What makes up the price of gas?

Consider the game of chicken that plays out every day across Pennsylvania State Highway 441. In Marietta, where the road hugs the Susquehanna River, a Rutter's Farm Store gas station stands on one side, a Sheetz gas station on the other.

Kelly Bosley, who manages Rutter's, doesn't even have to look across the highway to know when Sheetz changes its price for a gallon of gas. When Sheetz raises prices, her own pumps are busy. When Sheetz lowers prices, she has not a car in sight.

She calls Rutter's headquarters to report the competition's new price and wait for instructions.

'I call a lot of times and say, 'They went down, hurry up! Hurry up! Call me! Call me!' Or it could be where theirs goes up, and I'll say, 'Take your time! You know, I like being busy.' But I have no control over that.'

You think you feel helpless at the pump?

Bosley makes a living selling gas - and even she has little control over what it costs.

So how exactly are gas prices set? What determines the hair-pulling figure you see displayed in large electronic or plastic numbers? Why is a gallon of gas, say, $4.11 - not $4.10 or $4.12? Why is the price different across the street?

It all starts with oil.

The biggest factor in the skyrocketing price of gasoline is the historic ascent of crude oil, which has surged from $45 per barrel in 2004 to more than $135 this past week, setting new record highs all the while.

In the first quarter of this year, based on a retail price of gas that now seems like a steal - $3.11 a gallon - crude oil accounted for all but about a dollar, or 70 percent, of the cost, according to the federal government.

The rest is a complex mix of factors, from the cost of turning oil into gas to taxes to marketing costs to, sometimes, nothing more than the competitive whims of your local gas station owner.

Not that understanding the breakdown makes it any less cringe-inducing to fill 'er up.


First a primer on how gas gets to your tank:

Once oil is pumped from the ground, it can be sold on the spot market, a last-minute trading arena where oil companies and distributors buy and sell to each other, or straight to refiners. After it's brewed into gasoline, the product can again be sold on the spot market, or directly to wholesalers, who in turn can supply their own stations or sell it to other retailers.

Each step of the way, buyers and sellers negotiate a price until, finally, drivers pay the ultimate tab at the pump.

At the starting point of all this is the price of oil - which, like the oil itself, is nothing if not crude.

The knee-jerk villains are the oil companies, fat with multibillion-dollar profits, frequent targets of populist anger. But wait: The oil companies don't set the price of oil or the cost of a gallon of gas.

Prices are a function of the open market, the result of futures contracts being traded on the New York Mercantile Exchange, or Nymex, and other exchanges around the world.

Buying the current July crude oil futures contract means you're buying oil that will be delivered by the end of July. But most investors who trade futures have no intention of ever accepting the underlying oil: Like stock investors who frequently buy and sell their holdings, they're simply betting that prices will rise or fall.

Of late, on the Nymex, oil futures have been rising.

Why? Blame the falling dollar. Oil is priced in U.S. dollars, and the weaker the dollar gets, the more attractive dollar-denominated oil contracts are to foreign investors - or any investor looking for a safe haven in the turbulent stock market.

The rush of buyers keeps pushing oil futures to a series of new records, and the rest of the energy complex, including gasoline futures, has followed. That pushes up the price of gas that goes into your tank.

'Crude is the driver,' said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill. 'As long as it stays up there, gasoline's not going to be able to decline much at all, even if demand slips. That's just the way it is.'

There is some evidence Americans are buying less gas as the price marches higher, and common sense suggests they would cut back even more if gas rose to $4.50 or $5 a gallon.

Lower demand should mean lower prices - but it takes time for that to happen, given the enormous scale of refining operations that produce gasoline.

'Once demand begins to slow, that needs to translate into inventories, then you get some price weakening,' Ritterbusch said. 'But it takes a while.'

Oil and gasoline prices often move in the same direction, but they aren't linked directly. In fact, while oil prices have more than doubled in the past year, gasoline is only up about 19 percent during the same time.

Oil prices often fluctuate with production decisions from the Organization of Petroleum Exporting Countries, which supplies about 40 percent of the world's crude, or when conflict in the Middle East or Nigeria threatens supplies.

For example, oil prices rose $2.46 in one day last month amid reports a ship under contract to the Defense Department fired warning shots at two boats in the Persian Gulf that may have been Iranian.

A Navy spokesman later said the origin of the boats was unclear, but the news raised concerns that a conflict between U.S. and Iranian forces could cut oil supplies from the region. That same day, gas prices rose another 2.1 cents to a then-record national average of $3.577 a gallon on other supply concerns.

And the rise has only grown more dramatic. Oil sprinted higher this past week, rising more than $4 a barrel on Wednesday alone and past $135 on Thursday.

As for gasoline prices: They're closely tied to demand from U.S. drivers and how efficiently refineries are operating. Falling production or inventories often send prices skyrocketing.

Those prices can vary greatly depending on the region.

The Gulf Coast is the source of about half the gasoline produced in the United States, and areas farthest from there tend to have higher prices because of the cost of shipping gas via pipeline and tanker truck all over the country.

Some of those places, like California and New York, also have higher local taxes that push the price higher.

Oil companies may not set the price of oil and gasoline, but not everyone is willing to sit back and let them claim to be innocent bystanders.

In particular, for the second time this year, Big Oil's biggest executives were on Capitol Hill in recent days getting pummeled by many in Congress for their record profits while Americans struggle with record fuel prices.

'Where is the corporate conscience?' Sen. Dick Durbin, D-Ill., asked the top executives of the five largest U.S. oil companies.


What happens when that gasoline makes its way to your neighborhood gas station?

Major oil companies own fewer than 5 percent of gas stations. Most are owned by small retailers - and many of them say they're struggling these days to turn a profit on gas. That's because wholesale gasoline prices have risen sharply in recent months - again, blame it on crude - but station owners have been unable to raise pump prices fast enough to keep pace.

And you can't keep jacking up the price when drivers are buying less.

Gas station owners face a balancing act: They must try to maintain a price that allows them to afford the next shipment of gasoline but not give the competition an edge.

Stations pay tens of thousands of dollars for each gas shipment before they see a cent in the register. Eventually, many make only a few cents on a gallon of gasoline, a margin that can disappear altogether when credit card fees are added in.

Thank goodness for beef jerky and sodas.

Most gasoline retailers long ago got past any illusion they can make money by selling gas. They rely on gas sales to drive traffic to their shops, where they hope auto repairs or food and drink sales will help them turn a profit.

'You're always out there competing with the guy next door - literally with the guy across the street - and worried too about how you're going to pay for your next supply,' said Rayola Dougher, a senior economic adviser at the American Petroleum Institute, the oil industry's trade association.

In the Philadelphia suburb of Havertown, Pa., earlier in the week, Sunoco station operator Steve Kehler received a load of gasoline - 9,000 gallons - which, at a wholesale price of $3.729 a gallon, cost him 4 cents more than the previous load.

That left him in a sticky situation: Should he raise prices right away to recoup some of his higher gasoline expenses, or should he hold off for a couple of days in hopes his competitors will also have to raise their prices?

'I'm surrounded by $3.89's, and I'm already at $3.91,' said Kehler, referring to his prices and those of some nearby competitors. 'I'm going to play a little waiting game right now.'

The $33,600 Kehler must pay for his overnight gasoline delivery won't be debited from his bank account for a few days. That gives him a little breathing room, time to hold prices steady. Hiking prices too quickly will hurt sales.

'I'll probably change it tomorrow night, at closing,' Kehler said. 'I'll go up 4 cents.'

That will put Kehler at a gross margin of about 20 cents a gallon. After paying credit card fees, labor and rent, Kehler will be lucky to break even on his gasoline sales.

SideBar: How two stations set their prices

By John Wilen

AP Business Writer

HAVERTOWN, Pa. - Steve Kehler spends most of his time working on cars or managing paperwork at the auto repair shop and gas station he runs in this Philadelphia suburb.

Unless an overnight gas shipment forces him to play another round of pricing roulette: Should he raise prices to keep up with pressure from his wholesaler? Or will that kill sales?

'It's not an exact science,' he said.

Earlier this week, Kehler's wholesale price jumped by 4 cents a gallon. The price is set by Sunoco Inc., from whom he leases his gas station and is contractually obligated to buy.

Shipments arrive overnight, whenever a remote sensor tells Sunoco that Kehler's tanks are low. The wholesale increase means Kehler will have to raise his pump prices soon - if he wants a shot at breaking even on gas sales.

That decision - the type of pricing dilemma gas station managers face daily - is not as much of a no-brainer as you might think. If a station raises its prices before its competitors, it may lose gasoline sales. But the longer station managers wait - with wholesale prices rising - the more money they lose. And sometimes they have no choice but to cut prices to keep cash flowing in.

In the end, Kehler decides to wait a full 24 hours before raising his prices by the 4 cents a gallon his own wholesale prices have already risen.

Eighty-eight miles west, in the quaint south-central Pennsylvania river town of Marietta, Kelly Bosley spends more time worrying about the coffee bar and sandwich counter than gasoline sales at the Rutter's Farm Store she manages.

Unless the Sheetz gas station across the street changes its prices. A change in Sheetz's prices typically triggers a call to headquarters. As a company-employed manager, Bosley has to wait for a go-ahead from headquarters to raise prices.

Bosley says she has been asked to change prices as much as twice a day, but lately only gets a price-change call three times a week. Kehler changes prices with each new load of gasoline - about every three to five days.

Like many gas retailers, Kehler has accepted the fact that he's not going to make money selling gasoline. He hopes the pumps will drive business to the moneymaking side of his business - auto repair.

At many other stations, it's the convenience store that rules the roost. Gas is seen as a loss leader, something a station sells to attract the people who will then be tempted to buy much higher-profit-margin items like coffee and sandwiches.

To keep the customers coming, Bosley's Rutter's is adding a smoothie and milkshake machine, and already offers coffee and cappuccino drinks as well as made-to-order sandwiches.

Neither Kehler nor Bosley like high prices, which hurt sales and anger customers.

'We're all reluctant to hit that $4 mark,' said Kehler, who said raising prices from $3.99 to $4 will have more of an impact on sales to the driving public than a typical one-cent hike.