Introduction to How Gas Prices W

How We Explain Long Term Fluctuations in the Price of Gas

What does our gasoline cost?

Historical Gas Prices (Adjusted for inflation) United States
Year	Price Per Gallon
1950	$1.91
1955	$1.85
1960	$1.79
1965	$1.68
1970	$1.59
1975	$1.80
1980	$2.59
1985	$1.90
1990	$1.51
1995	$1.28
2001	$1.66
2002	$1.31
2003	$1.52
2004	$1.79
2005	$2.28
2006 (so far)	$3.03
Source: U.S. DOE

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2_____ Introduction.

Gas keeps America's fleet of vehicles rolling. There is nearly 1 vehicle per person in America.

It takes 65 billion barrels of oil per year, from which 42 to 45 gallons can be refined per barrel, to keep America driving and flying. That figure increases 2.6% annually.

Though gas prices can fluctuate by 50% within a year, gas is much cheaper than in other parts of the world.

Inflation affects what we pay for gas. When compensating for the declining purchasing power of the dollar, the chart shows that the real price of gas (in current purchasing power) became about 50% more expensive than in 1950. Said differently, in real purchasing power, the $2.25 gas in Dearborn lies about midway between what we were paying during the 1980-85 time frame.

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3_____ The Litre

So the crude oil costs the G7 Countries around 30 cents per liter, with not much variation.

However, delivery of the refined oil can add from 5 cents to 15 cents per liter, adds wider variations due to shipping, insurance, and the refinement of light (liquid) and heavy (less liquid) crude oil, and sour and sweet crude (with and without sulphur) into gasoline, aviation gas, and jet fuel.

The most important variation in cost are the taxes imposed.
Notice that taxes added from 21% to the cost in the USA (the lowest tax imposed by a G7 country) to 56% of the cost in the United Kingdom. Increases in costs of resources (such as wages paid to labor), will reduce supply.

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4_____ The Supply Chain

When you pump $20 dollars into your tank, that money is distributed among
- drillers,
-distillers,
- deliverers,
- filling station owners, and
- local, state, and federal government.

There's a supply chain with groups who are each responsible for raising the price by the value they add to the material they have purchased. 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 many other factors that determine what you pay at the pump. We discuss five more such entities below, and mention unforeseen events. No matter how expensive gas becomes, all these business people get their share of your gasoline dollar.

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5_____ The Gallon

Within the USA, crude oil markup is 41%.
(Add red + blue + green.)

Dearborn Price X cost = ...	Taxes	Distribution and Marketing	Refining	Crude Oil Cost
$2.25 X .20 =	.45
$2.25 X .11 =		.25
$2.25 X .10 =			.23
$2.25 X .59 =				1.33

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5 _____ Summary

Where Your Money Goes When You Pay for Gas:

(1) Crude oil (59%)
- The biggest portion of the cost of gas -- as of February 2006, about 59 percent -- 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). New discoveries can add to supply while war can shut down supplies. The amount of crude oil these countries produce determines the price of a barrel of oil. Crude-oil prices averaged around $37 per barrel (1 barrel = 42 gallons) in 2004 (Source: U.S. DOE). And, after Hurricane Katrina, some prices were almost double that. In July 2006, crude-oil prices averaged around $72 per barrel (1 barrel = 45 gallons. Weather affects delivery and can disrupt supply.

Light, sweet or heavy crude?
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.
(2) Refining costs (10%)
- The refining of crude oil makes up about 10 percent of the price of gasoline. To learn more about oil refining, read How Oil Refining Works.
(4) Distribution and marketing (11%)
- 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. Together, these two factors account for about 11 percent of the price of gasoline.
(5)Taxes (20%)
- Taxes, including federal and local, account for about 20 percent of the total price of gas in the United States.
--Federal excise taxes are 18.4 cents per gallon, and
--state excise taxes average 20 cents per gallon. There may also be some additional state sales taxes, as well as local and city taxes.
- In Europe, gas prices are far higher than in America because taxes on gas are much higher. For example, gas prices in England have risen as high as $6 per gallon, with 78 percent of that going to taxes.

(6) Station markup (2-10 cents per gallon?) - While it isn't represented in the diagram above, of course some of the actual money you spend at the pump does go to the service station. Service stations 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. However, some states have markup laws prohibiting stations from charging less than a certain percentage over invoice from the wholesaler. These laws are designed to protect small, individually-owned gas stations from being driven out of business by large chains who can afford to slash prices at select locations.

Distributional Issues
Gas prices also vary from state to state for several reasons.
--Taxes are probably the biggest factor in the different prices around the country.
-- 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.

Unforeseen Events
World events, wars and weather can affect gasoline 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.

Results Measurement:
Step one - (for 10 points) Using your highlighter, underline those items on your handout which affect the long term supply of oil.
Step two - (for 10 points) Compare your findings with those of your study partners.
Step three - (for 10 points) Write a paragraph in which you decide which factors have had the most pronounced effects on gasoline prices during your lifetime.
Step four - (for 3 points) Have you smiled and enjoyed your exposure to the laws of supply and demand?
Step five - Yes or No? Has your team of three earned its 100 points today?

Links to return to

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page 1 Goals 1 and 2

page 2 How We Explain Short Term Influences on Price of Gas

page 3 How We Explain Long Term Influences on Price of Gas

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