The price of crude oil has the largest impact on the price of retail gasoline.
But that raises an important question, one that many motorists were likely thinking as they filled up their tanks over Labor Day weekend.
Why can gas prices appreciate when crude oil prices are steady, or even dropping?
The reason is simpler than you might think.
Good Ol’ Uncle Sam
In short, while gas and crude oil are positively correlated, the price of crude oil today represents, on average, only 66% of the retail gasoline price.
So what makes up the balance, exactly?
For one, taxes make up the second-largest component of gasoline prices.
Today, on average, 12% of the price of gasoline at the pump reflects taxes imposed by both the federal government and state governments.
As of January 2014, according to the U.S. Energy Information Agency (EIA), federal taxes equated to $0.1840 per gallon, while the average state tax was $0.2717 per gallon.
The third and fourth components are refining and distribution and marketing. Each reflects 11% of the retail gasoline price.
What to Expect
While tax rates and distribution and marketing costs are typically steady, the price of crude oil and refining costs are more volatile.
Crude oil is truly a global market. Even though the United States is drilling at record levels due to hydraulic fracking and horizontal drilling, global crude oil prices are still affected by growing demand in emerging markets, the influence of the Organization of Petroleum Exporting Countries (OPEC) on prices, and geopolitical risk. This translates to a limited downside for the price of crude oil in the short to medium term.
Refining costs can have a major impact on gasoline prices, and can change rapidly. Beyond scheduled maintenance periods, other unknowns – such as temporary outages, delivery pipeline disruptions due to severe weather, bottlenecks, and other technical issues – can affect prices.
Now, gasoline inventories are the cushion between major short-term supply and demand imbalances.
Gasoline prices tend to increase as the available supply of gasoline grows smaller relative to demand or consumption. A drop in inventories may cause wholesalers to bid higher for available supply over concern that future supplies may be inadequate.
Imbalances have also occurred when a region changes from one fuel type to another (for example, to cleaner-burning gasoline) as refiners, distributors, and marketers adjust to the new product.
Based on the chart below, U.S. supplies are at the midpoint of the five-year average.
Still, while there’s no notable shortage of U.S. gasoline supplies, we shouldn’t be complacent. There are too many variables that could disrupt inventory levels, particularly in light of the approaching hurricane season.
So how do you profit from any potential uptick in prices?
How to Trade or Invest
Trading gasoline is not for the faint of heart. It requires persistent attention to the markets and access to a myriad of data.
The easiest way for the average investor to play the gasoline market is through refinery stocks, like Valero Energy Corp. (VLO) and Tesoro (TSO). Remember, higher crude prices are a negative for refiners, whereas high distillate prices, including gasoline, are a positive.
If you want to take a more advanced route, one can speculate on gasoline prices by trading the CME-Nymex RBOB gasoline contract, which represents 42,000 gallons of physical gasoline. There’s also the E-mini RBOB (QU) representing 21,000 barrels (futures only). Finally, there’s the exchange-traded fund United States Gasoline Fund LP (UGA), which tracks RBOB futures.
And “the chase” continues,