How Gas Prices Work

Gas prices.
 

A basic understanding of the factors that cause gas prices to fluctuate

One day gas prices are up, the next day they're down. If you're like millions of drivers on the road today, you've probably wondered at some point or another who determines the price of gas, why fuel prices are higher during certain seasons, why prices vary at different gas stations and why the cost of gas is different in different parts of the country.  In this section, we help to answer these questions by offering a high level overview of the factors that cause gas prices to fluctuate.
 

Gas Prices Influenced by Supply and Demand

It's been reported that the U.S. accounts for more than 40 percent of the world's gasoline consumption. We own more cars and drive longer distances than people in other parts of the world.  As such, the demand for gasoline here in the U.S. is higher than in many other regions of the world. By some industry accounts, approximately 20 million barrels of oil are consumed each day by the U.S. and almost half that amount is used for gasoline in cars. In all, it's estimated that the U.S. uses nearly 180 million gallons of gasoline every day.
The age old law of supply and demand dictates that when demand is high (as it is here in the U.S.) and supply is low, prices rise.  The variable here is supply, which can change if the world's crude-oil market tightens or if gasoline usage outpaces refinery production.  As a result, when demand is high and supply decreases, gas prices usually always increase.
 

Gas Prices and Seasonal Influences

Along those same lines, gasoline is in higher demand during certain parts of the year versus others.  As a general rule, gas prices tend to rise in the summer due to an increase in driving, especially during summer holidays such as Memorial Day or the Fourth of July.    When demand is higher, gas prices typically increase.  But the law of supply and demand isn't the only thing that influences how much you'll pay at the pump.
 

The Five Factors of Fuel Prices

In addition to supply and demand, there are five other factors that impact how much you'll pay for gasoline.  These factors are:
 
  • Crude oil
  • Refining costs
  • Distribution and marketing costs
  • Taxes
  • Individual gas station markups

Crude Oil

Most of the cost to buy gasoline goes to the suppliers of crude oil, and that cost is primarily determined by the Organization of the Petroleum Exporting Countries (OPEC). The price of a barrel of oil is determined by the amount of oil these countries produce.  For example, in 2004, the price of crude oil averaged about $34 per barrel. In 2008, those figures went well over $100 per barrel during certain months, and well over $130 per barrel during July of that year (according to the U.S. Department of Energy website).

Simply put, when the price of crude oil fluctuates based on supply, gas prices fluctuate as a result.
 

Refining Costs

Though there may be plenty of crude oil available, the type of oil available can impact how much you'll pay at the pump.  For example, oil can be heavy or light, sweet or sour, or have other characteristics that make it easy — or difficult — to refine.  For the most part, light, sweet oil is easier to refine, while heavy, sour oil requires more refinement and as a result, added expense to do so.   
As a result, it's not just the amount of crude oil produced but also the type of crude oil produced that plays a role in determining gas prices.
 

Distribution and Marketing

Crude oil is shipped to refineries, then to distribution points, then to gas stations from which we purchase it. Because there are costs associated with transporting crude oil from point A to point Z, these costs are factored into the price of gasoline and passed along to consumers as part of the price per gallon we pay. 

In addition to transportation costs, there are advertising costs associated with marketing a particular brand of oil.  Again, these costs are factored into the price of gas and passed along to consumers.
 

Taxes

Just as most everything we buy is taxed, gasoline is no exception. Federal and state taxes are taken into account, as are additional miscellaneous taxes and fees (storage tank fees, environmental fees, etc.).
 

Station Markup

Individual gas stations are entitled to mark up the price of a gallon of gas at their discretion. In most cases, the markup is only a few cents per gallon, however, some might add as much as 10 cents or more. Some states have laws in place to prohibit stations from charging less than a certain percentage over wholesale invoice prices.  These laws are designed to protect smaller, individually-owned gas stations from being overpowered by larger gas chains that can afford to drastically slash prices.
 

Regional Factors

Other variables — such as differing state tax rates — affect the price of gas.  Distance from oil refineries also plays a role. Stations located closer to the Gulf of Mexico (where many refineries are located) have lower transportation costs and lower gas prices as a result.  World events and weather, such as hurricanes or floods, can also impact gas prices. 
 

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