As the cost of gas soars, here’s what’s driving the price at the pump
Canadians are facing record high gas prices, making driving more unaffordable and fueling the rising cost of everyday goods and services.
Over the past year, gasoline prices have jumped more than 50%, pushing the cost per liter to over $2 in many parts of the country. At the same time, inflation – which stands at 6.8% nationally – continues to outpace wage growth.
But when it comes to the staggering cost of gasoline, what exactly is behind the price consumers are paying?
Here is a brief explanation on how to understand prices at the pump.
What is the main contributor to high gasoline prices?
The price of gasoline can be broken down into four components: the price of crude oil, the cost of refining it into gasoline, the station owner’s profit margin and, of course, taxes.
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The main driver of high gasoline and diesel prices is the price of crude oil, which now costs 75% more per barrel than in May 2021.
“That’s the main reason why prices are higher today than they were a few months ago,” said Trevor Tombe, an economics professor at the University of Calgary.
Crude oil supplies have become more limited after Russia was placed under sanctions for its invasion of Ukraine. A major crude oil producer, Russia’s withdrawal from the world market has pushed prices up US$20 a barrel since the invasion began on February 24.
And with gasoline demand increasing as it usually does in the summer, prices are climbing even higher.
LOOK | What is fueling record high gasoline prices in Canada?
What about taxes?
Several taxes are levied on gasoline, both federally and provincially.
The federal carbon tax adds 11 cents to the cost of every liter of gasoline, a figure that is drawing criticism as fuel becomes more expensive.
“It…brings a lot of political anger out of people because it’s another tax,” said David Detomasi, associate professor of international business at Queen’s University.
But the idea that the carbon tax is causing high gas prices is a misconception, Tombe said.
“While, you know, 11 cents per liter is a significant level overall, it’s not driving the recent increases we’re seeing,” he said. “It’s really about world oil prices, and it’s really driven by things way beyond the control of the Government of Canada.”
The federal carbon tax is expected to increase, however: it increased by 2.2 cents per liter this year and will continue to increase until it reaches $170 per tonne by 2030.
Do gas stations make a lot of money?
When you fill up your vehicle, you may have the illusion that gas stations make a lot of money.
But retailers keep very little of what you pay for at the pump. In fact, they’re making less profit on every fill-up now than a year ago. Retailers are currently adding, on average, 6.9 cents to the price of a liter of gasoline, compared to an average of 8.6 cents a year ago, meaning their profit margins have shrunk by 20%.
“The companies that make the gasoline are doing pretty well. But the retailers and outlets aren’t getting rich,” Detomasi said.
Is more oil produced to increase supply?
U.S. oil companies have increased drilling activity by nearly 60% over the past year, according to a closely watched weekly tally of operating rigs by oil services firm Baker Hughes. In Canada, drilling activity in April was up 134% from a year ago, Alberta says Department of Treasury Board and Finance.
However, the Organization of the Petroleum Exporting Countries is responsible for 30% of world oil production. After cutting production during the pandemic, the cartel of 13 oil-exporting nations has been slow to grow – despite pressure from the West as it tries to find an alternative to Russian oil.
In addition, Detomasi said oil exploration budgets have been drastically reduced in recent years, contributing to a tighter global oil supply. He attributes this drop in investment to the price of crude oil, which fell dramatically after 2014, and to the social and political movement to limit the use of fossil fuels.
“The political risk and expense of expanding new exploration for a company is high,” he said.
However, Tombe said the main obstacle to exploration was falling oil prices – the price per barrel of oil fell from over US$100 in 2014 to just under US$30 in 2016.
“The main reason for the decline in production, exploration and development of new oil and gas resources is that until recently oil prices were very, very low,” the economist said.
How are the oil companies faring?
Oil companies are seeing their profits rise alongside gas prices.
Shell’s profits in the last quarter tripled from the same period last year, raking in $9.1 billion. Saudi Aramco, Saudi Arabia’s main oil company, saw its profits increase by 82%, bringing in nearly $40 billion.
But Tombe said high profits are a function of high prices, a phenomenon that is neither surprising nor unusual.
“High oil prices are positive for oil and gas producers – absolutely,” he said. “But it’s not profit that’s causing the high prices, it’s the other way around.”
Will gas prices drop soon?
Gas prices are historically volatile and difficult to predict, the economist said.
They also tend to be cyclical in nature, meaning they rise during economic booms and fall during downturns. At the start of the pandemic, for example, gasoline prices fell dramatically to a low of 78 cents per litre, leading oil producers to slow production.
In the short term, prices can also change significantly from day to day. On Friday, gasoline prices fell dramatically in some parts of the country. Tombe said these swings can occur due to changes in competition, and since crude oil prices haven’t fallen, margins have likely changed for producers.
Laura Lau, chief investment officer of Brompton Funds, said strong demand for petrol as people travel more, coupled with low supply, means petrol prices are likely to remain relatively high in the near term.
“Longer term in terms of price, things [will] normalize,” she said.
Markets expect the price of oil to come down a bit in the long run. Futures contracts, which track the price of oil at a specific time in the future, expect a barrel of oil to cost US$89 in May 2023. On Friday, the price per barrel closed around $113 US.
The war in Ukraine is a key factor that could significantly change gas prices. If the situation stabilizes, Tombe said oil prices are likely to fall.
“You really can’t predict what’s going to happen,” he said.