Gas Prices 101

There is no magic to the price of gas. At $3.89 a gallon, about where prices are today (or soon will be) the components break down approximately as follows:

$2.64 – Cost of Crude Oil

$0.48 – Taxes (and up to $0.68 in some states like Hawaii)

$0.33 – Refining

$0.30 – Distribution/Marketing/Retail Cost of operation

$0.09 – Profit to Refiner (EXXON, BP, etc.)

$0.05 – Profit to gasoline retailer (BP, Shell, EXXON, S/A, Holiday, Kwik-Trip, etc.)

Obviously, the oil necessary to produce gasoline is the biggest cost item. But where does the oil come from? Most people would immediately think of large, multinational corporations like EXXON/MOBIL, BP, Shell, and others. But they would be only partially correct. The reality is that less than a third of the world’s oil comes from so-called “Big Oil” – the vast majority comes from hundreds of small, independent outfits with fewer than 100 employees.

Adding to the confusion is that the term “oil company” can mean some very different things. Most people think of EXXON, Shell, BP and others – names they see on the gas stations in their own neighborhoods. But while they do indeed “drill for oil” many of these companies are also major gasoline retailers, and are therefore huge CONSUMERS of oil.

Meanwhile, many major producers of oil are not private, for-profit companies, but are in fact government owned entities like Venezuela’s “Petroleos de Venezuela” (PDVSA) or ARAMCO of Saudi Arabia. These organizations SELL crude oil to gasoline refiners/retailers (like EXXON and BP), as well as to tire companies, plastics producers, and other manufacturers of petroleum-based products. (Note: these oil-consuming manufacturers are many of the same companies that are unjustly demonized as “speculators” for simply attempting to lock in their costs in advance of potentially rising prices. But that’s a story for another day).

Thus, contrary to popular perception, when oil prices are high, it does not benefit the refiners/retailers (like EXXON, BP, etc.) – in fact, high oil prices result in SMALLER profit margins. Why? Because oil prices are to a gasoline refiner/marketer what wheat or corn prices are to a cereal producer/marketer like General Mills.

When the cost of the “raw material” used to make ANY product goes up, retail prices may rise but margins shrink. For example, in 2007, when gasoline averaged less than $3.00 a gallon, EXXON made a net profit of 10.8%, but when gas was $4.00 a gallon in 2008, their net profits DROPPED to 10.6%. Note that this is EXXON’s profit on ALL operations – gasoline is one of the least profitable products, generating less than 9 cents a gallon.

Now, naturally, the mainstream press touted the “huge increase in oil company profits” in 2008. But what they failed to point out is that while EXXON made LESS on each gallon of gasoline they sold (around 8 cents), they sold MORE TOTAL GALLONS (due to huge increases in demand worldwide – Americans alone burn 10,000 gallons of gasoline EVERY SECOND). So of course the total profits in dollars went up, but the net profit percentage fell.

And for those who advocate “the government” controlling gasoline prices, a lesson in basic economics might be useful. Just ask yourself this question: If you were a gasoline refiner/distributor, and it cost you approximately $3.75 to refine and distribute a gallon of gas, and the U.S. government were to set the maximum pump price at, say, $2.50, how much gasoline would you produce for use in the United States?

Answer: Zero.

Because the cold harsh reality is that gasoline (just like oil) is a WORLD commodity – and no matter where it comes from, the price will be set by the world market. And NO commodity will go where the cost exceeds the price – it will go elsewhere, or cease being produced altogether.

It took decades of destructive and misguided liberal policies to get us where we are today: no new gasoline refineries in 30 years, no new nuclear generators since the 1970s, blocking the use of our huge reserves of coal, the incredibly disastrous burning of our corn for fuel (Ethanol) which not only reduces your car’s mileage, it has pushed food prices through the roof. Then there are the mountain of silly “green” initiatives to combat a mythical threat (global warming). All of these policies should be reversed.

But the bottom line is that in the short term it is simply insane for America NOT to drill everywhere we can, as fast as we can. Especially since the rest of the world is already doing exactly that – some of them right in our own back yard.

John Caile