How gas prices work
We're certain that we're not the only ones that shake our heads in disgust when we roll by a gas station (and bow our heads in shame when we actually have to fill up). With the price of gas starting to come down, we certainly all are a little puzzled about what influences fuel prices. Howstuffworks.com comes to the rescue with a overview about what factors control the price of gasoline and the price of oil. While this is far from an exhaustive analysis at the elements that influence energy prices, the article does provide more in-depth analysis about the hot button topics in the economics of fuel.
The only explanation that we did not see is how oil companies are making record profits with oil AND its derivative product, gasoline, at such high prices. We want to see a step by step look at each stage in the process from well to wheels, and where each side takes its cut. Otherwise, the howstuffworks.com article does give more time to the subject than we typically see in other media outlets. So get going and find out what goes into making a $3.00 gallon of gas.
Reader Comments (Page 1 of 2)
Joe Hayes 10:36AM (9/24/2006)
Don't forget the political aspect too, heh. Prices seem to get lower around election time :/ I think there's just as much politics involved as supply, demand, formulation, or if the Arabs had a bad day.
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Dave 10:46AM (9/24/2006)
One thing that wasn't mentioned was delivery schedules. Deliverying gas from the local storage facility to the station costs money. Delivering more gas than the station can handle costs more because you have to transport gas back as well. Many stations will lower their price right before a delivery to make room for the incoming shipment if they need too.
You'll see the truck show up and voila...instant price hike!
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ME 11:37AM (9/24/2006)
Um, demand?
There is an unlimited demand for gasoline, why wouldn't the oil companies charge more?
Did consumption drop when the price nearly doubled? Nope. How high does the price have to go before the consumer reacts, and by react I mean reduce consumption, not just bitch about it while they fill their tank?
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Juan 11:42AM (9/24/2006)
Reducing consumption is harder than it sounds for a lot of people. I recently bought a car with bad gas mileage, but I owe more on the loan than it's worth. I'd love to wave my magic wand and turn it into a Corolla, but that's not going to happen until I pay (dearly) for awhile. Mass transit just isn't an option for a lot of American cities, too. I can't use it where I live.
Sure, a few people can ride their bikes to work. But that's not going to make a major impact on demand.
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jordan 11:50AM (9/24/2006)
Re: Juan
Very true, as not many people realize that if you're close enough to ride your bike to work, you probably aren't using that much gas in the first place because you probably live relatively close to your place of employment.
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motorman 12:16PM (9/24/2006)
the crude oil speculators drove up the price and the cost of speculation was stated to be about $20/$25 of the barrel price. once they backed off the price came down.
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Adam 1:03PM (9/24/2006)
How oil companies make record profits:
So there's x demand for gasoline. An oil company can produce 95% of demand x for 50¢ a gallon. The other 5% costs that company $3.00 to produce. Since the oil company doesn't want to lose money on that last 5%, it sells all the gas for $3.00 a gallon. So 95% of the gasoline is making the company $2.50 a profit on each gallon.
If $3.00 were above the limit some people were willing to pay for gasoline, the demand x would fall. If 5% of people were not willing to pay $3.00, that would bring us down to 95% demand and 50¢ gas.
And then when the gas price falls to 50¢, those people not willing to pay the $3.00 start buying again, the demand exceeds the 50¢ supply, the gas prices increase...
Politics has nothing to do with it. It's all market forces.
Side note: you ever notice how gas prices fall a bit when an oil company announces the discovery of an oil field in a friendly country and/or nearby the market it would be selling to? The oil traders are thinking "hmm, with this new supply, we'll be able to make gas more cheaply soon..." (My three paragraph example above is kind of simplified - oil traders more price their gas on where they think supply and demand will be in the future, not where it is right at this moment, but the example more or less holds true.)
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LaserBeams 1:05PM (9/24/2006)
There's some good info from the DOE here, too:
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/primer_on_gasoline_prices/html/petbro.html
I once had a neat little formula, that knowing the state tax rate, and the price of a barrel of crude oil, you could get a value within a few cents of the actual price, but I seem to have misplaced it.
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Richard Warren 1:18PM (9/24/2006)
How it actually works:
Production is about the same year round
Refining about the same
Transportation about the same
Some minor disturbance creates speculation on the comodity market.
Prices rise
and-------
What really remains the same is we are bent over and smile as we listen to all the bullshit spewed.
This is about profit, plain and simple while it can be made, it's called profitering.
Shall we take bets that because of some contrived shortage or excuse that heating oil goes up in a few weeks? Read an older book "The seven sisters" see what really goes on in the oil business.
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jamie 3:11PM (9/24/2006)
What most people fail to figure in is the inflation rate. The value of the U.S. dollar has slid 50% so far this year. Eg. the Canuck buck was worth 60 cents U.S. at the beginning of the year. Now it has appreciated to over 90 cents to the Yankee green back. This is also true of almost all other internationally traded currencies. The purchasing power of the U.S. dollar has crumbled dramatically this year and is expected to tank even further.
Why?...The U.S. national debt is breaking an unsustainable $8.3 trillion; and as a result most conservative currency traders are dumping the dollar for the Euro, gold or silver. They expect the dollar to be devalued soon, and it will be.
The treasury must pay out $2 billion a day to maintain this risky level of debt. The economy is crashing and no new money is coming in. In fact China accumulates $17 billion of U.S. currency a month that it cannot find investments for. Nobody wants excess U.S. dollars.
But so long as the U.S. countinues to buy imported oil and goods, the pressure to devalue the dollar will increase. The imports that we buy only serve to strangle our own economy.
The crash is just around the corner. Then gasoline will rise overnight to where it should be...$6.87 a gallon. Get used to it! The current economics demand a revaluation. How can 4% of the world's population (the U.S.) continue to gorge itself on 25% of the world's oil production? The rest of the world has emerged from the dark ages. A major overhaul is in the works.
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Cara 9:07PM (9/24/2006)
While I agree that money making is the concept in the oil and gas industry, there is not much the conusmers can do about controlling prices. I hate those darn emails about not buying gas on this day and that day to show them "we" mean businees. That's crap. Everybody needs gas and will continue to need it as long as cars and traveling is necessary. Whether you cry and complain about it, you still need it. It is a necessity and not a "want". Maybe it is a want for some short commuters who can find alternate means of transportation.
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Poleaxe 3:46PM (9/24/2006)
Jamie, the Canadian dollar was not worth 60 cents American a year ago. The Canadian dollar's low was about 63 cents, and that was around five years ago. The value of the US dollar has not slid 50% this year. You are a clueless imbecile, without even the most basic grounding in economics, and zero grasp of facts even when you have them correct. Please stop talking out of your ass. Reading the big oil conspiracy theorists' ignorant ravings is painful enough without you adding your stupendous idiocy to the mix.
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funksobruva 3:59PM (9/24/2006)
Adam, you can't really be serious...
"Politics has nothing to do with it."
Get ye back to economics school, boy!
Even there, you'll learn about how politics weigh heavily on a commodity like oil (and therefore gas). The two are inextricably tied, and will be until there's some competition. Not for who distributes it, but for the fuel itself.
Even though it's fiction, a movie like "Syriana" should get you thinking about ways that politics weigh into the oil trade.
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Ryan 4:03PM (9/24/2006)
"Side note: you ever notice how gas prices fall a bit when an oil company announces the discovery of an oil field"
-NOPE.
"How gas prices work"
-LMAO!!!!!!!!!!!!!!!!!!!!!!!!!!!
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Ryan 4:07PM (9/24/2006)
"How gas prices work"
I think that's classified information
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Finished Law School 4:16PM (9/24/2006)
The gas prices began their rise during the early spring so that there would be a high price during the summer driving season giving oil companies a nice fat profit. Once the summer driving season ended so did the high prices.
It is cyclical and will happen again next year.
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Ryan 4:23PM (9/24/2006)
"Once the summer driving season ended so did the high prices."
-Where?
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Chris 7:54PM (9/24/2006)
I still find it funny when I hear people bitch about how it cost them $40 to fill their tank up for a week as they hold their $7-$8 Starbucks in their hand. Or when they buy bottled water at over a $1 per 20oz. bottle. Sure, it sucks to pay $2.50 a gallon but maybe if you cut back on the stupid expenses like Starbucks, cigarettes, and alchohol personal finances wouldn't be so bad.
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Ryan 8:46PM (9/24/2006)
"17. I still find it funny when I hear people bitch about how it cost them $40 to fill their tank up for a week as they hold their $7-$8 Starbucks in their hand."
-First off a 16oz non-fat double latte is $3.78 at Starbucks not $7-8$ and second it's not $40.00 fill ups people are bitching about it's: $60-$100.00 fill ups.
-Chris,
Maybe YOUR EXACT argument IS WHY people are bitching about gas prices, because it DOES into disposable income more, and more and more. For other it cuts deeper into their income, far deeper than the disposable portion of it.
-Where are all of you people that try to rationalize big oil in real life?! I mean I know a lot of people, from friends, to family and then co-workers and not a single ONE defends ANYTHING about gas prices.
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VincentP 9:32PM (9/24/2006)
Record profits are from 2 sources:
Source #1. Oil companies are not only in the buisness of refining and retailing gasoline. They also invest heavily in finding and drilling of crude oil. When the price of crude goes up (from geo-political events, natural disaster, wars, etc.), it still costs them the same to pump the oil from the ground, but now they get extra $ for each barrel, which is pure profit.
This is actually good that AMERICAN companies get their own crude rather than buying all foreign oil from foreign governments. Would you rather have OPEC gain all the extra profits, or Exxon/Mobil?
Source #2. Game Theory. This is the most often overlooked and least understood impact on prices when there are few suppliers to a market. Normally, in a purely competitive market (many buyers, many sellers), neither the buyer nor seller has an influence on the market price.
But in an oligopoly (few sellers), each seller has an influence over the market price. Without going to much into the mechanics (look up up on Wikipedia if you want more details), the confusion of a market "shock" (hurricane, wars, etc.) gives the suppliers an opportunity to collude legally via market price signals. (e.g. I raise my price, you follow, repeat.)
This collusion eventually erodes as the market stabilizes. The pressure then builds to undercut your competitor, and take all his buisness (aka price war), which is what were seeing currently.
All this price activity is highly profitable, and the airlines practice it constantly (to much success until Southwest came along and didn't play along). To most companies an oligopoly is the place to be - enormous profits without the government regulation of a monopoly.
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