Did you ever wonder what determines the price of a gallon of gasoline?  Good.  Because I did a little research and thought I’d pass along some useful information to you.  That way, when you fill up your gas tank, you’ll have some idea of why you’re paying what you’re paying.  Now, I know you’ve seen grandstanding politicians call for investigations into the Big Bad Oil Companies and their gross profits, but the truth is that the price of gasoline is purely a function of supply and demand.  Let me explain:

The cost components of a gallon of gasoline as of Feb. 2008 are as follows:

Crude Oil:                                           69.7%
Federal and State Taxes:                     13.2%
Refining Costs and Profits:                   7.2%
Distribution and Marketing:                  9.9%

The prices ultimately paid by consumers at the pump reflect these components of which the costs and taxes of the retail station owner are built in.  So, if you are pumping gas into your car that costs: $3.02/gallon, the cost breakdown is as follows:

Crude Oil:                                            $2.11
Federal and State Taxes:                      $  .40
Refinery Costs and Profits:                   $  .22
Distribution and Marketing:                  $  .29

Let’s take a closer look at these components:

Crude Oil:

As you can see, the cost of crude oil makes up the largest percentage of the price of gallon of gas.  Crude Oil is a commodity that is traded in the world marketplace daily.  I’m sure you’ve heard that oil is trading at record high prices.  This is directly related to the increase in world demand for oil.   As you know, the economies of the world’s industrialized nations run on oil.  As these economies grow, their demand for oil increases.  The market price of oil depends on the suppliers ability to meet this demand.  The United States is the world leader in oil consumption at approximately 20 million barrels per day, but countries like China and India have burgeoning economies that are consuming more oil every year.  China’s oil consumption has increased 7% per year since 1990.  This increasing demand has driven up the cost of crude oil in the world marketplace.  Now because oil is a commodity, there is also much speculation that goes on.  That speculation can be driven by: weak inventory reports from oil consuming countries, natural disasters that restrict oil provider’s ability to provide oil, bad weather that affects oil production, investor sentiment on future oil supply, labor problems, and war.  Now, we’ve heard a lot lately about the gross profits of the oil companies.   Some shameless politicians looking to curry favor with the ignorant have even called for investigations into their profits.  This is ridiculous.  When demand for oil exceeds supply, the price goes up and the oil provider’s profits increase, but that is the same with any business with a unique product.  10 years ago, when oil was $22/barrel, no one was complaining that the oil companies were making too little.  The fact is that oil providers provide oil, and when demand increases, the prices and profits naturally go up.  Why shouldn’t they reap the benefits of higher prices?  They went into the oil business to make money.  They provide us with the oil that we desperately need.  If they didn’t make money providing the oil, they wouldn’t be in business, and we wouldn’t have oil (by the way, everyone with a 401K is invested in these oil companies and is sharing in their gross profits).

Federal and State Taxes:

It’s funny how we don’t hear politicians call for investigations into Big Government and their outrageous tax profits. The fact is that taxes are a significant component of the price of a gallon of gas.  For each and every gallon that we pump, we pay about 40 cents to our federal and state governments (nationwide average).  That’s gouging.

Refinery Costs and Profits:

Crude oil cannot become gasoline without being refined.  The economics of the refining process varies depending on the type of crude oil being refined, the complexity and configuration of the refining equipment, and the desired final product.  These components are impacted by the many different state environmental requirements which add a tremendous amount of cost to the process.   It is also important to note that we haven’t built any new refineries in the United States since the 1970’s.   Breakdowns in the refinery process due to limited capacity, old technology and new regulations can lead to a disruption in gasoline supply and increase costs. 

Distribution and Marketing:

Gas is shipped by pipeline from the refineries to strategically located terminals and then delivered by truck to individual stations.  Whether the station is owned by the refinery itself or is an independent, the final cost that you pay is a factor of the station’s gas purchase cost, the station’s taxes, the cost to run the station, local competition, location, and overall marketing and profit strategy.

Well, there you have: a short tutorial on the price of gasoline.   In conclusion, the reason we are paying more for gas now is that there is more demand for oil worldwide than there is supply, we pay high gasoline taxes, and our refineries are limited by their old technology and environmental regulation.  So, what can we do?  That’s easy.  We can elect fiscally responsible representatives that will cut our taxes, permit the construction of new refineries, and vote to procure more of our oil domestically.   


...more columns by Todd