What goes into the price of gasoline?

It's been a wild ride for gasoline prices over the past two years. Canadians grew accustomed to record prices that peaked in the summer of 2008 at an average of $1.40 a litre.

And just as quickly as prices hit those highs, the bottom fell out of the crude oil market. The price of a barrel of oil which had peaked at close to $150 US in July, fell to under $40 a barrel by December.

Gasoline prices in parts of Canada dipped to below 70 cents a litre for the first time in years.

Throughout the wild ride, Canadians were asking questions:

• How can prices go up and down (usually up) so quickly? 
• Why do prices seem to rise just before the weekend? 
• Why are prices all the same? 
• Why don't we see gas price wars any more?

Talk of conspiracy mingles with the gas fumes. Many people just don't seem to accept the oil industry's explanations — supply problems, refinery breakdowns, bad weather, seasonal demand, and so on.

So what exactly goes into that final pump price? There are three main drivers. The cost of crude oil is obviously one. The others include refining and marketing costs and taxes. And while it's tempting to link the rising cost at the pump simply to the rising cost of crude, that's not the whole story.

Crude remarks

First, let's look at how the price of crude fits into the picture. Since gasoline is made from crude oil, it comes as no surprise that this is by far the biggest factor affecting what we pay at the gas pump. The 

international yardstick used to measure crude oil is the barrel - even though it's impossible to actually buy one of these barrels. (Don't confuse a barrel with an oil drum, which contains 55 U.S. gallons.) A barrel of oil contains 42 U.S. gallons, which is equivalent to about 159 litres. From there, some simple arithmetic can give a rough guide to show crude's influence on gasoline prices.

Let's take the early May 2008 crude oil price of $125 US a barrel (oil is always priced in U.S. dollars). At 159 litres per barrel, $125 US crude works out to about 78 cents US a litre. Since the Canadian and U.S. dollars were very close to par in mid-April, no adjustment for currency conversion is needed.

So let's assume 78 cents of every litre of regular gasoline would be due to the cost of the crude. What accounts for the rest? For a big chunk of that, it's necessary to look at two (or sometimes three) levels of government.

The tax bite

You've no doubt seen the stickers on gas pumps that show how much of your gas dollar is spent on taxes. And while it's true that the various taxes on fuel do add up, they aren't the biggest culprits when you notice that pump prices have suddenly risen by five cents a litre for no apparent reason.

Let's look at the effect of taxes. First, there's the federal excise tax on gasoline. That's a flat 10 cents a litre — enough to raise about $4 billion a year for the federal treasury.

Add to that provincial flat taxes that range from a low of 6.2 cents a litre in Yukon to 16.5 cents a litre in Newfoundland and Labrador. Add five per cent GST (or 13 per cent HST in Newfoundland and Labrador, Nova Scotia and New Brunswick) and you complete the tax picture. Almost. Quebec also applies provincial sales tax. Three cities also impose a tax on gasoline — 1.5 cents a litre in Montreal, 12 cents a litre in Vancouver and 3.5 cents a litre in Victoria.

Add it all up, and you get a national tax average of about 32 cents a litre, according to April 2009 figures from Natural Resources Canada. A similar estimate comes from Calgary-based MJ Ervin & Associates, an independent consulting firm that publishes a widely watched weekly pump price survey.

Refining and marketing margins

Crude oil must be refined to turn it into fuel that can be used in cars. The refiner's margin is the difference between what the refiner pays for crude oil and what gasoline can sell for in the wholesale market.

Once crude is refined into gasoline, it is sold to marketers or distributors, who then pass along higher prices to the grumbling motorist filling up at the local gas station.

Figure on at least 13 cents a litre for the refining and marketing costs and margins, again according to Natural Resources Canada figures. This amount varies from region to region. Since January 2008, the national average has been 18.4 cents a litre — with a range of 11.8 cents a litre to 26.8 cents a litre.

So, for May 2008, we have about 78 cents for the crude costs, about 32 to 33 cents for taxes, 13 to 14 cents for refining and marketing. Do a little rounding and you come up with about $1.24 a litre, which was close to the average price of a litre of gasoline that month.

For April 2009, oil averaged $49.36 US a barrel, making the crude oil component of a litre of gasoline about 31 cents US — or approximately 38 cents Cdn, factoring in the exchange rate. Add 31 cents for taxes and 20.2 for refiner and marketing margins and you get 89.2 cents a litre — again, close to the average price of gasoline that month.

The charts below illustrate how gas and oil prices have fluctuated since January 2008. For each month, we took the average national price of a litre of gasoline and compared it to the cost of a barrel of oil.

The first chart breaks down monthly changes in the cost of each component of a litre of gasoline.

The second chart tracks the percentage change in the average national price of a litre of gasoline and a barrel of oil.

But the final cost of gas is more than just the sum of crude oil costs, taxes and refining and marketing margins. The price you pay is also subject to "market forces."

What's the outlook during the 2009 recession?

Gas and oil prices bottomed out in December 2008, as the worldwide economy went into freefall. But prices have been steadily increasing since then. By the second week of May, the price of a barrel of crude topped $60 US and — across the country — the average price of a litre approached $1 as Canadians prepared for the first long weekend of the summer driving season.

But most market watchers are suggesting we won't see the same spike in prices in 2009 that we saw a year ago. Demand for oil remains sluggish. The Paris-based International Energy Agency is forecasting a three per cent drop in global oil consumption in 2009.

The Organization of Petroleum Exporting Countries (OPEC) predicts global oil demand will drop two per cent this year, despite talk of economic recovery in China and hints of the return of some growth to North America sometime in the next few months.

In the United States, the Energy Information Administration says the U.S. has more crude oil in storage than at any time since 1990.

That should mean somewhat stable prices for the next while depending — of course — on those market forces and unforeseen circumstances.

Are we being gouged?

That's a question that often comes up — especially when we're having to hand over $10 more to fill up our car than we did a month earlier.

As with the crude oil market, the wholesale gasoline market is completely unregulated — it responds to typical supply and demand factors. High gasoline inventories and low demand lead to lower wholesale prices; the reverse will lead to higher prices.

Sometimes, the wholesale gasoline market reacts with shocking speed and force to very temporary situations. The 9/11 attacks led to a slight increase in crude prices, but a huge jump in gasoline prices. The same thing happened after hurricanes Katrina and Rita in summer 2005.

It is, of course, the integrated oil industry that controls many of the supply levers between oil field and gas pump — a situation that leaves skeptics shaking their heads at industry denials of price-gouging.

'Gouging' or 'market forces'?

Weather and the other reasons offered up by the industry are just too convenient, according to some observers. Hugh Mackenzie, a research associate at the Canadian Centre for Policy Alternatives, says there's no question Canadian motorists are being gouged. He's taken a look at the levels pump prices are at and compared them to where they should be, given current oil prices, taxes and "typical" refining and marketing margins.

In the summer of 2005, crude prices rose by $10 US a barrel. Mackenzie says that would have justified a 7.9-cent-a-litre increase in gas prices. Instead, we saw prices rise by 40 cents a litre by Labour Day weekend after Hurricane Katrina blew through. "Just plain gouging," says Mackenzie.

Based on Mackenzie's calculations, the Canadian Centre for Policy Alternatives developed an online gasoline price gouge meter. Just enter the current retail gas price and the nearest city and see what you should be paying, according to Mackenzie. He acknowledges that the oil industry isn't always in "gouge" mode, so you may well find you're getting a "bargain."

The petroleum industry says the CCPA's "gas gouge" meter utterly fails to account for the fact that gasoline is a commodity that rises and falls along with local and regional supply and demand forces. That's why a production problem at a big refinery can quickly boost gas prices, because there's no way to make up for the shortfall — other refineries are usually running flat out.

By the same token, a regional glut of gasoline will drive down prices. That's why southern Ontario sometimes has gasoline prices below Alberta's, even though Ontario levies higher taxes. In fact, the gasoline used by motorists in central and eastern Canada is often refined from oil imported from Algeria or Norway. What some call gouging, the industry calls normal market forces.

For the record, the federal Competition Bureau has carried out six major investigations since 1990 into allegations of collusion or price fixing in the retail gasoline industry. Each time, it said it had found "no evidence" to suggest that price increases were a result of a "conspiracy to limit competition in gasoline supply." Blame "normal market forces," it says.

But in June 2008, a Competition Bureau investigation found evidence of a regional cartel. The bureau laid criminal price-fixing charges against 13 people and 11 companies in Quebec, accusing them of phoning each other to fix gasoline prices in four Quebec communities. Three companies have pleaded guilty.

When all the posted gas prices are the same in one area, some people see conspiracy. The industry sees healthy competition. "What other product can you compare the price of while driving at 60 kilometres an hour?" the retailers ask.

Federal figures show that average refining and marketing margins in Canada have actually remained quite stable over the past couple of years. Those fat profits the oil industry earns are usually due to two things - the rising price they get for the oil they produce and the extra money they earn from boosting production when prices are high.

Whatever your feelings on gasoline prices, just don't blame the poor gas jockey at your local station. Many of the "big oil" stations are actually independently owned. Retailing gas just isn't where the big money is these days.