Why Are Gas Prices Going Up If Oil Prices Are Coming Down?
The price of crude oil is down over 9 percent so far this year, but gas prices are up over 15 percent. What gives? Shouldn’t the price of gas at the pump decline if crude oil is declining? This seems like a logical question, but short of conspiracy theories, there is a reason behind the price disparity. The price of crude oil, oil that is “raw” or unrefined, is only 64 percent of the cost of gas; the price of gas at the pump has less to do with the price of oil and more to do with what happens to the crude oil before it is converted into gasoline.
Refineries process crude oil not only into gasoline, but also into jet and diesel fuels, heating oil, and many forms of lubricants. Because oil is processed into gasoline, the price of crude oil quoted in the daily news is not the price of gasoline, but rather the price of that “raw” or unrefined oil before it is processed. The refining process adds cost to the price of gasoline from the base price of crude oil. Additionally, some states, like California, impose tighter restrictions on how gasoline is refined which also increase costs.
Price at The Pump:
Due to maintenance requirements, refineries must shut down temporarily or reduce capacity. Despite strategically located refineries (concentrations on the west and east coasts, and the gulf coast regions,) excess supply at one refinery is not easily transported to another refinery. As a result, the supply of gasoline declines. If such maintenances coincide with demand surges, the net result is higher gas prices. In addition, there are fewer and fewer refineries as in the past, which also impacts prices. According to the US Energy Information Administration (eia.gov), there are 144 operating refineries in the US as of January 2012, down from over 300 in 1982. Unforeseen events such as fires, hurricanes, and other disasters at or near refineries can also disrupt supply, causing prices to rise. For example, both the recent fire at a Chevron refinery in Richmond, CA and Hurricane Katrina in 2005 caused gas prices to spike because capacity declined while demand remained constant.
Commodity traders also impact the price of gas by trading derivatives. Such traders are not just speculators as many suspect. Many derivative traders are industries that use crude oil based products and are attempting to protect themselves from price swings. For example, refineries, airlines, major industrial companies, and even countries trade futures contracts (type of derivative) to lock in future prices. An airline would buy a futures contact to set their jet fuel cost for a given period of time to manage their expenses. As with any investment, sometimes momentum or media hype leads to increased speculation which can cause crude oil prices to rise or fall and ultimately impact gas prices.
While actions by OPEC, sanctions on Iran, and other geopolitical risks can cause crude oil prices to fluctuate; the price of crude oil is not the only determining factor for what you pay for gas at the pump. As mentioned above, crude oil makes up only 64 percent of the price of retail gasoline. The other components include: refining (18%), taxes (11%), and distribution (7%), according to the US Energy Information Administration.
Ara Oghoorian, CFA, CFP® is the president and founder of ACap Asset Management, Inc., a “Fee-Only” investment management firm located in Los Angeles, CA specializing in helping doctors and physicians make sound financial decisions. Contact Ara at firstname.lastname@example.org or on the web at www.acapam.com for a complimentary consultation.