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On May 17 this year, crude oil breached the psychologically important $70/barrel barrier. That same week, U.S.A. pump prices leaped to an average of $3.218 a gallon, just half a cent below the all-time high. Over the past ten years, according to the Energy Information Administration (EIA), retail prices have nearly quadrupled: American motorists paid 376.9 percent more just to “fill ‘er up”. Why the seemingly-unstoppable upward spiral in the price of gasoline, so vital to the everyday life of all car-owning citizens?
The answer, though heavily debated these days, is an old friend, the “law of demand and supply”. Global demand for petroleum products continues to rise unabated in the face of finite, even erratic supply. No new oil fields of any significant size have been discovered or come online in recent years. OPEC turns up its nose at all suggestions that wellhead production and exports to the rest of the world are plainly inadequate to meet demand. Creaky refineries are no help either, having to shut down for repair and maintenance just when supplies are tight.
Geopolitical crises have done their share to worsen the supply situation. The benchmark “light, sweet” crude price stood at around $28 per barrel before Coalition Forces invaded Iraq. Owing to political instability, outright pipeline sabotage and fires, Iraqi production has fallen by half and benchmark prices exceed $70 a barrel.
And the long-term outlook is for demand to outpace supply. Reviewing several studies on the subject, William Rees of the University of British Columbia concluded that world oil production might peak as soon as 2010.
In the United States, oil extraction never again matched the rate achieved about 1970. If no new supplies come on stream, the odds are that there will be a 20 percent supply-demand gap worldwide by 2020.
To Mr. John Q. Public, however, there is an air of unreality about such economic abstractions. Short of switching to pricey hybrid, compressed air or all-electric vehicles, all he knows is that he has precious few price alternatives in the gasoline, oils and lubricants market. And yet, he also has to contend with various imposts and excise taxes. In some countries, these levies amount to more than the cost of production and distribution combined.
Besides the cost of crude oil, the other components of the retail price of gasoline are taxes, refining, distribution, marketing and dealer full cost (including “fair profit”). Full cost recovery by refineries is significant, amounting to about a 19% share in the States, although different formulation requirements of individual states can raise this.
Taxes boost the final price of gasoline by at least as much. Even before factoring in country and local taxes, Federal and State excise taxes comprised around 19 percent of the retail cost of a gallon of gasoline.
At that, the American driver can count himself fortunate. Last month, a gallon retailed for $ 7.75 in the Netherlands. Over $4.00 of that were taxes, set high to discourage individual driving and encourage the Dutch to use public transportation to work
All in all, gasoline prices are high partly because of the long supply chain and because of public policy intervention with taxes as the implementing tool. By and large, however, the cartel-like behavior of OPEC and the long-term price trend of crude oil combine to cause the continuous rise in the price of gasoline at retail. As well, fluctuations in price are triggered by (often seasonal) fluctuations in the supply-demand equation.