How the Strait of Hormuz affects the price of filling your gas tank

On paper it makes little sense. Ship traffic through the Strait of Hormuz, roughly 7,000 miles from the United States, is restricted and gasoline prices in this country soar? 

The strait is the major export route for oil produced by Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Iraq, Bahrain and Iran, according to the International Energy Agency. But since Feb. 28, when the Iran war began and the narrow passageway between Oman and Iran became a battleground, U.S. gasoline prices have soared — and the prices of consumer products and services are poised to jump as well. 

Most oil passing through the strait goes to Asian markets, according to the U.S. Energy Information Administration. And due to greater domestic production, the U.S. is importing less crude oil from the Persian Gulf than it has in 40 years, EIA said in a March analysis.

So why are U.S. consumers paying so much more for gasoline? Globalization.

“Supply disruptions anywhere in the world can also affect prices everywhere in the world because we live in a global market,” explained Jeff Lenard, a vice president of the trade group National Association of Convenience Stores. “Oil and refined products like gasoline are traded on the commodities markets. Places with short supply are willing to pay more for product. That drives up the global price.”

Gas prices are tied to the global supply and demand for crude oil, meaning a disruption to the supply anywhere can have an effect everywhere, said Patrick De Haan, head of petroleum analysis at GasBuddy, which tracks gas prices.

“It’s because the price of oil is based on how much is available in total. Since oil from there is in short supply, the rest of the oil all around the world becomes more expensive,” De Haan said.

A gallon of regular gasoline Monday cost an average of $4.52, according to AAA up from $4.14 a month ago and $3.14 a year ago. Consumer prices overall were up 0.9% in March, and were averaging 3.3% higher over the past year.

Dissecting prices

While the Middle East oil disruption affects prices throughout the world, retail pump costs can vary dramatically from state to state across the U.S.

California’s average Monday was $6.16, the nation’s highest, AAA reported. Next were Washington, $5.76, and Hawaii, $5.65. The lowest averages were in Oklahoma, $3.95, Mississippi, $3.98 and Arkansas, $4.

The price of crude oil is the biggest part of the price consumers pay at the pump. EIA estimates that it makes up 51% of the retail cost. Distribution and marketing account for 11%, refining costs and profits 20% and federal and state taxes 18%.

That means dramatic changes in the price of crude have a huge impact on retail prices.

 

The National Association of Convenience Stores estimates that each dollar the price of oil increases could be 2.4 cents a gallon at the pump.

Brent crude, the world benchmark, was $70.50 the day before the U.S. and Israel struck Iran. Monday morning, it was more than $104.

The $34 a barrel increase since the war began would mean a 82-cent per gallon increase. 

Competition can keep prices from rising too much. No gas station wants to be an outlier projecting much higher prices than the one across the street.

Taxes and gasoline prices

There are other factors impacting gasoline prices, notably taxes that vary from state to state. 

The federal tax on gasoline has been 18.4 cents a gallon since 1993. President Donald Trump said Monday he supports freezing the tax, though he offered no timeline. A suspension would need congressional approval, and Republican leaders have in the past been reluctant to embrace any pause.

While the average state tax is 33.55 cents a gallon, it varies widely. California’s taxes and fees are estimated at 70.9 cents a gallon, the nation’s highest. The lowest tax and fee rate is in Alaska, 9 cents a gallon.

California’s costs are also boosted by other factors, including its tough environmental standards. The state requires a special blend of gasoline that aims to help air quality.

“This fuel burns cleaner but is more expensive to produce because it requires more processing steps and expensive blending components,” EIA said.

Another reason for the higher prices is California’s reliance on in-state refineries. It doesn’t have as much proximity as other states to interstate supply pipelines

Ripple effects

About 20% of the world’s oil passed through the strait prior to the war. But reopening the strait would be unlikely to suddenly bring prices down.

“In complex supply chains, a disruption in one critical link, even if only briefly, can cascade through the system, well beyond the initial event,” Pinar Keskinocak, professor at the H. Milton Stewart School of Industrial and Systems Engineering at Georgia Tech, said in an analysis. “As delays persist and compound, interconnected systems often take a long time to recover, rebalance, and return to normal.”

“I don’t expect there to be an open flooding of barrels just leaving the region,” said Jerome Dortmans, co-head of global oil and products trading in Goldman Sachs Global Banking & Markets, in an analysis.

And if the Iran crisis continues and the strait remains restricted, more price pain is probably ahead.

“A prolonged disruption of Middle East oil trade would create oil market conditions for which there is no historical precedent,” said a March report from the nonpartisan Congressional Research Service.