Who decides the cost of gasoline?

Who decides the cost of gasoline?

One, one thousand. In the second that it took you to read that the United States of America used 4,611 gallons of gasoline. That’s right, we are consuming over 4,600 gallons of gasoline a second. We consume over 10,300 gallons of oil and petroleum products a second. And we still think we’re paying too much money for gasoline.

The easy answer to how the price of oil is decided is global supply and demand. The Department of Energy says the price of oil is about the same around the world if you don’t count in transportation or taxes. The United States, Japan, and Europe collectively use about fifty percent of the world’s oil consumed. But the rate of consumption in emerging markets, especially China, is growing at a much faster rate than the United States. But that is the easy answer.

Another factor in the price of gasoline is how much reserve we use. We traditionally have about 21 days supply of gasoline; not a whole lot. If Nigeria decided to force a point or a hurricane hit, we would have only 3 weeks supply at the rate of demand we use gasoline. If you take a look at the stockpile reserves you will see an inverted curve to the price of gasoline in many cases. This doesn’t happen when you overlay the supply numbers or the demand numbers.

Think of the stockpile reserve as your bank account. In order to balance it you take the ending balance from the previous month, less the amount you spend plus the amount you brought in and you have your current total stockpile reserve. Our current production of refined gasoline is only 263,000 barrels a day less than we are consuming. Why, then, are we still importing 1.2 million barrels per day of motor refined gasoline? Because our stockpile reserves are still low. In 1991 we had 30 days supply, this time last year we had 22.7 days of reserves; this week we are still only at 21.4 reserves of motor refined gasoline.

Refined motor gasoline costs us more on our trade deficit, but doesn’t always have an effect on the price of gasoline, as is the case this week. Gasoline is going down because our production is up, there are no major problems globally and the hurricane season isn’t in turmoil. That’s the second easy answer.

Another component that is harder to grasp is that oil is a commodity and like all commodities, oil is traded on the stock market. Just like all other commodities on the stock market people speculate on oil, whether it will go up or down in price. People will also speculate on the volatility, betting (if you will) on whether there will be a hurricane or a war and what that will do to the price of oil. These people do not buy or sell oil, they buy and sell speculation, paper contracts. There are two primary markets where paper barrels of oil are traded in the futures arena.

You have the spot market and the futures market. When a company buys on the spot market they are buying and selling oil for cash and it is delivered immediately. The market that most people trade oil on is the New York Mercantile Exchange (NYMEX) and the second one in London is called the International Petroleum Exchange (IPE). The NYMEX trades on the West Texas Intermediate (WTI) oil, London trades on Brent crude, which is why you see shows such as CNBC report the WTI price. Countries pay the same for oil, but you will see a difference in the price of oil-based on the grade of oil and transportation costs.

Think of time; all time is based on Greenwich Mean Time. Oil works the same way. If the grade of oil is higher than WTI, the price will be higher. Transportation costs are based on Cushing, Oklahoma, known “the pipeline crossroads of the world”, and how many miles it has to travel from there. The current spot market price for oil will be influenced by the futures market because people that trade believe the futures market is an indication of where prices are headed. There are groups that question whether these traders should be allowed to bet on such a valuable commodity because it does have an influence on the price of oil. But how? Some people are hedging their bets, such as wildcatter T Boone Pickens did back in ’86.

Margonelli’s book tells of how Pickens thought the price of oil was going to fall, so he hedged his oil at $28 a barrel. Indeed, it did fall and he made a killing. People understand trading when you buy low and sell high, we do that when we see the price of gasoline going up at the tank; we all drive our cars to the station and fill up to save a couple of cents. When trading in futures one can sell before they buy and buy after they sell, without taking delivery of the product, as long as they do all of their transactions before the expiration date. Margonelli goes on to say that only 5 percent of the oil futures traded on the NYMEX actually gets delivered.

Since oil is such a big part of our national security there are people who think it shouldn’t be allowed to be traded because they don’t want to see the price of gasoline go up because one greedy person wants to make money. And there have been attempts to manipulate the market with terrorist acts. In Lisa Margonelli’s book, Oil on the Brain, “In 1997 police arrested members of the KKK who intended to blow up a gas pipeline to finance other terrorist activities. In 1999 Vancouver police arrested a man who had explosives and enough timers for fourteen bombs. He was planning to blow up the Alaskan pipeline so he’d make money in the oil futures.”

By the way, last week, June 15, 2007, we used 4,662 gallons of gasoline a second.

One, One thousand.