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Business & Tech

Unraveling the Mystery at the Pump

A look at how gas prices are determined and why they're rising.

As the hit to the wallet gets harder, many drivers are wondering: How are retail gas prices are determined?

And some are thinking of giving up driving altogether—or at least as much as possible.

“If gas continues to go up, I’ll probably have to have a purpose to drive somewhere,” said Anne Leadbeter, a single mom in Huntley who works full-time in West Dundee during the day and attends McHenry Community College at night.

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Naturally, gas station owners account for some of it as they try to cover their operating costs, but for the most part, retail gas prices are directly related to the price of crude oil.

And while the relationship between the two may appear simple, it’s actually quite complex. Think of it as a game of bumper cars with the four different sides from which you can get “bumped” each side factoring into the price of gas.

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First, there’s the opposing driver facing you, the one you can see coming a mile away. We’ll call him “Taxes"—as in state, county, municipal, etc. etc. You can also get bumped from the left and right sides, which, in this analogy, is the cost of refining crude oil (left) and distribution and marketing costs (right).

A disruption of one, or an increase in the other, almost always affects retail gas prices. Lastly, you can get bumped from the car behind you, the pesky one you never see coming.

Driving this car is the price of crude oil and, unfortunately, it’s this car’s bump that does the most damage.

According to the U.S. Energy Information Administration’s most recent data, crude oil accounted for 67 percent of the price, or $3.10, of a gallon of regular gasoline in January 2011. On average, taxes and refinery costs were the second (13 percent) and third highest (11 percent), respectively.

So when crude oil surged past the $100 per barrel mark as it did recently, Chicago area gas prices followed, jumping to $3.50-plus per gallon, making that bump from the car behind you feel more like a shove from an 18-wheeler.

There’s still one important underlying factor that determines gas prices: supply and demand.

“Most of the countries in the world have a reliance on oil and gas,” said Khan Mohabbat, an economics professor at the Northern Illinois University in DeKalb. “The U.S. is recovering so the demand is increasing, and the recovery of the U.S. is relatively moderate, not very fast. But the increase in demand in China, India, Indonesia as well as Brazil is exceptionally strong. For instance, China. They expect the rate of growth in China to be around 10 percent this year.”

Aggravating the supply and demand model is, of course, the turmoil in North Africa and the Middle East where both the Tunisian and Egyptian governments have been ousted and the Libyan government struggles to hold on.

“When you look at the supply side, you find that the upheaval in the Middle East is putting an exorbitant amount of pressure on oil prices,” Mohabbat said. “Some of the pressure is from, of course, those who like to make a quick buck out of it, but some of it is real. Passage of an oil ship is very difficult and very risky today through the Suez Canal and so on.”

An example of just how supply and demand factors into oil prices came late last week when a report of shots fired on Saudi Arabia protestors  and oil prices spiked $3 in just 12 minutes and Libya’s announcement that its Al Jurf offshore oil field had stopped production kept oil prices above the $100 per barrel mark.

However, less than 24 hours later the price dropped to $99.01 on news that a 8.9 earthquake and ensuing tsunami had struck Japan, the world's third-largest oil consumer. Oil finished Friday at $100.70.

While the turmoil in North Africa and the Middle East does not involve the U.S.’s top five oil suppliers—Canada, Mexico, Venezuela, Saudi Arabia, Nigeria—it has resulted in higher oil prices for us.

“Oil prices are determined by the supply and demand for the world as a whole,” Mohabbat said. “So the U.S. price actually follows the world price. If the world price rises, so does the U.S. price.”

With the supply of oil an ongoing concern, and immediate demand showing no signs of easing up, higher prices already have some local residents rethinking their driving habits, a strategy last utilized in 2008 when oil eclipsed the $100 mark in March and peaked at $147 in mid-July.

Drivers can help keep their wallets safer by increasing their gas mileage.

Beth Mosher, a AAA Chicago spokesperson, said drivers should consider carpooling, keep their tires properly inflated and, whenever possible, consolidate their errands. Mosher also recommends drivers shop around for the best gas prices.

Technology has made price searches much easier with many companies, including AAA, offering downloadable apps or website tools.

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