How Crude Oil Prices Affect Gas Prices
Oil prices have created huge swings in pricing at the pump
Crude oil prices have determined at least half of the price of each gallon of gas over the last decade. As 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.
In December 2020, the average price of a gallon of regular gasoline was $2.21. Around 49% of that was the price of crude oil. Another 19% was distribution and marketing, 22% was federal and state taxes, and 10% 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: In April, the combination of an oil price war and a worldwide pandemic helped to send the price of oil below zero, to nearly -$37 per barrel (/b). However, this unprecedented occurrence is more appropriately attributed to a technical imbalance in the futures market. Speculative investors, who were long on oil, but had no intention of taking delivery, fueled a massive sell-off of expiring contracts. Oil prices subsequently moved into positive territory, but the price of gas remained below $2/gallon until June, when oil prices rebounded to $40/b, sending gas to $2.17/gallon.
- 2015: Prices fell below $37/b 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 around $113/b in April. By the next month, gas prices had reached $3.96/gallon. Oil prices remained higher than $90/b 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, an important oil transport channel. Gasoline prices, likewise, remained steadily higher than $3/gallon until late 2014.
- 2008: Oil skyrocketed to around $145/b in July. That sent gas prices to $4.11/gallon. By early December, oil had dropped to around $49/b, and gasoline had dropped to $1.87/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 as 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 producing 40% of the world's crude oil. 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 Dec. 18, 2020, the U.S. stores 638.1 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. 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 14% of the world's oil production, China is the next biggest user, followed by India, at about 5%, Russia and Japan, each at 4%.
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 housing in 2005. When the housing bubble burst in 2006, it led to the 2008 financial crisis.