Brad Causey
Brad Causey,
Editor and Publisher
R. Shannon Pollard
Kevin Sommers
David R. Wehry
James E. Foy
The Freedom Letter
The Price of Gasoline
It is now the height of the summer driving season. At the end of June, the price for a gallon of regular unleaded gasoline, in the United States, varied from a low of $1.69 (Tulsa) to a high of $2.27 (San Francisco). The mid-range and premium grades are, naturally, higher. I spent $45.00, about 3 weeks ago, on a single tank of gasoline. The clerk asked me if I needed a loan! Funny, or is it? Why are prices so high, and why do they vary from station to station, city to city and region to region? The answer could be an old song title. Is it "blowin in the wind", or something a bit more complicated? Turns out the real answer has elements of both.
I have received a number of generic e-mails from friends lately about boycotting the oil companies on specific days, and/or not buying from certain multi-nationals because they buy oil from the Arabs, etc. As you may have noticed, none of these wild ideas are effective. Why? The main reason is competition. The great economist Adam Smith said: "Under competitive conditions, individuals acting naturally in their own self interest, with a minimum of government interference, will do the greatest good for society as a whole." Although these words were written over 200 years ago, they are still true today.
First, let us review the elements of the price of gasoline. Step # 1 is exploration. We must discover where the crude oil (raw material) is located. With current technology, companies are fairly proficient at finding new sources. In fact, contrary to popular propaganda, our current worldwide known reserves will last at least 500 years, given current rates of consumption. We are finding more, all the time. But, even if all the data looks good, the only way to know for sure if crude exists in a specific place, is to set up a derrick and drill. Everything costs money. The research, the exploratory drilling, labor, etc. Step # 2 is extraction. Some wells are under the ocean floor. Some are in artic areas such as Siberia and Alaska. Some are in the desert. Still others are in rural areas, all over the world. Either way, one must find a way to safely extract the crude and safely store it until it can be transported. Step # 3 is transportation. After the oil is extracted and stored, it then must be transported to a refinery. Generally it is sent through a pipeline to a nearby port. It is then loaded on a large tanker ship and then embarks on a journey half-way across the world. For instance, the travel time alone between the Persian Gulf, and the United States Texas gulf coast takes almost a month. Not to mention the time of loading and off-loading the cargo. Time is money. Step # 4 is refining. Crude oil is simply the raw material from which gasoline (and various other products) is derived. It must be refined into a usable substance. Steel, for instance, is a combination of iron ore, coal, heat, and other materials. A very complicated, and lengthy process. Similarly, gasoline is the product of lengthy, complicated and expensive refining process. In the 1920's when cars became relatively affordable, lead was discovered to be an inexpensive method for boosting the octane of fuel. In the 1970's, when the federal government mandated emission controls, the lead had to be removed because of its effect upon the platinum within the catalytic converters. This, of course, increased the cost of refining gasoline. In recent years, the government has mandated certain urban areas only be allowed to sell a special blend of gasoline which they have deemed "cleaner" than the norm. This fuel requires a separate refining process, with different additives. This is virtually the entire reason why gasoline costs more in Los Angeles and Chicago than it does in Atlanta and St. Louis. Step # 5 is transportation from the refinery to the retail outlet. Some quantity is done through another set of pipelines and/or rail. Most is done by tanker truck. This is how the finished product is delivered to your neighborhood filling station. We sometimes forget that the truck/pipeline/train has to be manufactured, purchased, fueled and operated. The human element has to be paid. Step # 6 is the retail sale of the finished product. Included in the price we pay at the pump is federal, state, and sometimes local tax. The federal tax on a gallon of gasoline is between 18 and 19. In Tennessee, the state tax is another 21. Dependent upon your location, the state tax is somewhat higher or lower. Anyway you slice it, the retail taxes alone are about 40 per gallon. A good example: If you pay $1.89 for a gallon of gas, the actual gasoline costs only $1.49. This one and a half dollars buys the exploration, extraction, transportation, refining, additional transportation, and final sale of a product that allows us the freedom to live a modern life. Sounds like a bargain to me.
We sometimes forget that our economy is very dependent upon oil. Most packaging is plastic, and therefore oil based. Think of all the plastic/polymer items around your house. It is possible to make plastics from other raw materials, but they are all a lot more expensive than oil. 12% of the cost of the food you buy at the supermarket is transportation alone. Oil is simply the basic element of modern, industrial life. Unless you grow your own food, and generate your own electricity, your entire existence depends upon the delivery of goods to market. At the moment, 99% of everything gets there because of fuel extracted from oil. And unless you walk, or are able to ride a bicycle, you getting there to get it, depends upon fuel also.
A basic law of Economics is also at play. Although the quantity of known reserves has actually increased in recent years, the quantity of refining capacity in the United States has barely stayed even. A new refinery has not been constructed in the States for over 20 years. New federal regulations are the main culprit. In that same twenty years, demand has increased considerably. Not only in the United States, but especially in the far east. India and China being the prime examples. An increase in demand (for the finished product) without an increase in supply will result in an increase in price. Without the threat of competition, our current price would be a lot higher than it is.
The price of a domestic barrel of crude oil last week (dependent upon the source) is between $36.22 and $37.68. European offshore prices vary between $31.45 and $34.85. The majority of refineries operate on contracts. The current contract for middle east oil is hovering around $35.00 per barrel. A barrel, by the way, is 42 gallons. It is simply a measurement much like a bushel would be to a farmer. One year ago, prices varied between $26.00 and $32.00 per barrel. You historians should know that 22 years ago, the price of West Texas Intermediate crude oil reached $40.00 per barrel. Ask yourself, how much has the price of a car or truck increased in twenty years? How about the last house you bought? Food? Clothing? Jewelry? Health care? Oil is one of the few commodities that has actually decreased in price. Adjusted for inflation, the price of gasoline in the United States is cheaper than it was 25 years ago. Still want to complain? Think of something else you buy fairly regularly by the gallon. Milk: $4.39 per gallon. Orange Juice: $3.39 per gallon. Either of these is a lot simpler to produce than a gallon of gasoline. In fact you could buy a cow and milk it yourself if you wanted to. You could grow (or buy) some oranges and squeeze them yourself. Do you? Probably not. You also have probably not complained about the price of orange juice or milk to your friends. Maybe you should, because they both cost a lot more than a gallon of gasoline.
Two more quick examples. Water and inkjet printer cartridges. If you are not at a professional sporting event, you can pick up a 20 ounce bottle of Aquafina or Dasani for about a dollar. Since a gallon is 128 ounces it would take between 6 and 7 bottles to equal a gallon. Let's be nice and say 6. Have you completed the math? Bottled water costs a lot more than gasoline, even if you buy it in quantity. A little odd for something that covers over 2/3rds of the earth's surface. Another good example is an inkjet printer cartridge. Whether it is Epson, HP or some other brand, they are all expensive. Let's assume that your standard black inkjet cartridge has 6 ounces of ink. (I think this is a little on the high side, but you get the idea) 128/6 = 21.33. Let's again be nice and say it takes only 20 cartridges to make a gallon of ink. At an average of $25.00 per cartridge, this would total $500.00. Makes gasoline seem almost free! I know that most cartridges have the printer head and other mechanisms etc. But, come on guys, they are still way too expensive!!
Still don't believe me? I was recently in contact with a friend of mine who lives in western Europe. The price of gasoline there (The Netherlands) is $6.81 per gallon. (It is sold by the liter) The tax portion of it is almost a dollar. The tax alone in Britain, is almost $2.00 per gallon. The price of a gallon of gasoline in Japan has been well over $5.00 for the last decade. The difference, between Europe and Japan (other than taxes) is the lack of competition both at the wholesale and retail level. In America we have real competition. The price would be a lot higher, if we did not.
In conclusion, although I don't like paying $2.00 a gallon for gasoline any more than you do, the facts clearly show that it is a comparative bargain. Complain if you must, but society would be better served if we got the government out of the oil business, and started complaining about the really high priced commodities such as water, milk, orange juice and inkjet printer cartridges.
Comments Are Appreciated
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