How Crude Oil Prices Affect Gas Prices
Oil prices have created huge swings in pricing at the pump.
Crude oil prices determine at least half of the price of each gallon of gas. Since oil prices change daily, gas prices are constantly fluctuating too.
The rest of the price of gas is based on refinery and distribution costs, corporate profits, and state and federal taxes. While those secondary factors remain relatively stable,
In July 2020, the average price of a gallon of gasoline was $2.18. Around 44% of that was the price of crude oil. Another 22% was state and federal taxes, while 22% was distribution and marketing. The remaining 11% was refining costs and profits.
Examples of How Oil Prices Affected Gas Prices
Oil and gas prices have been especially volatile since the 2008 financial crisis. The following chart illustrates their relationship, including major peaks and valleys over time.
West Texas Intermediate is a crude oil used as a benchmark in U.S. oil pricing. Based on this benchmark, crude oil prices have risen and fallen dramatically multiple times since the 2008 financial crisis.
- 2020: The combination of an oil price war and a worldwide pandemic helped drop the price of oil below zero, to -$36.98/barrel in April. This kept gasoline prices well below $2/gallon. By July, prices rebounded and eclipsed $40/barrel and gas rose to $2.18/gallon.
- 2015: Prices fell below $37/barrel by the end of the year, driving gas prices below $2/gallon in early 2016. Gasoline prices remained between $2 and $3 per gallon for most of the next five years.
- 2011: The price of oil reached $113.39/barrel in April. By the next month, gas prices had reached 3.96/gallon. Oil prices remained higher than $90/barrel for the bulk of the next three years, dropping below that mark only briefly a few times in the aftermath of Iran threatening to close the Strait of Hormuz. Gasoline prices, likewise, remained steadily higher than $3/gallon until late 2014.
- 2008: Oil skyrocketed to $145.31/barrel in July. That sent gas prices to $4.11/gallon. By December, oil had dropped to $31.10/barrel, and gasoline had dropped to $1.74/gallon.
Like most of the things you buy, supply and demand affect oil prices. More demand, like the summer driving season, creates higher prices. There is less demand in the winter since only some northern states use heating oil.
Oil price futures, traded on the commodities exchange, also affect oil prices. These prices fluctuate daily, depending on what investors think the price of oil will be going forward. Commodities traders are a big factor in determining oil prices.
OPEC is an organization of 14 oil-producing countries that will produce and estimated 32% of the world's oil by the end of 2020. In 1960, these countries formed an alliance to regulate the supply and the price of oil. They realized they had a nonrenewable resource. If they competed with each other, the price of oil would be so low that they would run out sooner than if oil prices were higher.
As of June 30, 2020, the U.S. stores 655 million barrels of oil in the Strategic Petroleum Reserves. The federal government uses it to increase supply when necessary, such as what they did after Hurricane Katrina. The government also uses this reserve to ward off the possibility of political threats from oil-producing nations.
The 1973 OPEC oil embargo was the first time OPEC flexed its muscles. It cut off oil to the United States, limiting supply. Prices rose and shifted power away from U.S. oil producers. OPEC's goal was to keep the price of oil at around $70/barrel. A higher price would have given other countries the incentive to drill new fields, which are too expensive to open when prices are low.
The United States also imports oil from a non-OPEC member, Mexico. This makes America less dependent on OPEC oil.
What Affects Demand
The United States uses about 20% of the world's oil. Much of this is for transportation. The country built a vast network of federal highways leading to suburbs in the 1950s.
Utilizing about 15% of the world's oil production, the European Union is the next biggest user, followed by China, at about 13%.
What Else Affects Oil Price Futures
Oil futures, or futures contracts, are agreements to buy or sell oil at a specific date in the future at a specific price. Traders in oil futures bid on the price of oil based on what they think the future price will be. They look at projected supply and demand to determine the price.
If traders think demand will increase because the global economy is growing, they will drive up the price of oil. This can create high oil prices even when there is plenty of supply on hand.
It's called an asset bubble. This happened to gold prices during the summer of 2011. It happened in the stock market in 2007 and in housing in 2006. When the housing bubble burst, it led to the 2008 financial crisis.
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