How are gas prices set?

Oil

We all know that gas prices are never the same, and they vary like minute-to-minute almost. It’s pretty ridiculous.

Do you know why this happens all the time? Well … there are lots of reasons. While lots of people like to think it’s the president of the United States who sets gas prices, in reality, that’s just not the case (although there may be some element of input, which I’ll run through). So if somebody tells you it’s the president’s fault, tell them it isn’t, and you’ll know why because you read this blog.

First I’ll divide the cost of gas up, then run through the different things that affect the gas-pump price.

This blog is fo’eva interesting.

Who gets the money!?

When you pay for gas, you aren’t just paying your local gas station. Instead, the money goes different places per gallon.

Here’s how it’s divided up per gallon: 70% goes for crude oil (the stuff that becomes gas after refinement), taxes (state and fed) take up 15%, 10% goes to marketing costs, and only 5% of the cost goes for refinement (which really means the actual people working and refining and diesel is a bit more expensive to refine).

Since 70% goes to crude oil, it stands to reason that the crude price has a HUGE impact on gas prices. So it’s not necessarily summer opportunism that drives the prices up, rather, it’s the price of crude oil.

Where does crude oil come from!?

Well, increasingly it’s the United States (thanks NORTH DAKOTA!), but a huge majority comes from the Middle East — not surprisingly.

In 1960 there was a cartel formed in the Middle East. **A cartel btw is an organization that is created with the express mission to keep prices of a certain thing as high as possible (like a drug cartel).** This group is called the Organization of the Petroleum Exporting Countries (OPEC). It’s basically wealthy Middle-Eastern countries.

OPEC has states as members (know what states are!), and they operate on a one-member-one-vote system (who says the Middle East isn’t democratic?). I don’t know all the details of membership, but I know you have to meet production quotas and pay money to be a part of the organization (in 2008, Indonesia was out because it couldn’t meet the production demand). The state members of OPEC decided to nationalize oil (make it the state’s property) and use it to have their say in international affairs. Eventually OPEC took some profits to reinvest back into poorer states, and they implemented centrally planned economies.

OPEC can also be used for malicious purposes. Leading up to the first Gulf War in ’91 (Iraq wanted Kuwait’s oil fields), Saddam Hussein wanted to raise international oil prices to fund his war. The purpose of that war, btw, was to double Iraq’s oil producing capacity in order to challenge Iranian power. However, Saddam didn’t count on the United States to credibly back its Kuwaiti ally. Anyway, continuing:

So OPEC was formed to protect a product — oil, which the Middle East obviously knows the entire world wants. People in the United States weren’t very happy with this. Instead, in 1960 Standard Oil (which owned 75% of the US market) decided to lower the price of oil that OPEC set, and Esso and the others followed suit. During the formative years, OPEC needed to establish their market dominance.

Eventually OPEC made the United States listen. During the 70s, the US aided Israel in a war, and eventually OPEC raised oil prices, which caused oil scarcity. The Middle East knows it’s our Achilles heel. Now what?

The United State’s Supreme Court answered the question of whether or not any legal action could be taken against OPEC in 1979. No go. The Supreme Court ruled that OPEC is untouchable because it’s a group of states, and states can do whatever they want. Had they been an organization of oil producers (commercial type people), then there could be legal action taken (within the United States anyway).

In the end, OPEC is a pretty smart organization, and they know what they’re doing. They watch the oil prices of other producers like Canada, Russia, and the United States and price competitively so their oil prices are most desirable. Not to high, not too low — just right.

In response to the oil embargo of the 70s, the United States implemented the “Strategic Petroleum Reserve.” When crude oil comes in the United States, some of it has to be sent to this reserve, which is housed in Louisiana and Texas I believe. In 2007, George Bush increased the capacity of this reserve to 1 billion barrels — the largest reserve in the world. Kind of an insurance policy if you will. Bill Clinton actually made a deal with oil producers and released 30 million barrels to keep prices down for consumer house heating in 2000.

The name of the game is always to combat producer countries to maintain a reasonable barrel rate.

OTHER STUFF!

There is other stuff determining prices of gas. Taxes are big, and they vary from state to state. Also, local competition from gas stations should theoretically drive prices down, but I’m not 100% sure this happens all the time. Also, there is the distance between the gas station and refinery that adds cost to the gas.

Disruptions in crude oil flow also affects gas prices. Maybe a tanker was lost at sea, some trains are out of commission in the United States, a hurricane wiped out oil refineries or pumps, or terrorists hijacked refineries in the Middle East (very plausible — look at ISIS). Finally, environmental standards affect prices. After all, if you want to reduce fog, it costs. At the end of the day, demand drives prices up, because everyone wants that MONEY!

Final thoughts

Some people say that with the United States increasing production, prices will go down. Well … I would say maybe. That depends on how it all works out. While the United States is reducing its dependence on foreign oil, the oil producers also export oil a whole lot. So whatever is profitable for the producer, the producer is going to do. Just because the oil is being drilled in the United States doesn’t necessarily mean that it’s all staying in the United States. So if  China will pay $100 a barrel and the US will pay $80, then China gets it.

Really it depends on what export restrictions there are, and how much oil has to stay within the border (if any). Also, domestic producers want to maximize profits just like OPEC does … so the only thing trading OPEC for domestic producers does is eliminate the international political element … which I suppose is pretty big.

Also, producers are drilling surface fossil fuels for the most part. This is the cheap stuff. There is more fossil fuel deeper, but that in turn will drive the cost up because it’s more expensive to extract. So fuel may continue to increase simply because it’s harder to get.

Finally, the new fuel alternatives are starting to gain momentum (with fighting from the oil producers). There is going to be a pretty big fight between gas and whatever is an alternative, and if there’s one thing that I learned from watching There Will Be Blood, it’s that the oil business is cutthroat — not to mention I doubt the car manufacturers want to spend ridiculous profits to redesign all their cars. In the future, expect massive propaganda and PR campaigns from both sides.

Despite all this hoopla, gas prices are actually relatively stable if you look at it over time. The spikes we see are usually due to international developments or natural disasters. These fluctuations are annoying to consumers, but the overall idea is to keep the product coming in at reasonable prices for everyone.

Now go fill up punk, it’s actually a decent price … well, I would prefer ’96 prices.

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