How the cost of oil affects the price at the gas pumps

It’s a good time to be a driver, with gasoline prices dropping well below $1 per litre in most Canadian regions. Consumers mostly have the five-and-a-half-year low price of oil to thank, but many more factors go into the cost of fuelling up. Here’s a look at how the cost of a barrel of oil affects the price on display at your local gas station.

Why oil goes up and down

Suncor Energy Inc.’s PumpTalk blog compares the final retail cost of gas to a three-layered club sandwich, with the price of crude oil forming the meaty base – about 50% of the final cost. The global price of oil fluctuates based on supply and demand and market sentiment. Hedging and the futures market, in which traders essentially bet on where the price of oil is headed, make things more complicated.

Jason Parent, vice-president of MJ Ervin and Associates, a consulting and data firm specializing in the downstream petroleum industry, said there’s no consensus on the effect of such trading on the price of oil. He said he thinks it may increase volatility in the oil market, but doesn’t have much effect on the price consumers ultimately pay at the gas station.

Dan McTeague, a senior petroleum analyst for gasbuddy.com and founder of tomorrowsgaspricetoday.com, disagrees.

“The financialization of commodities, particularly oil, electric and gasoline, has led to increased, higher prices,” he said. “It also helps explain the behaviour of these prices dropping as dramatically as they are, because they aren’t responding to the physical market.”

In addition, Mr. McTeague said the Canadian dollar’s role in the price of gasoline is often overlooked. When the price of oil falls, the value of the Canadian dollar tends to fall along with it, since our economy is so closely linked to the oil industry.

The international crude market is linked to the American dollar, so a lower Canadian dollar means the retail price of gasoline doesn’t fall as far as it would otherwise, Mr. McTeague said. That’s one reason why gas tends to be so much cheaper in the U.S.

“People say, hey, hang on, crude has dropped US$2.50 a barrel, we should be getting a two-and-a-half-cent decrease on gas. Not quite,” Mr. McTeague said. “The drop in crude is tempered by the drop in Canadian currency.”

From wellhead to wheels

Where the oil that powers your car comes from depends on where you live. Gasoline sold in Western Canada likely came from Alberta oil, while gas on the east coast is more likely to have been refined from imported oil. Overall, Canadian refineries buy about 60% of their oil from Canada, importing the remaining 40% from Saudi Arabia, Iraq, Algeria, the U.S. and other countries.

Where the oil comes from and the cost of transporting it has little effect on the final price consumers pay at the pump, Mr. Parent said. According to the Canadian Fuels Association, which represents the transportation fuel industry, the cost of refining the gasoline accounts for about 13% of the retail price, with distribution and marketing responsible for about 6%.

Mr. McTeague said Canadian refiners set the price of the gasoline they produce by adding about six cents per litre to the New York Mercantile Exchange rate for wholesale gasoline, but that number fluctuates. On Wednesday, the NYMEX rate for wholesale gasoline was $0.42 per litre, about five cents per litre higher than the average price of crude.

The wholesale price [of gasoline] can move independently of crude prices

The market for gasoline is different from the market for crude oil, which means if the price of oil drops 10%, the price of gas may drop less than that or not at all. For example, demand for gas tends to go up in the spring as driving conditions improve. If the price of oil continues to drop in March, the price of gas could nevertheless stay flat because of the increased demand.

“People see crude prices moving and they expect retail to move accordingly and there’s actually not a very good relationship between the two on a day-to-day basis,” Mr. Parent said. “The wholesale price [of gasoline] can move independently of crude prices.”

All in all, it typically takes about 30 days for oil to go from the wellhead to your car, but it can take up to three times longer than that depending on factors such as the location of the refinery and gas station, how the crude oil was transported and whether it’s being stockpiled to wait out low prices.

The price at the pump

We’ve talked about the market for crude oil and the market for wholesale gasoline, and the different factors affecting each. The final price you pay at the gas station is also affected by local competition, taxes, regional demand and how much gasoline the station has on hand.

For example, Mr. McTeague said gas was still more than $1 per litre in Sudbury on Monday. That’s because gas stations outside major cities sometimes have to get rid of the gasoline they stocked up on when prices were higher before they get a new shipment of the lower-priced stuff.

And then there are taxes, which are responsible for almost one-third of the final retail price. Depending on where you live, those taxes might include a federal tax, a provincial tax and a harmonized sales tax. The gas station also tacks on a few cents per litre for its operating costs and profit.

What’s the bottom line?

What you really want to know, of course, is how much money you can expect to save because of the low price of oil. Citing a Citigroup Inc. report that predicted the benchmark price for oil will stay at about US$55 in 2015, Mr. McTeague said the average Canadian family stands to save about $1,500 on direct gasoline costs this year, with related reductions in the cost of living translating to an additional $500 to $1,500 in savings.

“If prices remain where they are or drop a little lower, then you can see where the savings will be in excess of $17 billion — that’s with a B — for the Canadian economy and for consumers in Canada,” Mr. McTeague said.

How it all adds up: The factors affecting Thursday’s price of gasoline in Toronto

$0.37 per litre: Wednesday’s average crude oil price
+ $0.02 per litre: Transportation to the refinery (estimate, varies)
+ $0.045 per litre: Difference between Wednesday’s NYMEX wholesale price of gasoline and the price of crude oil
+ $0.045 per litre: The amount Canadian refiners typically add above the NYMEX wholesale gasoline rate (estimate, varies)
+ $0.10 per litre: Federal tax on gasoline
+ $0.147 per litre: Provincial tax on gasoline in Ontario
+ $0.08 per litre: The gas station’s retail margin
x 13%: The Harmonized Sales Tax rate
= $0.91