Supply And Demand
The marketplace forces of supply and demand determine the price of fuel. If demand grows or if a disruption in supply occurs, there will be upward pressure on prices. By the same token, if demand falls or there is an oversupply of product in the market, there will be downward pressure on prices.
Those principles apply at the service station level as well. If a retailer prices its gasoline too high, and without regard to competition, the retailer's customers may take their business to another station with lower prices. If a retailer loses enough volume, the retailer may then reduce prices in order to retain its customers.
Competition among retail outlets thus affects pricing. You may notice that sometimes there are price differences between two gasoline stations on a busy street corner and between those outlets and the only station on a long stretch of highway. More choices generally mean more competition for business.
And although retail outlets may sell gasoline carrying the brand of a major oil company, most dealerships are owned and operated by independent business people who are free to set the prices for their products and services.
Like agricultural products, such as wheat and corn, and precious metals, such as silver and gold, crude oil is traded on the world market. Recently, crude oil prices have risen dramatically, driven by rising global demand and political instability in several oil producing countries.
Crude oil prices are important in determining gasoline prices because crude is the primary raw material used to produce gasoline and other petroleum products. In some cases, the price of crude oil may account for up to half the price of a gallon of gasoline.
There are 42 gallons of oil in each barrel of oil. If the price of crude oil is $75 a barrel, the cost of the raw material required to produce a gallon of gasoline is $1.78. This figure does not include costs incurred to transport crude oil to a refinery, refine the oil into gasoline, transport the gasoline to distribution hubs or wholesalers, deliver the gasoline to retail locations or operate service stations.
While crude oil is traded in a global market, gasoline is part of a regional market. Crude oil prices are important in determining gasoline prices because crude is the primary raw material used to produce gasoline. The price of crude oil may account for over half the price of a gallon of gasoline.
Transitions in supply can also affect the short-term availability of gasoline. Going into the peak summer driving season, refineries are adjusting their gasoline formulas to help protect the air quality in warmer weather. And, because of changes to federal energy legislation passed in 2007, many states are switching to ethanol-blended gasoline.
Many states require specific formulations of gasoline — there are currently 18 separate gasoline formulas for different regions of the country-and it is often difficult to import gasoline supplies from one region to another.
Each gallon of gasoline also is subject to numerous taxes and fees, which vary by state. In California, the price of gasoline includes a federal motor fuel excise tax, a California motor fuel excise tax, state and local sales taxes as well as other state and local fees totaling more than 66 cents a gallon. View state tax chart.
After the crude oil is processed through the refinery, the finished gasoline product is transported to a terminal, where it may be sold to a wholesaler for distribution to the wholesaler's retail network or delivered to the retail location. There the retailer sets the "street price," which includes a margin to account for the retailer's cost of doing business at that particular location and the retailer's profit.
Costs related to natural gas consist of four main components: production, transmission, distribution and commodity price as determined by the marketplace. When the gas is produced, it is transmitted over long distances by pipeline from the wellhead to a local gas company. Once at the gas company, it is stored and then distributed to local customers. The price of natural gas consumed is determined by supply, demand and other market conditions.
The price of heating oil is determined by supply, demand and other competitive factors, and is affected by the price of crude oil, refining costs and distribution and marketing costs. Just like gasoline and natural gas, the price of heating oil is ultimately set by the marketplace. Competition in areas with multiple suppliers or dealers may impact prices. Households located in remote locations may pay higher prices.
Regulatory steps to reduce air pollution have also influenced gasoline markets. Many states require the use of various blends of cleaner-burning gasoline, often called "boutique fuels," that are specially formulated to meet federal and state emissions regulations. Gasoline sold in California is not the same as gasoline sold in Arizona or Las Vegas. Creating these different fuels results in "island" markets and inhibits the ability of refiners and marketers to move supplies from one region to another to meet local or regional demand. There are currently 18 separate formulas of gasoline mandated for different regions.
Another significant influence on gasoline prices are taxes, which can vary dramatically across different markets. Differences in state and local sales and excise taxes can add as much as 40 cents per gallon (cpg) in certain areas. The American Petroleum Institute reports the national average for gasoline taxes is 45 cpg. Alaska has the lowest gasoline taxes in the country at 18.4 cpg, while New York and California have the highest, at 60.9 cpg and 58.3 cpg, respectively. Washington is third highest at 55.9 cpg.
Permitting requirements for petroleum infrastructure can also affect gasoline markets. Although demand for gasoline in the United States has grown over the years, no new refineries have been constructed since the 1970s. In order to meet demand, the U.S. must import large volumes of gasoline and other petroleum products.
In any market situation, supply and demand imbalances can affect prices in both the short and long term.
If the supply is disrupted, as it was after Hurricanes Katrina and Rita in 2005, short term demand for the product may exceed the supply on hand and put upward pressure on prices. Consumers all over the country, even those outside of the Gulf of Mexico region most directly affected by the hurricanes, observed a rise in prices at the pump. Why was that the case?
The basic reason was the imbalance between supply and demand. Gasoline, including gasoline blending components, moves from region to region. When crude oil and gasoline production were shut in following Hurricanes Katrina and Rita, the country's gasoline supplies were reduced approximately 10 percent. Gasoline supplies were moved to the Southeast from other parts of the country, affecting supply in those areas. That put upward pressure on prices, as supply was affected but demand remained high.