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How Crude Oil Prices Affect Gas Prices


Mans's hand holding fuel nozzle in car

Most of the changes in gas prices are due to oil prices.

Photo: Dimitri Otis/Getty Images

Crude oil prices make up 71% of the price of gasoline. The rest of what you pay at the pump depends on refinery and distribution costs, corporate profits, and Federal taxes. Usually, these costs remain stable, so that the daily change in the price of gasoline accurately reflects oil price fluctuations. (Source: EIA, FAQ, December 6, 2013)

It usually takes about six weeks for oil price changes to work their way through the distribution system to the gas pump. Oil prices are a little more volatile than gas prices. This means oil prices might rise higher, and fall farther, than gas prices.

Historical Oil and Gas Prices:

Oil and gas prices have been especially volatile since the 2008 financial crash. Here's a look at their peaks and valleys, and what caused the price swings.

  • 2014 - Prices remained around $100/barrel. That's because the U.S. has plenty of shale oil.
  • 2013 - Oil rose swiftly to $118.90/barrel on February 8, sending gas prices to $3.85 by February 25. Prices had started rising earlier than normal thanks to Iran's threatening war games near the Straits of Hormuz.
  • 2012 - Again, Iran threatened to close the Straits, sending oil prices to their peak of $128.14/barrel on March 13. Gas peaked on April 9 at $3.997/gallon. Both returned to normal until August, when commodities traders began bidding up oil prices to $117.48 on September 14. They were hedging against the Federal Reserve's QE3 program, which they thought would lower the value of the dollar. This would force oil (which is priced in dollars) higher. Then, Hurricane Isaac closed refineries, sending gas prices to $3.939 by September 17. Gas prices rose to $4.50 a gallon in California thanks to local distribution shortages.
  • 2011 - The price of oil didn't reach its spring peak of $126.64/barrel until May 2. Unusually, gas prices peaked at the same time, hitting $4.01/gallon. Gas prices stayed above $3.50/gallon all summer due to fears about refinery closures from the Mississippi River floods.
  • 2010 - Oil prices stayed within the range of $70-$80/barrel until December 3, when they breached $90/barrel. Gas prices followed suit, staying below $3.00/gallon until December 6.
  • 2009 - This time, gas prices fell first, dropping to $1.67/gallon on December 29. Oil fell to $39.41/barrel on February 18 as investors bolted from any investment except ultra-safe U.S. Treasuries.
  • 2008 - Oil skyrocketed to its all-time high of $143.68/barrel on July 8, sending gas prices to $4.165 /gallon. For more, see Gas Prices in 2008. (Source: EIA, Historical Brent Crude Oil Prices, Historical U.S. Gas Prices)

What Causes High Oil Prices?:

Like most of the things you buy, oil prices are affected by supply and demand. More demand, like the summer driving season, drives higher prices. There is usually less demand in the winter, since only the Northeast U.S. uses heating oil. However, oil prices are also affected by oil price futures, which are traded on the commodities exchange. These prices fluctuate daily, depending on what investors think the price of oil will be going forward.

What Affects Oil Supply?:

OPEC is an organization of 12 oil-producing countries that produce 46% of the world's oil. In 1960, they formed an alliance to regulate the supply, and to some extent, the price of oil. These countries realized they had a non-renewable 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.

OPEC's goal is to keep the price of oil at around $70 per barrel. A higher prices gives other countries the incentive to drill new fields which are too expensive to open when prices are low.

The U.S. stores 700 million barrels of oil in the Strategic Petroleum Reserves. This can be used to increase supply when necessary, such as after Hurricane Katrina. It is also used to ward off the possibility of political threats from oil-producing nations.

The U.S. also imports oil from non-OPEC member Mexico. This makes it less dependent on OPEC oil. NAFTA is a free trade agreement that keeps the price of oil from Mexico low, since it reduces trade tariffs.

What Affects Oil Demand?:

The U.S. uses 21% of the world's oil. Two-thirds of this is for transportation. This is a result of the country's vast network of Federal highways leading to suburbs built in the 1950s. This decentralization was in response to the threat of nuclear attack, which was a great concern then. As a result, the country has not developed the infrastructure for a national mass transit system.

The European Union is the next biggest user, at 15% of the world's oil production. China now uses 11%, as its use has grown rapidly. (Source: CIA World Factbook, Refined Pretroleum Consumption, 2011 estimates)

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. That's known as an asset bubble. This happened in 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. Article updated February 27, 2014

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