“It all starts with oil… As for gasoline prices: They’re closely tied to demand from U.S. drivers and how efficiently refineries are operating. Falling production or inventories often send prices skyrocketing.”
(The Associated Press) – Consider the game of chicken that plays out every day across Pennsylvania State Highway 441. In Marietta, where the road hugs the Susquehanna River, a Rutter’s Farm Store gas station stands on one side, a Sheetz gas station on the other.
Kelly Bosley, who manages Rutter’s, doesn’t even have to look across the highway to know when Sheetz changes its price for a gallon of gas. When Sheetz raises prices, her own pumps are busy. When Sheetz lowers prices, she has not a car in sight.
She calls Rutter’s headquarters to report the competition’s new price and wait for instructions.
“I call a lot of times and say, ‘They went down, hurry up! Hurry up! Call me! Call me!’ Or it could be where theirs goes up, and I’ll say, ‘Take your time! You know, I like being busy.’ But I have no control over that.”
You think you feel helpless at the pump?
So how exactly are gas prices set? What determines the hair-pulling figure you see displayed in large electronic or plastic numbers? Why is a gallon of gas, say, $4.11 – not $4.10 or $4.12? Why is the price different across the street?
It all starts with oil.
The biggest factor in the skyrocketing price of gasoline is the historic ascent of crude oil, which has surged from $45 per barrel in 2004 to more than $135 this past week, setting new record highs all the while.
In the first quarter of this year, based on a retail price of gas that now seems like a steal – $3.11 a gallon – crude oil accounted for all but about a dollar, or 70%, of the cost, according to the federal government.
The rest is a complex mix of factors, from the cost of turning oil into gas to taxes to marketing costs to, sometimes, nothing more than the competitive whims of your local gas station owner.
Not that understanding the breakdown makes it any less cringe-inducing to fill ‘er up.
How it all works
First a primer on how gas gets to your tank:
Once oil is pumped from the ground, it can be sold on the spot market, a last-minute trading arena where oil companies and distributors buy and sell to each other, or straight to refiners. After it’s brewed into gasoline, the product can again be sold on the spot market, or directly to wholesalers, who in turn can supply their own stations or sell it to other retailers.
Each step of the way, buyers and sellers negotiate a price until, finally, drivers pay the ultimate tab at the pump.
At the starting point of all this is the price of oil – which, like the oil itself, is nothing if not crude.
The knee-jerk villains are the oil companies, fat with multibillion-dollar profits, frequent targets of populist anger. But wait: The oil companies don’t set the price of oil or the cost of a gallon of gas.
Prices are a function of the open market, the result of futures contracts being traded on the New York Mercantile Exchange, or Nymex, and other exchanges around the world.
Buying the current July crude oil futures contract means you’re buying oil that will be delivered by the end of July. But most investors who trade futures have no intention of ever accepting the underlying oil: Like stock investors who frequently buy and sell their holdings, they’re simply betting that prices will rise or fall.
Of late, on the Nymex, oil futures have been rising.
Why? Blame the falling dollar. Oil is priced in U.S. dollars, and the weaker the dollar gets, the more attractive dollar-denominated oil contracts are to foreign investors – or any investor looking for a safe haven in the turbulent stock market.
The rush of buyers keeps pushing oil futures to a series of new records, and the rest of the energy complex, including gasoline futures, has followed. That pushes up the price of gas that goes into your tank.
“Crude is the driver,” said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill. “As long as it stays up there, gasoline’s not going to be able to decline much at all, even if demand slips. That’s just the way it is.”
There is some evidence Americans are buying less gas as the price marches higher, and common sense suggests they would cut back even more if gas rose to $4.50 or $5 a gallon.
Lower demand should mean lower prices – but it takes time for that to happen, given the enormous scale of refining operations that produce gasoline.
“Once demand begins to slow, that needs to translate into inventories, then you get some price weakening,” Ritterbusch said. “But it takes a while.”
Oil and gasoline prices often move in the same direction, but they aren’t linked directly. In fact, while oil prices have more than doubled in the past year, gasoline is only up about 19% during the same time.
Oil prices often fluctuate with production decisions from the Organization of Petroleum Exporting Countries, which supplies about 40% of the world’s crude, or when conflict in the Middle East or Nigeria threatens supplies.
For example, oil prices rose $2.46 in one day last month amid reports a ship under contract to the Defense Department fired warning shots at two boats in the Persian Gulf that may have been Iranian.
A Navy spokesman later said the origin of the boats was unclear, but the news raised concerns that a conflict between U.S. and Iranian forces could cut oil supplies from the region. That same day, gas prices rose another 2.1 cents to a then-record national average of $3.577 a gallon on other supply concerns.
And the rise has only grown more dramatic. Oil sprinted higher this past week, rising more than $4 a barrel on Wednesday alone and past $135 on Thursday.
As for gasoline prices: They’re closely tied to demand from U.S. drivers and how efficiently refineries are operating. Falling production or inventories often send prices skyrocketing.
Those prices can vary greatly depending on the region.
The Gulf Coast is the source of about half the gasoline produced in the United States, and areas farthest from there tend to have higher prices because of the cost of shipping gas via pipeline and tanker truck all over the country.
Some of those places, like California and New York, also have higher local taxes that push the price higher.
Oil companies may not set the price of oil and gasoline, but not everyone is willing to sit back and let them claim to be innocent bystanders.
In particular, for the second time this year, Big Oil’s biggest executives were on Capitol Hill in recent days getting pummeled by many in Congress for their record profits while Americans struggle with record fuel prices.
“Where is the corporate conscience?” Sen. Dick Durbin, D-Ill., asked the top executives of the five largest U.S. oil companies.
Soaring gas prices have led to cries for a variety of answers, from Hillary Rodham Clinton and John McCain’s suggestion to suspend the federal gas tax this summer to President Bush’s call to open the Arctic National Wildlife Refuge in Alaska and some offshore waters that are now off limits to oil development.
Others have suggested a windfall profits tax on oil companies, although some economists say that might actually hurt supply. Oil companies say they’re not to blame for spiking fuel prices, and their earnings, measured against revenue, are in line with other industries.
On top of that, rising oil prices have sharply cut profit margins for refining, and that hits the major oil companies – which both pump oil and refine it for use as gasoline.
A giant like ExxonMobil can handle the blow. Its refining and marketing profits for the first quarter were down 39% from a year ago, but Exxon still banked a nearly $11 billion profit because of the hefty prices earned on crude it pumped out of the ground.
Smaller refiners aren’t so fortunate. Sunoco Inc.’s refining and supply business lost $123 million in the first quarter, hurt by lower margins. Tesoro Corp. lost $82 million for the same period.
In any case, huge profits at big oil companies like ExxonMobil and Chevron aren’t because of high prices at the pump. Their massive profits are tied to their exploration and production arms, which are benefiting from record crude prices.
Higher crude costs also have squeezed profits at the refining arms of companies like ConocoPhillips, which don’t produce enough crude themselves to refine at full capacity without buying more oil from other producers.
CEO Jim Mulva said ConocoPhillips, the second-largest U.S. refiner behind Valero Energy Corp., buys about 2 million barrels of crude a day at market prices to refine into gasoline and other products.
“If oil costs us $30 a barrel or $40 a barrel or $120 a barrel, that’s why the cost of gasoline is what it is,” he said. “It’s not because of taxes. It’s not because of … refining and distribution. It’s because of the cost of oil.”
But it’s not only about the price of oil. Other costs are a factor – though they’ve remained relatively stable.
For example, federal and state taxes added 40 cents to a gallon of gas in the first three months of this year, roughly the same amount as they added four years ago.
California’s 63.9 cents of tax is the nation’s highest, Alaska’s 26.4 cents the lowest. How the money is used varies from state to state, though the federal take helps to build and maintain highways and bridges.
Marketing and distribution costs – the tab for delivering gasoline from refiner to retailer – were 27 cents to start the year, only 6 cents above the cost four years ago.
The cost of refining added 27 cents to a gallon in the first quarter of this year, a nickel less than what it added in 2004, according to the Energy Information Administration.
That refining occurs at sprawling industrial complexes across the U.S., with most of the biggest along the Gulf Coast. Barrels of crude arrive each day by pipeline, ship and barge. The refineries, by heating, treating and blending the raw oil, turn out products like diesel and lubricating oil.
And, of course, gasoline.
A ‘waiting game’
What happens when that gasoline makes its way to your neighborhood gas station?
Major oil companies own fewer than 5% of gas stations. Most are owned by small retailers – and many of them say they’re struggling these days to turn a profit on gas. That’s because wholesale gasoline prices have risen sharply in recent months – again, blame it on crude – but station owners have been unable to raise pump prices fast enough to keep pace.
And you can’t keep jacking up the price when drivers are buying less.
Gas station owners face a balancing act: They must try to maintain a price that allows them to afford the next shipment of gasoline but not give the competition an edge.
Stations pay tens of thousands of dollars for each gas shipment before they see a cent in the register. Eventually, many make only a few cents on a gallon of gasoline, a margin that can disappear altogether when credit card fees are added in.
Thank goodness for beef jerky and sodas.
Most gasoline retailers long ago got past any illusion they can make money by selling gas. They rely on gas sales to drive traffic to their shops, where they hope auto repairs or food and drink sales will help them turn a profit.
“You’re always out there competing with the guy next door – literally with the guy across the street – and worried too about how you’re going to pay for your next supply,” said Rayola Dougher, a senior economic adviser at the American Petroleum Institute, the oil industry’s trade association.
In the Philadelphia suburb of Havertown, Pa., earlier in the week, Sunoco station operator Steve Kehler received a load of gasoline – 9,000 gallons – which, at a wholesale price of $3.729 a gallon, cost him 4 cents more than the previous load.
That left him in a sticky situation: Should he raise prices right away to recoup some of his higher gasoline expenses, or should he hold off for a couple of days in hopes his competitors will also have to raise their prices?
“I’m surrounded by $3.89’s, and I’m already at $3.91,” said Kehler, referring to his prices and those of some nearby competitors. “I’m going to play a little waiting game right now.”
The $33,600 Kehler must pay for his overnight gasoline delivery won’t be debited from his bank account for a few days. That gives him a little breathing room, time to hold prices steady. Hiking prices too quickly will hurt sales.
“I’ll probably change it tomorrow night, at closing,” Kehler said. “I’ll go up 4 cents.”
That will put Kehler at a gross margin of about 20 cents a gallon. After paying credit card fees, labor and rent, Kehler will be lucky to break even on his gasoline sales.
But many times, he loses money selling gas. Kehler, like most other service station operators, relies entirely upon his car repair business for income.
Of course, the plight of retailers is little consolation for drivers.
Mayra Perez said she works two fast-food jobs to help support her family, and gasoline is becoming harder to afford. She said perhaps the government should step in to help ease the burden, possibly by placing price limits on gasoline.
She was filling the tank of her compact car in Miami this past week to the tune of $3.89 per gallon for regular gas.
“This is horrible,” she said. “On the weekend, my husband and I use only one car to save on gas.
“But then there’s the cost of food, milk, eggs, the rent.”