How Are Gas Prices Set?

With gas prices reaching record highs, we're all somewhat sensitive to the pain that we're feeling at the gas pump. The pain of high gas prices can be compounded by paying more because we live in a certain area. I live in Pittsburgh, which usually has gas prices which are close to, if not a little below, the national average.

Prices fluctuate somewhat throughout the area, and usually I'll see a price differential of a few cents, but what I saw this week shocked me. Gas prices are usually higher in my part of the city, so I wasn't surprised to see prices as high as $3.09. But, after seeing the $3.09 gas price close to my home, I was stunned to see a $2.95 gas price only twenty minutes away on the same day, in a location that is actually closer to the city. This discrepancy put me on a mission to figure out how gas prices are really set.

So, I did what I always do when I have a question that I can't answer - I did a Google search. Typing in "how are gas prices set," I found some relatively old Senate testimony that really didn't say anything (what a surprise!). Then, I did some more searching under different terms (I won't go into detail, but it took a rambling 10-word "gas price" question) and found a United States Government Accountability Office (GAO) report from May 2005 titled "Factors That Influence the Retail Price of Gas." That seemed close enough to what I was looking for, so I dove into the 61 page report and here's what I found.

First, gas prices can vary between locations for a variety of reasons. These include closeness to supply, application of gasoline taxes at a state/local level, differences in gasoline blends (as mandated by federal or state guidelines to meet clean air requirements), and local competition. This all makes sense, and can certainly account for why Californians and New Yorkers have higher gas prices than Midwesterners. But how can there be such a big gap between gas prices in the same city?

Well, it all goes back to competition. The GAO reports that the number of gas stations has decreased by almost 17% over the past several years, from 202,000 in 1994 to 167,000 in 2003. This means that some areas have more gas stations than others, allowing for increased gas price competition. What is so ironic is that the low price gas that I saw actually was in an area with fewer gas stations - go figure!