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Why gas prices will keep on rising

06/24/2008

Record oil prices won't reach the pump right away, because gasoline has some catching up to do. And oil prices are only one factor in what you pay.

Gasoline prices have moved into record territory and are not likely to ease significantly anytime soon, leaving millions of consumers to wonder what's driving gas prices and when they will start coming down again -- if ever.

Let's see how those increases add up.
Americans spent about $26 billion more on gasoline through the first nine months of 2004 than they did over the same period in 2003, a 16% increase, according to the Energy Department.

Annual household energy bills have increased by an average of $1,000 during the past four years, draining more than $500 billion from the economy, according to a September report from Consumers Union and the Consumer Federation of America.
What goes into the price of gas? We'll help answer that and other questions you may be pondering as you watch the pump dials spin ever higher.

Where does your gas dollar go?
Crude oil is only one component of the pump price of gasoline, along with taxes, refining, marketing and distribution. But its by far the biggest slice, making up slightly more than half of the price.
 
So why aren't gas prices rising as fast as crude oil? Crude prices have been boosted by growing worldwide demand, particularly in China, and a supply that has been vulnerable to political instability, bad weather and other production disruptions, such as a recent refinery explosion in Texas. Speculators further juice the price, which has wobbled up and down as much as $20 a barrel over the past year.

Roughly, for every dollar that the average 42-gallon barrel of crude rises, gasoline will go up by about 2.4 cents. But it's not really that simple.

Over the long haul, higher crude prices do lead to higher gas prices. But the oil prices that make headlines are "spot" prices, referring to the price of the last barrel sold. Most oil is sold under long-term contracts, which tends to delay the impact of higher spot prices.

That means gas prices still have room to grow. And as with any commodity, the rules of supply and demand are in play. When demand outstrips the gasoline supply, as happened in summer 2004, the price goes up.

Why do prices vary from state to state?
Typical gas price surveys show a spread of about 50 cents a gallon from the cheapest state to the most expensive (usually Hawaii). Price swings in the higher-price states tend to be more dramatic as well.

Several factors are at work here. "State tax differences are a major component in differences across states," says Michael Noel, an economist at the University of California, San Diego, who studies gasoline pricing. Those taxes can vary more than 20 cents per gallon between states at the top and bottom of the range.

Also important: the blend of gasoline required in a state and the ease of access to crude oil markets. In states around the Gulf of Mexico -- where refiners are close to a steady supply of crude -- gas is generally much cheaper than West Coast states, which must bring in oil over long distances.

And California sees more price volatility than other regions because it depends on a unique formulation of gasoline. Only a limited number of refiners are able to create the blend, which leaves the state much more vulnerable to short-term disruptions in supply or spikes in demand.

How high are prices, really?
Ready for some cold comfort? While gasoline prices are at or near their all-time high in absolute terms, they fall well short of the record when adjusted for inflation. Moreover, prices in the United States are still far below those in many other developed nations.

Adjusted for inflation, gas was selling for $2.59 in 1980, while dipping below $1.50 for a period in the mid-1990s. For gasoline to rise again to its February 1981 peak, current oil prices would have to rise to about $80 a barrel.

Are the gas companies gouging us?
Certainly, oil companies prosper in times of rising prices -- just look at how well energy stocks have performed in the midst of recent market doldrums. But the industry is quick to defend its practices and profits as comparable to other sectors.

In areas such as California that rely on "boutique" fuel blends, some observers say that refiners have too much power to limit supply in order to drive up prices, though it's hard to distinguish between the exercise of "market power" and true scarcity.

"Each time the price of gasoline increases," Noel says, "some consumers immediately point to the potential for collusion or price gouging amongst oil companies. Numerous government investigations over the years have failed to turn up any such evidence. Prices are determined at each level by the laws of supply and demand."

One reason that gasoline prices are volatile, Noel says, is that demand is relatively insensitive to price changes. Overall, people just keep on driving to work, no matter the pump price.

Rick VanderKnyff

MSN Money by Rick VanderKnyff, http://moneycentral.msn.com/content/Savinganddebt/Saveonacar/P98745.asp