Who Makes Up the Price of Gas?

By John Lawrence / Will Blog for Food / May 12, 2012

In this article we explore how the price of gas at the pump is determined. This is an opaque subject which has been heaped in layers of obfuscation because the oil companies don’t want you to know what a huge scam they are perpetrating on the American public systematically ripping them off at the gas tank. They want you to think that gas prices are set by immutable, impersonal factors like the “world oil market” over which we have no control nor ever could we.

When the oil company executives went before a Congressional hearing in May 2011 as gas prices hit $4.00 a gallon, Rex Tillerson, CEO of Exxon Mobil, was asked “how are oil prices set?” He responded that they were based on the marginal cost of producing the next barrel of oil. Nothing could be further from the reality of the situation although it would be a worthy aspirational ideal, something to shoot for in a more perfect world.

The Big 5 oil companies – Exxon Mobil, Shell, ConocoPhillips, BP America and Chevron – defended their huge tax breaks and subsidies despite record and eye popping profits as necessary to incentivize them to drill for more oil implying that more domestically produced oil would lessen dependency on imported foreign oil and keep the price down. This is also a total crock. Prices are set on the “world oil market” and have nothing to do with whether or not the oil is produced domestically or abroad.

According to Public Citizen:

 Big Oil CEOs testify Thursday before the Senate Committee on Finance to defend the trillion dollars in profits they have made in the past decade thanks to you, the American consumer. Some in Congress will defend the billions of dollars in tax breaks and royalty relief taxpayers give to these same companies each year.

 Public Citizen recently crunched the numbers and found that Big Oil’s profits aren’t the only eye-popping statistic – what the industry is spending its money on is equally astonishing. Big Oil lavishes more on stock buybacks, dividend payments, lobbying and marketing than on U.S. oil investments. Our research shows that since 2005, the largest five oil companies operating in the U.S. spent nearly half a trillion dollars buying back their own stock and paying dividends to shareholders. That’s more money than they spent investing in their U.S. infrastructure.

This contradicts the industry’s insistence that its billions of dollars a year in tax breaks are needed to create jobs and keep gas prices affordable. In fact, Big Oil’s investment decisions are driven by market prices of crude oil, not U.S. tax policy.

It’s time our leaders stop bowing to corporate interests and put an end to the “take the money and run” tactics of Big Oil that are nothing short of highway robbery.

While the speculation-fueled price of oil per barrel has continued to escalate, the underlying costs to produce oil haven’t. Consider this: On average, it costs $20 to produce a barrel of oil. Big Oil sells it to us for more than $100. This generates the massive cash flow that fuels oil companies’ profits and spending.

Ever wonder who pays for those ubiquitous “touchy-feely” TV ads by ExxonMobil, Chevron and the Oil and Gas Industry that you see day in and day out? You do. Without them the price of gas at the pump could be lower.

But despite the oil company executives’ dissimulation, deception and mendacity, there are several factors that go into the witch’s brew of oil and gas prices: namely, royalties paid to the owner of the oil before its extracted, the law of supply and demand and speculation. First, the oil as it sits in the ground, unbeknownst to most American citizens does not belong to the oil companies. It belongs to them! It is a public resource no matter how much the executives would try to persuade you that it is private property.

Oil corporations pay the Federal government (meaning you the taxpayer) royalties in return for the right to drill on government (citizen) owned property. During most of the twentieth century, oil and gas companies generally paid between 12.5 and 16.7 percent in royalties for a lease to drill on public land or water. This is one of the lowest rates paid to a government anywhere in the world! In comparison Norway’s citizen/taxpayers get a 50% return on their oil assets.

According to the US Goverment Accountability Office:

 Based on results of a number of studies, the U.S. federal government receives one of the lowest government takes in the world. Collectively, the results of five studies presented in 2006 by various private sector entities show that the United States receives a lower government take from the production of oil in the Gulf of Mexico than do states – such as Colorado, Wyoming, Texas, Oklahoma, California, and Louisiana – and many foreign governments. Other government-take studies issued in 2006 and prior years similarly show that the United States has consistently ranked low in government take compared to other governments.

So American taxpayers/consumers are being ripped off by oil companies before the oil even gets out of the ground! If higher royalties were paid, this would offset the price of gas at the pump and/or reduce taxes. In any event this would benefit the American consumer/taxpayer. Moreover, royalties have been fraudulently underpaid or exempted from for years. In 1995, both houses of Congress passed and President Bill Clinton signed the Deep Water Royalty Relief Act (S.395), which granted a royalty “holiday” to oil and gas companies drilling in government-owned deep waters in the Gulf of Mexico for leases sold between 1996 and 2000. In 2005, Congress passed and President Bush signed the Energy Policy Act of 2005 (H.R. 6). which included a variety of provisions to provide royalty relief to oil and gas companies.

But wait there’s more:

During the mid-nineties, whistle-blowers and the Project on Government Oversight (POGO), a government watchdog group, filed suit against sixteen oil companies for failing to pay their required royalties. POGO’s suit was filed under the False Claims Act (FCA), which provides citizens the power to sue on behalf of the federal government for fraud. In these cases, the Justice Department has the right to join the case. This ultimately happened in the POGO case. From 1998 to 2001, a dozen major companies, while acknowledging no wrongdoing, paid $438 million to settle charges that they had intentionally misreported their sale prices for oil (in order to pay lower royalties).

So while the big oil companies were recording record profits, paying little if any taxes to the Federal government (causing you to pay more) and receiving subsidies, they were also committing fraud by underpaying royalties which were minimal in the first place.

Now that we’ve got the oil out of the ground, what is the next step? Why placing it on the world oil market which means that US oil companies will sell it anywhere in the world to the highest bidder. You might think that they would sell oil extracted in the US to US consumers first and then this would be supplemented by oil bought from abroad – the so-called foreign oil – to make up the shortfall in which case oil would be subject to the law of supply and demand within the US but such is not the case. American consumers are expected to buy gas that is subjected to the law of supply and demand among world consumers which means that as demand goes up in China and India, for example, American gas prices will rise even as demand within the US is falling. Dependency on foreign oil is a misnomer and a bugaboo. Our supposed dependence on foreign oil has nothing to do with the price of oil. What we’re really dependent on is that “our” oil companies sell us “our” oil based on world oil market prices which means that they extract from us much higher prices than if they sold us “our” oil based on the domestic oil market. In other words oil produced on US real estate and sold to US consumers would end up being cheaper than oil placed on the world oil market and priced accordingly. So drilling for more oil on American soil has nothing to do with lessening our dependence on foreign oil because the pricing of oil we consume has nothing to do with how much oil is extracted from American soil.

To the extent that the law of supply and demand comes into effect which, as we shall see, is minimal, it is easily seen that this factor gives the lie to Tillerson’s claim that the price of oil is based on the “marginal cost of the next barrel of oil that is produced.” The law of supply and demand states that the seller will sell his product for the highest price he can get irregardless of cost. The selling price has nothing whatsoever to do with cost. It only has to do with demand. Edvard Munch probably produced “The Scream” for less than $10. Yet it sold recently at auction for $119 million. A Liz Claiborne sweater for which the worker in Thailand is paid 3 cents to make sells for $170. The law of supply and demand insures that cost has nothing to do with selling price. Insofar as the price of oil is affected by supply and demand, the same thing holds true.

The next factor to be considered is speculation. Oil being a commodity is traded on the commodities exchange. Futures contracts are bought and sold. What this means is that gas prices aren’t simply set by the law of supply and demand but that speculators who are only in it purely for profit can drive up the price of oil. These are people who have no interest in ever taking delivery of the oil. They will buy a futures oil contract only to sell it (hopefully at a profit) before the oil has to be delivered. It has been estimated that 80% of the oil market is under the control of speculators. None other than Rex Tillerson, CEO of ExxonMobil, has testified that this has caused a 40% spike in gas prices. So “market forces,” namely the selling of oil on the world market instead of just the domestic market and speculators have control of and can manipulate the price of gas at the pump in order to gouge the American public and increase their profits. Although the Commodities Futures Trading Commission was ordered to put position limits on speculators under the Wall Street reform act passed by Congress in 2010, they have failed to do so. This has allowed the continuation of unbridled speculation which translates into an additional $750. a year going directly from your pocket into those of the Wall Street speculators every time you fill up your vehicle!

Some believe that speculators control the market completely and supply and demand has nothing to do with it. In a blog titled “Futures Prices Determine Physical Oil Prices,” JD contends that spot oil prices adjust to futures prices and not the other way around as is commonly thought. The spot oil price is simply the price of physical oil if you went out and bought some today. It is not too hard to see why the futures oil price would control the market if most of the oil market was tied up in futures contracts. If that were the case, there would simply not be enough oil on the spot market for current users, and oil consumers would be forced to buy from those who held the futures contracts in which case they would have to pay the futures contract price not the spot oil price. Supply and demand would have little to do with it since there would be relatively little supply on the current physical oil market.

All of this begs the question of why does oil and gas have to be subject to market forces and speculation at all? The answer to that question is that this maximizes profits for the oil companies and Wall Street while providing a disservice to American citizens/taxpayers. If the price of oil was not set by “the market”, if control of natural resources was in the hands of or controlled by the citizens/taxpayers, we wouldn’t have the ridiculous situation that supply of oil is as great as it’s ever been while demand is exceedingly low, yet the price of gas at the pump has doubled compared to what it was when supply was lower and demand was greater.

In the documentary “GasHole” the nefarious activities of the oil companies are pointed out including the elimination of any technology such as the water injected carburetor which results in a car getting 100 mpg and the electric car that was killed by the oil companies in the 1990s as recorded in the documentary “Who Killed the Electric Car?”. Before the turn of the 20th century, in 1893, Rudolf Diesel developed a fuel source based on peanut energy. He said, “The use of vegetable oil for engine fuels may seem insignificant today. But such oils may become, in the course of time, as important as petroleum.” His demise is also shrouded in mystery, and his engine invention moved forward — using oil, another example of how the oil corporations bought out or forced out every alternative to the use of oil to propel vehicles. In 1904 progressive muckraker Ida Tarbell wrote “The History of Standard Oil” in which she pointed out how John D Rockefeller had used unethical business practices to force out smaller oil producers. As a result the Standard Oil monopoly was broken up into smaller companies based on states. In New Jersey it became Standard Oil of New Jersey which later became Exxon. In New York it became Mobil etc. Under the Clinton administration these two corporations were allowed to merge again into ExxonMobil.

The biggest crock is that the way to lower gas prices is to produce more domestic oil – drill, baby, drill. This is because oil prices are set on the world oil market not on any kind of domestic oil market. The way to lower gas prices is for the American people to take control of the resources they purportedly own. We can hire the oil companies to do the work for us of getting the oil out of the ground and refining it, but we should control gas prices, not the oil corporations or the “markets” namely Wall Street speculators. If We the People controlled the price of gas, it could be more rationally based on, as Rex Tillerson said, “the marginal cost of producing the next barrel of oil,” instead of oil prices set by the “world oil market” and speculators.

Editor: Go here to the original – as we did not repost all the links that the original provided.