From Oil Field to Gas Pump: What Really Determines What We Pay?

In Part 1, we followed a barrel of crude oil from the ground to the refinery and looked at the many products it can produce.

Now comes the question that hits much closer to the wallet.

A fuel sign observed in Front Royal on Monday, Sept. 21, showed regular gasoline at $4.09 a gallon and diesel at $6.39.

The United States produces enormous quantities of oil. The country has also been described as “energy independent.” Much of the crude oil imported into the United States comes from countries much closer to home than the Middle East.

So why should events in the Middle East affect what someone pays for gasoline in Warren County?

The short answer: oil is a global commodity.

Being a major oil producer doesn’t put a wall around the American petroleum market, and “energy independence” doesn’t necessarily mean what many people think it means.

What Does ‘Energy Independent’ Actually Mean?

When people hear that the United States is energy independent, it is easy to interpret that phrase as meaning we produce everything we need and no longer depend on foreign energy.

That’s not how the term is generally used.

The United States can produce enormous quantities of oil and natural gas and export large amounts of energy while still importing crude oil and petroleum products.

Imports and exports can occur at the same time.

One reason goes back to something we discussed in Part 1: Not all crude oil is the same, and not all refineries are designed to process the same crude.

Some U.S. refineries were built and equipped to process heavier crude oils. American producers may be producing other crude grades that can command attractive prices elsewhere.

Geography matters, too. Sometimes importing a particular crude into one part of the country makes more economic sense than transporting domestic crude long distances.

So a country can be a major producer — and even export large amounts of energy — without becoming disconnected from international markets.

Why Does the Middle East Matter?

Imagine that a barrel of crude oil produced in the United States can be sold for $80 on the world market.

Would a producer voluntarily sell that same barrel domestically for $50 simply because it came out of American soil?

Generally, no.

Buyers and sellers respond to market prices.

That is the key to understanding why an international event can affect U.S. prices even if the gasoline in your vehicle didn’t begin with crude oil from the country where the event occurred.

Oil moves through an interconnected world market.

If a major producing region suddenly supplies less oil — or traders believe supplies could be disrupted — buyers may compete for the remaining barrels.

Prices can rise.

Those higher prices can spread through the international market and affect the value of crude produced elsewhere, including in the United States.

The Middle East is particularly important because it contains major oil-producing countries and critical transportation routes used to move petroleum to world markets.

A serious threat to those supplies or shipping routes can therefore matter far beyond the countries directly involved.

A motorist in Front Royal doesn’t have to be buying gasoline made from Middle Eastern crude to feel the effects of a disruption in the global oil market.

Who Sets the Price of Oil?

No one person in an office decides what a barrel of oil should cost tomorrow.

Prices emerge from buyers and sellers trading crude oil in global markets.

Supply and demand are central.

When the world needs more oil than producers are readily supplying, prices tend to rise. When supplies are plentiful compared with demand, prices can fall.

But expectations matter, too.

Oil markets look forward.

A hurricane threatening Gulf Coast oil and refinery operations, war near an important producing region, sanctions, production decisions by major oil-producing countries, economic growth or recession, and changes in worldwide demand can influence prices.

That means prices can move before motorists see an actual physical shortage at their local gas station.

Crude Oil Is Only the First Cost

Crude oil is a major part of what motorists ultimately pay, but crude doesn’t magically appear as gasoline at the corner station.

Someone has to refine it.

Refineries have their own operating costs and their own supply-and-demand pressures.

A refinery shutdown for maintenance or an unexpected equipment problem can reduce the amount of gasoline or diesel available in a region even when plenty of crude oil exists.

That distinction is important.

The country can have abundant crude oil while experiencing tighter supplies of a particular refined product.

Gasoline and diesel inventories also matter. If supplies of one product become unusually tight while demand remains strong, its price can rise faster than the other.

That helps explain why diesel and gasoline don’t always move together.

Why Was Diesel $2.30 Higher?

Front Royal prices observed Monday provide a striking example: $4.09 for regular gasoline and $6.39 for diesel—a difference of $2.30 per gallon.

Crude oil alone cannot explain why two products from the same raw material cost so differently.

Diesel has its own market.

It is essential to trucking, agriculture, construction, and other industries. Distillate fuels are also connected to the heating-oil market.

Diesel and other refined petroleum products can also be exported, connecting their prices to demand outside the United States.

If diesel supplies are tight relative to demand, its price can rise substantially above gasoline.

Taxes account for a small portion of the difference. The federal tax is 18.4 cents per gallon on gasoline and 24.4 cents on diesel.

That’s a six-cent difference — nowhere near enough to explain a $2.30 spread.

The rest must come from market conditions, refining, inventories, distribution, and the wholesale price retailers must pay.

Then the Fuel Has to Reach Front Royal

After gasoline or diesel leaves a refinery, its journey isn’t over.

Fuel can travel through pipelines to regional terminals and storage facilities. From there, tanker trucks deliver it to individual service stations.

Every step has a cost.

Transportation, storage, and distribution expenses can vary by region. A supply interruption affecting a pipeline, terminal, or refinery can create a local or regional problem even if the nation as a whole has adequate petroleum supplies.

This is why gasoline prices can differ from one state to another — and sometimes noticeably from one town to another.

Taxes also vary by state.

Then there is the retailer.

The price displayed on a Front Royal gas station sign reflects what that business must pay for fuel, along with taxes, operating expenses, and the margin it needs to sell the product.

That retail portion is only one piece of a much larger chain.

More American Oil Doesn’t Automatically Mean Cheap Gas

Another common question is straightforward: If gasoline is expensive, why not simply drill more oil in the United States?

Increasing production can add supply, and over time additional supply can put downward pressure on prices if other conditions remain the same.

But there isn’t a direct switch connecting an American oil well to the price sign at a Front Royal gas station.

New production takes time. Producers make drilling decisions based partly on what they expect oil will be worth and whether a well will be profitable.

And once that oil is produced, it enters a market connected to the rest of the world.

There is also the refinery question.

More crude oil doesn’t automatically create more gasoline or diesel if refinery capacity is the constraint.

That is why oil production and gasoline prices can sometimes appear to move in ways that seem contradictory.

They are connected, but they aren’t the same market.

So Are We Dependent on Foreign Oil?

The answer depends on what we mean by “dependent.”

The United States does not have to obtain all — or even most — of its petroleum from overseas to be affected by international prices.

The better way to think about it is this:

The United States is a major energy producer operating inside a global energy marketplace.

American producers sell into that marketplace. American refiners buy within it. American companies export petroleum products, and American businesses import crude and petroleum products when it makes economic or operational sense.

As long as those markets remain connected, a major change in world supply or demand can eventually reach American consumers.

That is very different from saying every gallon of gasoline in Front Royal came from the Middle East.

It didn’t have to.

The price can travel around the world even when the particular barrel of oil doesn’t.

From the Oil Field to Your Wallet

That $4.09 gallon of gasoline makes more sense when you can see the whole chain.

Oil first has to be produced. Its value is influenced by a global crude market. It has to reach a refinery and be turned into gasoline. The gasoline must then be transported, stored, and delivered. Federal and state taxes are added, and the retailer incurs costs to sell it.

Diesel follows a similar path but enters a different market with its own supply and demand.

That’s why there isn’t one simple answer to the question, “Why is gas so expensive?”

And it’s why saying America produces a lot of oil — while true — doesn’t by itself tell us what gasoline should cost.

The number glowing on a Front Royal gas pump is the final result of a chain stretching from an oil field through refineries, pipelines, terminals, and tanker trucks — and through a worldwide market where events thousands of miles away can change the value of a barrel produced much closer to home.

Perhaps the most important distinction is also the simplest:

Producing our own oil and setting our own oil price are two very different things.