How Crude Oil Prices Affect Gas Prices
Crude oil prices make up 71 percent 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. These costs remain stable, so that the daily change in the price of gasoline accurately reflects oil price fluctuations. High oil prices are what makes gas prices so high. (Source: "Frequently Asked Questions," Energy Information Administration.)
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. That means oil prices might rise higher, and fall further, than gas prices. But you can still use oil prices to predict tomorrow's gas prices today.
Examples of How Oil Prices Affected Gas Prices
Oil and gas prices have been especially volatile since the 2008 financial crisis. Here's a look at their peaks and valleys, and what caused the price swings.
2008 - Oil skyrocketed to its all-time high of $143.68/barrel on July 8. That sent gas prices to $4.16/gallon. Before 2008, prices remained below $90 a barrel.
2009 - 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. Treasurys.
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.
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.
2012 - Iran threatened to close the Strait of Hormuz, through which flows 20 percent of the world's oil. Oil prices rose 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. 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. That 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.
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 aggressive war games near the Strait of Hormuz.
2014 - Prices fell to $62/barrel by the end of the year. Gas prices fell to $2.45 a gallon. That's because the United States produced plenty of shale oil. In addition, the Organization of the Petroleum Exporting Countries didn't lower supply quotas.
2015 - Prices fell below $36/barrel in December. That drove gas prices below $2.00 a gallon.
2016 - The price continued to fall in January, to $26/barrel by the end of the month. Gas prices fell to $1.83/gallon on February 15. When OPEC announced a production cutback in November, oil prices rose above $54/barrel in December. Gas prices rose to $2.42/gallon.
To read more about West Texas Intermediate oil prices since 1974, go to Oil Price History.
Like most of the things you buy, oil prices are affected by supply and demand. More demand, like the summer driving season, creates higher prices. There is less demand in the winter since only the northeast United States uses heating oil.
But that just one of the factors that determines oil prices.
But, 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. Commodities traders are a big factor in making oil prices so high.
OPEC is an organization of 12 oil-producing countries that produce 46 percent of the world's oil. In 1960, these countries formed an alliance to regulate the supply and the price of oil. They 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.
The 1973 OPEC oil embargo was the first time OPEC flexed its muscles. It cut off oil to the United States and limiting supply. Prices rose, shifting power away from U.S. oil producers. OPEC's goal is to keep the price of oil at around $70 per barrel. A higher price gives other countries the incentive to drill new fields which are too expensive to open when prices are low.
The United States stores 700 million barrels of oil in the Strategic Petroleum Reserves. The federal government uses it 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 United States also imports oil from non-OPEC member Mexico. This makes it less dependent on OPEC oil. The North American Free Trade Agreement is a free trade agreement that keeps the price of oil from Mexico low since it reduces trade tariffs.
What Affects Demand
The United States uses 21 percent of the world's oil. Two-thirds of this is for transportation. The country built a vast network of federal highways leading to suburbs in the 1950s. This decentralization was in response to the threat of nuclear attack, which was a great concern then. As a result, America did not develop the infrastructure for a national mass transit system.
The European Union is the next biggest user, at 15 percent of the world's oil production. China now uses 11 percent, as its use has grown rapidly. (Source: “Refined Petroleum Consumption,” Central Intelligence Agency.)
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 called 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.