From Washington to Wall Street, a lot of institutions get blamed for high gas prices. We explore what actually drives the price at the pump.
You may have heard that gas prices were up in 2021. You may have also heard that President Biden or, conversely, fossil fuel profiteers are to blame. Unlike the price of milk or other commodities, many of which are also up due to inflation, the price of gas is thought of as a bellwether for the current economic moment. It’s a price nearly everyone has to pay, and it’s posted prominently on street corners. So, there’s a lot of attention paid to the price of gas. Unfortunately, there’s also considerable confusion about why the gas at your local filling station costs what it does.
The national average cost of a gallon of gas peaked this past November at $3.41 (they have since dipped slightly to $3.30 as of this printing). That’s up 60% from Nov. of 2020. The economic upheaval of the pandemic has played a significant role in this price spike as demand cratered in 2020, leading oil companies to cut production. As economic activity rebounded in 2021, demand soared beyond even pre-pandemic levels, while production and supply haven’t caught back up. This classic disparity between supply and demand is driving gas prices up.
The Energy Information Administration divides the cost of gasoline thusly: the cost of crude oil, refining costs and profits, distribution and marketing, and federal and state taxes. Below, we’ll break down each of these and explain what’s influencing them in our current moment.
First, the cost of crude oil. Unrefined petroleum, or crude oil, is traded on world markets and its price follows the basic economics of supply and demand. Major producers include OPEC (Organization of Petroleum Exporting Countries), Russia, and the United States. Currently, the price of crude oil is hovering just below $80 a barrel. That’s up 50 percent year-over-year and at its highest since 2018. Crude oil makes up roughly half the price of a gallon of gas.
An important piece of context: in recent years OPEC nations and Russia have maintained more limited production at the same time that the US ramped up its own production, largely in an effort to protect their profits. Today, even as demand rises, OPEC states and Russia have only made modest increases in production, and only after pressure from other countries including the US and the European Union. The US has also tapped strategic oil reserves in recent months to help ease gas prices.
Refining crude oil into gasoline (and other petroleum products) and the profits of oil producers and sellers makes up another 15-25 percent of the cost of a gallon of gas. Hurricanes and the Texas cold snap put many gulf coast refineries off-line for weeks or months in 2021. These closures were felt most acutely in the Rocky Mountains and the West Coast.
A big reason why supply isn’t keeping up with demand relates back to the profits of the large, publicly traded, multi-national fossil fuel companies and a widespread change in outlook. Despite record profits for the industry, less of that money is being funneled back into new drilling and is instead going to shareholders and stock buybacks. For many companies, investing in new wells just isn’t smart. Ventures like those in the North Dakota oil fields can go from boom to bust while both independents and conglomerates alike are operating at a loss in order to scale production. Coupled with pandemic related uncertainty and a Biden Administration’s energy policy that seeks to shift away from fossil fuels, all this has shareholders and boards erring on the side of caution and reaping record profits in the meantime.
There’s always a gap between wholesale prices and retail prices of any commodity, it’s where retailers make their money. Markets typically favor sellers who price their goods competitively. But the current gap between wholesale and retail is seeing a greater lag than usual in response to market fluctuations. The Biden Administration has complained about this kind of profiteering, but market volatility is encouraging sellers to maximize their profits when and where they can.
Taxes account for between 16-22 percent of the price of a gallon of gas. Federal taxes are set at 18.4 cents per gallon. Additional state taxes vary, with states like Alaska on the low end at 14.6 cents and California at the high end at 66.9 cents. Some states add sales or “use” taxes like those in Indiana (7%), Michigan (6%), and county level taxes in Hawaii.
Marketing and distribution make up the final 10-14 percent of the cost of a gallon of gas. Distribution costs has also risen with the snagging of supply chains, most particularly the national shortage of truck drivers.
The Biden Administration has come in for criticism of its cancellation of the Keystone XL pipeline, which had been planned to pump Canadian tar sands oil from Alberta to refineries in the southern US. Though a big win for environmentalists, others point to the Keystone cancellation as contributing to our current gas crunch. Experts argue that the additional refining costs of tar sands oil would likely be priced into any additional supply and therefore have little to no effect on the price at the pump.
At the end of the day, the price of a gallon of gas is subject to many different forces, from the pandemic and extreme weather events to global economic trends and current US energy policy. Though they are dipping slightly, experts warn that high gas prices are likely to persist through much of 2022.