Petroleum Prices…. Perplexed?
With summer right around the corner and prices at the pump gearing up for their seasonal increase, the fluctuation in fuel costs often leaves people puzzled. Why is gas more expensive during the summer? What determines the price of oil? Shouldn’t gas prices and the price of oil be correlated? Surprisingly, there are quite a few factors that contribute to the confusion from environmental regulations requiring different fuel mixes at different times of the year, to the basic availability and supply of raw materials.
We are all aware that gas prices rise and fall seasonally. Usually they begin to rise around Memorial Day as more Americans begin to hit the road in their vehicles increasing demand for fuel, but contrary to popular belief, this incremental increase in demand does not account for the majority of the usual summer price increase. The majority of the summer price hike is a result of what is referred to as the seasonal gasoline transition.
As a part of the Clean Air Act, the Environmental Protection Agency (EPA) began the Reformulated Gasoline Program (RFG) in 1995. During the summer months, refineries are required to produce a summer blend of reformulated gasoline which reduces emissions of toxic air pollutants, such as benzene, as well as pollutants that contribute to smog1. Not surprisingly, this gasoline is more costly to refine, and more costly to purchase when it arrives at your local gas pump. Although it is more expensive, the EPA estimates that about 75 million people breathe cleaner air because of RFG2.
The change to reformulated gasoline during the summer does not explain all volatility in the price of fuel. There are quite a few variables in the equation of pump prices regardless of season; crude oil, taxes, refining costs and profits, and distribution and marketing costs. Because none of these costs are static, the price of fuel is constantly adjusting based on these underlying components.
By far the biggest variable in the price of fuel is its primary ingredient, crude oil. Oil is responsible for approximately 70% of the price of gas when it arrives at the pump3. The price of oil fluctuates based on supply and demand but this doesn’t translate directly to changes in pump prices. Most often there is a delay in correlation, or seems to be no correlation, between the rise and fall of oil prices and the prices we see at the gas station.
The main reason for this disconnect is explained by the fact that we are dealing with two different commodities. Even though one is produced from the other, the current supply of refined gasoline and the current supply of crude oil are never the same. Sometimes we may have a surplus of gasoline and a shortage of oil, or a surplus in oil and a shortage of gasoline. This is the main reason why although gasoline is produced from oil, prices of the two commodities seem to lack correlation with one another over the short term.
In 2013 the United States consumed about 134 Billion Gallons of gasoline4, a number which has actually been declining from its peak over the past couple of years. In spite of this, and although we are constantly finding new oil reserves, I don’t expect the price of gas to retreat back to the lower levels we all recall anytime soon. On a positive note, with the development of alternative energy sources and more energy efficient modes of transportation, the reduction of our dependence on this finite resource, and thus its cost, is looking more like a reality with every new innovation.
1, 2 Environmental Protection Agency: http://earth1.epa.gov/otaq/fuels/gasolinefuels/rfg/index.htm
3 Environmental Protection Agency: http://www.epa.gov/airquality/peg_caa/carstrucks.html
4 US Energy Information Administration: http://www.eia.gov/dnav/pet/hist/LeafHandler.ashxn=pet&s=mgfupus1&f=a