Driving into the local service station, you notice that the gas prices have risen about a nickel since you stopped there last week. But what can you do? -- you need gas! While dispensing gasoline into the fuel tank, you watch the pump display tick by the $20 mark well before your tank is full. Gas prices have a major impact on our lives, affecting the economy and our daily activities.

Photo courtesy Phillips Petroleum Company
Americans are using a record amount of gas, which contributes to higher gas prices.

Gasoline is the bloodline that keeps America moving. Our personal vehicles alone guzzle 115 billion gallons of gasoline and diesel fuel each year, according to the Motor & Equipment Manufacturers Association (MEMA). Add commercial vehicles, recreational vehicles and other machines that run on gasoline and the number is even more astronomical. In 2001, the average fuel economy of cars and light trucks hit their lowest points since 1980, which only compounds the problem of higher gas prices.

Gas prices have always been a sore spot for consumers. To the average person, it probably seems as though there's little rhyme or reason to how gas prices are determined. Over a period of a month, the cost of a gallon of gas can fluctuate by as much as 15 cents or more, as it did between April and May of 2001. In this edition of stuff.dewsoftoverseas.com, we will take the mystery out of the gas pump by showing how gas prices are determined and exactly where your gas money goes.

Guzzling Gas in America
Americans have an insatiable thirst for gasoline, and with sport-utility vehicles (SUVs) growing in popularity we are only getting thirstier. Just look at the roads and highways and you'll see that a severe gas shortage would practically cripple the country. Americans drive more than 2.6 trillion miles per year in automobiles, light trucks and SUVs, according to a MEMA report. That's equal to 14,000 round trips to the
sun. Today, we drive almost twice as much as we did in 1980 (1.5 trillion miles), when gas prices were at their highest.

Photo courtesy Phillips Petroleum Company
A gas station in Denver, CO

Historical Gas Prices*
    1950 - $1.91 per gallon
    1955 - $1.85
    1960 - $1.79
    1965 - $1.68
    1970 - $1.59
    1975 - $1.80
    1980 - $2.59
    1985 - $1.90
    1990 - $1.51
    1995 - $1.28
    2001 - $1.66
*prices adjusted for inflation, represent year-2000 dollar
Source: U.S. DOE
The United States consumed an average of 19.5 million barrels of oil per day (bbl/d) in 2000, according to the Department of Energy. Of that, 43 percent was used for motor gasoline. The rest was used for distillate fuel oil, jet fuel, residual fuel and other oils. Each barrel of oil contains 42 gallons (159 L), which yields 19 to 20 gallons (75 L) of gasoline. So, in the United States, something like 360 million gallons (1.36 billion L) of gasoline is consumed every day. When you consider that there are about 100 million households in the United States, this averages out to about 3.6 gallons (13.6 L) per household per day.

Typically, the demand for gas spikes during the summer, when lots of people go on vacation. Holidays like Memorial Day and the Fourth of July create logjams of tourist traffic during the summer. This high demand usually translates into higher gasoline prices, although that's not always the case. For instance, while gas prices soared 31 cents in April and early May of 2001, reaching $1.71 per gallon, analysts at Bank One predict that gas prices will decline during the 2001 summer, expecting that refineries will increase capacity and oil levels won't dip.

Price increases generally occur when the world crude-oil market tightens and lowers inventories. We will discuss who controls the crude-oil market later. Also, growing demand can sometimes outpace refinery capacity. In the spring, refineries perform maintenance, which can place a pinch on the gasoline market. By the end of May, refineries are usually back to full capacity.

Where Your Money Goes
When you pump $20 dollars into your tank, that money is broken up into little pieces that get distributed among several entities. Gas is just like any other consumer product: There's a supply chain and several groups who are responsible for setting the price of the product. The media can sometimes lead you to believe that the price of gas is based solely on the price of crude oil, but there are actual many factors that determine what you pay at the pump. No matter how expensive gas becomes, all of these entities have to get their slice of the pie.

Source: U.S. Department of Energy

Let's look at where your money goes when you pay for gas:

  • Crude oil - The biggest portion of the cost of gas -- about 37 percent -- goes to the crude-oil suppliers. This is determined by the world's oil-exporting nations, particularly the Organization of Petroleum Exporting Countries (OPEC), which you will learn more about in the next section. The amount of crude oil these countries produce determines the price of a barrel of oil. Crude-oil prices rose to as high as $37 per barrel (1 barrel = 42 gallons or 159.6 L) in 2000, and were at $28.05 per barrel as of August 13, 2001 (Source: U.S. DOE).

  • Refining costs - The refining of crude oil makes up about 20 percent of the price of gasoline. To learn more about oil refining, read How Oil Refining Works.

  • Distribution and marketing - Crude oil is transported to refineries, and gasoline is shipped from the refineries to distribution points and then to gas stations. The price of transportation is passed along to the consumer. Marketing the brand of the oil company is also added into the cost of the gasoline you buy. Together, these two factors account for less than 10 percent of the price of gasoline.

  • Taxes - Taxes, including federal and local, account for about 27 percent of the total price of gas in the United States. Federal excise taxes are 18.4 cents per gallon, and state excise taxes average 19.96 cents per gallon. There may also be some additional state sales taxes, as well as local and city taxes. In Europe, gas prices are far higher than in America because taxes on gas are much higher. For example, a gallon of gas in England cost $4.71 in September 2000, with $3.40 going to taxes.

  • Station markup - In order to stay in business, service stations have to add on a few more cents to make a profit. There's no set standard for how much gas stations add on to the price. Some may add just a couple of cents, while others may add as much as a dime or more. However, some states have markup laws prohibiting stations from charging less than a certain percentage over invoice from the wholesaler. These laws are designed to protect small, individually-owned gas stations from being driven out of business by large chains who can afford to slash prices at select locations.

Gas prices also vary from state to state for several reasons. Taxes are probably the biggest factor in the different prices around the country. Additionally, competition among local gas stations can drive prices down. Distance from the oil refineries can also affect prices -- stations closer to the Gulf of Mexico, where many oil refineries are located, have lower gas prices due to lower transportation costs. There are also some regional factors that can affect prices.

Global Gas Prices*

Most expensive per gallon:
(1 gallon=3.8 L)

    Hong Kong - $5.38
    London, England - $5.05
    Oslo, Norway - $4.54
    Seoul, South Korea - $4.52
    Paris, France - $4.28

Least expensive per gallon:

    Caracas, Venezuela - $0.40
    Jakarta, Indonesia - $0.45
    Kuwait City, Kuwait - $0.76
    Manama, Bahrain - $0.82
    Abu Dhabi, UAE - $0.92
*prices as of September 2000
Source: Runzheimer International
 Regional Differences
In some regions of the country, gasoline is required to meet higher environmental standards in order to reduce the amount of smog created by burning gasoline. Producing this cleaner-burning gasoline can cause problems in refining, distribution and storage, which increases the cost of gas. "The result of this targeted approach to air quality has been to create gasoline market islands," John Cook, director of the petroleum division of the DOE's Energy Information Administration, said before the U.S. House of Representatives Committee on Energy and Commerce on May 15, 2001.

Cook pointed at California and the Chicago and Milwaukee areas as primary examples of gasoline-market islands. The clean-burning requirements in each of these areas are unique to that individual area, and only a few refineries can produce the specialized products. High demand, a supply problem at a refinery or a problem with a pipeline can cause pricing in these areas to surge.

In California, the state government has set its own reformulated gasoline rules that are stricter than the federally mandated clean-gas laws. This is why Californians pay a higher price for cleaner fuels -- this, plus a local sales-and-use tax of 7.25 percent, an 18.4-cent-per-gallon federal excise tax and an 18-cent-per-gallon state excise tax. California's distance from the refineries located near the Gulf of Mexico can also add to the cost of gasoline if it chooses to obtain gas supplies from those refineries.

The other area where prices can far exceed the U.S. national average is the Midwest. In 1999, the Midwest region became subject to new reformulated gasoline rules. The Midwest uses a special gasoline that is produced using ethanol instead of methyl tertiary butyl ether (MTBE). Ethanol is used in the Midwest because of the region's abundance of corn, which is the main raw material used to make ethanol. Few refineries outside the region produce this type of reformulated gasoline, which means there may often be a limited supply of the product.

Control of the Oil Market
Crude oil inventories have the single biggest effect on gas prices, and the United States depends heavily on foreign oil supplies. In January 2001, the United States imported 273 million barrels of oil. The single largest entity impacting the world's oil supplies is the Organization of Petroleum Exporting Countries (OPEC), a consortium of 11 countries: Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

Photo courtesy Phillips Petroleum Company
Most of the American crude-oil supply is imported using tankers similar to this one.

Together, these 11 nations account for 40 percent of the world's oil production and 77 percent of the world's oil reserves, according to the Energy Information Administration (EIA). When OPEC wants to raise the price of crude oil, it simply reduces production. This causes gasoline prices to jump because of the short supply, but also because of the possibility of future reductions. When oil production dips, gas companies get nervous. The mere threat of oil reductions can raise gas prices.

In April 2001, OPEC decided to reduce their collective production by one million barrels per day. This was at the same time that American consumers saw gas prices rise -- and continue to rise through May 14, peaking at an overall average of $1.71 per gallon. (Average prices are figured by factoring in prices of different octanes and prices from different areas of the country.)

Beyond OPEC, there are several other countries that contribute to the world's crude-oil supplies, including the United States, Mexico, Canada, Angola, Equatorial Guinea, Russia and China. EIA expects that the oil production from these nations will rise by 1.4 million barrels per day over the next two years. OPEC tracks the oil production of these nations and then adjusts its own production to maintain its desired barrel price.

Domestic Supplies
After seeing how much oil the United States imports, it may be surprising to know that the United States is the world's second largest producer of oil. In January 2001 alone, the United States produced an estimated 181 million barrels of crude oil. The biggest production region is around the Gulf of Mexico, and the largest producing state is Texas. The Gulf Coast region is home to two important producing areas: the Permian Basin, located in west-central Texas and eastern New Mexico, and the federal offshore portion of the Gulf. Other big oil-producing states include Alaska, Louisiana, California, Oklahoma and Arizona.

Even with the United States producing so much oil, it is still heavily dependent on foreign sources. It's that dependence that crippled the country during the oil embargo of 1973 and 1974. To make sure that this situation never happens again, the federal government formed the Strategic Petroleum Reserve (SPR). While most domestic oil is sent directly to refineries and then to the consumer market, some of it is held back and sent to the SPR.

 Strategic Petroleum Reserve
When foreign oil production decreases, you often hear the media talk about the U.S. Strategic Petroleum Reserve (SPR). It currently stores about 570 million barrels of oil in underground salt caverns along the Gulf of Mexico. Given that the United States imports about half of its oil, the Strategic Petroleum Reserve holds about a 60-day supply of oil if all imports were suddenly and totally cut off.
This page has more information about how the storage sites work.

Photo courtesy U.S. Department of Energy
An aerial view of the Bryan Mound storage site of the Strategic Petroleum Reserve

On September 22, 2000, President Clinton directed the U.S. Department of Energy to tap into the SPR to bolster oil supplies. When oil supplies shrink, the SPR can be used to help make sure that people have enough affordable oil to heat their homes. President Clinton authorized the Department of Energy to release up to 30 million barrels of oil in a swap with oil companies. The companies took the oil in fall 2000 and will have to return it by fall 2001.

The SPR is the largest emergency petroleum supply in the world. It was first used during the Persian Gulf War in 1991 to keep oil plentiful and prices stable. The SPR costs about $21 million per year to operate and employs about 1,150 people.

 Arctic National Wildlife Refuge
The federal government is also considering new places to drill for oil, including the Arctic National Wildlife Refuge (ANWR) in Alaska. By tapping into this oil-rich region, the federal government believes that it can lower American dependence on foreign oil. In 2001, a bill (S. 389) was proposed in the U.S. Senate to open a portion of the ANWR for oil development.

The Arctic National Wildlife Range was established in 1960 to protect the “unique wildlife, wilderness and recreational values” of the area. In 1980, Congress passed the Alaska Lands Act, which renamed the area and more than doubled its size. Today, the ANWR encompasses nearly 20 million acres, which is about the the size of South Carolina. The same act authorized the study of the oil and gas potential of the northern part of the Refuge, called the 1002 Area. This region is still being looked at as a possible oil-development site, but environmental groups say that any oil production would upset the natural ecosystem within the ANWR.

It's still uncertain just how much oil exists under the ground of the ANWR. A 1998 analysis conducted by the United States Geological Survey (USGS) estimates that there are about 7 billion barrels of profitable oil in the 1002 Area alone, but the price of crude-oil determines how profitable that oil is. If the price of crude oil dips below $16, the cost of producing the oil would offset any profit. Prices were at $28.05 per barrel as of August 13, 2001. Look for future editions of stuff.dewsoftoverseas.com to provide more in-depth coverage of the ANWR.

The issue of gasoline prices is often a volatile one. As long as cars and other vehicles run on gasoline, the price of gas will continue to affect every part of our economy. Many scientists are looking at new technologies, such as fuel cells, to reduce our dependence on oil and gas.

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