If you own a car, you’ve probably noticed that gas prices change from day to day. They can rise or fall a penny or two per gallon, or as much as 30 cents overnight. This change in gas prices is a source of concern for many drivers. It’s impossible to predict, hard to budget for and annoying to deal with. So why is it that gas prices fluctuate so wildly?
Distribution of Costs
When you pay for gas, the money is broken up and distributed among several organizations involved in the supply chain. This includes everything from the gas station to the refinery to the US Government. The cost mainly breaks down into four segments. For example, out of $1, here is how the money is distributed:
- 12 cents go to taxes
- 12 cents go to the refinery that produced the gasoline
- 11 cents is distributed to those who ship, market and handle the gas
- 66 cents (the majority) goes to cover the cost of the crude oil
OPEC and Crude Oil
The cost of crude oil is determined largely by OPEC, the Organization of the Petroleum Exporting Countries. OPEC currently has twelve member countries. These are Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.
Crude oil is generally judged as either light or heavy, and as either sweet or sour – which has nothing to do with flavor – as ways to judge how easily it can be refined into gasoline and other products. Light, sweet crude is the easiest to refine, and most refineries are set up to process it. Unfortunately, it is also growing increasingly rare. Heavy, sour crude is much more abundant, but most refineries can’t handle it without expensive reconfiguration.
The price of a barrel of crude oil is determined by several factors. As OPEC produces more oil, the prices for each individual barrel go down. The quality of the oil affects refinery costs, which can increase the price of gas.
Demand and Distribution
Worldwide demand for gasoline is going up. It will not stop rising until an alternative energy source is found and made commercially viable for developing nations. As it stands, gasoline is an astonishingly powerful source of energy. Solar fields, wind farms and other green energy sources cannot compete with the power output of a gallon of gasoline. On the other end, nuclear power can, but is expensive to produce and maintain — not to mention dangerous and highly regulated.
As countries expand their infrastructures, more and more gasoline is required. India, China and other developing nations will continue to demand more gasoline until the price of a gallon becomes prohibitive.
At the same time, getting this gasoline to these locations around the world is an incredible challenge. Only a small handful of countries produce enough oil to export it, and it has to be shipped around the world. Shipping companies need to be paid, the workers need to be trained and it needs to successfully make the journey. Anything that affects the supply lines will affect the cost of gasoline.
- Pipelines can break, like the BP disaster in the Gulf of Mexico
- Ships can sink, such as the Exxon Valdez
- Weather systems can interrupt shipping, as well as ruin distribution networks or gasoline storehouses – think Hurricane Katrina
- Political instability among OPEC nations, or war that interrupts supply lines, also has an effect
Trading on the Mercantile Exchange
Even though oil is produced primarily in non-US countries and it is consumed worldwide, oil is largely traded on the world market using US Dollars as currency. This means the fluctuation in the value of the US Dollar affects the price of gas. When the USD declines in value, it takes more dollars to purchase the same amount of oil — meaning a general price increase per barrel.
Oil is traded on three main markets. The first is the contract market. The majority of the oil that is traded ends up here — companies, dealers, refineries and other groups trade and buy barrels of oil, fulfilling contracts and delivering product.
Spot markets work to fill the gaps. Some companies need more oil than they have delivered to them on contract, and other companies have more oil than they need. The spot market matches these two groups up and evens out the supply and demand for oil. These trades are not bound by contract, which means companies can make excellent deals on their purchases or sales.
The futures market is the most complex system of oil trading and is largely a form of speculation. Huge numbers of barrels are traded on the futures market, but very few of them are ever delivered. During one particular seven-year period, over five million barrels were traded, but only 31,000 were ever delivered as a result of the deals. Despite the low volume of actual deliveries, the futures market is driven by the fluctuation in every factor that influences the price of gas, meaning it is a good indicator of how gas prices fluctuate.
Unrelated Factors Why Gas Prices Fluctuate
Many people like to blame US Presidential elections for altering the price of gas. In reality, the president has virtually no effect on gas prices. Likewise, actual gas stations have very little to do with the change in gas prices. Only about five percent of the gas stations in the US are owned and operated by oil companies, meaning they have a relatively marginal effect on the price of gas at the pump.
Individual gas stations often have contracts to sell gas at certain prices, which limits the amount of profit they can gain from a given shipment of gas. As businesses, they want to strike a balance between the cost of buying gas and the price they sell it, but they can’t simply charge too much. If they tried, other stations could under-cut them and the loss in volume would negate their profits.