Gas price increases over the past thirty months

Gas prices are beginning to rise again after remaining steady for a period of several months. Prices last week are now averaging $2.169 per gallon after sitting around $2 per gallon (Kahn, 2009). Crude oil prices are increasing as well, up to $58.14 for a barrel off Brent crude. Despite this recent increase, prices are substantially lower than at this time in 2008 when the price peaked in early July. The increase in crude prices has been the main driver over gas price fluctuations in recent months, if only because of the high volatility in crude prices. In practice, however, there are a wide range of variables that are responsible for gas prices. This paper will explore the different variables of gas prices and analyze their impacts on the dramatic rise, fall and rise again in gas prices.

The price at the pump reflects a variety of different cost inputs. In 2005, the price of crude accounted for 53% of the price at the pump. State and federal taxes were tied with refining costs at 19% of the price, the remaining 9% being attributable to distribution and marketing costs. The year before, the price of crude was only 47% and taxes were 23%, illustrating that this figures are somewhat volatile. The price of crude, however, is the largest component and trends around half the price at the pump.

The price of crude is determined by a wide range of factors, one of which is supply and demand. Both of these factors are global, given the global nature of the petroleum market. The United States is presently the largest consumer of petroleum. Of America's energy needs, 29% is for transportation, which is almost entirely petroleum. Industrial is 32% of America's energy needs and petroleum is the largest component of that as well (Annual Energy Review 2007). U.S. petroleum demand has increased substantially over the past several years, but there was no evidence of a spike to which the recent gas price surge could be attributed.

The demand side of petroleum is driven also by other countries. In particular to crude prices was demand from emerging economies such as China and India. This trend has been building for several years (Reuters, 2005). While India denies that its consumption is a factor (Zaidi, 2008) their claims do not address the growth rate in oil consumption, and that this outstripped expectations for a short time. China's oil consumption, for example, grew 11.9% in 2008 (Xinhua, 2009).

The supply side of crude oil is loosely controlled by OPEC. This trade group represents the interests of many of the world's major oil-producing nations. OPEC nations account for 28.74 barrels per day out of the total world estimated market of 84.18 million barrels per day. The cartel controls world oil supply and price, setting its production based on the expected production of non-OPEC producers and the expected world demand (Daya, 2009).

Crude prices are also affected by speculators on the global commodities markets. Oil is traded on commodities exchanges such as the New York Mercantile Exchange, and is typically purchased on credit (leverage). This increases the amount of oil that any one investor is able to sell. Commodities exchanges have historically been immune from speculative buying because the buyer must take physical delivery of the product. This has historically limited the market to oil companies, airlines and other major users. However, speculators have been able to enter the market, as long as they are able to unwind their positions before they are forced to take delivery. This speculation increases the volatility in the oil markets, such that over the first half of 2008 they behaved irrationally. A large number of unusual investors are recorded in this group -- the California pension fund, Harvard Endowment fund, hedge funds, sovereign wealth funds and a variety of institutional investors (Kroft, 2009).

After crude, the second largest component of gas prices are federal and state taxes. The Federal gas tax is 18.4 cents per gallon (Gaspricewatch.com, 2009). This has not changed in recent months and so is not a significant contributor to the price increase. State tax regimes vary significantly. All states have a gas tax, ranging from 7.5 cents per gallon in Georgia to 32.1 cents per gallon in Wisconsin. Many states also allow for local and county taxes (Ibid). Few states taxes increased during the run-up of early 2008.

Refining costs also account for 19% of the price at the pump. Most refining takes place close the market, although the U.S. is served by some refineries in the Caribbean. The greatest amount of U.S. refining capacity is along the Gulf Coast (EIA, 2009). There is no evidence that an increase in refining costs occurred to justify the price increases recorded. However, there was a capacity shock during Hurricane Ike. The impending hurricane forced refineries to cease operations. The threat of supply shortages caused a rebound in prices, which had been declining over the course of the summer prior (Schoen, 2008).

The final variable, marketing and distribution costs, is often cited as a source of gas price spikes. Gasoline companies are handed significant blame, although more often than not they are merely the messenger that the public is shooting. The oil companies are buyers on the commodities market, and are as apt to be caught up on supply/demand mismatches as any other oil purchaser. The one area where oil companies do make a contribution is with percentage markups. This means the markups are higher when the price is higher and lower when the price is lower. As a consequence, oil companies make higher profits when gas prices are higher. This creates the illusion that they are controlling the prices, but that is not the case.

Of the four components of fuel prices, the most relevant remains the price of crude. Over the past 30 months we saw world demand surge as a result of expanding Asian economies. Supplies were not increased to match this demand, driving prices upwards. As the global economy began to falter, demand fell back in line with supply, resulting in a decrease in gas prices.

The second major factor, albeit a controversial one, is the rampant speculation on the commodities markets. Oil was rising, and speculators went to cash in. This drove the bubble of the first half of 2008. With that bubble now eliminated, the price of oil has fallen back into its normal equilibrium. This has resulted in a substantial drop in the price of crude, which in turn results in a substantial drop in price at the pump.

Other factors play a much less important role. Taxes have remained steady, so played no role in the run-up in oil prices nor in their subsequent decline. Other factor costs have remained relatively steady, barring the speculation of a supply stoppage during Hurricane Ike. So while the price at the pump cannot be attributed entirely to the fluctuations in the price of crude, there is a strong correlation. The key for consumers is to understand that the presence of speculators in the commodities markets increases the volatility in the crude oil market. As long as this is the case, and emerging nations continue to increase their consumption, the price of gas will have significant upward pressure exerted upon it.