The price of crude hit yet another record high on Tuesday, rising briefly to more than $70 a barrel. Meanwhile, a gallon of gasoline in the United States costs an average $2.72, almost 75 cents more than it did a year ago. Slate readers often e-mail to ask how the two prices are related and how gas prices work in the first place. Today, the Explainer addresses their queries.
Rising oil prices are sometimes blamed on diminished capacity at U.S. refineries. Isn't that counterintuitive?
Yes. When American refineries shut down or reduce production, they stop buying crude oil. And when U.S. demand for crude oil goes down, you'd think prices would drop accordingly. But for some reason, when refineries shut down—as many feared they would in the face of Hurricane Katrina—the price of oil actually goes up.
The most likely explanation for this unusual effect goes as follows: First, the shutdown of refineries reduces the supply of gasoline (which is a refined oil product) and therefore increases its price. Other refineries then try to take advantage of higher gas prices by increasing their production. To increase production, they need more crude oil, so they start bidding from suppliers on what may be unfavorable, spur-of-the-moment terms. This could cause the price of oil to increase.
Why are gas prices at the pump always listed to nine-tenths of a cent?
No one seems to know exactly where or when the practice originated, but everyone agrees gas was sold at the pump in fractions of a cent at least as far back as the 1920s or 1930s, when automobile culture really began to take off.
Some say that the fractional pricing was introduced in response to federal gasoline taxes that were themselves assessed in parts of a cent. Others say that tiny price changes of a tenth of a cent were more significant back when a gallon of gasoline didn't cost much more than a dime. And everyone agrees that pricing at nine-tenths of a cent gives the station owner the same advantage a grocer might get for charging $1.99 rather than a whopping $2.00 for a bottle of sparkling water.
Whatever its origin, the practice is now built in to the pricing system. Federal and state taxes on gasoline still work out to a fraction of a cent per gallon and get paid when distributors purchase fuel from the refineries. The distributors who sell to the filling stations often set their prices such that the total after tax ends with nine-tenths of a cent. The station owner who buys it can then just mark up the price by a few whole cents and pass along the nine-tenths to the consumer.
In the 1980s the government of Iowa abolished nine-tenths-pricing on the grounds that it was deceptive but then rescinded the ban four years later.
In the last year, retail gas and crude oil prices have both gone up by about 40 percent. Do prices at the pump always follow oil prices so closely?
Though gasoline is made from crude oil, the price of oil doesn't by itself determine the price of gas. When you buy gas at the pump, you're paying for the crude oil, but you're also paying for a refinery to convert that oil into gas. You're also covering the marketing and distribution of that gas, as well as the profits taken out by each middleman along the distribution chain. Taxes push up the price even more. According to the Energy Information Administration, the price of crude oil accounted for only 44 percent of the price of gasoline in 2003.
Prices at the pump seem to go up as soon as the price of oil rises. But station owners aren't selling gas made from that oil. What gives?
When the price of oil goes up, some station owners adjust their prices at the pump to prepare for an increase in wholesale gas prices down the line. Once wholesale gas prices do go up, there isn't much delay before station owners feel the pinch: A busy station gets shipments every day, or even multiple times per day, so it's likely to face any price hikes as soon as they occur. Long-term supply contracts between station owners and their suppliers are no help: They often stipulate a floating price pegged to the cost charged at the refineries. So, a price change at the refinery would quickly pass along to a station owner.
Explainer thanks Neal Davis, of the Energy Information Administration, John Felmy of the American Petroleum Institute, Bob Slaughter of the National Petrochemical and Refiners Association, Greg Scott of the Society of Independent Gasoline Marketers of America, Tom Dicke of Southwest Missouri State University.