Seven reasons gas prices rise and fall

Refineries are gigantic complexes, some covering several square miles. Refining uses heat and chemicals to separate crude into different products. Not just gasoline: the list is long, and includes diesel, jet fuel, heating oil, kerosene, motor oil, and feedstocks for products from drugs to cosmetics.Because they’re big and complex, refineries are expensive: BP recently sold a Houston-area refinery to Marathon Petroleum for about $600 million. That’s just the plant: the cost of refining also includes labor, maintenance and chemicals; plus a refinery burns part of its own output to run equipment that processes the crude. The EIA estimates that refining accounts for about 8% of the cost of a gallon of gasoline.Once the oil’s out of the ground, then what? Well, it must be refined because cars, planes and furnaces don’t burn crude oil. Large refineries like the ones on the Gulf Coast can process hundreds of thousands of barrels every day, the output of thousands of oil wells – wells that may be thousands of miles away. To get the crude to refineries, companies build networks of pipelines on land, or use tankers on water.Something you probably didn’t know: the oil refined at a Shell refinery comes from a pipeline company, but not (necessarily) from a Shell well. Refiners buy crude oil on the basis of physical and chemical properties, not where it comes from or who pumped it out of the ground.You probably realize that a tanker is expensive, but so are pipelines: a ballpark cost is about $1 million per mile, plus terminals, pumping stations and the maintenance to keep them operating safely. That’s part of what the EIA estimates accounts for 8% of the cost of an average gallon of gas.The U S Energy Information Administration (EIA) estimates that two-thirds of the price of gasoline is the cost of crude oil. Crude prices vary with oil quality, but there are two reference prices: West Texas Intermediate (WTI) and North Sea Brent (Brent). Today, a 42-gallon barrel of WTI trades for about $93 and Brent sells for $113 (see current prices in real time here). If a barrel of oil costs $100, then the crude oil used to make a gallon of gasoline costs about $2.38 all by itself.Why does oil cost so much? Because it's not that easy to find and get out of the ground. Oil companies invest hundreds of millions, even billions,to find crude oil. A well drilled in the deep Gulf of Mexico might cost $150 million, and there’s a chance the well won’t find enough oil to pay for the well. In 2011, ExxonMobil was spending around $100 million every day looking for new oil – more than $3.5 billion for the year. That number didn’t include production; just finding new oil. Do you still think that an oil company's making $100 million in profits in a quarter is a rip-off?View the list »
A gasoline pump at a BP service station.

Industry newsletter

Gasoline prices are a hot topic, especially when they go up like they have in Houston recently. Gas is a strange market, though: for one thing, can you think of anything else you use daily whose price is advertised on street corners? Groceries don’t do it with milk or bread, and clothing stores don’t do it with tube socks; but every gas station posts prices in letters two or three feet tall. What makes those prices rise and fall, apparently without reason? Many people think that big oil controls the price at the pump, but they're mistaken.

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  • The U S Energy Information Administration (EIA) estimates that two-thirds of the price of gasoline is the cost of crude oil. Crude prices vary with oil quality, but there are two reference prices: West Texas Intermediate (WTI) and North Sea Brent (Brent). Today, a 42-gallon barrel of WTI trades for about $93 and Brent sells for $113 (see current prices in real time here). If a barrel of oil costs $100, then the crude oil used to make a gallon of gasoline costs about $2.38 all by itself.Why does oil cost so much? Because it's not that easy to find and get out of the ground. Oil companies invest hundreds of millions, even billions,to find crude oil. A well drilled in the deep Gulf of Mexico might cost $150 million, and there’s a chance the well won’t find enough oil to pay for the well. In 2011, ExxonMobil was spending around $100 million every day looking for new oil – more than $3.5 billion for the year. That number didn’t include production; just finding new oil. Do you still think that an oil company's making $100 million in profits in a quarter is a rip-off?
  • Once the oil’s out of the ground, then what? Well, it must be refined because cars, planes and furnaces don’t burn crude oil. Large refineries like the ones on the Gulf Coast can process hundreds of thousands of barrels every day, the output of thousands of oil wells – wells that may be thousands of miles away. To get the crude to refineries, companies build networks of pipelines on land, or use tankers on water.Something you probably didn’t know: the oil refined at a Shell refinery comes from a pipeline company, but not (necessarily) from a Shell well. Refiners buy crude oil on the basis of physical and chemical properties, not where it comes from or who pumped it out of the ground.You probably realize that a tanker is expensive, but so are pipelines: a ballpark cost is about $1 million per mile, plus terminals, pumping stations and the maintenance to keep them operating safely. That’s part of what the EIA estimates accounts for 8% of the cost of an average gallon of gas.
  • Refineries are gigantic complexes, some covering several square miles. Refining uses heat and chemicals to separate crude into different products. Not just gasoline: the list is long, and includes diesel, jet fuel, heating oil, kerosene, motor oil, and feedstocks for products from drugs to cosmetics.Because they’re big and complex, refineries are expensive: BP recently sold a Houston-area refinery to Marathon Petroleum for about $600 million. That’s just the plant: the cost of refining also includes labor, maintenance and chemicals; plus a refinery burns part of its own output to run equipment that processes the crude. The EIA estimates that refining accounts for about 8% of the cost of a gallon of gasoline.
  • Refined gasoline doesn’t do any good sitting at the refinery: it has to get to the station where you can pump it into your tank. From the refinery, finished products go through pipelines to terminals across the country. At a terminal, the gasoline goes into tanker trucks that ferry it out to the corner store. And then you buy it.The EIA estimates that this distribution plus marketing (things like television ads and stickers on NASCAR rides) runs about 11% of the cost of a gallon of gas.
  • And then there’s taxes. On average, Americans pay 49¢ per gallon in federal and state taxes combined. Federal taxes account for 18.4¢ while state taxes range from 8¢ per gallon in Alaska to almost 50¢ per gallon in Connecticut and New York.Those five costs account for the basic price of a gallon of gasoline; the profit margin at most stations is another few cents per gallon.Prices at nearby stations may differ due to different gasoline quality (for instance, proprietary additives) and different costs of doing business: property taxes, cost of land and building, insurance, etc.  And, of course, some stations charge more because they’re in “convenient” locations, such as near city centers and airports.
  • Refining, transportation, marketing and taxes are the kinds of costs that change only slowly. So why does the pump price keep rising and falling? The answer is supply and demand, which influences the costs at two key points. The first is crude oil prices.Oil companies don’t have the luxury of setting the price of their product, because oil is traded on a global market. The global price of oil is affected by many factors, most of which can be lumped together under supply, demand or both. When traders believe that the supply of crude oil will increase faster than demand, crude oil prices fall. Crude oil prices fall when the economy looks bad, because that means demand will decrease. Crude oil prices rise when the Organization of Petroleum Exporting Countries (OPEC) tightens production, because that means supplies will decrease. Wars and political upheaval, major weather events, even major discoveries can tug the world crude oil price in different directions.
  • Crude oil is a global market, but gasoline is a regional and at times, local market. As the chart shows, the price of gas is related to the crude oil price, but there can be variations. Local supply and demand also control the wholesale price of gasoline as buyers for retail chains bid on gasoline deliveries for their stations; often weeks or months in the future. If traders believe that supplies will decrease or demand will increase, the bid price rises. Here are some common reasons this might cause wholesale gasoline prices to rise:Decreased supply when refineries shut down for maintenance or to change their gasoline formula; for instance from “winter gasoline” to “summer gasoline” or to increase gasoline output and decrease heating oil production.Decreased supply when a refinery goes off-line due to weather, such as hurricane Katrina; or other event such as the August, 2012, fire at a Chevron refinery in Richmond, California.Increased demand as economy improvesIncreased demand for summer vacation season.or fall:Increased supply when refineries expand or re-open.Increased supply when local crude oil supplies expand.Decreased demand when economy falters.Decreased demand when summer driving season ends.
  • Some facts you may not know about oil companies and gasoline:Oil companies own very few of the stations that bear their name. Most are locally-owned franchises.The gasoline sold in an Exxon station probably didn’t come from an Exxon refinery, and it almost certainly didn’t come from an Exxon oil field.The gasoline sold in your nearby Chevron station probably came out of the same pipeline and from the same refinery as the gas sold at your local Kroger store. It’s the additives that make brands different, and they’re added while the gasoline is in the truck.Gas stations don’t make much money on a gallon of gas; usually 7-10¢ gross profit per gallon (gross, not net).There’s some profit made at every step along the way in getting gasoline into your tank.
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, Houston Energy Industry Examiner

In thirty years as an oil patch geologist, Rex Knepp has worked for major, independent and international oil companies; a regulatory agency; consultants; and a software vendor. His work has contributed to exploration and production projects on six continents. In spite of these strong petroleum...

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