A Primer on Gas Prices

Gasoline, one of the main products refined from crude oil, accounts for just about 17 percent of the energy consumed in the United States. The primary use for gasoline is in automobiles and light trucks, and farm, recreational and other equipment. While gasoline is produced year-round, extra volumes are made in time for the summer driving season. Gasoline is delivered from oil refineries mainly through pipelines to a massive distribution chain serving 167,000 retail gasoline stations throughout the United States. There are three grades of gasoline: regular, mid-grade and premium. Each grade has a different octane level. Price levels vary by grade, but the price differential between grades is generally constant.

The components of the retail price of gasoline.

The cost to produce and deliver gasoline to consumers includes the cost of crude oil to refiners, refinery-processing costs, marketing and distribution costs and finally the retail station costs and taxes. The prices paid by consumers at the pump reflect these costs, as well as the profits (and sometime losses) of refiners, marketers distributors and retail station owners.

In 2003, the price of crude oil averaged $28.50 per barrel, the crude oil accounted for about 44% of the cost of a gallon of regular grade gasoline. In comparison, the average price for crude oil in 2002 was $24.09 per barrel, and composed 43% of the cost of a gallon of regular gasoline. The share of the retail price of regular grade gasoline that crude oil costs represent varies somewhat over time and among regions.

Federal, state and local taxes are a large component of the retail price of gasoline. Taxes (not including county and local taxes) account for approximately 27 percent of the cost of a gallon of gasoline. Within this nation average, federal excise taxes are 18.4 cents per gallon and state excise taxes average about 21 cents per gallon. Also, eleven states levy additional state sales taxes and other taxes, some of which are applied to the federal and state excise taxes. Additional local county and city taxes can have a significant impact on the price of gasoline.

Refining costs and profits comprise about 15% of the retail price of gasoline. This component varies due to the different formulations required.

Distribution, marketing and retail dealer costs and profits combined make up 14% of the cost of a gallon of gasoline. From the refinery, most gasoline is shipped by pipeline to terminals near consuming areas, and then loaded into trucks for delivery to individual stations. Some retail outlets are owned and operated by refiners, while others are independent businesses that purchase gasoline for resale to the public. The price on the pump reflects both the retailer's purchase cost for the product and the other costs of operating the service station. It also reflects local market conditions and factors, such as the desirability of location and the marketing strategy of the owner.

Why gasoline prices fluctuate.

Even when crude oil prices are stable, gasoline prices fluctuate due to factors such as seasonality and local retail station competition. Additionally, gasoline prices can change rapidly due to crude oil supply disruptions stemming from world events, or domestic problems such as refinery or pipeline outages.

Seasonality in the demand for gasoline. When crude oil prices are stable, retail gasoline prices tend to gradually rise before and during the summer, when people drive more, and fall in the winter. Good weather and vacations cause US summer gasoline demand to average about 5% higher than during the rest of the year. If crude oil prices remain unchanged, gasoline prices would typically increase by 10-15 cents from January to summer.

Changes in the cost of crude oil. Events in crude oil markets were major factors in all but one of the five run-ups in gasoline prices between 1992 and 1997, according to the National Petroleum Council. About 47 barrels of gasoline are produced from every 100 barrels of crude oil processed at US refineries, with other refined products making up the remainder.

Crude oil prices are determined by worldwide supply and demand, with significant influence by the Organization of Petroleum Exporting Countries (OPEC). Since it was organized in 1960, OPEC has tried to keep world oil prices at its target level by setting an upper production limit on its members. OPEC has the potential to influence oil prices worldwide because its members possess such a great portion of the world's oil supply, accounting for about 39% of the world's production of crude oil and holding more than two-thirds of the world's estimated crude oil reserves.

Rapid gasoline price increases occur in response to crude oil shortages, such as the Persian Gulf War. Gasoline price increases in recent years have been due in part to OPEC crude oil production cuts, turmoil in key oil producing countries and problems -with petroleum infrastructure within the US.

Product supply/demand imbalances. If demand rises quickly or supply declines unexpectedly due to refinery production problems or lagging imports, gasoline inventories (stocks) may decline rapidly. When stocks are low and galling, some wholesalers become concerned and supplies may not be adequate over the short term and bid higher for available product. Such imbalances have occurred when a region has changed from one fuel type to another as refiners and marketers adjust to the new product.

Gasoline may be less expensive in one summer when supplies are plentiful vs. another summer when they are not. These are normal price fluctuations, experienced in all markets.

However, prices of basic energy (gasoline, electricity, natural gas, heating oil) are generally more volatile than prices of other commodities. One reason is that consumers are limited in their ability to substitute between fuels when the price for gasoline, for example, fluctuates. So, while consumers can substitute readily between food products when relative prices shift, most do not have the option in fueling their vehicles.

Gasoline prices differ according to region.