The Bloating Of Gas Prices

Photos (Enlarge photo) What determines the price of gas for the day? (Photo by Liz Kim)

When was the last time you went to fill up your car and left the gas station muttering, "Wow, that was a bargain!"? Probably quite some time ago. If you're like most people, you've become disgruntled with the endless price fluctuations, feel victimized by the superhuman forces who control petroleum prices, and yearn for the day when the vengeful gods of righteous prices will slash fuel costs so that you can top off your tank for under 10 bucks.

Well, those gods will have plenty of targets upon which they can wreak their terrible retribution. Prices are not merely determined by some turban-wearing dude with an unpronounceable name who decides to raise the cost of oil so that he can buy his butler a sable-lined sofa. Since nothing excites us here at Edmunds.com more than exposing the bloated underbelly of fat corporations (well, that, and animal husbandry), we thought that we'd outline the process of manufacturing the 77 million barrels of oil that we consume daily, as well as the myriad of market influences that cause the variant fluctuations that decide whether or not you can get the chili dog as well as the Flamin' Hot Cheetos at the Shell Mart.

Lifecycle of a Gallon of Gas
Fossil fuels are made of decomposed plant and animal matter that has, through millions of years, been chemically transformed to coal, petroleum and natural gas. So really, what you're putting into your car are ground-up velociraptor parts (cool...someday Grampa will be powering an F-150!). Since fossil fuels are buried deep beneath the Earth's crust, oil companies seek to find rich reservoirs underneath the soil. Much of the planet possesses these deposits, but some of these areas are more richly stocked, and are more easily accessed, such as in the Middle Eastern countries. Factors that determine the facility with which oil can be accessed are terrain, weather conditions, and militant environmentalists opposing offshore drilling. So even before companies start to dig, a Byzantine process of consulting geologists, engineers and government officials has begun. Picturesque scenes, like that of James Dean twirling around a gushing well, don't regularly occur, unless you're a poor mountaineer who barely kept his family fed and you just happened to be shootin' at some food.

After these hurdles are cleared, the rhythmic action of the oil pump culls the product from the earth, which is then transported, sometimes by trucks but usually via pipelines, to a waterlogged port to be loaded onto gargantuan tankers so that it may be shipped overseas. If the U.S. is its destination, and a port, such as that in Houston, isn't large enough, it must be unloaded at an offshore facility then reloaded onto an American vessel with an American crew, then dumped on shore before it can be trucked to the refinery. All this equipment must be operated and maintained, and is subject to such whims as the Gulf War skirmish (which destroyed supplies as well as tankers) or other military action which drives up the demand for jet fuel.

At the refinery plant, the crude product is processed, and the different components are separated into byproducts such as fertilizer, plastics, the shiny stuff of which your local bus driver's pants are made, and Vaseline. The oil is manufactured into different types of fuel as well, such as diesel, aviation, and for home heating oil. Gasoline comprises 45 percent of the final product.

Along with the basic costs of refining the oil, which range from 50 cents to $3 per barrel, the federal government has different criteria for the fuel used in the United States, established by different environmental laws. The removal of lead, for instance, costs 3 cents per gallon of gas, and the reduction of sulfur costs an estimated 1 to 5 cents per gallon. Large-scale industrial disasters, such as the massive fire at a California refinery in the summer of 1999, can affect the supply for a large geographic area.

After the oil has been converted into gasoline, it is once again either trucked or sent via pipeline into different regions of the country. Among the dozens of pipelines that weave across the continent is the Colonial pipeline, a 5,349-mile network that ferries 80 million gallons of petroleum a day between Houston and New York. Pipelines, too, are subject to various economic and social conditions. For instance, the great energy crisis of California in early 2001 will ultimately affect gasoline prices, as the rolling blackouts affect the operation of the pipelines, and result in shortages.

At this point, the gas is distributed to various parts of the country, where it is further refined according to state and local specifications. For instance, the California mandate for clean-burning gasoline is stricter than the federal guidelines, and additives such as the controversial MTBE (methyl tertiary butyl ether), which has been found to reduce harmful automotive emissions, is mixed into the formula. That raises the price another 3 to 5 cents per gallon.

Finally, the completed product is delivered to one of 180,000 gasoline retailers around the country. But wait -- there's more! On its way to the gas station, each gallon of gasoline picks up 18.4 cents in federal taxes, 23.1 cents in state and local sales taxes, and a severance tax (assessed when the oil is extracted out of the ground), meaning approximately one-third of the cost of a gallon is going to the government. Factor in refining costs and profits (13 percent) and distribution, marketing and retail station costs and profits (14 percent), and you realize that only a third of the cost of a gallon of gas is actually for the crude oil used to make the gasoline.

So there you have a picture of how a triceratops burrowed its way into your fuel tank. But we still haven't even begun discussing market fluctuations! Here are some variables in the marketplace that further affect the price of gas.

Variables in the Market That Result in Price Volatility
Primarily, the issue of supply and demand is always a critical factor. At its base is the production of crude oil. The Organization of Petroleum Exporting Countries (OPEC), a consortium of 13 countries that produces almost 40 percent of the world's supply and controls 67 percent of the reserves, tries to keep world oil prices at a target level by imposing a production limit. Inherent within any economic law is that, surprise, surprise, corporations are greedy. They want as much money as possible for their product. Can you blame them? And they've pretty much got a product that everyone needs, one that can't be substituted by any other product. Oil companies have a monopolistic grip on their product, earning mind-boggling profits year after year; ExxonMobil posted net revenues of $16.9 billion in 2000, the most money earned by any U.S. company. Ever.

By forecasting demand, oil companies control the amount of oil they sell, because the basic law of economy states that the greater the demand, the more limited the supply, and the more value the supply can fetch. Of course, since the legitimacy of the powers of Dionne Warwick and her Psychic Friends is questionable at best, debacles inevitably arise. Most recently, in 1997, OPEC decided to boost its output because of the healthy economy. This is when the vast sucking sound of the Asian economies resounded, and drove down demand, resulting in a global surplus. Early in 1999, the price per barrel reached a 70-year low of $11 a barrel; we were paying less than a dollar for a gallon of gas. In March of the same year, OPEC, as well as Mexico and Norway, agreed to curtail output, which coincided with the slow recuperation of Asian countries. The surplus disappeared and inventory was at an all-time low, and oil was selling at $30 per barrel.

Know what? The burden of blame falls largely on our own shoulders. We Americans comprise 5 percent of the world's population, yet we consume 30 percent of the world's resources. The demand for crude oil was up 2 percent in the first six months of 1999, largely due to our affinity for light trucks and their gas-guzzling ways.

Gasoline prices tend to rise during the summer because more people are wont to go on trips, thus raising demand about 5 percent, translating to a 3.5 cent increase per gallon.

Retailers must also stay competitive, contingent upon operating costs, rent fluctuations and proximity of supply. Again, simple law of economics: If, at one intersection, there are four different gas stations, which one would you go to? The one with the clean bathrooms? The one without the leering attendant? You'd probably choose the one with the cheapest prices, right? In a crowded marketplace of a capitalist economy, you've got to match the other guy's price or risk losing a customer. However, if your gas station is situated on a long stretch of desert, say, between Barstow and Las Vegas, and there's not another sign of life for 50 miles, you can pretty much dictate what the poor schlub whose needle is pointing toward empty will pay.

California is a special case for gasoline prices; we fruits and nuts pay, on average, 18 cents more per gallon than other U.S. regions, and are more suspect to price oscillations; on January 18, 2001, the little old lady in Bakersfield will pay 50 cents more per gallon to fill up than The Donald did in the station off of 42nd and Fifth, and 75 cents more than her sister did in Kentucky.

Several factors contribute to this utter injustice. First, only six companies produce gasoline for the most populous state in the union (which constitutes the sixth-largest economy in the world), so there's not much competition on the left coast. Second, California requires uniquely formulated gasoline, which adds anywhere from 5 to 8 cents per gallon, but only a few refineries manufacture the blend. Thus, if there is a disruption in supply -- say a refinery fire or a pipeline rupture -- the relief supply from the Gulf Coast and foreign refineries is limited to those factories producing California-friendly gasoline, and the price soars before relief is seen.

Americans Have it Easy
We've seen that there are several enormous forces that determine the flux of the price of gasoline, from corporate greed to acts of nature. Yet the fact remains that we still grumble every time we extract the twenty from our frayed billfolds to fill up our cars (but have no problem paying $4 per gallon for Evian), and nostalgically long for the days when gas was 50 cents per gallon. What we're neglecting to take into account, of course, is inflation. On average, over the past 20 years, the price of gasoline has risen 7 percent. The US dollar inflated over 100 percent in the same period.

Plus, the rest of the world views Americans as spoiled brats, among other reasons, because we cry about an increase in gas prices. Norway, the world's second-largest oil importer, regularly forks over around 5 bucks per gallon of regular unleaded. The Brits are saddled with the highest petrol prices, at $5.75 per gallon, which, as usual, comes out of their toothpaste money.

We must realize that fossil fuel is not a renewable resource. As we've explained here, a labyrinth of fluctuating factors affect prices, so even though we're far from depleting our current reserves, we can't take for granted the supply system or affordability of gasoline.

So maybe next time you'll be nicer to your gas station attendant when your fuel light starts flashing. It's not his fault that it takes $70 to fill the tank of your Excursion.

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