Breakdown of Gas Prices

Where the dollars at the pump go

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.