from other countries. With only one-third of its oil produced domestically, the U.S. supply is subject to dramatic shifts beyond its control. Any moves by oil exporters to restrict supply by drawing down inventories are a clear sign that prices could rise accordingly. (Learn more in Meet OPEC, Manager Of Oil Wealth.)
Gasoline production is also a function of total refining capacity. According to the U.S. Energy Information Administration, in 2009, the total U.S. capacity was 17.7 million barrels per day, one-fifth of the total world capacity of 85.9 million barrels per day. If the supply of crude exceeds refining capacity, that oil won't make it to the marketplace until the existing inventory is cleared.
The U.S. has 141 refineries with atmospheric crude oil distillation capacity. The five largest refineries are located in Texas and Louisiana, each producing an average of 475,000 barrels per day. Refinery maintenance is normally done in early spring, so any resulting production or safety issues that force suspension of operations can cause a short-term spike in prices.
Americans have a huge demand for gasoline, driving about 3 trillion miles per year. More recently, the price of crude has risen as a result of growing demand in highly populated countries such as China and India. These are both growing industrial economies with a corresponding thirst for more oil. Economic conditions around the world are also a predictor of oil futures.
Pump prices are also moved based on seasonal demand, particularly during the summer months when driving vacations are most common. In addition, summer-grade fuels that burn cleaner are more costly to refine. Gas prices are subject to shifting demand for non-gasoline petroleum products. For example, if more crude is needed for jet fuel or plastic manufacturing, this will put further pressure on gas prices as less crude is available for gasoline refining.
Any increases in taxes will find their way to the pump almost immediately. In the U.S., 18.4 cents are added to every gallon of gas by the federal government. An average tax of 29.7 cents is also added at the state and local level, bringing the average total tax to 48.1 cents per gallon. That represents about 15% of the average cost of gas in the U.S. as of January 24, 2011 according to the American Petroleum Institute.
The total tax varies from a low of 26.4 cents in Alaska to a high of 66.1 cents in California. That spread of almost 40 cents per gallon illustrates that geographic location plays a significant role in what you will pay at the pump. With several states on the verge of bankruptcy, increasing gas taxes is a possible source of additional revenue that would immediately impact consumers.(Check out The Industry Handbook: The Oil Services Industry.)
While markup at the gas station is added to yield a profit, this is controlled in areas where there is sufficient competition. In most cases it's less than ten cents per gallon.
The U.S. government can influence local prices by releasing crude from the Strategic Petroleum Reserve (SPR). This action has the temporary effect of reducing prices but at some point the supply would have to be replenished, possibly at higher prices. The SPR consists of four sites along the Louisiana and Texas coasts that have a total capacity of 727 million barrels. This represents a two-month supply if all imported oil was cut off simultaneously.
Weather is a major factor, especially in areas where there is offshore drilling. Crude almost doubled in the aftermath of Hurricane Katrina. The BP (NYSE:BP) oil spill in the Gulf of Mexico and the Exxon Valdez spill in Alaska are just two examples of man-caused disasters that caused a price spike.
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The Bottom Line
With dwindling oil reserves and increasing worldwide demand, it seems that gas prices have only one way to go in the long run - up. Add the risk of wars, civil unrest, tanker pirates and other world events and there's a recipe for even more upward pressure on prices.
In the U.S., there's an ongoing battle between environmentalists and those who want to open more areas to drilling. There are also battles at the state level where some states have imposed stricter formulation standards than those dictated by the federal government. As prices continue to rise, the pressure will mount to loosen standards and grant drilling rights to previously restricted areas.
Mutual Funds & ETFsLearn more about the United States Brent Oil exchange-traded fund, the characteristics of the fund and the suitability and recommendations of it.
Mutual Funds & ETFsFind out more about the ProShares Ultra Bloomberg Crude Oil ETF, the characteristics of UCO and the suitability and recommendations of UCO for investors.
SavingsPrices for oil and natural gas are highly correlated. But investors should be aware of different factors affecting the prices of these commodities.
EconomicsConsumers incur switching costs when they receive a monetary or other type of penalty for changing a supplier, brand or product.
InvestingEven as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
EconomicsMarket penetration is the measure of how much a good or service is being used within a total potential market.
EconomicsThe marginal rate of substitution determines how much of one good a consumer will give up to obtain extra units of another good.
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