What Determines Gasoline Prices?

When gasoline prices rise, consumers certainly notice. That attention makes rising gasoline prices (never falling ones) a perennial hot-button political issue, with industry and politicians occasionally trading blame for the rising costs. Here, we take a look at the factors that determine gasoline prices at the pump.

Oil Prices: The Crude Reality

Crude oil is the raw commodity used to make gasoline, so crude oil prices play the most important role in setting gasoline prices. According to the U.S. Energy Information Administration, the price of crude oil accounted for 56% of the price of gasoline in the decade through 2020, on average. But that average conceals wide fluctuations. In 2020, with crude prices down sharply amid the COVID-19 pandemic, crude accounted for just 43% of gasoline costs.

Crude is the most widely traded global commodity and among the most widely used. Crude prices are set in deep and liquid global markets. The market power of groups including OPEC and international oil companies has diminished over time with the development of alternative sources of supply and growth in demand from developing countries.

Not all grades of crude oil are equally useful for making gasoline. Lighter crude—oil that is less dense—will produce more gasoline per barrel than heavy crude. Sweet crude, meaning grades with lower sulfur content, are preferable to sour crude, which has more sulfur.

At the local level, the preferable crude grade is one likely to yield the most profit given the processing capabilities of a given refinery. Costlier light sweet crude is no prize for a refinery equipped to process heavy sour grades.

Refining Has a Price

No matter the crude grade, putting it into the gas tank of a car won't get you anywhere but to a repair shop. Hence the need to pay refiners to distill crude oil into gasoline and mix in the required additives.

The 42-gallon barrel of crude oil yields 19 to 20 gallons of gasoline along with 11 to 12 gallons of fuel oil.

In the decade through 2020 refining costs and profits accounted for 14% of the retail price of gasoline, on average. Gasoline production costs vary with seasonal and regional blending requirements designed to reduce pollution, as well as the cost of required additives including ethanol.

The price of wholesale gasoline partly reflects supply and demand factors distinct from those for crude oil. For example, U.S. gasoline prices typically rise in the summer in response to higher demand. U.S. refining capacity increased less than 1% in the decade through 2021, lagging growth in demand. Increased U.S. exports of gasoline have further constrained domestic supply.

When gasoline prices rise, suppliers tend to get blamed. A CNN poll in 2008 found 62% of respondents blamed rising gasoline prices on "unethical behavior" by suppliers, versus 32% who cited supply and demand. In remarks American Fuel and Petrochemical Manufacturers, an industry group, says members don't set prices.

Distribution and Marketing

Once crude is refined into gasoline, the fuel has to be shipped to a storage tank, and eventually distributed to local gas stations. Those stations require staff and maintenance. Distribution and marketing costs accounted for 14% of the U.S. retail price of gasoline in the decade through 2020, on average.

Distributors and marketers have, like suppliers, come under fire for their alleged role in manipulating gas prices. The FTC said in September 2021 it would oppose mergers providing increased opportunities for "potential price coordination and other collusive practices in the retail fuel industry." In November 2021, U.S. President Joe Biden asked the Federal Trade Commission (FTC) to probe "whether potentially illegal and anti-competitive behavior in the oil and gas industry is causing higher prices for consumers."

Enter the Taxman

State and local taxes accounted for 16% of the retail gasoline price in the decade through 2020. Federal taxes and fees were 18.4 cents per gallon for gasoline and 24.40 cents per gallon for diesel as of July 1, 2021. State taxes averaged 30.63 cents per gallon for gasoline and 32.29 cents per gallon for diesel as of the same date.

State gasoline taxes ranged from a high of 58.8 cents per gallon in California to a low of 8.95 cents per gallon in Alaska as of Jan. 1, 2022.

The federal gasoline tax rate has not changed since 1993. Many state tax rates on gasoline have recently increased, in contrast, to help road repair spending keep up with inflation amid recently depressed demand. Virginia most recently raised its tax by 5 cents per gallon in July 2021, while New Jersey increased its gasoline tax by 9.3 cents per gallon in October 2020.

Gasoline taxes can be much higher overseas, recently averaging about $4 per gallon in western Europe.

Consumer Demand

Consumer demand also plays an important role, its rebound since the early stages of the COVID-19 pandemic accounting for much of the rise in retail gasoline prices from their 2020 average of $2.17 per gallon.

U.S. gasoline consumption plummeted in 2020 amid COVID-19 restrictions but largely rebounded in 2021. Gasoline prices must range widely to balance supply and demand because U.S. consumers tend to be slow to adjust the amount of driving they do in response to changes in the price of gasoline.

Demand has likely become less responsive to price changes over time as the proportion of income spent on gasoline has decreased. As of October 2021, 10 gallons of gasoline cost the equivalent of about 3.1% of weekly per capita disposable income, down from 4.8% in 2011.

The Bottom Line

Like crude, gasoline is a widely traded commodity and its wholesale prices are set in deep and competitive markets. Large gasoline distributors can wield a lot of market power at the local level, and have recently drawn official scrutiny. In general, blame over higher gasoline prices directed at a particular politician or an industry deserves to be examined skeptically.