What I hope to do in this video is to explore the relationship
between oil and gas prices, and you do see that there is
a very strong correlation between how they trend.
This right over here is oil prices quoted at a specific point on the planet
This is dependent on where you are and as you can see this is
in US dollars per barrel. In early 2008 around $100
It went up to about $140 then came back down
and then it's been trending up ever since, now it's about $100 per barrel
this is where we see the oil prices on a per barrel basis
And then related to that you see the gas of gasoline
this is even more geographically specific because not only do you have
transportation costs but you also have very
region specific taxation for oil and sometimes
regulation but taxation is the big part of it
but you do see that it trends up when oil prices
trend up, and then it goes down and this is on
a per gallon basis and these are the prices right
over here in New York. But they don't move competely
locked up, if anything you can see that the oil price on a per
barrel basis is much more volatile than the gasoline
prices right over here but there is the same
general trend, when the oil prices moves up
this tends to move up but it's not always in the same
percentage but there's definitely a relationship.
Now, before trying to figure out when you pay, say
$4 at the pump how much up that is oil and how much
is refining and how much is transportation
Let's at least kind of build up to that
to think about how does the oil even end up in your
car, then we can build up that price of the oil.
Or, the price of the gasoline I should say.
This right over here, you're probably familiar with these,
these are oil rigs, two very different types: this
This is an offshore oil rig, this is a land based oil rig
but they're both doing the same fundamental thing:
they're drilling into the ground until they get to a pocket of oil
and then they will pump that oil out
and try to transport it to the market somehow, first
going through a refinery. Offshore is really fast and it
really is an engineering marvel how they do it
It might be sitting out here in the ocean and it will
literally go to the bottom of the ocean, go to the sea
floor and then drill from there to actually get to the
oil pockets so it's really an engineering marvel
and you have to be very careful, it can be very dangerous
working on an oil rig and obviously if there's an accident
it can be an environmental nightmare like we saw
with the BP situation but it is undoubtedly an
engineering marvel. Now, once you have that oil you need
to get it to a refinery so that the oil can be
broken up into its useful parts, and the way it
is typically transported to a refinery is some combination
of a pipeline or an oil tanker, this right over here is actually
the Alaskan pipeline, it takes oil from the very northern part
of Alaska to the southern part so that it can then be
put onto oil tankers which can then transport it anywhere
in the world to refineries. It could go straight to a tanker
actually in some offshore places you could use a tanker or sometimes if they're
close enough to land they actually might have a pipeline
that will take it to land where it can go to a refinery
or go to an oil tanker so that it can be transported
even farther. And then from there it gets to a refinery
So we can start to think about how the price of oil is built up
before we even think about what a refinery
even does. So let's say that the current price of oil
and I kind of rigged the numbers, to work out fairly well
But let's say the current price of oil is $90 per barrel.
So a barrel (this is just a units thing) is equal
to 42 gallons. So if I say I have a barrel of water
I'm really saying that I have 42 gallons of water.
And now all 42 gallons of crude oil do not turn into
42 gallons of gasoline, out of 42 gallons
of crude oil you can get about 19 or 20 gallons of
gasoline, to make the numbers easy I'll just go with 20.
And then the rest will be other stuff, so 22 gallons of other stuff
It might not even be 22 gallons, some of it will just be
waste, some of it will be by-products some of it is actually
used to fuel the refining process.
I won't write that number, the rest is "other stuff."
So let's say, this refinery is paying $90 per barrel
when it gets it, so that incorporates what the oil procuders
are getting, and it also takes care of the transportation
costs to the refinery, and let's say jsut for the sake
of argument that the refinery can sell
Let's say that it doesn't even take care of the transportation
network, let's say there are people willing to buy directly
from the refinery at the refinery, they are willing to buy
gasoline at $3.25 per gallon, so the gas at refinery,
people are willing to spend, the transporters are willing to pay them
$3.25 per gallon, and so from this barrel they're going
to get 20 gallons of gasoline, they can sell that
at $3.25 per gallon so you're going to have
20 * 3.25 = $65 for the gasoline
And then let's just say, for the sake of argument,
they get $35 for the other stuff
Some of this other stuff is actually quite useful, it's stuff like
motor oil, it could be jet fuel, it could be natural gas
All sorts of... and it can obviously be fuel to actually fuel
the refinery, and so let's actually start building this up over here
so one way to think about it, let me draw it this way
so the price we're up to $3.25, this is what the price is
exiting the refinery, what the refinery is getting for it.
So, let's say this is one dollar, this is two dollars,
and this is three dollars, and they're getting $3.25
$3.25 would be like that, that is what the
refinery is getting and one way to think about it
It's not completely... not all of their profit is coming from the gasoline
But one way to think about it is the refinery, after refining
all of this barrel of crude oil that they paid $90 for,
they're going to get $65 for the gasoline and then
they're going to get $35 for the other stuff
so they made a combination of $100. They were able to buy
crude oil at $90, do what they had to do, and then
they were able to sell it for $100, so one way to think
about it, at least in this situation, 90% of what they were
getting for it is their cost, it breaks down between
the other stuff and the gasoline, so it's not super easy to break
down, but you can say in this example a good chunk
of it was the cost of gasoline. And it obviously depends how
you account for it but a good chunk of it is the cost of
the crude, and this right over here you could say is
how much the refinery actually makes and that the amount
it actually gets versus what it costs, so the amount
they actually get for the product they produced versus the crude oil
that they had to pay for, this margin is often called
the crack spread. Just to understand what a refinery
is doing, it's breaking up the crude oil into its various parts
It's actually a very simple, well I don't want to say "simple process"
When you look at a refinery you obviously don't think it's a
simple thing, but the idea for the process is actually
fairly straightforward, it takes the crude oil
and it heats it up through a boiler, so right over here
the crude is getting really hot. This is the boiler,
the boiler is often fueled by some of the outputs of
that oil, and then it goes into a distillation column.
That's why you see all the towers over here in an oil refinery
Those are the distillation columns, and so in the
distillation columns the different parts of the oil have
different boiling temperatures. So the very long
carbon chains in the oil have very high boiling
temperatures, so as hot as they are they're not
going to boil, they're going to stay in their liquid form
down here, and then the slightly shorter chains are
going to boil and evaporate a little bit but
then as they rise they're going to cool down and
then they might condense right over here and they can
be pulled away in pipes, and then things that have
slightly shorter chains than that will go a little bit higher
before cooling to even lower temperatures before going
back into a liquid state, and they can be collected
over here... all the way until you get to the very
shortest chains, like the natural gas, that would be
collected out of the top. The gasoline that you put
in your car might be collected right over here from this
So essentially you're breaking up that oil into
its different parts. As for some of the different parts..
this might be motor oil over here, the thing you use to
lubricate, not fuel, your engine. You might have
jet fuel up here, then you have a whole ton of different
fuels, this might be kerosene, and all sorts of things...
you are able to take out of that crude oil.
But anyway, let's get back to the gasoline.
So the refinery got $3.25, now we have to
transport that gasoline, so let's say 10 cents for
transportation. This is at about $3.25 here, so now
we're going to have 10 cents for transportation
I'll just write transportation for short.
And then it goes to the gas station, and as I mentioned
gas is heavily heavily taxed and it depends on what jurisdiction
what country or even states within countries
but for the sake of simplicity let's just say that
it's taxed at about 50 cents a gallon, which is not that
different from what it's taxed at in many states.
So now we're at 50 cents a gallon so that would be
right around... this is tax right over here going
to the state and federal government, so let's see
$3.25 is what the refinery got, 10 cents for transportation gets
us to $3.35, 50 cents for tax gets us up to $3.85
and then now we're at the gas station, it'll essentially
cost $3.85 for the fuel, but the gas station
needs to make some money to pay their costs
so the gas station sells you that fuel at a $4 per gallon
So you might say, hey! they gas station made 15 cents
But actually a huge amount of that 15 cents goes to the
credit card processors because most people
pay at the pump with their credit cards, so that's why
some gas stations like it, even give you a discount when
you pay in cash because of that 15 cents, as much as
or in general about 5 cents of that will go
to the credit card fees. So the retailer will be
left with about 10 cents of margin.
So anyway, hopefully that gives you a sense of how
crude oil turns into gasoline, and when you pay at the pump
what is the breakdown for the different players
and how much of the money is going to those different
players.