Factors in the Price of Gas

Old-timers called oil "Texas Tea," but the US oil industry really started in Pennsylvania, with the 1859 discovery of light crude burbling between rocks in a farmer's creek. People at first used it to grease machinery and light lamps. Fifty years later, rigs pumped black gold from wells across the country and fortunes were made. Now, as then, oilmen cagey about their claims don't say much about what they know. But some will talk about how they know it.

In an industry where the top five oil companies last year booked US$1.5 trillion in sales, thieves target that intelligence. In February, for example, Petrobras, the US$112 billion state-owned oil giant in Brazil, had four laptops and two hard drives stolen. They contained "secret and important information," the company told Brazilian news outlets, about an ocean reservoir that in the next few years could produce up to 8 billion barrels of oil. Brazilian police are said to be investigating. Geologic information like the sort believed to have been stolen from Petrobras is one piece of the "upstream" part of the business, where companies and countries explore and drill for oil deposits deep in the earth. Analysts combine geologic and seismic data with what-if engineering models showing how best to get the oil out and the projected costs of such a multiyear project, explains Louie Ehrlich, CIO and president of Chevron Information Technology.

Then there is the "downstream" work of refining crude oil into something usable, such as gasoline or diesel, and of getting those products sold and delivered. Those jobs generate information on refinery capacity and throughput, for example, and the cost of marketing and distribution.

Exxon and Chevron, the biggest oil companies in the United States, are known as "integrated," meaning they work both the upstream and downstream ends of the business. Petrobras does, too, though Ehrlich points out that no company is perfectly integrated, meaning that what it finds in the ground always ends up in its own refineries. Chevron might find crude that its refineries don't handle, he says. "Some types of oil require more complex refining capability to process." Chevron produces about 2 million barrels of oil per day and only refines about 15 per cent in its own refineries.

Others focus on just one end or the other. Valero, for example, is the biggest US refiner, concentrating on the downstream work of turning oil into other things to sell.

Upstream usually costs more than downstream. Exxon, for example, spent US$15.7 billion on upstream jobs in 2007. Chevron, US$15.5 billion. But downstream costs stack up, too. Exxon's were US$1.1 billion and Chevron's US$3.4 billion.

Prices at the pump reflect these expenses. The cost of crude oil constitutes most of the price of gas, accounting for 73 per cent of today's $4-plus figure, according to the US Department of Energy. Refining, meanwhile, is 8 per cent; so is distribution and marketing. The remaining 12 per cent goes to US state and federal taxes. Each oil company analyzes its costs and potential income, says David Smith, an IT consultant to the oil industry at Electronic Data Systems, trying to profit at each step (except for taxes, which are fixed).

Traditional economic principles of supply and demand alone fall short when you try to forecast prices, Smith says. "With political instability, fear about Iran and Iraq-those have ripple effects and an emotional response at the pump," he says.

"You have to blend that volatility with real-time market data and factors you can't predict."