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Marketplace Scratch Pad

Gas Prices 101

Scott Jagow Feb 13, 2009

I was on the phone with my parents last night, and my Dad was grumbling about the price of gasoline. Why is it, he asked, that oil prices keep dropping and gas prices keep going up? His answer was that energy companies have us by the uh… shirt collar. We talked about refining capacity, blah, blah, all the things you hear about when it comes to this. But I wanted to understand it better. So I called this guy in Texas who writes about energy issues. His name is Robert Bryce.

Bryce wrote a book called “Gusher of Lies,” which tears down the idea that energy independence is truly attainable or even as desirable as many say. You can read a review of the book here. Whether or not you agree with him, Bryce knows how the energy markets work.

You may know some of this already, but here’s what Bryce told me, paraphrased:
Oil prices are $37 a barrel because there’s too much oil in reserve. People aren’t using as much of it, obviously, but the reserves are building up to levels we haven’t seen since Iraq invaded Kuwait in 1990. This week, the Energy Information Administration said there are 350 million barrels of oil just sitting there.

The logical conclusion would be that gas prices would fall too, since the oil’s piling up.
But oil production and gas refining are very separate things. First of all, oil is a world market. Gasoline refining is essentially a US market. More than 90% of the gasoline used in the US comes from the US. Less than 40 percent of the crude oil used by our refineries comes from this country.

Second, refiners are mostly independent companies or operations that make decisions based solely on what’s known as the “gasoline crack.” It sounds like a horrible street drug, but actually, this is the margin. It’s value of the gas over the value of the oil. A few months ago, when oil plummeted and so did gas prices, refiners were getting killed on the gasoline crack. They weren’t making any money.

Now, those companies are cutting back on their refining. It’s as simple as that. They want to make some money. Since oil is a world market, there are many other factors that influence the price — political tensions, OPEC, you name it. With respect to gasoline, it’s much simpler. I guess my Dad’s right. They have us by the shirt collar.

Unless, of course, you want to walk home from work today.

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