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What's up with oil, gasoline prices?

With crude oil hitting record levels and gasoline prices nearing last summer's highs, a number of factors are affecting what you can expect to pay at the pump.
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With crude oil hitting record levels and gasoline prices nearing last summer's highs, a number of factors are affecting what you can expect to pay at the pump.

What are the main factors behind the rise in oil prices?
The price of oil is set by a global market of buyers and sellers — each look at a variety of factors before deciding how much they are willing to pay or accept for a barrel of crude. Some of those factors are short-term trends, such as weekly statistics on oil supplies in storage. Traders also look at economic trends that may indicate changes in demand for oil.

But since some traders have no intention of ever using the oil, prices can also move on just the potential for future changes in supply or demand. With continued signs of strong economic growth, and multiple hot spots in key oil producing countries, many of those traders make bets on little more than a news flash. And many are betting that prices will go higher.

Who is making money from all this?
Right now, oil producers — both countries and companies — are among the biggest winners. Though the market price for oil has doubled in the past two years, the cost of producing each new barrel hasn’t gone up much. That means most the rise in price is pure profit. That’s why big oil companies have been reporting huge profit gains in the past year. (Oil company profits are also bigger than other big companies because oil production is concentrated among relatively few players. Overall, the oil industry’s return on its investment is about average for large American corporations.)

The other big winners have been the investors — also known as speculators — who have bought and sold oil as the price has risen. Strong demand from these investors has also driven rising prices even higher. With interest rates and stock market returns relatively low, huge pools of capital have moved into this kind of commodity speculation looking for higher investment gains.

Aren’t oil companies and gasoline dealers just price gouging?
As long as the markets are working properly — both the global market for oil and the local market for gasoline at the pump — it’s tough to make the case for “gouging.” There are laws on the books in many states, usually invoked when a disaster like a hurricane brings a short-term cutoff of supplies, against profiting unfairly from these shortages. But so far, very few cases of gouging have been successfully prosecuted. As long as dealers don't get together and set prices (that's called price fixing), they're free to charge what they think the market will bear.

Some argue that the markets aren’t working properly because oil and gasoline production and refining is too concentrated in the U.S. But those U.S. suppliers still have to compete against imports of both crude oil and gasoline from foreign producers.

Given enough political pressure, there’s no reason Congress or the White House couldn’t impose a cap on U.S. gasoline prices. Many countries artificially control pump prices — either by heavily subsidizing gasoline to keep prices low or, more commonly, by imposing heavy taxes to reduce consumption. But price caps would do little to increase supply or cut demand, and some analysts believe price caps could bring outright shortages.

What’s the impact of regulations on gasoline for the summer?
There are two sets of regulations that could squeeze gasoline supplies this summer. Refiners have been working for several years to prepare for new low-sulfur refining requirements that begin to take effect in June. The new regulations have also meant changes for pipeline operators who ship gasoline and other refined products. If everything goes as planned, gasoline supplies won't be interrupted. But, much like the Y2K computer bug, no one will know for sure what the impact will be until the regulations take effect.

Refiners are also phasing out the use of an additive called Methyl tert-butyl ether, or MTBE, that is required in some regions of the country to cut air pollution during the summer months. Gasoline blended for winter has to be flushed out of the system and replaced with summer blends, which is one reason supplies are drawn down every spring: you can't sell winter gasoline in summer.

Because MTBE has been found to contaminate groundwater, refiners in many regions where it hasn't already been banned are replacing it this year with ethanol. But despite increases in ethanol production, it’s not clear that all refiners will be able to get enough to meet demand.  Part of the problem is that ethanol can’t be shipped by pipeline, so it has be transported by rail cars, which increases the shipment cost.

How much impact does the rise in oil price have on prices at the pump?
The cost of crude oil accounted for about 47 percent of the cost of a gallon of regular gas in 2004, the latest figures available from the Dept of Energy. Federal, state, and local taxes accounted for about 23 cents of every dollar spent at the pump. Uncle Sam gets about 18.4 cents per gallon and state and local taxes average about 21 cents — though state taxes vary widely.

Refining costs and profits take about 18 cents from every dollar spent to fill up your tank. The cost of distribution and marketing, along with retail dealer profits, together make up another 12 percent.

Gasoline prices are also affected by supply and demand, much the way crude oil prices move on the whims of market traders. Gasoline contracts are traded in the futures market, and wholesalers take their cue from those market prices. Retailers also factor in local conditions — like how many other outlets they’re competing with — when they decide what price to post.