U.S. gas prices hit an average of $5 per gallon for the first time last week, according to AAA. Americans are having to spend more of their hard-earned money on energy. But who is really to blame?
It is probably helpful to start with a breakdown of the components of the price of gas.
The cost of crude oil is the biggest cost component of a gallon of gas and can skew the cost. In January, via the U.S. Energy Information Administration, the cost of crude was just over half the cost of gasoline, at 52%. In February it was 61%, and as of March 2022, it was 59% of the total cost of a gallon of “regular” gasoline (diesel varies slightly). Given its overall weighting to cost, changes to crude oil prices have an outsized impact on final gas prices.
The remaining major cost areas include refining, marketing and distribution, and taxes. As of March 2022, refining was about 18% of the total costs, distribution and marketing about 12%, and taxes (federal, state, and local) about 12%, depending on your location.
It is worth noting that gas stations make very little, and they don’t reap windfalls when prices go up. Most gas stations are independently operated, even those that bear a brand associated with a major oil company. It is estimated that a retailer’s markup on a gallon of gas is around 15 cents, and the profit after expenses averages around 2 cents per gallon. Because of this low take, most gas stations supplement their business with selling a variety of other things, from cigarettes to beverages.
The cost of crude
The cost of crude oil is set by factors of supply and demand. Supply/demand imbalances can lead to major swings in the price of oil, as we have seen recently. Of course, there is also a major oil cartel that decides how much to produce at given times, which factors heavily into supply.
On the demand side, the world has seen massive shifts because of decisions made around the world related to the pandemic and the changes in behaviors that brought about. As people were locked down, demand plummeted, and as people emerged from lockdowns, demand increased. When China fully emerges from another series of lockdowns, as the number-one importer of oil in the world, it will add demand to the worldwide market.
In 2021, the U.S. used almost 20 million barrels per day; worldwide, around 100 million barrels per day were used. You can see why President Biden’s PR stunts of releasing a small amount of inventory from the U.S. strategic reserves wasn’t going to have a meaningful, lasting impact on pricing.
On the supply side, in addition to the whims of OPEC+ regarding production, a variety of domestic and international factors impact oil production. The push for green energy has thwarted the progress that the U.S. was making in energy independence and increasing supply. The Biden administration canceling oil and gas leases, shutting down pipeline progress, and having substantial red tape for drilling and production all factor into the market calculations on what supply will be like today and going forward.
Additionally, the demonization of this critical industry, including the push of ESG initiatives to direct capital away from traditional energy projects, has led to substantial under-investment in the sector, which also materially impacts the supply side of the equation. It is estimated that as much as a trillion dollars in investment has been postponed or canceled over the past few years, with a large part of that related to the ESG and green energy pushes.
According to the U.S. Energy Information Administration, looking at the U.S. field production of crude oil, while the U.S. was producing almost 13 million barrels per day of crude oil before the pandemic, we are now only at 11.655 million barrels per day (as of March 2022).
Europe has largely done the same and is paying the price, quite literally, for it. The Russian invasion of Ukraine took already increasing prices and added a new supply constraint on them, to some extent. The EU is still buying, and with the higher prices Putin is on track to make more money on oil and gas exports this year than last year!
Of course, if the U.S. and Europe had been leaning into more traditional sources of energy (along with expanding their green initiatives instead of trying to substitute the latter ahead of time), the supply would be closer to parity with demand than it is today, even with the invasion.
There is also a monetary policy component to this. If the Federal Reserve had been managing interest rates appropriately and not printing trillions of dollars, we wouldn’t be seeing inflation in everything, including oil and gas, at the same levels as they are at today.
Refining
People tend to forget about some of the other costs of gasoline. Refining is the process that turns the crude oil into not only gasoline but a variety of other products and components for products. These costs depend on the time of year and geography, based on laws that require different blends for different times of year and the associated climates. Input costs of items that may also be refined with the gasoline can also impact this cost (think ethanol). The supply-constrained labor market also makes wages more expensive throughout the organizations that do the refining.
Distribution and marketing
Oil needs to get from its location to the refinery. Once the oil is processed into gasoline, it doesn’t magically appear at the gas stations, either. All of the distribution related to eventually getting gas to you is intricate and expensive. Given that energy is required to transport the oil and gas, increasing energy costs end up being a double whammy for you at the pump. Again, the labor market is also making wages in distribution more expensive. The American Petroleum Institute (“API”) says on the marketing side, “Marketing costs are incurred to support the sale of gasoline by the refineries, distributors and wholesalers and the retailer.”
Taxes
API estimates that on average, 57 cents per gallon of gasoline goes to taxes. The federal tax is constant at 18.4 cents per gallon. State and local taxes vary widely. The high is California at 68 cents, and the low is Alaska at 15 cents, with the state average around 39 cents.
At least this is better than in Europe. Accounting firm UHY says that “on average taxes comprise 59% of the cost of the price of petrol and 52% of the cost of the price of diesel.” This high taxation is meant in part to discourage the use of such fuels.
Are the oil companies and greed to blame?
Oil companies work to supply you with gasoline, as well as other petroleum byproducts, regardless of the broader economic situation.
As noted, the biggest component price in gasoline is set by the market, with a thumb on the scale from OPEC+. With several U.S. companies delivering gas products, if one company wanted to charge even more for its products, other companies could take market share by setting a better price. Obviously, the constraint of supply factors in here as well.
During the sharp reduction in demand during the pandemic, major oil companies took huge losses. The five biggest companies (aka “Big Oil”) lost a combined $76 billion. But if you needed gas, they were still there for you. Furthermore, nobody offered to pay more to help them out.
Now that demand has increased far ahead of supply, the market has driven crude prices up, which has given them more revenue and, as that works, more profit.
In a June 10 tweet, Fox Business host Charles Payne said, “In 2020 Exxon lost $22.4 billion; federal government made $25.8 billion on gas taxes,” and pointed out the federal government is likely making much more today.
While people like to look for a scapegoat, price gouging isn’t what we are seeing today.
While it is easy to focus on gas prices because you see them every day, the supply/demand imbalance in the availability vs. need for traditional energy sources shows up elsewhere. It flows (no pun intended) through the entire economy, from the cost of moving goods and components for services to their destinations to a myriad of byproducts, including those impacting the availability and cost of food.
Some may say that price controls are the answer. They are never the answer. They lead to hoarding and less supply and never have the intended outcome.
You may hear that we should nationalize the oil companies. One only needs to look to Venezuela, which used to be the fourth wealthiest country in the world before nationalizing its oil. Now its citizens have a median net worth of zero.
The reality is we need energy. We needs lots of it. We need more of it. All kinds of energy. While new, “greener” sources of energy are being developed and scaled, we should, side by side, be investing in more traditional sources of energy as well, including nuclear energy.
President Biden could change all of our fortunes today and for the future by changing his energy policy. Signal to the markets that more investment will be going to traditional energy, alongside green initiatives. Clear the red tape and reinstitute drilling, leasing, and pipelines.
While we can’t turn on a tap overnight, those kinds of policies would start to show relief at the pump today, but even more importantly, secure our future, financially and in national security.[Editor’s note: This story has been edited to indicate the correct number of barrels per day.]