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Gasoline Prices

Author: Toni Johnson
Updated: December 6, 2012
This publication is now archived.

Introduction

Although considerable attention has been given to the role of market speculation in recent price volatility, many energy experts say demand is rising and oil supplies are increasingly constrained, which puts upward pressure on oil prices and, consequently, gas prices. Continued political unrest in the Middle East, a recovering global economy, and revived demand in emerging markets have all contributed to rising oil prices. U.S. gas prices in 2012 were more than $4 in some places and heading toward the record highs of 2008, when gas rose to nearly $5 per gallon. The U.S. Energy Information Administration (EIA) projects that 2012 will be the one of the most expensive years in history for motorists. The U.S. debate over protecting consumers against high gasoline prices has largely focused on increasing domestic supplies or finding ways to reduce consumer demand, but there is also concern about balancing these goals against environmental and economic issues.

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Components of Gasoline Prices

The EIA, an arm of the U.S. Department of Energy, breaks the price of retail gasoline into four components: the cost of crude oil; the cost of refining and fuel blending; federal and state taxes; and distribution and marketing expenses.

  • Crude oil: This is the raw material used to make commercial-grade gasoline, known in much of the world as petrol. The cost of crude oil accounts for the largest percentage of what U.S. consumers pay for gas at the pump. On average, about 51 percent of every dollar spent on retail gasoline went to crude suppliers in much of the last decade, according to the EIA. In 2008, when gas and oil prices were at their highest, crude represented an average of 75 percent of U.S. gas prices, and currently hovers at around 62 percent (PDF), according to a June 2012 report from oil industry advocate the American Petroleum Institute (API). According to the EIA, a $1 change in crude prices corresponds roughly to a 5-cent change in wholesale gasoline prices.
  • Refining: The process of turning crude oil into products for consumer use accounts for about 12 percent of the retail price of gasoline, on national average. In the United States, refining requirements in different regions can affect gas prices. California, for instance, has the most stringent air quality rules, including stricter requirements for ethanol fuel blending and sulfur content. Thus, gas prices in the West Coast region, dependent on California refineries, are significantly higher than the national average, even reaching record highs of $4.67 a gallon (LAT) in October 2012. Refining capacity can also have a price effect, as was the case in 2005 when Hurricane Katrina knocked out 20 percent of refining capacity in the Gulf region.
  • Taxes: The percentage of every dollar spent on gasoline that goes to federal or state governments has decreased in recent years. According to the EIA, taxes currently account for about 12 percent of the retail price Americans pay for gas, though this number is a national average and percentages vary significantly from state to state. The national average, including a federal tax of 18.5 cents per gallon, is 49.3 cents, but in some states, taxes are nearly 70 cents per gallon (PDF).
  • Distribution and marketing: The combined prices of purchasing and transporting gasoline from refineries to gas stations (often via intermediary distribution points) and the costs of operating the stations account for about 14 percent of the retail price of gasoline, according to EIA data.
Oil Supply and Demand

While U.S. consumption has fallen slightly in the last five years, China, the world's second-largest consumer of oil, and countries such as India and Brazil are seeing a marked increase in oil demand (Slate). Some experts say these emerging markets have played a major role in the volatility in crude prices, which in the last few years have fluctuated widely, going as high as $145 per barrel in mid-2008 before dropping to $30 and then rising again to above $100 in 2012. "As long as the emerging economies, especially the big ones, keep growing, the demand for oil will keep growing," said CFR's Michael Spence in March 2011. "So the kind of situation we saw before the crisis in 2006 through 2008, when there was a big spike in commodity prices, could return."

Demand also has outpaced new oil investment, leading to a tightening of global production capacity. For the last few decades, Saudi Arabia, the only country with notable spare production, has attempted to act as a price buffer by raising or lowering its production in response to the market, but in recent years the country has had less room to act (Reuters). Smaller margins of spare production capacity mean any potential disruptions in the oil supply have a marked effect. In 2011, the supply of oil in the Middle East became a significant concern and caused oil prices to increase as countries in the region, including Libya, one of the world's top twenty oil producers, became embroiled in an ongoing pro-democracy movement.

Some experts say that high oil prices are here to stay. "Oil prices have found a long-term floor at $90-95 per barrel and nearby spot oil prices could rise sharply if Middle East tensions increase again," said Marco Dunand and Daniel Jaeggi, founders of energy trading company Mercuria, in May 2012. However, Atul Arya, an energy expert and a former CFR adjunct senior fellow, cautions against predicting permanently higher oil prices. "We can't say with confidence that prices will stay high," he says, noting that historically, prices have bottomed out with new production coming online and demand has softened due to high oil prices and other economic factors.

Factoring in Ethanol

Nearly every gallon of gasoline in the United States contains at least 10 percent ethanol by volume, according to the EIA (PDF). A 2008 Energy Department study estimated that, on average, ethanol blending (PDF) saved the U.S. consumer anywhere from 20 cents per gallon to as much as 35 cents per gallon that year. A more recent ethanol industry report argues that in 2011, gas prices were at least 12 cents lower than expected, thanks to the fuel additive. In October 2010, the Environmental Protection Agency also approved the use of gasoline with 15 volume percent ethanol (E15) in vehicles with model years of 2001 or later. However, concerns related to automobile warranties, potential liability for fueling incorrectly, and infrastructure costs are likely to limit E15 use to low volumes in the near term.

But effects on prices, especially going forward, remain a topic of heated debate. Some critics argue that because of its heavy reliance on corn, ethanol is in competition with food, driving up food prices, especially for the world's hungriest. Corn also is subject to commodities market fluctuations and production problems (PDF) that could increase ethanol prices, as was the case in 2012 when drought pushed corn prices to record highs (WSJ).

Policies to Ease Gas Prices

Though lawmakers in the last decade have brought oil companies to task for high prices, oil executives claim they are just as much at the mercy of market forces as consumers. "No one person, organization, or industry can 'set' the price for crude oil," Marvin E. Odum, head of Shell Oil Company, told the Senate Finance Committee on May 12, 2011. "Stated simply, oil is a global commodity. And oil companies are price takers, not price makers." Some analysts note that though gross oil industry profits seems large, the industry's profit margin (which takes in the cost of oil production) makes on average a little over 6.5 cents for every dollar.

Still, the Obama administration and Democrats in Congress have made a number of attempts to end at least $20 billion in annual oil company subsidies, although experts say such a move is unlikely to affect gas prices. The GOP, in turn, has introduced bills (Bloomberg) pushing for the expansion of offshore drilling, cuts in regulation, and overriding the State Department rejection of the Keystone XL pipeline (WashPost). Analyses, however, highlight that these proposals would likewise have little impact (AP) on prices.

Increasing domestic drilling, proponents say, will reduce U.S. dependence on foreign oil as well as encourage lower oil prices by increasing supply. Shale oil advocates estimate production using hydraulic fracturing (inserting liquids into a well to push out trapped oil) could yield as much as two million barrels a day by 2015 (AP)—more than what is currently produced offshore in the Gulf of Mexico. Similarly, there is intense interest in boosting conventional offshore and deepwater production, which, some argue, could yield an additional two million barrels in the next five years.

There has already been a significant increase in U.S. oil production at 6.3 million barrels per day, the highest since 1997. A Congressional Research Service report by Neelesh Nerurkar shows that net oil imports dropped by 33 percent between fiscal year 2005 and 2011. An International Energy Agency report published in 2012 says that by around 2020, the United States is expected to surpass Saudi Arabia as the world's largest oil producer. However, how much that would affect oil prices is unclear since oil demand in other regions is also expected increase significantly over the next few decades.

Some experts contend that reducing consumption through demand-reduction policies is the biggest buffer against high gas prices. Under Obama's "All-of-the-Above" energy policy, the United States is implementing new corporate average fuel economy standards and tax incentives for consumers and producers of efficient cars. Additionally, President Obama has provided renewable energy producers and innovators with large subsidies. This Scientific American article explores demand-reduction policies, including increased use of biofuels and alternative-fueled vehicles, and attaching new crude oil or gas taxes.

Unlike API, which favors reducing current gas taxes to help the U.S. consumer, some experts see a massive increase in gas taxes—in effect raising prices even further—as the simplest way to deter consumption. The United States pays the lowest fuel tax and thus, lower fuel prices, than any other industrialized nation, and less than some emerging-market countries, such as China.

Albert Troszczynski contributed to this report.

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