Wednesday, June 11, 2008

Why Does Fuel Cost $4 a gallon?

Breakdown of Gas Prices

As motor fuel prices continue to increase, the blame for such increases are spreading far and wide. With reports of gas station vandalism, fuel tax revolts in Europe and legislative pleas to increase energy independence, I thought it would be interesting to evaluate what goes into the price of fuel. By using my trusty resource I found the following breakdown of fuel prices that I thought may be helpful.

When you pump gas 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:

· Taxes: 11 cents
· Distribution and Marketing: 6 cents
· Refining: 10 cents
· Crude oil: 73 cents

This all equals $1 dollars worth of gas, so for a typical gallon of gas price at $4/gallon the approximate national average is:

Taxes: 44 cents/gallon
Distribution: 24 cents/gallon
Refining: 40 cents/gallon
Crude Oil: $2.92/gallon

This is what the average breakdown looked like in April 2008. Let's look at those components in more detail.

· 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).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: U.S. 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 barrel [source: Forbes]. 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.

· Refining costs - The cost of refining diesel fuel can be considerably higher than the price of refining regular gasoline.

· 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 excise taxes are 18.4 cents per gallon, and state excise taxes average 18.2 cents per gallon. 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 (Utah is at 24.5 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.

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.
The most recent surge in gas prices is due to several factors, including all of those listed above. However, a new reason emerged during the spring of 2007: legislation out of Washington to incorporate more ethanol into transportation fuels, enough to reduce daily oil imports by 1.5 million barrels by 2017. Between October 2007 and April 2008, ethanol-blended gas was between 4 and 12 percent more expensive than regular gas.

In addition to new legislation and the items listed above, another factor to consider is the strength of the US Dollar. Because oil prices are set in US Dollars, anytime the US Dollar is devalued against other currencies the price of gas in dollars must increase to reflect the “true value” as represented in the world economy, where other currencies are being used to by fuel. Recently the FED Chair Ben Bernanke announced potential efforts to reduce inflationary pressure that can largely be attributed to the cost of fuel by attempting to strengthen the dollar and therefore drive down the cost of staple goods where prices of such goods are dependent upon the cost of fuel for production and transportation.
As you can see there are many things that go in to the cost of fuel. There is no one culprit, but rather a very complex web on factors that set fuel prices. Any manipulation of one factor can have significant impacts not only on the price of fuel but many other issues as well, to include financial markets, lending rates, monetary policy, tax policy, road construction schedules, environmental issues, etc, etc,

If you want a far more in depth discussion on this issue and how OPEC works, why gas prices vary in different parts of the country or energy independence you can find out much more at