From The Ground To The Gas Tank: How Gas Prices Are Determined & Why They Change

Posted on: 2 December 2014

What do you know about gas prices? Most people know the current price, and the fact that it rises often. A lot of panic usually surrounds gas prices. You may wonder what you'll be paying when you drive to your mother's house for Christmas or during your family vacation to the beach next summer. If you understand how gas prices work, it can help ease some of your panic and even allow you to estimate future gas prices more effectively. Here is a breakdown of how gas prices work, and why they rise.

How gas prices are determined

According to the Energy Information Administration, gas prices are made up by four categories.

  1. Crude oil
  2. Refining costs
  3. Distribution and marketing costs
  4. Taxes

The largest price determent for your gasoline is the price that refiners pay per barrel of crude oil. In recent years, crude oil skyrocketed to over $100 per barrel, which had gas prices averaging around $4 per gallon. However, now in late 2014, the prices are closing around $70 per barrel, and gas prices are hanging steady just below $3 per gallon.

The next factor for gas prices is the cost of refining the crude oil. Refiners need to refine and sell the refined oil for a profit.

The smallest determent of gas prices is the distribution and marketing costs. The cost of distributing the gasoline to retail stations makes up less than 10% of the gas prices.

Finally, the last factor in gas prices is the always dreaded taxes. The federal and state taxes you pay for your gasoline adds about 12% to the price per gallon. The percentage is based off paying $3.56 per gallon. It will slightly rise and lower with the gas prices; which begs the question, why do gas prices rise?

Why gas prices rise & fall

                Supply & demand

As previously stated, the price of crude oil is the major deciding factor of the current gas prices. Supply and demand play a major role in the rise of gas prices. When the crude oil supply is low, it causes the prices to rise. The Organization of the Petroleum Exporting Countries (OPEC) needs to be able to make the same profits; therefore, they have to charge more for each barrel of crude oil that they produce. As the supply increases, they have more wiggle room to lower the price and keep their books balanced.

Increasing demand leads to higher gas prices as well. As a country uses more crude oil for travel, heating, and trade, the prices rise to match the demand. If a demand is low, people aren't as willing to pay top dollar, allowing the prices to lower. No one can pay a lot of money for something that can't be sold easily.

                Value of the dollar

The value of the dollar is another reason why gas prices rise. If the value of the dollar in Canada drops, but the value of currencies stays the same in other countries, it leaves less profit for those who are selling to Canada. Therefore, all of the crude oil sold to Canada has to be priced higher to make up the difference.

                Futures market

Crude oil commodities are a major part of the futures market. The futures market is a stock market that trades commodities based on the future price. Something as simple as speculation can raise the cost of a barrel of crude oil. As the future price is speculated, more commodities are traded in the futures market. High speculation activity will raise the cost per barrel.

As you can see, the price of gasoline varies based on many different factors. The oil companies don't just pump gasoline out of the ground and send it to the gas station. Oil has to go through different companies, which is one reason it's important that it is cared for properly using premium connections. It need to be sold, refined, and sold again. Everyone involved has to make a profit before the gasoline gets to your vehicle to keep the economy going. If you're interested in finding out what gas prices will be in the future, check the futures market, prices of crude oil, and blogs from refineries.