Home > Uncategorized > Is the Price of Gasoline Really Too High?

Is the Price of Gasoline Really Too High?

The world’s dependence on gasoline has created a globalized market for the commodity which is ubiquitous and constant, but also dynamic and unpredictable due a number of different variables.  The gasoline market which exists in the modern world provides a very complex yet illustrative framework for examining the workings of economic models.  As most are aware, pump prices can be volatile at times, especially upward.  According to “Gasoline Prices” by Daniel Duffy, “Prices fluctuate due to many factors, including the competitiveness of the local market, seasonal demand, world events, and refinery disruptions.”[1]

In order to conduct a comprehensive analysis of the behavior of gas prices, one must have a strong understanding of the main cost components that comprise what becomes the retail price at the stations: crude oil, refining, marketing and distribution, and state and federal taxes.  It is important to internalize their respective percentages of costs, as well as what types of variables and factors are responsible for their changes in supply, demand, and price.

The first phase in the process is crude oil, which is the raw material from which gasoline is made.  The crude oil portion of the gasoline network also includes the exploration for new sources and harvesting of the materials, an important factor to consider.  It is the largest cost component in the price of a gallon of gas, at 62%, according to the United States Energy Information Administration.[2].  While this percentage fluctuates, its long-run upward trend is noteworthy.  “Crude oil prices are important in determining gasoline prices because crude is the primary raw material used to produce gasoline and other petroleum products.”2  Although there are exceptions, changes in the crude oil and gasoline markets are very connected, and often fluctuate in synchronicity.  “The primer [an online gasoline information gauge run by the E.I.A.] states that, on a pre-tax basis, the cost of crude oil is the most important determinant of all petroleum product prices, including gasoline. As a result, their prices tend to reflect the price of crude oil, if all other things are equal.”1 As a frame of reference, on March 26, 2012, crude oil comprised $2.91 of the $4.36, or approximately 67% of the pump price of a gallon of gasoline in California.[3]  This range has been trending upward, as back in 2009, the percentage of crude oil generally fluctuated in the 50-60 range, and as recently as 2004 the percentage was under 50.[4]  Unrest amongst OPEC nations and other international relations issues as well as natural disasters can and often do lead to volatile changes in crude oil supplies, thus increasing prices for consumers.  A prime recent example is the Arab Spring, which saw strife and strained relations in oil producing nations such as Libya create problems in maintaining a worldwide gasoline supply level. The majority of the rises in gasoline pump prices are the result of increases in crude oil costs.

The next step in the process is refining gasoline from crude oil.  According to Virginia Congressman J. Randy Forbes (R): “Oil refineries are plants where crude oil is processed and refined into more useful petroleum products, such as gasoline, diesel fuel, heating oil, and kerosene.”[5]  The refining process currently accounts for approximately 12% of the costs of gasoline,2 although this figure can be volatile at times, most notably due to refining industries operating with lower, “leaner” inventories of crude oil and gasoline in recent years, which leaves them susceptible to positive demand shocks by consumers, increasing costs in the short-run.  Examples of this were common in the years of 2009 and 2010, when refining percentage costs often went up into the high teens.

The third step in the process is distribution and marketing, and according to “How Gas Prices Work” by Kevin Bonsor and Ed Grabianowki, this category of costs includes the transportation of the crude oil to the refineries, the gasoline from the refineries to the shipment points and gas stations, and marketing of the oil company.[6] As of July 2012 distribution and marketing accounted for approximately 14% of the cost of gasoline, and this is a considerably high figure, historically speaking,2   as the percentage is often in the high single digits.  However, measurement of this category can vary, as retail gas stations often markup additional costs to pump prices to gain more profits, and these costs are computed here, as costs can be liberally classified as “marketing.”

Finally, the last set of costs of gasoline is federal, state, and local taxes.   The majority of the taxes placed on gasoline come in the form of excise taxes, although other forms exist, as well.  “There may also be some additional taxes, such as applicable state sales taxes, gross receipts taxes, oil inspection fees, underground storage tank fees and other miscellaneous environmental fees.”(2)2  When it comes to the United States, taxes are highly variable from state to state as well as within each state.  For instance, in California, taxes can comprise up to 19% of the pump price, while in other states the figure may periodically reach single digits.  In Europe, gas (or “petrol” as it is referred to) prices are considerably higher, and much of this is due to their high rate of taxation on gasoline.  As will be addressed below, taxes are also a very important aspect of gas prices when it comes to the political venue.

The market for gasoline, as has been discussed, is dependent upon many factors, and can change due to shocks in the political, natural, and economic realms.  As 2011 came around, we saw many nations beginning to attempt to re-emerge from the recession, leading to increased demand of gasoline and other fossil fuels.  According to “Why Congress Can’t Fix Your Gas Prices Pain” by Jessica Rettig, written in 2011, “While the world begins to rebound from the global recession, the demand for crude oil has increased, mostly in emerging markets like China, Brazil, and the Middle East.”[7]  From a distinctly American perspective, the weakening of the U.S. dollar is also responsible for some of the increase in gasoline prices.   “For Americans, the nation’s weakened dollar has put additional strain on gas consumers, as commodity prices have increased across the board.”7  Another factor to consider moving forward is the role that growing demand for gasoline will play in pricing. For example, one of the reasons for the surge in gas prices in 2008 was the growing demand.  With demand amongst developing nations anticipated to grow in the coming years, this could play a large role in determining worldwide crude oil and gasoline prices.

Many Americans are aware of the regional and state-to-state fluctuations in gas prices, but what determines this variability?  The two main reasons both have to do with location: ease of transporting the product, and the state and local taxes of the region.  According to CNN Money, “Added all up, gas taxes can range from a low of 26 cents in Alaska to a high of 66 cents in California, according to API.”[8] 

Because of the more localized nature of the gasoline market (as opposed to the globalized crude oil market), competition for gasoline can vary from one regional market compared to another.  Therefore, when discussing the topic of competition, it is conceivable how in certain markets, retail prices will vary to attempt to exploit demand elasticity, where a small decrease in the pump price will attract a large amount of customers, as local competition between gas stations can often be higly dependent on a difference of a mere few cents.

An interesting dynamic to the worldwide gasoline situation is the elasticity of demand for the product.  According to John F. Willenborg and Robert E. Pitts studies are not definitively conclusive: “Attendant with any suggested increase in gasoline prices is the assumption that consumption will decline in some relationship to the amount of price increase.  However, the issue of the elasticity of gasoline prices is far from clear.”[9]  This behavior is likely to continue, as patterns of interest in alternative energy sources and public transportation seem to fluctuate, due to a variety of known and unknown factors.  Amidst the uncertainty, one thing is clear when examining long-run behavior.  Accordingto Effects of Gasoline Prices on Driving Behavior and Vehicle Markets of the Congressional Budget Office: “The longer gasoline prices remain high, the broader the scope of actions consumers will take in response” (29).[10]

There are a number of proposed options for Congress to take legislative action in controlling gas prices.  Republicans favor exploring domestic drilling, thus increasing supply in the market and decreasing volatility that arises from dependence on imports, although opponents from the left often challenge this strategy, citing environmental concerns and questions about its effectiveness.  According to Rettig (2003), the United States has also considered tapping into the Strategic Petroleum Reserve, which is a domestic reserve supply created in the midst of the 70’s oil embargo and OPEC crisis.  However, opponents claim that this reserve is only for dire emergencies.  Finally, a long standing bipartisan consideration has been to take aim at OPEC itself, in an attempt to pass antitrust legislation aimed at prosecuting the member nations for price fixing.7  Amidst an era of some of the most heightened partisan gridlock in perhaps a generation, definitive action on the part of legislation seems doubtful.

The complexity of factors and transactions that go into a gallon of gasoline can be perhaps best condensed into the following passage:

The discussions on supply, demand, refining, trade, and stocks describe the oil market and how it is interconnected among all parts of the globe. The region-by-region supply and demand patterns interact with each other to establish a price level. Anything that disrupts the supply or demand in one part of the globe affects the prices in all parts. Demand surges, refinery outages, supply cutbacks can all cause prices to increase. Some increases are temporary, called price spikes, while others reflect longer-lasting market changes.1

The claim that gas prices, relatively speaking, are low is an interesting concept to address, specifically because how used Americans are to dealing with plaintive cries about rising prices.  However, when the level of necessity that our lifestyles have created for gasoline is taken into account, as well as rising price levels through inflation, the unsustainable nature of fossil fuels, and growing worldwide demand for gasoline, it is very conceivable to envision competition growing higher and faster in the years to come.  Are gasoline prices too high?  The answer just may depend on what your views of the roles of speculation, taxation, environmentalism, and diplomatic relations are in accordance to the dollars you pay at the pump.

[1] Duffy, Daniel. “Gasoline Prices”

[2] “Gasoline and Diesel Fuel Update” http://www.eia.gov/petroleum/gasdiesel/

[3] http://energyalmanac.ca.gov/gasoline/margins/index.php

[4] http://www.financialnut.com/why-do-gas-prices-fluctuate/

[5] Forbes, J. Randy “FAQ’s: Gas Prices”http://www.house.gov/forbes/newsroom/editorials/2008/gaspricesprimer.htm

[6] Bonsor, Kevin.  Grabianowski, Ed.  “How Gas Prices Work” http://auto.howstuffworks.com/fuel-efficiency/fuel-consumption/gas-price1.htm

[7] Rettig, Jessica.  Why Congress Can’t Fix Your Gas Prices Pain http://www.usnews.com/news/articles/2011/05/11/why-congress-cant-fix-your-gas-prices-pain

[8]Hargreaves, Steve.  Gas: Why I’m Paying $4 But My Neighbor Isn’t http://money.cnn.com/2011/03/01/news/economy/_price_states/index.htm

[9]Willenborg, John F. Pitts, Robert E. Gasoline Prices: Their Effect on Consumer Behavior and Attitudes (p. 24-31) http://www.jstor.org.navigator-cup.passhe.edu/stable/pdfplus/1250487.pdf?acceptTC=true

[10] Effects of Gasoline Prices on Driving Behavior and Vehicle Markets U.S. Congress Congressional Budget Office

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