Who Sets Gas Prices and Reaps the Profits?

Americans today are driving twice as many miles as in 1980, and in many cases they're using heavier vehicles as well - SUVs, heavy trucks, and family vans. We consume 20 million barrels of oil a day, of which 45% is converted into gasoline. 178 million gallons of gasoline are used up each day.

So who determines how much those gallons of gas cost? Why are some places fifty cents a gallon higher than other places? And how can we predict what gas will cost us in a month?

Taxes, Taxes, Taxes

It might surprise you to find out that an enormous proportion of your gas price comes from what your federal, state, and even local governments have decided is your fair share of the cost of driving. 13% of every gallon goes to the government, more than half that on average to your state government. Subtract that much from what you pay for your gas, and you'll see what you'd really pay for gas if the government kept its hands out of your pockets.

If you'll flip ahead to profits, you can see that taxes actually are a larger proportion of your gas prices than oil company profits.

The variation in state tax rates is the primary reason for different pricing in different regions of the country.

Processing and Refinery Costs

This is one area where you can fault the oil companies severely. Costs always go up when the supply is short, and we do not have enough refineries in America today. Worse, those that we do have are thirty years old or more, and are in dire need of upgrading. Had the oil companies worked toward this five or six years ago, we might today be seeing lower prices due to more efficient refinery processes and a less-limited number of refineries.

28% of your gas costs come from the refining process, where crude oil is converted into gasoline, diesel fuel, and other petroleum products from kerosene to motor oil. Short of building new refineries or upgrading our already-overburdened ones, this cost cannot be cut.

The really bad news: this proportion has gone way, way up in the last three years. Just in 2004, when gas was relatively cheap, this proportion was only 19%. Something is going on to make our refinery costs rise so quickly, and probably this is what we need to address soonest.

Transportation and Marketing Costs

It takes diesel fuel and manpower to ship your gasoline from the refinery to the reservoirs, and from the reservoirs to the gas stations. Truckers who ship your fuel are among the best-paid in the industry, simply because they must be among the best; an accident with any semi truck is bad, but one involving a fuel tanker can be disastrous. You can figure in at least 5% of your fuel costs to be transportation and marketing.

If transportation and marketing costs more than that 5%, it comes straight out of the oil companies' profits.

Oil Company Profits

Two different groups profit, in the end, on your gallon of gas: the oil companies and the end distributor. Oil companies make no more than 8% profit on your gas, out of which all their transportation and marketing expenses must be paid, and the gas station typically makes just pennies.

This may sound like a lot of money, until you think about it. When you invest a large amount of money in a stock, you certainly expect better than an 8% return on it. Even simple CDs at banks return between 5 and 6%, only 2% below the oil company's profit.

In addition, oil companies have many other expenses they must pay: standard business expenses like office rent and employee salaries, advertising, and yes, the inevitable big-business government lobbying.

The most profitable oil companies are the Supermajors, those that own the whole process, from oil fields to refinery to distributors; they can get a piece of profit from every stage. Less profitable oil companies only own distributors, or may only purchase oil by the barrel to send to refineries. There are a dozen ways to slice the pie.

But here's what you may not know: the largest oil companies are owned primarily or wholly by foreign interests: Citgo is owned wholly by Venezuela, BP by a British company, Shell by a Dutch conglomerate. The only major oil companies owned wholly or primarily by American companies are Exxon, Chevron, and Conoco. Moreover, of the ten largest oil suppliers, all but two are owned by foreign governments or companies: Mexico, Saudia Arabia, Venezuela. The two that are owned by American oil companies occupy only a sliver of the oil pie. Most American companies focus on energy as a whole, not just oil.

Additionally, American oil companies only get part of their oil from American oil fields; if foreign supplies are made more expensive by foreign oil field owners (like OPEC), their costs go up. With only an 8% profit margin, they must in turn pass those expenses on to American consumers. If you want to blame someone for higher gas prices, you probably should blame Saudi Arabia and Venezuela -- not that they'd care.

Realistically, a wide variety of pressures are forcing our pump prices up: a shortage of refineries, decrease of oil production in the Middle East due to the wars, lack of adequate American supplies, and problems with countries like Venezuela and Mexico. The most significant reason for the higher prices is the enormously increased demand from developing Asia, where car ownership has skyrocketed and power needs are increasing every day. It's a basic rule of economics: if demand goes up on a limited supply of anything, the price will also go up.

In the end, the environmental and political issues surrounding oil all point in the same direction our economic issues point - we need cheaper alternatives, and we need them now. It would be vastly more productive to all the issues at hand if environmentalists and oil companies quit arguing about whose reason is better, and instead started focusing on solving the problem shared by all of us: getting energy more cheaply, effectively, and cleanly. Which is exactly what American energy companies are doing today.