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Saturday, September 7, 2013

What makes gas prices change?

By David Cormier

Gas pump prices are affected by supply and demand
Crude oil and refining  accounts for the majority of gas cost
Why is it that when you go for gas on Monday it costs $2.96 and when you go back to the gas station 8 hours later it costs $3.08?

The prices of gasoline are normally affected by the price of crude oil and the level of gasoline supply relative to the demand for it.  Because of the increasing demand for gas and petroleum based products such as plastics throughout the world, there is increasing pressure on the suppliers to meet this demand.

Even when the prices of crude oil by the barrel are stable, the price of gas at the pump will fluctuate based on seasonal demand and local retail stations’ competition with each other unless the gasoline prices are regulated by the government.  Several factors play a role in the price of gasoline at the pump, which we will discuss below.

Seasonal demand

During different times of the year, the prices at the pump will tend to fluctuate in a more or less similar pattern.  In the spring and summer, when people drive more because the weather allows more outdoor excursions, the prices tend to rise.  Typically, the demand for gasoline is about 5% higher in the warmer months of the year.  Because of the weather, there are also some environmental regulations which will vary from state to state; however, the bottom line is that the gas sold in the summer months needs to be less prone to evaporation.  The gas will need to be refined with a different process to ensure the quality.

In the winter months, the likelihood of evaporation due to warmth is very low so refiners do not need the same refining process, meaning it costs less to produce.  In the winter, the fuel prices tend to fall slightly since people restrict the use of their cars to leave home only when necessary, whereas in the summer, everyone goes for trips.  Since the demand is less, the cost goes down.

OPEC supply

OPEC, the Organization of the Petroleum Exporting Countries, has one of the strongest influences on the price of oil worldwide.  It is a group of 13 countries which include Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.  The OPEC nations produce over 40% of the crude oil on the market and have oil reserves which collectively amount to over 66% of the worldwide total.  They can jointly raise the cost of crude oil worldwide at any time by simply reducing their production.  This means the demand will be higher than the supply coming onto the market.  These nations are also among the few countries which produce oil that have “spare output,” meaning that they can stockpile oil even after meeting the daily demand which gives them an advantage when it comes to controlling the oil prices.

Worldwide demand

As we discussed earlier, the main factor which determines the cost of fuel is supply and demand.  Recently, the demand for oil has been increasing steadily, especially in developing countries such as India where the population, trade, and economies have been growing.  While the demand for oil increases daily worldwide, the production typically stays at a constant level which means that people want more oil than is being produced, which will drive prices up.

Service stations and tax

The last significant factors to consider when evaluating the price of fuel are the taxes placed on the gas and businesses selling the fuel, and the profit that the service stations will need to tack on to the price per gallon.  Most taxes are government regulated and stay at a constant level, so the service stations have a standard price for the fuel (i.e. $3.14 per gallon).  Service stations cannot sell the fuel to the public at the price they paid for it, therefore they normally add a few cents per gallon (i.e. – actual sale price $3.17) to ensure profits.  However, most states will have a limit on the amount that any individual service station can charge so that the price remains within a certain limit.

About the author: David Cormier is a blogger for Sokolis Group, America's leading fuel management compay.

* Image license: US-PDGov