Wednesday, June 06, 2007

Where Does Your Gas Money Go?

There has been much talk in the blogosphere lately about boycotting gas companies, as a strategy for fighting high gas prices. Others have intelligently pointed out that delaying an inevitable gas purchase by a couple of days will do nothing to reduce overall demand, and therefore will not help to reduce prices. I have previously written that in my opinion, if anything, gas prices are too low...

Regardless of your position on the issue, I thought you might be interested to know where your gas money goes after you fork it over at the pump. On the way home last night I heard an intreresting news story on NPR that provided exactly that information. Briefly, the money is split as follows:

50% is the cost of crude oil
28% is the refining cost
14% pays for taxes
8% pays for distribution and marketing

If you are worried about your local gas station owner ripping you off and making a killing, you probably won't continue to think that way after you read that story. Turns out that your local gas station makes a rasor thin margin on the gas it sells and relies heavily on the sale of other items for its main source of profit.

Price gauging, if it exists, and I don't believe that it does, can only exist in the refining portion of the value chain. The retail gas business is highly price competitive. I mean, can you think of one other business that advertises its prices in foot high letters that you can read as you are driving down the freeway at 65 miles an hour? With such easily available information price competition is virtually inevitable.

If you have concerns about the high cost of gasoline, and want to place blame for that fact, look no further than the immutable law of supply and demand. When demand exceeds available supply the price rises until supply and demand come back into balance.

Of course, populist politicians on Capitol Hill and elsewhere don't care about market economics or about the truth. It is always easier to play to the masses and start pointless investigations about price gauging. If you think about it, it is pretty surprising in a country that prides itself on its capitalist system.

7 comments:

KMC said...

I have to disagree with you. Supply and demand is clearly not working here. Though demand for gasoline is strong and prices for refined gas are at their highest level ever, not a single refinery has been built in the U.S. since 1976.

Additionally, the big five oil companies have been buying out smaller, independent refineries and actually shutting them down. Refining capacity in the U.S. has decreased steadily since the beginning of the 90s.

S. B. said...

As someone who has long been concerned about the environmental and national security implications of our current pattern of oil consumption, I have often wished for a bigger gas tax, but that is unfortunately a non-starter with both political parties. I've been saying for more than 5 years now that one of the best things that could ever happen to this country is to have crude oil go to $70/barrel and then sustain that level for 5 or 10 years. (An overnight jump to $100 due to some war or something would be totally disruptive, but a gradual and sustained rise would frankly be very good for this country.) I know...everyone thinks that is crazy. But if you study alternative energy, viability for almost every technology is predicated upon a sustained level of oil above $50. Well...I've got my wish now, and sure enough, there is almost a "dot.com" level of frenzy from VC's to fund alternative energy technology. Also, companies like GE begin to get into the act. This is a good thing. I sure hope we don't subsidize lower oil/gas prices and mess this up before the whole thing gets off the ground.

And as far as retail dealers go, the article is totally right. I have talked with station owners. They break even on gas, but it generates a lot of traffic. Some of the traffic buys fountain Cokes for $1.50 that cost the owner 10 cents. That is where the money is...

Shadox said...

KMC, I am glad we finally found something we disagree on... :-)

If you read my post closely, I am saying that there is no price gauging happening at the retail level, i.e. your local gas station. I am also saying that I don't think that there is any grand conspiracy happening on the refining portion of the value chain, although I am leaving that one open.

I did some investigating, and it appears that in teh 20 years between 1982 and 2002, refining capacity declined slightly. The capacity is what counts, rather than the number of refinaries. I concede that this appears strange, however, I still maintain that there is probably another explanation to this phenomenon.

My reasoning is as follows: with the price of crude and the price of distillates so high, there is a massive financial incentive for refiners to add capacity and cash in. This clearly works for producers - each production company pumps as much as it can and tries continuously to raise production (I know this part from a recent project I did for work). On the retail side, retailers compete mercilessly, as we all know. I find it unlikely that refiners are the only ones that are able to maintain a workable cartel, to avoid all the scrutiny and to reduce capacity in order to manipulate prices. This is simply too big to work, especially in light of the fact that it is clearly not the case in other portions of the industry.

What am I missing?

KMC said...

You're correct in saying refining capacity is what's important. I was implying that, but I guess it didn't come across.

If there's a massive financial incentive to add refining capacity, why is it decreasing? I propose a cartel is exactly what is happening. Why can't a refining cartel happen? OPEC is a working cartel (though I concede right away that their power has waned). It is a fact that the big five control over half of U.S. refining capacity, up from about a third just ten years ago.

Every time I hear that 'plant maintenance' has shut down a refinery, I choke. Is it a coincidence this maintenance happens in the summer?

Bottom line, if supply and demand were working properly and refining profits have increased by 80% (which they have), why would the big five be reducing capacity?

I've seen the data I've used in a couple of places, but here's one to check out:

http://www.citizen.org/cmep/
energy_enviro_nuclear/electricity/
Oil_and_Gas/articles.cfm?ID=11829

Intipsicated said...

54+28+14+8=100

Oil companies are non-profit? Where did that 40 billion dollars in profits reported for 2007 come from?

Intipsicated said...

Also,

What about companies like Irving Oil and Exxon that don't buy the crude. They own oil well, refineries and gas stations (or franchise gas stations).

Gouging can, and most likely does, happen at all levels.

Again... 40 Billion!

Shadox said...

Intipsicated - to your two comments: oil companies are clearly not non-profits. You are misreading the data. Some oil companies own production - where they make their profit off crude oil sales; some own refinaries where they make their money off refining crude; some own distribution where they make money off selling gas at your corner gas station and so forth. The point of the article was that there is no gauging at the corner gas station level.

Your second conclusion - "Gouging can, and most likely does, happen at all levels" is a simple statement without any proof or data. Just because prices are going up, are you assuming that there is a coordinated conspiracy going on? The market sets price - it's supply and demand, simple as that. Producers would love to pump more oil from the ground at $125 a barrel, but they simply can't. Supply and demand. Welcome to capitalizm.