How Gas Prices Are Determined: From Crude to the Pump

Gas prices are a source of constant frustration for many drivers throughout the U.S. We often see the price at the pump change rapidly and without warning. And as we learned during the pandemic, prices don’t just jump by a few cents anymore, it’s dollars at a time.

Sudden fluctuations in gas prices are determined by a complex set of factors, including global oil prices, supply and demand, government policies, and taxes. In this article, we will explore these factors in detail to help you better understand how gas prices are determined and why they fluctuate so frequently.

Key Points:

• Fuel prices are determined largely by the cost of crude oil, the cost of which is subject to various global and geopolitical factors.
• The refinery process, marketing materials, state and local taxes, and gas station markups all also contribute to the final price of gasoline you’ll see at the pump.
• Additionally, seasonal changes, the demand in your area, and the overall global supply play a role in the fluctuation of gas prices.
• Predictions for the future of gas prices include a continued increase in electric vehicles and renewable energy sources, as well as potential supply and demand shifts in the global oil market.

What Determines Gas Prices?

While it is easy to assume that gas prices are simply based on how much crude oil is available, the truth is that the factors that determine gas prices are much more complex than that. These factors include:

• Global oil prices: As the main ingredient in gasoline, crude oil prices have a significant impact on gas prices. When crude oil prices rise, gas prices have to follow suit for gas stations and other businesses in the oil industry to make money.
• Oil refining costs: The cost of refining crude oil (aka, turning it into gasoline) also impacts gas prices. When refining costs are higher, gas prices tend to be higher.
• Distribution and marketing costs: The cost of distributing and marketing gasoline, including transportation costs and advertising expenses, can also impact gas prices.
• Government policies and taxes: Government policies, such as taxes and regulations, also have a significant effect on the price of gas. For example, taxes on gasoline can add a significant amount to the final price that consumers pay. So, when times are tough, the government can reduce taxes on citizens, reducing the amount consumers pay during inflation or economic uncertainty. 
• Supply and demand: Gas prices also reflect supply and demand factors, such as the availability of crude oil and the production capacity of refineries. When there is a shortage of gasoline, prices rise to reflect the scarcity.
• Seasonal demand: Gas prices also tend to rise during periods of high seasonal demand, such as summer when people are traveling more frequently.
• Market competition: Finally, gas prices in your specific area can also be influenced by market competition among gas stations in the area. When several gas station owners are competing for business, prices tend to be lower to attract customers.

Factor #1: The Cost of Crude Oil

While no one factor influences the cost of gasoline, crude oil is the primary ingredient for gasoline production, and as such, it has a significant impact on the price of gas. The price of crude oil is also determined by a variety of factors, including global supply and demand, geopolitical events, and production costs.

The global demand for crude oil is constantly changing depending on the state of the economy, the growing (or shrinking population) in a given area, and advances in technology. Geopolitical events such as wars, conflicts, and sanctions can also disrupt the global supply of crude oil, leading to fluctuations in its price.

Additionally, production costs play a role in determining the cost of crude oil. When the cost of production is high, oil producers are likely going to charge more to maintain profitability.

These fluctuations in crude oil prices have a direct impact on gasoline prices. When crude oil prices rise, gas prices tend to follow suit, and vice versa. This is because the cost of crude oil accounts for a significant portion of the final price of gasoline.

Factor #2: Oil Refining Costs

Refining crude oil into gasoline is a complex process that most of us don’t think too much about. Each of these steps incurs costs that can impact the final price of gasoline. On average, the cost of refining a gallon of gasoline can range from $0.40 to $0.70 per gallon.

Factors that contribute to the cost of refining crude oil into gasoline include:

• Energy costs: The refining process requires significant amounts of energy, which is extremely expensive. The cost of energy, such as electricity and natural gas, can impact the cost of refining gasoline.
• Maintenance costs: Refineries require regular maintenance and repairs to keep them running smoothly, even more so than other businesses, as refineries contain complex machinery and chemicals. These costs add up and impact the overall cost of refining gasoline.
• Labor costs: The refining process requires many skilled laborers to run smoothly, and this is a huge cost. 
• Environmental regulations (and the associated licenses): Refineries must comply with a range of environmental regulations, which adds to the cost of refining gasoline.

Factor #3: Distribution and Marketing

Once gasoline is refined, it must be distributed to retail locations where it can be sold to consumers. This is a long, expensive process that requires many employees and high-tech machinery.

Here are some of the key factors that contribute to the cost of distributing and marketing gasoline:

• Cost of transportation: The cost of transporting gasoline from the refinery to the retail location can be a significant expense. The mode of transportation used (e.g., pipeline, truck, or rail) will play a part in determining the final cost.
• Gas storage costs: Gasoline must be stored at various points along the distribution chain, including at the refinery, in transportation vehicles, and then finally at the retail location (aka, gas stations). The cost of storing gasoline must be included in the final price of the product.
• Advertising and marketing costs: Gasoline retailers spend significant amounts of money on advertising and marketing to attract customers. These costs can be passed on to consumers in the form of higher gas prices.
• Operational costs: Gasoline retailers have a range of operating costs, including salaries and wages for employees, rent for the gas station locations, and maintenance costs for all equipment. 

Factor #4: State and Local Taxes

Refining oil into gasoline is a huge process that has a significant impact on the environment. In response to that, federal, state, and local governments also impose taxes on gasoline. These taxes can vary widely, with some states and localities charging much higher rates than others, largely depending on the politics within the location.

Here are some basic facts that show how taxes affect gas prices:

• State and local taxes on gasoline can be levied in several ways, including as a fixed amount per gallon or as a percentage of the total price of gasoline.
• Taxes are used to fund a range of state and local government programs and services, such as road maintenance and repair, public transportation, and environmental initiatives.
• The average state tax on gasoline in the United States is currently around $0.30/gallon, but rates vary widely by state. For example, Pennsylvania currently has the highest state tax on gasoline at $0.61/gallon, while Alaska has the lowest state tax at just $0.08/gallon.

Additional Factors That Affect Gas Prices

The factors we’ve already mentioned have the most direct impact on the price of gasoline, but there are smaller factors that all add up and can have an effect on how much you pay. 

Geopolitical Events

Geopolitical events, such as conflicts or political instability in oil-producing countries can cause gas prices to fluctuate because there’s going to be a disruption in the supply chain. When there is disruption due to these events, it can lead to higher prices at the pump.

For example, the Arab oil embargo of 1973 resulted in a significant increase in the price of oil and gasoline. This embargo was caused by a dispute between the Arab members of OPEC and Western countries over support for Israel. The embargo led to a global oil shortage, which caused gas prices to skyrocket, resulting in long lines at gas stations and widespread economic disruption. 

Global Supply and Demand

When there’s a high demand for oil, but a limited supply, prices tend to increase. On the other hand, when there is a surplus of oil, prices tend to decrease. The reason why is fairly simple. When there is more oil available, it becomes easier to meet demand and suppliers have to compete for buyers, which leads to lower prices.

The Organization of the Petroleum Exporting Countries (OPEC) plays a significant role in the global oil market, and therefore the price you’ll pay for gas. OPEC is a group of oil-producing countries that use its market power to control the global supply of oil and influence the petrol price. When OPEC countries agree to cut production, the global supply of oil decreases, leading to higher prices. Conversely, when OPEC countries increase production, the global supply of oil increases, leading to lower prices.

OPEC's decisions can have a significant impact on gas prices in the United States and other countries that rely heavily on imported oil. For example, in 2020, OPEC and its allies agreed to cut oil production in response to the COVID-19 pandemic, which led to a reduction in the global supply of oil and an increase in gas prices in the United States.

Seasonal Changes

Yes, even different seasons affect gas prices, with prices typically higher in the summer than in the winter. There is generally more demand for gasoline during the summer months, as people take road trips and go on vacation. In addition, refineries often undergo maintenance and switch to producing summer-blend gasoline, which is more expensive to produce than winter-blend gasoline.

Furthermore, summer-blend gasoline contains additional additives that help reduce smog and pollution during the warmer months, as mandated by the Environmental Protection Agency (EPA). These additives are more expensive to produce than the ones used in winter-blend gasoline, which also contributes to the higher cost of gas in the summer.

Another seasonal factor that can impact gas prices is weather-related events, such as hurricanes or severe winter storms. These events can disrupt the supply of oil and gasoline, leading to short-term spikes in gas prices.

Local Consumer Demand

When there is a high demand for gasoline in a particular area, prices tend to increase in that area, if not across the board. This can happen for a variety of reasons, such as a surge in tourism, events that attract large crowds (i.e., sporting events or concerts), or an increase in local economic activity.

For example, if a major sporting event is taking place in a city, such as the Super Bowl, the gasoline demand may increase as more people travel to the city by car. This increase in demand can lead to a temporary spike in gas prices at local gas stations.

Gas Station Markups

Gas stations do make a profit on gasoline, but the markup is small and does not contribute significantly to the overall price of gas. Gas stations typically make a profit of only a few cents per gallon of gasoline sold.

The main costs associated with running a gas station include rent or mortgage payments for the property, employee wages, and equipment maintenance. In addition, gas stations also have to pay for the gasoline they purchase from refineries, which accounts for the majority of the cost of gasoline.

Understanding Trends in Gasoline Prices

Over the history of gasoline production, trends have come and gone. The factors that determine gasoline prices shift slightly and, with them, so does the price itself. 

Why Do Gas Prices Go Up?

Gas prices can go up for a variety of reasons, including increases in global oil prices, geopolitical conflicts, a larger demand than there is oil supply, and seasonal changes. In addition, unexpected events, such as hurricanes or pipeline or refinery issues can also impact gas prices.

When Do Gas Prices Go Down? 

Gas prices can also go down for a variety of reasons, including a decrease in the cost of crude oil, a decrease in demand, and the end of seasonal changes, such as going into the winter season.

How Has the Price of Gasoline Changed in the United States?

Over the past several decades, the price of gasoline in the United States has fluctuated significantly. Here are some of the more notable trends and changes:

• In the early 2000s, gas prices in the US averaged around $1.50 per gallon.
• Gas prices spiked in 2008, with the national average reaching over $4 per gallon.
• In 2020, gas prices dropped significantly due to the COVID-19 pandemic and subsequent decreases in demand, with prices averaging around $2 per gallon.
• As inflation took over, 2022 saw the highest gas prices the country has ever seen, with some states reaching over $5/gallon. 

What Was the Highest Average Price Per Gallon of Gas In The United States?

June 2022 saw the highest spike in gas prices, with gas costing $5.016/gallon, according to data from AAA. 

Which States Have The Highest and Lowest Gas Prices In The U.S.?

While this changes frequently, as of this writing (May 2023), according to data provided by AAA, the states with the lowest gas prices are:

• Mississippi at $2.993/gallon
• Texas at $3.069/gallon
• Louisiana at $3.094/gallon
• Alabama at $3.098/gallon
• Arkansas at $3.118/gallon

On the other end of the scale, the states with the highest gas prices are:

• California at $4.814/gallon
• Hawaii at $4.779/gallon
• Arizona at $4.689/gallon
• Washington at $4.586/gallon
• Nevada at $4.220/gallon

The Future of Gas Prices: Predictions

Predicting the future of gas prices can be difficult, as a range of factors can influence prices, which shift daily. However, industry experts and analysts have offered some predictions for how gas pricing works in the coming years.

• Some experts predict that gas prices will be lower this summer, down 20% from last year. Prices are predicted to average about $3.40/gallon. 
• While experts can’t see too far into the future, 2024 is expected to see a decline in the gas price as well, with prices likely to average $3.70/gallon. 
• While still a ways away, it’s likely that gas replacements — like electric vehicles — will ultimately replace oil, a costly and environmentally devastating product.