—>Did you know that gas price gouging almost never occurs as prices rise? Rather, it’s most often when dealers keep prices artificially high even as their costs fall. As gas costs were near $5 a gallon until falling and oil companies earn around $100 billion each year, it’s a good time to question what really goes into the price of gas. The numbers on the gas station sign hide a complex set of transactions. Before gas can power your car, it must be discovered as crude oil, traverse three markets, and be refined from crude into gas. Inside, we’ll explain the three markets, walk you through the role of refineries, and show how oil companies use creative tactics to manipulate gas prices…
The Three Markets: Contract, Spot and Futures
Both oil and gas are traded on three markets: the contract market, the spot market, and the futures market. Each is influenced by different factors and impacts the price of gas at different stages of production. Unlike the futures market, the contract and spot markets are not the kind of markets found on Wall Street; they are informal networks of businesspeople.
The Contract Market
Though it seems like oil companies spend most of their time ruining your day by raising the price of gas, their primary business is exploration. Once an oil company finds a field and coaxes it into producing crude, it takes that unrefined oil and sells to refiners. The vast majority of oil is sold by contracts. A veritable orgy of contracts signed between oil companies and dealers, oil companies and refiners, refiners and independent dealers predetermine the fate of most oil and gas.
Refiners plan their purchasing and refining activity to ensure that these contracts are fulfilled. In exchanged for this privileged standing, refiners charge contract customers a premium.
The Spot Market
Need some extra oil? Got a spare barrel you need to sell today? The spot market is for you. The spot market fills the gap left by the contracts market. When a refiner needs extra oil to meet its contracts, they find people with surplus oil on the spot market. Unlike the contract and futures markets, which trade pieces of paper, the spot market involves the trade of actual barrels.
The best deals are often found on the spot market. Since neither the buyer or seller is locked into a prearranged deal, the laws of supply, demand, and free market are mostly in effect.
The Futures Market
Crude oil is the bees knees of the American Mercantile Exchange. A futures contract might stand for 1,000 barrels of West Texas Intermediate to be delivered at Cushing, Oklahoma. The futures market represents that collective state of the oil market at any particular moment. When you hear reporters talk about the price of oil reaching $100 per barrel, they’re talking about the futures market. Because fluctuations on the futures market are driven by information, its prices guide the contract and spot markets.
The people buying and selling futures rarely, if ever, collect on their contracts; a seven year period saw 5 billion barrels traded, of which only 31,000 were ever delivered.
Refineries
Refineries are the temples where crude oil gets Bar Mitzvah’d into gas. Shifts in the refining world over the past two decades have helped ratchet up the price of gas. In the early 80′s, there were over 350 refineries, mostly owned by the oil companies. The oil companies didn’t see refining as a place to generate profit, but as an integral part of a larger operation.
If a refiner’s rack price is consistently too high, dealers will take their business elsewhere when their contracts expire. If the rack price is too low, buyers might swamp the refiner, leaving it unable to meet its contractual obligations.
To ensure pricing continuity, refiners used to call each other and share pricing information. Activist judges on the Supreme Court called this “collusion.” The refiners, unfazed by the justices, came up with a crafty alternative: publicly posting their rack prices. Somehow, the Ninth Circuit Court found this to be illegal, too. Nobody knows how refiners discuss their pricing arrangements nowadays, but we wouldn’t be surprised if it involved a members-only group on Facebook.
Despite multiple warnings, the American political system is so dysfunctional that very little has changed since a president named Jimmy Carter tried to get us to get serious about reducing our dependence on gasoline. Oh, cars and trucks get better gas mileage than they did back then. But the nation still lacks a coherent policy for radically reducing consumption.
The frustration over prices at the pump is likely a major contributor to Obama’s sagging approval ratings.
Earlier this month, Gallup’s daily tracking poll showed that the president’s favorability rating had slipped to 41 percent, tied with his lowest ever. Voters tend to blame the person in the Oval Office when gas prices soar.
I understand the frustration. Families struggling in the post-recession economic landscape — some still jobless, many earning less than they used to — are hard-pressed to fork over more and more money at the gas pump.
And for many of those families, driving has become a necessity. They’re not taking leisurely spring-break road trips. They’re trying to get to work, to the doctor’s office, to the grocery store.
Over the last 30 years, suburban and exurban development, especially in fast-growing Sunbelt cities, have produced sprawling mega-lopolises, wherein workers may live an hour’s drive (or more) from the workplace. Those suburbs aren’t exclusive enclaves of the affluent, either. Many suburbs are economically and racially diverse, so more families of modest means live far from work. A dime a gallon can break the budget.