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Why are Gas Prices so High?

Among all the commodities threatening to price out the common man, gasoline ranks among the highest. Read on for the main reasons which make gas prices so high.
Rita Putatunda
Did you know?
The price of a barrel of oil has almost quadrupled since 2000, and the average gas prices in the US have almost doubled since 2005.

The steep rise in gas prices over the years has put financial strain on people all round the world. Last year, the annual average gas price stood at $3.60, breaking all previous records. The domestic consumption in US has been low in the past few years, partly due to the aging baby-boomers, and partly because of the impact of the sub-prime crisis. A decreased consumption should ideally lead to a fall in the price of a commodity, but with gas prices, it has been the opposite. This is one of the reasons why most people find it difficult to fathom the reason for the high price of gas. In the following paragraphs, we will try to understand the factors that cause gas prices to increase.

What we Pay for a Gallon
  • Crude Oil: 64%
  • Refining Costs and Profits: 12%
  • Distribution, Marketing, and Retail Costs and Profits: 13%
  • Taxes: 11%
Increasing Demand
Although we have seen a decrease in the consumption of gas in US, emerging markets such as China and India have pushed the demand for crude oil. The fact that these two countries account for approximately 35% of the global population explains the reason for high demand for gasoline in these countries. According to statistics, China consumes about 9,000,000 barrels of gasoline everyday. India, on the other hand, needs 3,182,000 barrels on a daily basis to meet its energy needs. Although these countries do not export crude oil to US, the demand they create in the global oil market increases the likelihood of a price hike, notably by the Organization of the Petroleum Exporting Countries (OPEC).

Dominance of OPEC
OPEC holds the lion's share in global crude oil production. Their economies are highly dependent on the income generated by exporting crude oil to the world. To sustain their economy, OPEC deliberately decreases the production of crude oil, causing oil prices to increase. Economy is not the only reason OPEC looks at, politics also plays an important role in determining what it does with its vast reserves of oil. This was demonstrated in 1973, when the OPEC quadrupled oil prices for the US and Europe due to their support to Israel in the Yom Kippur War. Drastic measures had to be taken to counter the unprecedented event including gas rationing and implementation of 55mph speed limit. The aftermath was a steep increase in the inflation and unemployment levels across the US. The 1973 Oil Embargo made the world aware about the dependence of oil prices on the policies of OPEC.

Political Unrest in Middle East
Middle East has been politically volatile in the past decade or so. The Iraq war, the Arab Spring, and the threat of a nuclear Iran - all these factors have resulted in reduced oil production. Speculation has also increased in the oil industry on the status of Middle East as a credible oil-exporting region. Libya, which produced 2% of the global crude oil in 2010, witnessed a civil war which affected its production capacity drastically. Iran, which exports 2.2 million barrels of crude oil everyday, has been in the news for the past couple of years for its nuclear program. The issue is still unresolved and speculation about the future of trade relationship with a nuclear-armed country has led to an increase in the prices.

Hike in Refining Cost
In recent years, refining crude oil in the US has become expensive. Experts have cited two main reasons for this: Congressional mandates resulting in shifting towards the production of more environmentally clean gasoline blends, and the oil refineries on the Gulf Coast being shut down by Hurricanes Katrina and Rita. Along with refining costs, oil companies are cautious about new upgrades on existing refineries (a new refinery hasn't been built in the US since 1976), all of which has resulted in tightening the supply lines, even as the demand for oil has skyrocketed.

Oil Wells Drying Up
The main disadvantage of fossil fuels is that they are exhaustible; neither can they be replenished (not for another few million years), like batteries, nor are they perpetually available, like the sun or the wind. Heavy extraction of natural fuel reserves all over the world has led to what some have called 'peak oil', the point of maximum extraction of oil. This has caused panic among some oil companies and investors, leading to an increase in gas prices.

Fall of the Dollar
The value of dollar is inversely proportionate to the price of oil. Thus, if the dollar depreciates, the price of oil shoots up, and vice versa. Oil is traded in dollars in the international market. If the dollar depreciates against a foreign currency, the same amount of oil becomes available at a lesser prices in the foreign currency. For example, consider that a barrel of oil costs $100 -- equivalent to about 76 euros. In simple terms, if the dollar loses (or the euro gains) its value, less than 76 euros would make up $100. Thus, while dollar-paying countries will buy a barrel for $100, euro-paying countries will need to pay lesser amount. Most countries are quick to cash in on the depreciated dollar by buying more oil in their own currency. These fluctuations also contribute to the high prices of gasoline.

The good news for Americans is that the decline in oil prices may continue in 2013, and the prices will not go as high as they had in the last year. Irrespective of the fluctuations in the price of gas prices, we need to remember that the oil reserves around the world are non-renewable. To ensure that these reserves are not completely depleted, attempts should be made to develop alternative sources of energy. Signing off, we hope that this article helps you in understanding the underlying causes of high gas prices.