What drives the price of gas?

An oil executive and economist agree — the old principle of supply and demand are key to setting fuel prices.

During the winter of 2014, motorists in the United States welcomed a steep decline in the price of gasoline. What drives the price of fuel? Simply, supply and demand.

“The majority of the cost to manufacture gasoline and diesel is the cost of crude oil. The supply and demand sets the price for both gasoline and diesel. Diesel is taxed at a $.06 per gallon higher rate than gasoline,” said Tom Kelley, ’81, senior vice president of marketing for Marathon Petroleum Company. “Other factors for determining the price of gasoline and diesel would be how much supply is available, the time of the year and the demand. Competitive conditions factor in as well.”

Domestic oil production has increased dramatically over the past several years because of the shale boom, spurred by extraction technology called hydraulic fracturing, Kelley said. Crude oil is a finite resource, but the improved technology has dramatically increased the proven reserves.

Indiana State is contributing to this increase in domestic production. On university property east of campus, the Lawrenceville, Ill.-based Pioneer Company started horizontal drilling to reach oil and gas beneath the campus in late December 2013. The oil being extracted is a sweet crude oil, and it has low sulfur content, said Dan Bradley, president of Indiana State, during an April 1 presentation at the Westminster Village in Terre Haute.

“To ensure no student, faculty or staff members smelled the oil, a catalytic burner is used to burn off the methane produced by the wells. In the contract, if we smell odors from the wells, Pioneer Company would fix it immediately,” Bradley said.

The university’s agreement with Pioneer provides for royalty payments of not less than 15 percent for all oil products produced. Proceeds, which totaled $350,000 in the first year, will be used to address deferred maintenance on campus.

“Currently, around 100 barrels a day are produced in the latest data, which means it is producing roughly 800 to 900 barrels a week,” Bradley said.

With significant production increases spurred by hydraulic fracturing, the price of crude oil dropped dramatically, Kelley said.

“The United States is less dependent on foreign oil than we used to be. About 40 percent of our oil still comes from foreign sources,” Kelley said.

While a controversial method because of environmental impact concerns, fracking, as it’s commonly known, allows companies to extract oil in the same areas or reservoirs previously thought to be depleted.

“Crude oil was averaging slightly above a $100 a barrel for most of 2013 and 2014,” said Bob Guell, Indiana State economics professor. “There are different types of oils like Saudi Sweet, West Texas Intermediate and Brent oil. With various world standards of oil, all oils have different consistencies and properties; it is not just a homogeneous product. The result of these difference is that oils yield gasoline at different rates and at different costs.”

What triggered the drop in lower crude oil prices was increased production in the United States. WTI prices went as low as $39 per barrel, although it has recently bounced back more than $50 per barrel, remaining relatively stable since mid-February of this year, said Guell.

WTI oil dropped because of new production of oil in North Dakota. North Dakota oil is different from WTI oil in that it comes from tar sands, which is thicker oil and is less easily refined into gasoline, explained Guell. On top of that, it must be transported over rail to refineries, where oil produced in West Texas and Oklahoma is transported by much cheaper means — pipelines.

Before the recent domestic oil boom, an intergovernmental organization of oil-exporting countries, Organization of the Petroleum Exporting Countries, kept crude oil prices stable.

“Historically, when Saudi Arabia saw oil prices falling, it would cut its production by what was necessary so that the price of gas was relatively stable,” Guell said. “This time, Saudi Arabia made an explicit decision not to cut its production by the amount of increased U.S. production.”

No matter the cause of behind declines in fuel costs, it has a positive effect on the economy, giving motorists and businesses more money to spend elsewhere.

“With the current lower price of gas, the average driver is likely to save $600-700 a year,” Kelley said. “Potential impacts could be greater consumer spending, paying down debt or the ability for consumers to save. ”

Why is the price of gas different in Terre Haute than other cities in Indiana?

The closest refinery to Terre Haute is 50 miles away located in Robinson, Ill., and operated by Marathon. There are limited and specific places where the pipeline is interrupted by an ability to get gas out of it, Guell said.

“The closest pipeline terminal would be in Indianapolis. That is one reason why gasoline prices in Terre Haute and other cities outside central Indiana are higher than the they are in the Indianapolis area,” Guell said.

With the advancement of technology constantly evolving, the United States has an oil supply for about the next 100 decades, Guell said.

While some may say the drop in crude oil prices will slow future innovation, Kelley disagrees.

“I do not expect innovation to stall in the future. I think America is very creative, talented and entrepreneurial. In my estimation, we will always find ways to innovate in any price environment,” Kelley said.

Leave a Reply

Your email address will not be published. Required fields are marked *