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Personal Finance: What's up with gas prices?



Those who took to the streets on Memorial Day weekend last week will undoubtedly feel the higher gasoline prices, which have risen by an average of 30 percent over the previous year. AAA reports that the average price for a gallon regular Monday was just under $ 3, compared to $ 2.37 a year ago. As we all stuff more dollar bills into the tank, it is useful (if not necessarily palliative) to understand how gas prices are determined.

The first commercial oil well was drilled in 1859 in Titusville, Pennsylvania to produce kerosene replacing whale oil as fuel for oil lamps. Gasoline, a by-product of the refining process, was initially discarded as a waste product. In 1

892, the development of the automobile created a market for gas, which has since played an important role in the world economy.

The retail price of a gallon of gas is made up of four main factors. Most important is the price of the raw material crude oil. The value of an oil barrel varies according to supply and demand factors on the world market and accounts for 50 percent of gasoline prices. Recent production cuts by OPEC, geopolitical disruptions in Venezuela, Libya and Iran, as well as growing global demand driven by economic growth, have significantly increased oil prices over the past year, accounting for the lion's share of the rise in gas prices.

The next important component of fuel prices are federal, state and local taxes. Gas taxes now account for 19 percent of the regular gas price or 56 cents per gallon. Uncle Sam's intake is 18.4 cents (last increased in 1993). Rates vary widely from 58 cents a gallon in Pennsylvania to just 12 cents in Alaska, and local taxes averaged 4 cents a gallon. Tax revenues from fuel sales are usually earmarked for the construction and maintenance of roads.

The third factor in determining retail prices is sales and marketing. This component includes transportation costs from the refinery to the pump, blending with additives or ethanol, advertising, overhead and merchant profits. These items contribute about 17 percent or about 50 cents of the selling price.

After all, 14 percent of the retail price of gas accounts for refining costs and profits. The conversion of crude oil into useful commodities such as gasoline, diesel fuel and other petroleum products is a complex process that accounts for about 42 cents per gallon of the current gas price. There are currently about 140 mineral oil refineries in the US, compared to 164 just 20 years ago.

Most of us have observed significant fluctuations in gas prices even in times of relatively stable oil prices. In the short term, the price of pumps will rise in response to seasonal increases in demand as motorists drive more in the summer. In addition, AAA expects a 5 percent increase in the number of kilometers driven this summer compared to the last, increasing gas demand.

In addition, the refining performance is also subject to seasonal fluctuations. Federal and state environmental regulations require a reformulation of fuels in the summer to reduce the volatility (evaporation tendency) in the hotter months. Reformulated gas is more expensive and refineries close in the spring to convert, which limits supply during the changeover. On average, gas prices in August are 36 cents higher than in January due to purely seasonal factors.

Expect gas prices to retreat as heavy summer travel lasts, refineries switch to cheaper winter gas blends, and domestic oil production in the US continues to expand. Happy driving!

Christopher A. Hopkins, CFA, is Vice President and Portfolio Manager for Barnett & Co. in Chattanooga.


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