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How gas prices work
Let's see how it works?
Breakdown of Gas Prices
When you pump $20 dollars into your tank, that money is broken up into little pieces that get distributed among several entities. Gas is just like any other consumer product: There's a supply chain and several groups who are responsible for setting the price of the product. The media can sometimes lead you to believe that the price of gas is based solely on the price of crude oil, but there are actually many factors that determine what you pay at the pump. No matter how expensive gas becomes, all of these entities have to get their slice of the pie.
Let's look at where your money goes when you pay for gas:
· Crude oil - The biggest portion of the cost of gas -- as of April 2007, that's about 50 percent -- goes to the crude-oil suppliers. This is determined by the world's oil-exporting nations, particularly the Organization of the Petroleum Exporting Countries (OPEC), which you will learn more about in the next section. The amount of crude oil these countries produce determines the price of a barrel of oil. Crude-oil prices averaged around $37 per barrel (1 barrel = 42 gallons or 159.6 L) in 2004 (Source: U.S. DOE). And, after Hurricane Katrina, some prices were almost double that. In May 2007, crude-oil prices averaged around $60 per barrel (1 barrel = 45 gallons or 159.6 L).
Sometimes, gas prices go up even though there is plenty of crude oil on the market. It depends on what kind of oil it is. Oil can be classified as heavy or light, and as sweet or sour (no one actually tastes the oil, that's just what they call it). Light, sweet crude is easier and cheaper to refine, but supplies have been running low. There's plenty of heavy, sour crude available in the world, but refineries, particularly those in the U.S., have to undergo costly retooling to handle it.
· Refining costs - The refining of crude oil makes up about 28 percent of the price of gasoline. To learn more about oil refining, read How Oil Refining Works.
· Distribution and marketing - Crude oil is transported to refineries, and gasoline is shipped from the refineries to distribution points and then to gas stations. The price of transportation is passed along to the consumer. Marketing the brand of the oil company is also added into the cost of the gasoline you buy. Together, these two factors account for about 8 percent of the price of gasoline.
· Taxes - Taxes, including federal and local, account for about 14 percent of the total price of gas in the United States. Federal excise taxes are 18.4 cents per gallon, and state excise taxes average 18.2 cents per gallon. 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. Add that to the state excise taxes, and it can average 27.4 cents. It could be worse. In Europe, gas prices are far higher than in America because taxes on gas are much higher. For example, gas prices in England have risen as high as $6.65 per gallon, with 78 percent of that going to taxes.
· Station markup - While it isn't represented in the diagram above, of course some of the actual money you spend at the pump does go to the service station. Service stations add on a few cents per gallon. There's no set standard for how much gas stations add on to the price. Some may add just a couple of cents, while others may add as much as a dime or more. However, some states have markup laws prohibiting stations from charging less than a certain percentage over invoice from the wholesaler. These laws are designed to protect small, individually-owned gas stations from being driven out of business by large chains who can afford to slash prices at select locations.
Gas prices also vary from state to state for several reasons. Taxes are probably the biggest factor in the different prices around the country. Additionally, competition among local gas stations can drive prices down. Distance from the oil refineries can also affect prices -- stations closer to the Gulf of Mexico, where many oil refineries are located, have lower gas prices due to lower transportation costs. There are also some regional factors that can affect prices.
World events, wars and weather can also raise prices. Anything that affects any part of the process, from the moment the oil is drilled, through refining and distribution to your car will result in a change in price. Military conflicts in parts of the world with lots of oil supplies can make it difficult for oil companies to drill and ship crude oil. Hurricanes have damaged offshore drilling platforms, coastal refineries and shipping ports that receive oil tankers. If a tanker itself is lost or damaged, or leaks its oil into the ocean, that will put a dent in the market as well.
The most recent surge in gas prices is due to several factors, including all of those listed above. However, a new reason emerged during the spring of 2007: legislation out of Washington to incorporate more ethanol into transportation fuels. There has been a call for enough increase in ethanol production to reduce daily oil imports by 1.5 million barrels by 2017. As the ethanol production increased refineries couldn't keep up the demand and had to import more oil. This added to the increase in price.
Unfortunately, the rise in prices may not be over. Several things could happen to keep driving up the price of gasoline: continuing tensions over Iran's nuclear talks, worse conditions in Nigeria or another active and devastating hurricane season [Source: The Washington Times].