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Gasoline, just like any type of commodity in the market available for sale, is typically governed by the laws of supply and demand. While this is true in some measure, other factors play a significant part in determining its current price. Availability of supply and cost of production may play a big part in establishing its price but not the sole determinant in pegging its price. Other factors play significantly as well. That includes government regulation, taxes imposed, result of mergers, speculation, act of nature and political instability.

Crude Oil

Of all the factors that influenced the cost of gasoline, the cost of crude oil is the single most significant factor that influences our current gasoline price. It accounts up to 55 % of the total gasoline price. The cost of crude changes over time and varies among different regions of the country and the world. Crude oil cost, just like any commodity in the market is also determined by the law of supply and demand. As the law states, when supply cannot keep up with the demand, the price will naturally go up. This is also the case of crude oil where demand is perpetual while supply can be precarious due to a lot of factors.

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The price of gasoline is influenced by both the demand and the supply side. On the demand side, it is us consumers who determines it according to our consumption of energy and also generally the world’s economic growth or downturn. This happens when there is an economic growth where demand for energy increases and that means that the requirement for fuel will also naturally increases and that will translate for higher prices in crude. The opposite also applies just like what happened in the fall of 2008 where gasoline prices dropped below $2 due to the recession in the country. Where there is a downturn in economic activity that the demand for energy lessened and as such, also the demand for fuel.

On the other side of the equation is the supply side which is significantly influenced by oil producing countries and OPEC or Organization of the Petroleum Exporting Countries. OPEC exerts a significant influence on the price of crude because its member countries constitute 43 % of the world’s crude supply in 2010. That is more than half of the world’s requirement for crude coming from a single entity or organization that it can literally dictate the price of crude my contracting production or by overproduction.

When the nations that comprise OPEC choose to raise the price of crude oil, all it has to do is to reduce production and that will immediately in the price of crude. Because when there is scarcity of supply or a fear of future oil shortage, price of crude will inevitably go up. Classic example of this would be the incident in April 2001 when OPEC reduced its oil output by one million barrels per day which jacked up the prices of gasoline in the following month.

The Role of OPEC

While it is OPEC that accounts 43 % of the world’s supply of crude that it can dictate the amount of crude by merely contracting its supply, it cannot however do so in a whim. It has to maintain a certain price to subsidize its future exploratory cost for oil and also to shield itself from the depreciation of the dollar of which oil contracts are denominated. OPEC doesn’t want oil prices too high, or alternative fuel sources start to look good. OPEC has said its target price for oil is between $70-$80 a barrel. (See High Oil Prices Caused by Wall Street, Not OPEC)(Article updated April 15, 2011)

Refining Cost

Crude is the raw material of gasoline. But before crude can be made into gasoline that can be sold in gasoline stations, it has to be processed and refined first. The characteristic or type of gasoline that is made available is highly dependent on how it will be processed at the refinery where it is being produced. This stage of turning crude into a finish product gasoline also affects the cost of gasoline as it entails costs that are necessary.

In addition to processing crude into gasoline, there are also other costs associated to refining it such as distribution for it to reach the general public. From the refinery, it has to be transported to terminals near its market usually through a pipeline. And with it, it may be mixed with other petroleum products such as ethanol to satisfy government regulation and market specification. Afterwhich, it is delivered to gasoline stations by a tanker tank.

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The dealer in turn has to make profit as well as he resells it to the public. There in his pump prices will include his overhead and operating expense such as rent, wages, etch. This process can significantly influence the price of gasoline.

Competition and Marketing

While the need for gasoline is inelastic as almost all aspect of life needs energy for it to function, oil producers still has to compete for the attention of the consumers because there are other players in the industry. Such, just like any company, its overhead on marketing and advertising to beat competition can play a role in determining its price.

On the level of pump stations, prices of gasoline may also vary. As station gasoline owners have different overheads and also subject to competition, they may also adjust their pump price to attract more customers. This exercise will in turn influence the price of gasoline.

Taxes Meted on the Price of Gasoline

Government taxes also play significantly influence on the price of gasoline as it adds to its retail cost. Federal, State, and local government taxes are the next largest part of the retail price of gasoline. Federal excise taxes are currently 18.4¢ per gallon, and State excise taxes averaged 22.06¢ per gallon at the beginning of 2011. As of January 2011, 12 States levy additional State sales and other taxes on gasoline. Additional county and city taxes can have a significant impact on the price of gasoline in some locations [1] .

Mergers Also Affects the Price of Gasoline

When U.S GAO (Government Accountability Office) made a review on the series of mergers in the 1990’s that contributed to the increase of market concentration in the refining and marketing segments of the U.S. Petroleum industry, showed that the majority resulted in small wholesale gasoline price increases Changes were generally between 1 and 7 cents per gallon (McCool, 2007).

Regulatory Agencies Also Significantly Affects the Price of Gasoline

Regulatory agencies of the government also play a role in affecting the price of gasoline. For example, in order to meet national air quality standards under the Clean Air Act, as amended, many states have adopted the use of special gasoline blends-so-called “boutique fuels.” . . . higher costs associated with supplying special gasoline blends contribute to higher gasoline prices, either because of more frequent or more severe supply disruptions, or because higher costs are likely passed on, at least in part, to consumers (McCool, 2007).

Speculation on Commodities Trading Also Affects Oil Prices

Although typically it is the law of supply and demand that concludes the price of any commodity in the market including gasoline, there are exemptions in determining the pump price of gasoline. One example is speculation on commodities trading that can artificially drive oil prices up even if there is an ample supply and demand is low. Take the case on the year 2007 where oil consumption decreased from 86.66 million barrels per day (bpd) in the fourth quarter to 85.73 million bpd in the first quarter of 2008. At the same time, supply increased from 85.49 to 86.17 million bpd [2] .

Following the law of supply and demand, oil prices should have decreased as demand decreased and production increased. But the reverse happened defying the law of the market which is supply and demand. Instead, oil prices increased from $87.49 to $110.21 a barrel! Almost a 25 % increase in price when demand was low while supply is abundant. (Source: EIA)

This happened when investors speculated on the volatility of the market of Venezuela and Nigeria where it was rumored that hot money will be pouring into the commodities markets. This was because investors were withdrawing from the depreciating real estate and global stock markets and instead diverting their funds into oil futures. This created an asset bubble that result a surge in oil prices defying the law of supply and demand.

The Price of the Dollar Can also Affect the Price of Gasoline

The price of gasoline can also be affected by the strength or weakness of the US dollar as most oil contracts in the world are traded in dollars. As a result, oil-exporting countries usually peg their currency to the dollar. When the dollar declines, so do their oil revenues, but their costs go up. Therefore,OPEC must raise the price of oil to maintain its profit margins and keep costs of imported goods constant. (Source: USA Today,Oil Briefly Spurts Near $104 per Barrel, March 3, 2008).

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To illustrate, cost of exploration, production and refining oil, assuming that the oil came from Saudi Arabia, was spent is Saudi Riyal. But when the product bid, it is denominated in US dollars. The varying exchange rate can significantly affect the revenue of the producer that to insulate itself from the currency fluctuation, it has to increase its price as a buffer.

Political Instability and Tension Plays a Major Factor in Driving Gasoline Prices Up

Political turmoil and instability plays a major factor in driving the price of gasoline up. The recent news of political turmoil in the Middle East and Libya had a very significant influence on the price of gasoline. In fact, the recent rise on the price of gasoline can be solely attributed to this crisis in the Middle East and Libya. This can be attributed to the fear that oil supply and reserve might be disrupted and might run out that the global economy might run out of oil to fuel its industries. Whether the fear is real or not, it has to be understood that majority of the world’s oil supply comes from the Middle East. Such that when news of political instability erupts, the world immediately listens and reacts. Everybody has an interest in the Middle East and Libya because of its oil reserves.

Libya is the largest oil producer in Africa and the ninth in the world with 41.5 billion barrels (6.60Ã-109 m3) as of 2007. Oil production was 1.8 million barrels per day (290Ã-103 m3/d) as of 2006, giving Libya 63 years of reserves at current production rates if no new reserves were to be found. Any news or threat of the disruption of its supply will surely affect the price of oil both in real terms and in the commodities market. This can be best illustrated with how the rebellion spiked the recent price of gasoline.

Especially with a crisis with a political magnitude of ousting a President such as what happened in Tunisia and Egypt. When the highest office in the land is under siege, it will surely affect the policy of its country and how it runs its economy including its exports of oil. With regard to Libya, the threat to the disruption of oil supply was real. Its President Muammar Gaddafi has been using oil as a political chip with in his propaganda to ward of foreign assistance with the rebellion against his regime. And when circumstances did not work out according to his favor, bombed oil refineries with his fighter jets. That act of destroying refineries that produces and supplies oil sent a very strong message that the supply of oil is in jeopardy such that it resulted to a continuous spike in the price of oil.

That fear was not mitigated even if OPEC gave statement that it will increase its production to assure the world that there will be a continuous supply of oil. That even as the undersigned writes, the pump price of gasoline still continues to rise. That is how sensitive the world reacts to political instability in that region.

This political instability will immediately reflect in the commodities trading with the speculation that since supply has been disrupted due to political turmoil, the price of oil in the future will also eventually rise as the supply will contract. Traders bidding for oil prices will make their bid base on what they think or believe what will the price of oil at a specific date in the future. Taking into account the projection that since supply is disrupted, it will affect the supply in meeting the demand in determining oil prices. This will have a ripple or contagion effect of soaring oil prices up even if OPEC assured that they will produce enough oil to meet future demands.

Force of Nature

Force of nature or Acts of God can also significantly affect the price of gasoline. Especially when there is a disaster that destroys or hampers the supply of oil. The effect can be similar to that of political instability where speculators will bid at higher prices due to the disruption of supply. The only difference is that this is an act of nature while the former is caused by political disruption.

The classic example for this is when the Hurricane Katrina struck and forced workers from offshore drilling platforms to evacuate. This stopped the operations in the Gulf of Mexico and in turn halting the production of oil. This resulted in an unusual spike of the price of gasoline.