If you have been to the pump lately, you may be asking yourself, what is going on with these gas prices? In California, consumers are paying almost $4 a gallon for gas. While this may seem low to Europeans, this is the highest we have ever paid!
So, why do gas prices rise?
Over the long term (more than 6 months), the greatest single influencer of gas prices at the pump is the cost of crude oil. However, in the short term, marketplace forces such as supply and demand, competition, and fear can all play a part.
The Cost of Crude Oil
Crude oil prices have continued to rise over the last year due to strong demand by recovering developed economies such as the United States and China, limited spare production capacity in oil producing countries (or unwillingness to add more), and political instability, such as what we are seeing in Libya.
It is important to note, however, that crude oil accounts for only about 50% of the cost of a gallon of gasoline. To turn crude into gas, it passes various refiners and distributors that all add on to the price.
Increasing Demand for Oil and Gasoline
The surging demand for oil is being fueled by recovering economic growth in both the United States and China. According to the US Energy Administration, spare oil production capacity is only about 1% of current demand, leaving very little room to compensate for supply interruptions or spikes in demand.
Global economic expansion is driving a huge increase in demand for oil and gasoline. China, for example, is now the largest market in the world for new cars. This wasn’t the case five years ago. As a result, there is a surge in demand for gasoline, and the oil that is needed to create it.
Most of the world’s oil is located in some very dangerous and politically unstable regions of the world. This makes investment in developing the oil reserves nearly impossible. It also means that supply disruptions, whether real or perceived, can have a huge effect on the cost of oil. This is happening right now with the crisis in Libya.
Other Factors that Influence Gas Prices
Since crude oil must be refined into gasoline, it is important to look at the refiners when judging the price. Right now, there is a shortage of refineries to refine the crude oil, and as a result, the price spread between crude oil and the refined product can be great. Why is there a short supply of refineries? In the United States, it is due to the increased regulatory environment surrounding the refineries, due to several mishaps over the last decade. As a result, several large refineries in the US have either shut down or limited their output. Also, there are no plans to build new refineries.
Taxes also make up a significant component of the price of a gallon of gas. As of January 2011, the average tax on a gallon of gasoline in the United States was 48.1 cents per gallon for unleaded and 53.1 cents for diesel. This is a federal tax of 18.4 cents per gallon for regular gasoline, and 24.4 cents per gallon for diesel. Then the average state tax was 27.2 cents. The, in some localities, there is even a local tax!
If it makes you, as an American consumer feel any better, some countries, such as New Zealand, pay a 50% tax per gallon of gasoline!
Competition is also another short-term driving force in the price of gasoline. This is reflected by the number of gas stations in a given area. Everyone has seen the difference in price from a lone gas station away from town and the busy corner that has multiple gas stations competing for your business.
So What Does This Mean For Investors?
As an investor, I would stay away from companies that just explore for crude, or refiners. I like the fully integrated oil companies such as Exxon Mobil, Chevron, Shell, etc. These companies are able to capitalize on each individual part of the marketplace. As a result, these companies have been able to sustain large profits, and pay shareholders a nice dividend. Check out How To Invest in Oil to look at other plays for investors in this space.
For the very long term (20+ years), it is important to remember that oil is a limited natural resource. Today, most of the cheap and easy to extract oil has already been found and extracted. Therefore, over time, oil prices really have no place to go but upward. This is beneficial to investors of these integrated oil companies, who will reap the rewards of this price movement.
Readers, what tips and tricks do you have to save money on gas since gas prices keep rising?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.