Count yourself lucky if you don’t give a rat’s posterior about how gas pump prices are derived. Because if you do, like some of us, you’re set up for years of frustration. But understanding is achievable. So let’s get started.
World price, not a domestic price
“Canadian gas prices aren’t controlled in Canada; crude oil prices aren’t determined in Canada either,” notes Roger McKnight, the Senior Petroleum Analyst at En-Pro, a major Canadian energy consulting firm with over 1,400 North American clients.
So that’s the first building block to understudying the process — transportation fuel is fundamentally a global price, affected by certain domestic and local factors.
Crude oil pricing
Crude oil is the basic feedstock where we derive the various petroleum products.
A barrel of crude oil is defined as 42 US gallons. Different types of crude oil refine differently, but typically a 
barrel of crude oil will net about 40 percent gasoline and about 30 percent middle distillates (diesel, jet fuel, heating oil).
barrel of crude oil will net about 40 percent gasoline and about 30 percent middle distillates (diesel, jet fuel, heating oil).The remaining percentage is a collective of more specialized products, like asphalt and lubrication stock.
According to PetroCanada’s pie chart, we see that crude oil makes up about 48 percent of gasoline prices. Refining costs are pegged at 17 percent. Profit at 3 percent. Taxes differ according to region, but are approximated at 32 percent.
So basically half of gas pump prices is determined by the global price of crude.
“U.S. oil demand is not driving world oil prices. Driving world oil prices are places like China, which import nine and three quarters of a million barrels of oil a day.” – Jeff Rubin
West Texas Intermediate versus Brent
“The price of oil is higher than most North American motorists suspect,” notes Jeff Rubin, the ex-chief economist of CIBC World Markets investments, who recently wrote the best selling book, Why Your World is About to Get a Lot Smaller — Oil and the End of Globalization.
He adds that when you hear oil price news in the media, they’re usually talking about West Texas Intermediate (WTI) crude — a certain type oil “price settled” at Cushing, Oklahoma, and traded on the New York Mercantile Exchange.
“West Texas Intermediate has lost its role as a barometer of world oil demand, for almost a year now,” says Rubin.
“The new benchmark is the short-dated Brent futures, which is the price of North Sea oil. It’s been trading 10 to 15 dollars a barrel more than WTI since the beginning of the year. Feedstock for gasoline is 10 to 15 dollars a barrel more than the North American drivers would think, if they’re just listening to the radio.”
Rubin notes that the synthetic crude from Alberta’s tar sands go to Cushing via the TransCanada pipeline: “That stuff is heavy oil. Cushing is the only place were it can be refined.”
Because U.S oil demand has peaked and is relatively stagnate, inventory levels across North America, and especially at Cushing, are extremely high — to the point of glut. “I can't see how they can store any more,” says McKnight.
Implausible as it seems, all this inventory isn’t decreasing our gas pump prices, because, in the words of Jeff Rubin, “U.S. oil demand is not driving world oil prices. Driving world oil prices are places like China, which import nine and three quarters of a million barrels of oil a day. And that’s Brent oil.”
Most of the oil the U.S. uses is Brent oil anyway, from tankers arriving in New York or Louisiana.
WTI oil hasn’t been able to arbitrage (in this case, lower) world prices, because the oil is basically stuck in the middle of Oklahoma — a long way from China or India.
Notes Rubin: “When you hear we have high inventories, you presume it’s world inventory, but it’s actually mid-west refinery capacity… It’s a world oil price. Sure there are going to be discrepancies between markets between any moment in time, but a rising tide is lifting all boats. Triple digit prices (for barrels of crude) are going to make gas expensive all around the world, except in places like Saudi Arabia and Venezuela.”
“However misdirected, the price of crude is following emotion and intuition rather than fact.” – Roger McKnight
Speculators
Just as we begin to understand the levers of global oil supply and demand, consider this excerpt from the speech McKnight delivered recently at a major transportation conference in Toronto:
“By far the most important factor in today’s pricing theory is the involvement of the speculators and traders in both the financial and equity products. The daily movements of crude oil and its derivatives have virtually no relations to inventory levels, refinery runs or demand levels. However misdirected, the price of crude is following emotion and intuition rather than fact.”
Yikes.
McKnight says we only have to look at the current situation in Libya to get a feel of how this dynamic works: “Libya produces less than 2 percent of the global supply of crude, which is about 89 million barrels a day. For that (lost) portion, two percent, prices are going through the roof?”
Refinery Issues
Canadian consumers also must deal with supply issues in their local markets. They are only 15 refineries in Canada. Shell Canada shut down its Montreal refinery in last January, and the chances of another refinery opening in Canada is nil and nil.
McKnight says it costs about $100 million just for the paperwork, to propose a 400,000-barrel per day refinery. “Then it would take ten years and many billions to build it. You wouldn’t get a drop of product in ten years, but the specifications for gasoline, diesel, etc., will definitely change during that time. Why build then, when you can bring in gasoline from your refineries in China?”
McKnight notes that China has a glut of gasoline at the moment, and is currently California’s main gasoline supplier.
Refinery production can be hurky-jerky and effect supply, and therefore local prices. For example, refineries typically run a two-season schedule: heating oil and other products from May to September; gasoline from October to March. Refineries are shut down for those transitions.
Oh yeah: taxes
The more taxes built into pump price, the less sensitive is that price to world oil prices, notes Rubin, because it makes crude a smaller portion of the price. So we have that to be thankful for — our higher gas taxes have cushioned the crude oil price shock at the pumps.
He notes that $150 barrel oil will translate to $2 per-litre gasoline, a price the Europeans, by nature of their even higher taxes, have already been paying for a decade or more.
“They’re not giving it away. How cheap do think gas can be?” – Jeff Rubin
Downstream issues
Decades of sudden price jumps, when there is little apparent reason, have hardened Canadian motorists into oil company cynics. Is this justified, Mr. Rubin?
“I’m not going to say that there hasn’t been gouging on occasion, but that’s missing the forest for the trees. Brent is trading around $117 right now. They’re not giving it away. How cheap do you think gas can be?”
Rubin adds that as profitable as gas stations are perceived to be to motorists, integrated and international oil companies are actually trying to get out of these “downstream” parts of their organizations, to concentrate more on “upstream” initiatives, such as exploration, production, R&D, and refining.
And finally, McKnight notes we should be thankful for the current strength of our loonie against the U. S greenback. If the loonie were weaker, as it usually is, the pump pain would be even more extreme.
Editor's note: The best defense to high gas prices is to buy fuel from stations who offer the lowest prices in your area. For that, we recommend the frequently-updated website gasbuddy.com. Or, you know, to drive less.
