The Real Reason for High Gas Prices

For much of this year, gas prices have been sky-high. Consumers and businesses alike have felt the pain. Trucking and distribution companies, as well as the airlines, are just some of the businesses hurt by higher fuel costs. For consumers, the impact is more obvious -- more money spent on fuel means less money to spend on other items.

Why has gas been so expensive this year? And while prices have recently started to fall, what does the future hold?

The gas price puzzle
The fact that gasoline prices have been so high this year is understandably baffling. Domestic production of gasoline's biggest component, crude oil, is surging while, at the same time, imports are falling.

Meanwhile, the demand for gas has been falling sharply over the past five years. Since 2007, Americans have been driving fewer and fewer miles because of tough economic times and the aging of baby boomers. They've also been trading their older gas-guzzlers for newer, more fuel-efficient vehicles, as well as switching over to alternative means of transportation.

So with domestic supply up and gasoline demand down, why have some consumers been shelling out more than four bucks for a gallon of gas?

Why gas prices have been so high
To answer that question, let's take a look at what consumers paid for in a gallon of gas in March.

As you can see, crude oil makes up the bulk of the price you pay at the pump. So to understand gas prices, we have to look at the factors driving the price of crude oil.

While speculation and the value of the dollar do play a role, crude oil prices in the long run are driven primarily by global demand and supply fundamentals.

A growing global economy demands more industrial resources, and oil, the so-called lifeblood of modern economies, is at the top of that list. For much of the past decade, stronger growth in emerging markets such as China and India has sent global demand skyrocketing. So while surging domestic production may have reduced our reliance on imports, our pump prices are still captive to the supply and demand fundamentals of a global marketplace.

Reductions in global supply, especially when unexpected, play an important role as well. In the first quarter of the year, non-OPEC supplies, which comprise 60% of the world total, fell by 750,000 barrels a day. Reduced output from non-OPEC countries raises the market's reliance on OPEC's spare capacity, which tends to raise prices.

And finally, there's Iran. As the world's fifth largest oil producer, just the threat of a supply disruption in the region caused prices to spike. Concerns regarding Iran's nuclear program resulted in what energy analysts call the "Iran premium" built into oil prices, which kept them significantly more elevated than they otherwise would have been.

But in the past month or so, favorable developments in the global oil market have gradually started to ease the pain at the pump.

Why gas prices have started to fall
Gasoline prices fell to a national average of $3.71 per gallon recently, down from an early April high of $3.94 per gallon. As we head into the Memorial Day weekend, consumers can expect further declines with some estimates projecting a national average of $3.60 a gallon. According to the Oil Price Information Service's chief oil analyst, several parts of the country could see prices as low as $3.25 during the long holiday weekend.

The main reason? Crude oil fell to a six-month low last week and is down 11% this quarter. After months of global supply issues, oil inventories are back on the rise, boosted by improved capacity in Saudi Arabia and increased production from Iraq and Libya. In addition, weaker economic growth in Europe and the U.S. has helped curb global demand. And finally, tensions regarding Iran's nuclear program appear to be easing, though they remain one of the biggest threats to another price hike.

According to a forecast by the Energy Information Administration, gas should average $3.79 per gallon during the summer driving season. While still slightly higher than last summer's average, it's a far cry from earlier predictions of four to five bucks a gallon.

Implications for oil companies
When the price of oil rises, it tends to benefit certain oil companies. Conversely, when the price of oil falls, these companies see lower returns. The more levered the company, the greater the reaction to the oil price movement.

For example, a giant like ExxonMobil (NYSE: XOM  ) would not be nearly as heavily affected by a large movement in the price of oil as other companies like Murphy (NYSE: MUR  ) , Hess (NYSE: HES  ) , or Apache (NYSE: APA  ) . Indeed, the data support this observation. Since crude oil peaked in mid-March, shares of Murphy, Hess, and Apache have all followed a downward trend.

While these firms tend to rise and fall with oil prices, one company has found ways to profit regardless of price fluctuations. It's an under-the-radar oil and gas equipment provider that's set to crush the market. You can read about it in The Motley Fool's special free report "The Only Energy Stock You'll Ever Need." Find out the name of this company before the market catches on. Click here to access your report -- it's totally free.  

Fool contributor Arjun Sreekumar does not own shares of any companies listed above. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 25, 2012, at 5:15 PM, merz0024 wrote:

    Why are we still using a 250-year old economic model to explain a system that doesn't adhere to it?

    Every price move you will ever see in the oil market is dictated by risk/reward and rumors.

  • Report this Comment On May 26, 2012, at 11:53 AM, GrumpyOldGuy wrote:

    Even if I took everything in this article at face value there are still unexplained occurances. Such as, (1) gas prices recently reached levels near where they were when oil was at $145.00 a barrel. (2)In Portland, Oregon gas was selling for $4.20/gallon Thursday, Friday it went to $4.35/gallon.

  • Report this Comment On May 27, 2012, at 11:01 AM, PEStudent wrote:

    Exxon-Mobil claims that only 6% of its profits are from gasoline sales in America. Since their 2011 profit was $39.9B, then $2.4B was from U.S. gasoline sales. In 2011, the U.S. Energy Information Agency tells us 134B gallons of gasoline were sold in America, 6.8% of it by Exxon. That's 9.1B gallons of gas. So Exxon profits $2.4/9.1 = 26 cents per gallon of gas in the USA. They claim they profit 7 cents! Conveniently they separate their production, refinery, and retail sales and make it look like their only profit comes from retail.

    Similarly, my purchasing company could buy baseballs for $7, sell them to my distribution company for $22, then sell them to the local little league for $21, and tell the little leaguers' parents (and the IRS) that I was taking a $1/baseball tax loss on the baseballs! Now if I could bribe enough Congressmen to give my purchasing company huge tax breaks, I would still be profiting by 200% on the baseballs, but I could claim a tax loss! And articles written by low-math skill writers, content to parrot my claims, would be championing my claim that I'm losing money! Similar to what this article is doing for Exxon!

    So a major fault of this article is the cost of the crude oil. For most of the oil pumped in the USA, the oil companies pay an average $6.65 in royalties to the U.S. taxpayer and $2.50 to pump and transport it. It then sells it to it's own refineries for $100. So the "69%" of the cost of making gasoline is based on the $100, not the actual $9.15 it costs the oil company.

    When the price of raw materials goes up for companies, they almost universally have lower profits. But the reverse occurs for the oil companies!

    During the year we went into a tremendous recession, 2008, one reason was the price of gasoline (over $4/gallon), yet Exxon-Mobil didn't just beat its all-time record profit, it QUADRUPLED it! Did they and their equally-enriched competitors drop the price of gasoline to help save Americans from much tragedy? Not a cent!

    Note that Venezeula's Citgo paid for heating oil for hundreds of thousands of Americans who couldn't foot the suddenly-high fuel oil bill. One American Veteran said on Citgo's commercials: "I almost froze to death fighting for America in the Korean War: I never thought my country would let me freeze to death at home in my old age."

    And Exxon-Mobil, Chevron, etc? Their attitude is "let 'em freeze."

    So my attitude toward the so-called "American" oil companies: let 'em pay.

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