How Gas Prices Work
Quick Links: A History Of Gouging | The Futures Market | But Wait - There's More!
It is widely known that the gas companies don't get that much money in profit at the pump. The breakdown of gas prices is roughly 65% crude oil, 10% refining, 23% tax and 2% profit. And yet, gas companies make money hand over fist. How does this happen?
What you need to know is that the gas companies are in total control of their product. Every bit of gas you pump in to your tank goes through at least five steps before it gets to your car: Exploration, Excavation, Refinement, Distribution, Retail. Each part of the process is done by a profit-seeking company at some % markup.
Suppose gas costs $180/barrel and we assume a 20% profit margin of each company along the way. That number is completely hypothetical and overly simplistic as different amounts are made at different stages, but for the purposes of this demonstration it will do. By the time it goes through each intermediary company and finally reaches the pump that barrel is worth $373.25. So $193.25 has been made by the companies along the way. Then the gas station sells the refined fuel for 2% profit, earning the gas company $7.46/barrel profit.
That seems reasonable, doesn't it? There is one little-known problem though: the gas company owns every company that ever touches that barrel. That means in our hypothetical 20% markup example, the gas company makes over $200 on that $180 barrel of oil.
I'm sure some you'll want to scour the Internet looking for other sources to back up my claims, but I'm afraid you aren't likely to find any because it's not information they want getting out. My source is a former VP of Esso Imperial Oil named Russell Milland, who has intricate knowledge of how gas companies work together to maximize their profits. Here's a hint: just because you're filling your tank at Shell station doesn't mean you're getting Shell gas.
A History Of Gouging
After Hurricane Katrina, gas prices everywhere soared. In Toronto they reached as high as $1.30/L. Later in 2005 the Canadian Centre for Policy Alternatives (CCPA) did an in-depth study on the matter, and in their report concluded that given the cost of a barrel of oil at the time, gas should have cost $0.90/L. The report went on to say $1.10/L would be profiteering, and $1.25 is simply gouging. They did another study in 2007 that demonstrated the prices were again at gouging levels, and had been for months.
Arguments have been raised as to what the profit margins were over these times rather than just profits, and the reports above do not contain those numbers, but consider this: the 12 cent price hike for Hurricane Ike happened before the hurricane even touched ground, meaning there was not yet any shortage to account for. What do you suppose that did for their profit margins?
After Katrina gas prices basically settled in to a comfortable parity with the cost of oil. When oil cost $110/barrel, gas at the pump cost about $1.10/Litre, and so on. This is where analysts said the price should be, so all was well. After the economic crisis hit in September and October of 2008, and people were using less oil, the price of a barrel of oil plummeted to $70, with some analysts forecasting prices as low as $50. And yet, in Canada, the price remains over $1/L.
This is where inconsistency starts kicking in. They tell us it will take as long as 90 days to see a decrease in the price of oil, but it sure didn't take 90 days for the price to go up when the cost of oil went up. And do you think if the cost of oil gets back up over $90 that we'll ever see gas prices lower than 90 cents/L? And it's not just us who are noticing this, either.
Ed Mayo, the chief executive of Consumer Focus, accused the industry of delaying price cuts.
He said: "Energy companies all put their prices up arguing that it was down to rising costs of oil and gas, but now that is reversed, we are seeing delay, blather and procrastination. We believe that consumer prices need to come down with no ifs and buts over the coming weeks.
"When companies all put prices up at the same time, there were suspicions of a lack of competition. Now, they are all delaying together."
They say this is partly due to a flaw in the futures market (that article will be referenced by another link at the bottom of the next section), but mostly it's greed. Gas in America is selling at the equivalent of 65 cents/Litre in some places, but in Canada it's still almost double that. The Government is not at fault for high gas prices, but I assure you they'll never do anything about it because they make a large fortune from it in taxes. For the price of gas to come down, those markups have to shrink.
The Futures Market
Since it's part of the problem, here's basically how the futures market works: you buy something on the understanding that the price will be $100 in 3 months. If the price goes up from that, you sell in 3 months as per the arrangement and make lots of money. If the price drops, you sell more futures to someone else at the lower price to minimise your losses, taking you out of the market on that commodity entirely. Then, because the price is trending downwards so sharply in this case, people stop buying because it's a losing proposition. Since nobody's buying or selling, the prices remain the same even though the costs are down, until the terms on some futures contracts come up and they're forced to sell at the reduced rate. A more detailed explanation of the futures market is available here.
The real problem is that for most commodities, the people buying futures are involved in the industry, but for some reason oil is habitually bought by people who aren't in such a position. Lots of people who never touch the oil invested all at once a few years ago, meaning the oil companies suddenly had all this extra money they had to spend somewhere, so they spent it on the exploration phase, which is expensive. The disparity is that prices in the U.S. are going down immediately, but prices in Canada remain high, which is a very good indication that blaming the current high prices on the futures market is a load of crap.
(in reference to the Futures Market link in the previous section)
Consumers don't misunderstand; they know they are being fleeced. When crude went up between January and July of this year Canada's refiners passed on the cost to motorists immediately. Now that crude is down, the resulting and future savings are being pocketed by the same refiners. This article is misleading and erroneous. In fact, no such lag exists in the US markets today where crude in Canadian dollars settled at 71.9 cents/litre, while wholesale gasoline was offered for an additional 3.7 cents/litre.
Accepting this nonsense from a noted consultant for the Canadian oil industry is how refiner/marketers justify charging you an extra 9-19 cents/litre depending on where you live in Canada.
Its unfortunate the article, shared by several media today, did not have to the benefit of all the facts.
But Wait - There's More!
Gas isn't the only thing that comes out of those oil barrels. One of the products that comes from oil is called Bitumen, which is the main ingredient in asphalt; it's what holds it all together. It starts sticky, then dries non-sticky. It is also sold at a ridiculous markup, which is currently stressing asphalt producers and driving up the cost of roadwork.
Another thing that comes from oil is motor oil, which your car needs in order to run properly. Oil is also a main ingredient in plastic, which is found just about everywhere. Oil is important, but the gas companies shouldn't be holding us hostage with the cost of gas.