Why Does Gasoline Cost So Much, Daddy?

Basics of the Petroleum Industry VI: The Economics of Big Oil (and Your Local Gas Station)

For most of us, our chief exposure to the economics of the oil industry comes in the form of two-foot-high letters displayed somewhere along the streets we travel to work or play. Though we may not know the current price of a barrel of crude oil¹ - may not even know how big a barrel of oil is² - we are usually aware of the price of gasoline in our neighborhood. What most of us don't know, as a rule, is why gasoline costs what it does. The answer is simple on the surface, and devilishly complex below that simple answer.

One simple fact is that oil companies, no matter how large or small, do not set the price of their product. Crude oil and refined products are commodities, like corn and pork bellies; and the price of commodities are by commodity traders who broker deals between sellers and buyers. Traders perform a balancing act between the least a seller will accept for the product and the most a buyer will pay for it. According to the law of supply and demand, buyers will pay more for a commodity when supply decreases. That's why whenever there is a restriction in the supply of oil production within or imports to the USA, the price rises. Even more, whenever there is fear of a reduced supply - due to weather, natural disaster, or political instability - the price also rises. In fall of 2008, the price of oil fell dramatically because of the belief that that economic upheaval would reduce demand for petroleum in large markets like Southeast Asia. The same supply and demand cycle affects beef and milk (mad cow disease, anyone?) and corn and soy beans: like farmers who are paid less for crops after a good growing season, oil companies get less for their product when the supply exceeds the demand.

Remember, too, that the cost of the raw materials (crude oil) is only about 65% of the price of your gasoline: there are also the costs of transporting the crude oil to a refinery, refining it, and transporting the refined product to your local station; not to mention the cost of the additives, most of which are also petroleum products. Besides the cost of producing, transporting, and refining the gasoline you bought on the way to work today, the station that sold you that gasoline also has to pay for the property and building (a small station can easily cost more than a million dollars to build and equip), employees, and the rights to sell that particular brand - very few stations that sell Exxon gasoline, for instance, are owned by the company. Most are owned by local business-men and -women. Oh, and one more cost: taxes. On top of a federal tax of 18.4 cents per gallon, every state (and some large cities) also charges "road-use" taxes. Depending on where you live, taxes range from a total of 26.4 cents/gallon (Alaska) to 65.8 cents/gallon in California (see a list of US state tax burdens here). Internationally, except for a few petroleum-exporting countries such that subsidize the price of gasoline (e.g., Venezuela and Saudi Arabia), taxes can be even higher; though the proceeds are frequently used to pay for public transportation.

Remember the twenty gallons of gasoline that cost you fifty bucks this morning? The station probably made less than a dollar of net profit - that's why they want you to come inside and buy snacks in their convenience store. Back in the mid-nineties, when oil was at nine dollars per barrel, the company I worked for made most of its profit off "The four Cs"- cigarettes, coke, chicken, and condoms - in their chain of convenience stores, and actually lost money selling gasoline. If you really want to make a gas station owner happy, come inside and pay $1.59 for a bottle of water after you're done pumping - you may double his profit on your visit.

What should you take away from this? First, oil companies don't set the price of their product -- they're at the mercy of the law of supply and demand. Sure, when prices are set high they can rack up substantial profits, but when prices fall, they'll take it in the shorts. Second, the guy in the local gas station doesn't arbitrarily jack up the price to try to fleece you: the station owner has plenty of costs to cover, not just the price of the raw material - and it's fairly likely that the station isn't making a great deal of money off the sale of gasoline in the first place.

This is number six in a series of minilectures on the oil industry:

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production
5) Refining 
6) The Economics of Big Oil <== You are here.  The next installments is:
7) The Future of Oil


¹ If you're curious, it's displayed to the right of this blog entry (assuming the gadget is working today)
² A barrel is 42 US gallons, a smidgen less than 159 liters, or just under 35 imperial gallons. It's a unit of measurement, however, not a physical container: petroleum and petroleum products aren't poured into 42-gallon drums and shipped; it's pumped into large tank trucks, rail cars, and tanker ships; or they're pumped in a continuous stream through a pipeline.

copyright © 2009-2016 scmrak

Statistics Never Lie - but Liars Use Statistics

If you’ve visited your local Valero gas station lately, you might have noticed a little political theater right there at the pumps. Not content with spending their money on K Street lobbyists in hopes of influencing the government in their favor, the Texas-based oil and gas company has instituted a “grass-roots” campaign in hopes of quashing climate legislation. Like most, although not all, other fossil-fuel companies, Valero’s management (led by CEO William R. Klesse) is staunchly – almost virulently – opposed to climate legislation. This may in part reflect the extreme rightward political leanings of former Oklahoma congressman Don Nickles, a board member, but is a position that is in no way unusual at the top of the industry. Rank-and-file employees, especially scientists (of which there are few on boards of directors) are less hard-line, by the way.

All that means, however, that Valero has begun displaying posters at company stations (many former Diamond Shamrock sites) flatly stating that the Waxman-Markey climate legislation passed by the House of Representatives this past summer is, in the words of Klesse, “a hidden tax.” Klesse further claims that “more than a million high-paying jobs will disappear from our already weakened economy, with no measurable improvement in global climate change.” Perhaps Klesse is concerned that one of them will be his, for which he was compensated to the tune of $10.5 million in 2008 (per Forbes). Valero’s poster, attributed to an organization called Voices for Energy (apparently another name for “Valero”) repeats Klesse’s statements, and states flatly that the Waxman-Markey bill will raise the price of a gallon of gasoline by seventy-seven cents - or more!!! democracydata.com, the domain hosting Voices for Energy, is a Virginia-based political consulting organization that terms itself specialists “in database management and zip to district matching supporting virtually any sort of grassroots lobbying activity.” Grassroots my ass: it’s just astroturf.

So anyway, let’s get to the claim of “77 cents per gallon.”

The impression left by the wild-eyed Uncle Sam is that, if Waxman-Markey passes, your gasoline will cost at least 77 cents more per gallon the next day. However, the 77-cent estimate comes from a compilation of studies performed by the American Petroleum Institute (API), an industry trade association and advocacy group, and represents their estimate of the increase ten years out in 2019 (ignoring inflation, if any). API didn’t crunch the numbers themselves, however; they used numbers from a study published by EIA, the Energy Information Administration (the statistical agency of the U. S. Department of Energy, nominally independent). To sum up that study: EIA estimates that if energy markets were to continue unchanged, the average price of a gallon of gasoline in 2019 would be $3.62/gallon. With Waxman-Markey in place (unchanged from its current form), EIA estimates a best-case scenario of $3.74/gallon and a worst-case scenario of $4.29/gallon – the 65-cent difference is due at least in part to variable estimates of the effectiveness of carbon offsets in reducing costs. The API’s, and Valero’s, 77-cent “estimate” is that worst-case scenario, in which no refiner or producer reduces costs by a single penny – perhaps out of distaste for the practice of using carbon offsets…

The EIA figures are used by the Congressional Budget Office (CBO, the non-partisan agency that provides economic data to the legislature), which has estimated that the use of all available carbon offsets would cut the cost of the cap-and-trade legislation by 70%, or about 54 cents of that worst-case scenario. CBO, by the way, calls the API figures “extreme” and protests that the use of the EIA’s 77-cent figure misrepresents the non-partisan group’s calculations.

Undeterred by the protests of non-partisan statistical organizations, however, the API not only continues to quote that 77-cent figure, but has also allied itself with that paragon of non-partisanship, the Heritage Foundation, to figure out on a state-by-state basis how much the cap-and-trade will “cost” people.


Both EIA and CBO have stated that the effects of using carbon offsets, details of which are still vague, on the ultimate costs can't be reliably calculated - which is part of the reason for the sixty-five cent spread in their estimates. For the API to use only the estimate that best supports their cause is, however, to be expected. It's akin to a Celtics fan shouting that The Sporting News says his team will will 80 games this year when the article says "between 60 and 80." And, of course, the Nets fans will sneer that the News said the Celtics would only win 60...

As always, the best policy is to take the Heritage Foundation’s numbers, add them to Ralph Nader’s, and divide by two… To recap: statistics never lie, but liars use statistics - only they don't use all of them. The API is cherry-picking...