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Why Are Petroleum Retail Prices so Erratic?

May 14, 2011

Do you know where your petroleum dollars go? With all the market dynamics skyrocketing then dropping petroleum prices, a look at the components that makeup petroleum prices is far overdue.  Several of my previous discussions, clearly showed the historical rollercoaster ride in at the pump prices of petroleum, see “Exxon Mobil and Shell Report Soaring Profits,” and “Petroleum Retail Price Played by the Oil Industry!”

This discussion attempts to better understand why petroleum retail and crude oil prices are so erratic.

Historically, the chart above below shows the average annual retail petroleum as prices in nominal terms (what you actually pay) and in inflation adjusted terms (red line) from 1918 to 2009.

Source:, July 21, 2010

According to, the chart shows:
• “…..the average price of a gallon of gas from 1918 to 2009 was $2.39 in inflation adjusted dollars.”
• “….. anytime during that period when the price of gas was above $2.39 in inflation adjusted terms it was expensive and whenever it was below that price it was cheap”
• “….. then in 1988 gas was very cheap but in 1981 and in 2008 it was extremely expensive on a historical basis.”
• “….. 1980 – 81 the gas prices rose above $1.00 for the first time.”
• “….. four years earlier in 1976 gas was $0.60 per gallon and in 1969 it was only $0.35 a gallon.”
• “….. In 1981, $1.35 would be the equivalent of $3.24 in inflation adjusted terms for 2010 dollars.”
• “….. from 1998 where the average price was $1.02 and by July 2008 it had increased to $4.02, a 294% increase in 10 years.”
• “….. 1998 gas had gotten really cheap allowing people to buy gas guzzlers like SUV’s and Hummers. But that reversed in 2008 as prices rose above the long term average.”
• “….. for 2009 at $2.34 it was extremely close to the long term average price of $2.39.

What we currently pay for in a gallon of regular gasoline is shown in the following graphic. The primary price components include the cost of Crude Oil, Refining, Distribution & Marketing and taxes. Not surprising, the major factor in the price of petroleum is crude oil.

The contribution of Crude Oil to at-the-pump price of petroleum is further reinforced by the following graph showing the relationship of these four components from the year 2000 to the present.

Source:, July 21, 2010

During this period, crude oil remained the primary component of petroleum but increased from a low of 41% in 2002 to a high of 72% in 2008. Currently, crude oil remains relatively high at 68%. Interesting, the tax component dropped from a high of 33% in 2002 to a low of 11% as of March 2011.

Since oil in the major cost component in petroleum, a deeper look at crude pricing is warranted but not as straightforward. Prices for crude are very volatile and change each and every second. What causes the crude prices to change so frequently? To begin with let us understand why crude oil is so expensive or what all factors determine or derive the prices of crude oil. Factors leading to crude prices are reported by Oiltrades ( to be:

Demand for Oil
1. Fuel Needs – More demand for a commodity deader it is likely to get. The summer season driving generally leads to an incremental demand for fuel which pushes the crude price upwards. An opposite trend is prevalent in winters as far driving demand is concerned.

2. Heating Needs – Crude is also basic source to meet the heating requirements during winter season. Therefore its demand to meet the heating needs is increased in winter season pushing the prices upwards.

3. World Economy – As lot of crude oil goes into fuelling requirements of many industries (both for running the industries and transportation of raw materials and finished goods) around the world, as robust world economy would mean greater demand for crude and vice versa.

4. Commodity Exchanges – As crude is traded as a commodity on futures exchange the speculative trends are responsible for increase and decrease of crude oil pricing.

Supply for Oil
1. Supplier Groups – Organization of the Petroleum Exporting Countries (OPEC) is a supplier group that controls 46% of the world’s supply of the crude. These groups based out of various different factors can decide to increase or decrease supply application of crude oil directly affecting the prices in the international markets. OPEC member countries were quick to realise that they controlled major chunk of world’s oil economy and if they compete against each other their net realizations will be very low. So they decided to form a cartel which takes joint decisions with regarding to controlling of oil supply and prices.

2. War Situation – As production of crude oil is limited to a geographical region, any unrest in these areas can limit the crude supply in the world market leading to instant rise in oil prices. World witnessed this phenomena at the time of Gulf war when the oil prices went shy high. Now international community as a whole takes care that peace prevails in this region and local legitimate interests could be protected.

Political unrest can restrict access to that country and importing and exporting from that country can become more difficult. This leads in a perception of a decrease in supply, which according to the economic principle of supply and demand, will cause the price of oil per barrel to rise. Notice, there may not be an actual decrease in supply, but the perception is enough to cause prices to fluctuate.

3. Bilateral Treaties – Bilateral treaties between two countries concerning supply of oil can also control oil prices and its supply.

4. The American Dollar – The U.S. dollar is the currency most often used when talking about the crude oil industry. It is devalued as crude oil prices go up. A dollar buys less oil, therefore causing inflation in countries that drill and export oil but don’t use the dollar as their primary form of currency. As inflation rises, it affects non-dollar economies negatively. Because global economies are very interlinked, these economies then affect others, causing the global economy as a whole to struggle.

5. Global Economy – Crude oil prices are a great example on how global our economy has become. Even though we have different political and economic systems worldwide, the web we’ve created of importing and exporting miscellaneous goods ends up being both good and bad. Political unrest, market crashes, or supply and demand issues in one country can affect the whole world, and crude oil exemplifies that perfectly, especially with what’s going on today.

These factors based on supply and demand theory and traditional market dynamics seem reasonable. Nevertheless, there is a feeling that some other insidious factors maybe behind the makeup of crude oil pricing behavior. Recent news worthy columns suggest some stealthily activities, such as:

• AA asks European Union to investigate oil market manipulation …, Apr 28, 2011 … AA asks European Union to investigate oil market manipulation … All these companies have benefited from soaring crude prices which …

• Raymond J. Learsy: Oil Market Manipulation has Crude Prices Sky High, Aug 23, 2010 … The current price of crude taken together with the country’s jobless rate makes no sense at all. Clearly the price of oil has lost all …

• Feds Strengthen Ability to Combat Gas Price Manipulation, Apr 14, 2011 … “We urge you to use this authority aggressively to ensure that recent crude oil market price spikes and volatility are not the result of …

• Oil prices to be probed by US regulator CFTC –, May 30, 2008… market manipulation in the US crude oil market amid record prices which … Oil prices fell yesterday after the US Energy Information …

• Obama team to probe oil market manipulation, Reuters Apr 21, 2011 … Instant view: Obama team to probe oil market manipulation … U.S. crude oil prices shot to over $113 a barrel this month, the highest level …

• Government uncovers oil price manipulation – Jul. 24, 2008Jul 24, 2008 … In May, under the backdrop of record oil prices and calls from legislators to crack down on speculative oil trading and market manipulation, the CFTC … not ultimately use crude oil – are to blame for the rising prices. …

• The Great Oil Price Swindle- Market Manipulation or Fraud? :: The …, May 31, 2008 … What’s Next for the Stock Market, Gold, Silver and Crude Oil – …. surge in prices to record levels is the result of manipulation or fraud. …

• Think Progress » The Contango Game: How Koch Industries Manipulates …Apr 13, 2011 … CHANG: The drop in crude oil prices from more than US$145 per barrel … allow us to benefit from the contango market where crude prices are …

• Traders – Understanding Market Manipulation Crude Oil – Nov 25 …Traders – Understanding Market Manipulation Crude Oil – Nov 25 … hidden relationship between price, spread and volume to counter market manipulation. …

• Probe of Crude Oil Trading Disclosed –, May 30, 2008 … Yesterday was another chaotic day for crude oil prices, … people from market manipulation during a time of record prices at the pump.” …

Inclosing, the prices we pay to fill-up at the pump are derived from a highly integrated set of domestic, global and geo-political factors overwritten by classical human behavior.  As plausible as these explanations tend to be, their complexity and unpredictability provides a lock of understanding that opens the door to misuse and abuse.

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