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Why is gas so expensive?

August 1, 2008

The news at the pump is grim: With the average cost of a gallon of gas well above $4 and rising, people are asking, "What happened?" Unfortunately, there is no simple answer. But here is what government and industry experts say are some key factors that impact fuel prices:

Rising demand, dwindling supply. Like every commodity, gasoline's cost is determined by supply, demand and competition. The odds are stacked against us on all three fronts:

  • As easy–to–drill crude oil supplies become tapped out, increasingly costly exploration into the far reaches of the world – combined with ever more complex and expensive oil extraction techniques – are required to increase supply.
  • World demand for fuel has risen exponentially, as developing nations like China and India clamor for a larger share of fuel.
  • The vast majority (over 90 percent) of the world's oil reserves are controlled by nationalized oil companies – many of which are in unstable areas like the Middle East, Nigeria, Libya and Venezuela.

Component costs of gas. According to the Department of Energy, the breakdown for the four cost components of a gallon of gas is:

  • Crude oil costs. The vast majority of the cost – approximately 75 percent – derives from the price oil refining companies pay for crude oil. So, for example, when host countries ratchet up the price of crude oil as they have lately, fuel costs at the pump quickly follow suit.
  • Taxes. Federal, state and local taxes account for about 10 percent of the cost, on average.
  • Refining. About 10 percent of the price reflects the operational cost to and profit by the company that refines the crude oil into useable products, such as gasoline.
  • Distribution and marketing. The remaining 5 percent is the average retail price of gas at the pump minus the sum of the other three components, as well as costs associated with operating gas stations.

Gas station expenses. The price can also reflect the costs associated with operating a service station, including expenses for rent, salaries and accepting payment through credit and debit cards, if station operators choose to do so. One component of the cost to accept cards, which gas retailers' pay to their banks, is interchange fees, which enable the payment system to function.

To help ease the pain at the pump, Visa recently capped the per–transaction interchange fee for Visa–branded consumer debit card purchases at $0.95 per transaction. A similar fee restructuring is also in place for Visa credit card fuel purchases. On a $60 fill–up, this reduction yields a 14 percent savings in interchange fees; for a $120 fill–up, the interchange savings would be 43 percent.

Visa's hope is that oil companies will in turn pass some of these savings along to their stations and ultimately to customers, who are bearing the brunt of gas sticker shock.

Knowing why gasoline is so expensive doesn't make it any less painful on your wallet, but it should help you better understand the facts behind who is part of the problem and who is working to be part of the solution.

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This article is intended to provide general information and should not be considered health, legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.

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