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The Relationship Between Oil and Gas Prices

August 2, 2012

As a consumer of gasoline it can be frustrating to watch the price of oil go up and down, yet the price of gas doesn’t move in step.  Why does the price of oil drop, but the price of gas at the pump doesn’t?  Why does the price gas seem to go up faster and higher than the price of oil?

The natural inclination of most consumers is to assume their local gas station is gouging them to make a higher profit.  Actually, this isn’t the case at all.  Most gas retailers make a very thin profit margin on the gasoline they sell.  That’s why most gas stations also have a convenience store.  It’s virtually impossible for a gas station to sell enough gas to make enough of a profit to even keep the doors open.  They make a much higher profit margin selling food and drinks inside.  They actually use the gas pumps as a means to get customers into their convenience store.  So, don’t view it as a gas station that has a store, it’s really a store that has gas pumps.

Interestingly enough, when the price of gas goes up, the retailers margins actually get squeezed even worse.  They actually make more profit when the price of gas falls.  So, don’t get angry with your local gas station owner.  They’re on your side!

What Makes up the Price of a Gallon of Gas?

Oil

The pump price is not based on the cost of the fuel that is currently in a station’s underground tanks.  Instead,  the price is set by how much it will cost to buy the next delivery.  This cost is influenced by local conditions, pipeline fees, distribution costs, refinery margins and crude oil prices.  That’s a lot of variables affecting the cost of your fill-up.

The biggest piece of the pricing pie is the cost of crude oil.  While crude oil is a commodity that’s traded on exchanges around the world, it’s not traders and speculators that cause the price to rise and fall, but supply and demand…or more accurately, perceived supply and demand in the near future.

As large nations with emerging economies, such as China, India, Russia, etc., grow, their demand for crude grows with it.  This puts far more pressure on the demand side than anything the happens in the US.

From a supply point of view, geopolitical tensions can create major disruptions to supply.  OPEC and other oil producing organizations can also restrict production in order to maintain what they believe is a fair price for their product.

Taxes

oil and gasThe next biggest component in the price of your gallon of gas is taxes.  Gasoline is taxed at the Federal, State, and local levels to provide money for highways and other transportation infrastructure needs.  This is the one area where the government can help.

There is much news made over how much drilling should or shouldn’t be done in the US and coastal waters.  However, historical statistics have show that the amount of new oil drilling in the US has little to no affect on the cost of your gallon of gas.  First of all, it takes a long time for a new oil well to start producing oil.  Secondly, the new supply offers little impact as compared to the world-wide supply.  I’m not saying we should avoid new exploration and drilling, but keep in mind that won’t ease your pain at the pump.  However, lower gas taxes would!

The drawback to lower fuel taxes is this could only be done for a short period of time before the transportation infrastructure in our Country would start to deteriorate at a pace that’s even quicker than it is today.  In other words, that’s not a long term solution, either.

There are other ways the government car help the issue from a demand point of view, such as requiring higher fuel mileage ratings for new cars, modernizing fleets of government vehicles, and most of all, lessening military actions.

The Bottom Line

Oil and gas prices will never run in lock step because of the number of variables that make up the price of a gallon of gas.  The only way to lower the price of gas of any significance for any period of time is to increase oil production while simultaneously cutting the consumption of oil.  In today’s world, neither of those are very likely.  We should probably get used to the idea of high gas prices and adjust our personal usage and household budgets accordingly.

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