When it comes to gas prices, the most basic law of economics, supply and demand, drives the price fluctuation, among a compilation of other factors. The pricing of gasoline is affected by crude oil prices, refining and distribution costs, local demand, taxation, governmental regulations, the local availability of gasoline, international political stability, and natural disasters.
Supply and Demand
The most fundamental factor affecting gas prices is the marketplace force of supply and demand. If demand grows or if a disruption in supply occurs, there will be an upward pressure on prices. If demand falls or there is an oversupply of product in the market, there will be a downward pressure on prices.
The U.S. is the largest user of gasoline, at 20% of the world’s oil consumption; the European Union follows, at 15%; China uses 10%, with its consumption growing rapidly. A great deal of new demand has been coming from the two largest economies of the developing world, China and India. Currently, they are using oil at levels approaching U.S. consumption rates of just a few years ago. Many Middle Eastern countries, which produces 30 percent of the worlds supply, are increasing their consumption rates, which means they are keeping more of their oil home and decreasing external supply.
From Crude Oil to Gasoline at the Pump
Crude oil is the primary raw material used to produce gasoline. In some cases, the price of crude oil may account for up to half the price of a gallon of gasoline. In March 2012, crude oil prices made up 67% of gasoline prices. Other distribution of costs includes transportation of crude oil to the refinery, refining the oil into gasoline, transporting the gasoline to distribution hubs or wholesalers, delivering the gasoline to retail locations, and operating service stations. The rest are local, state, and federal taxes.
Local Taxation, Regulation & Demand
While crude oil is traded in a global market, gasoline is part of a regional market. In these markets, each gallon of gasoline is subject to a federal tax along with numerous taxes and fees that vary state to state. Many states also require specific formulas of gasoline to meet federal and state emissions regulations (there are currently 18 separate gasoline formulas around the country). This results in “island” markets that inhibit refiners and marketers from moving supplies from one region to another to meet local or regional demand, creating large price fluctuations for a gallon of gas around the country. Permitting requirements for petroleum infrastructure also affect gasoline markets; no new refineries have been constructed since the 1970s, so the U.S. must import large volumes.
Colorado and the Rocky Mountain states routinely have some of the cheapest gas prices in the country. This is due to the fact Rocky Mountain states are fairly self-sufficient with supplying their oil and gas needs, and require little help from other regions. Refineries within the Rockies supply most of the regional demand.
International Oil Affairs
Crude oil prices are very much connected to world events. Most of the world’s oil comes from somewhat volatile areas of the world; even the threat of war of domestic unrest can cause prices to rise.
In an attempt to protect the U.S. against disruptions in oil supplies and some of the political market fluctuations from oil-producing nations, the U.S. stores 700 million barrels of oil in the Strategic Petroleum Reserves. The U.S. imports a large portion of its oil from our North American partners of Canada and Mexico, to make it less dependent on OPEC oil. Also, with increases in domestic production, our reliance and exposure to the political uncertainty in certain areas of the world will further enhance our energy security and as such our price stability.
Demand imbalance can also be due to supply disturbances from natural disasters. As an example, Hurricanes Katrina and Rita destroyed a great deal of America’s refining capability, shutting down 10% of the country’s production, creating an excess demand for supply and upward pressure on prices. Gasoline supplies were moved to the Southeast from other parts of the country, affecting regional supply in those areas and thus raising prices since supply decreased while demand remained high.