What you pay for at the pump
How gasoline prices are determined
What you pay for at the pump
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Several factors affect the price of gasoline. The cost of a barrel of oil plays an important role, but so too do the costs of refining and transporting that oil, as well as the taxes that apply.
Today’s weather, yesterday’s hockey game and the price you’ll pay at the pumps—the conversation is predictable when Canadians make small talk. The actual price of gasoline is less so. Prices have reached record highs and have come crashing down. So why does the price of gasoline change so much?
Many different costs associated with production and retailing are built into the price of gas. Some costs are determined in Canada and others in international markets.
How global crude oil markets work
The largest component of gasoline prices is crude oil, which is used in transportation, manufacturing and electricity generation. Changes in global supply and demand affect the price for crude oil. This means that the overall level of economic activity is the most important factor in determining demand for oil: a booming global economy means more demand, while a slow economy means less.
But most oil producers can’t increase production quickly, so when demand goes up, the price of oil rises. Prices also rise if demand doesn’t drop when the supply of oil is disrupted, like when international sanctions are imposed on an oil-producing country.
Over the long term, the economy adapts to the price of gas. Drivers purchase more fuel-efficient vehicles and oil producers invest to increase capacity. For example, high levels of demand in the early 2000s drove up gas prices. Prices then decreased between 2014 and 2021 as producers found new ways to extract oil, which increased supply.
From the well to the pump
Variations in the price of crude oil are the single biggest cause of changes in gas prices.
Crude oil is sold by the barrel, and its density is one factor used in setting its price. Light oil is less dense, which makes it easier to refine during the process of creating gasoline. As a result, the per-barrel price for light oil is higher than for dense oil. Dense, or heavy, oil is more difficult to refine, which is why it fetches lower prices. The costs to purchase and refine a barrel of oil are built into the price you pay at the pump.
Learn how much crude oil, refining, retailing costs and taxes contribute to the price of gasoline.
Operating costs and taxes
While the type of crude oil affects the price of gasoline worldwide, other factors are uniquely Canadian.
Exchange rate
Oil is usually priced in US dollars, so the exchange rate has an effect on the price of gas in Canada. Buying oil or gas becomes more expensive when the value of the Canadian dollar against the US dollar declines, and that affects gas prices.
Fuel retailing
Consumers buy gasoline from retailers, and those retailers take a profit too. Low prices attract more customers, but higher prices increase profit margins and help offset retailers’ costs. Retailers sometimes change gas prices several times in a day because of changes in supply and demand:
- Retailers can raise prices when demand is strong, like before a long weekend when drivers need to fill up.
- Retailers can lower prices to attract customers during quiet times, like late at night.
Taxes
Fuel taxes also affect gas prices and are one reason why the price at the pump varies across Canada. Fuel taxes include provincial and federal sales taxes and carbon taxes. A few municipalities have an additional tax on gas.
Pipelines
Canada has an extensive network of pipelines that transport oil. The network includes nearly 20,000 kilometres of interprovincial oil pipelines that are federally regulated as well as many other smaller pipelines that don’t cross provincial borders. The largest pipelines cost billions of dollars to build and can take decades to pay off. Some are owned by companies that produce oil, and others by pipeline companies that charge fees to use them. In both cases, pipeline costs are built into gas prices.
Refining
Refining costs include the costs of turning raw materials into gasoline and the net refining profit margin. The profit margin is the difference between the price the refiner sells its final product for and how much it cost the refiner to make that final product. While refining costs contribute to the price of gasoline, refineries can affect pump prices in other ways.
The price of gasoline can go up when refineries unexpectedly stop operating. Prices don’t usually increase when refineries close for planned maintenance. But unplanned closures can limit the supply of gasoline—especially when multiple refineries are affected—and lead to a sudden increase in gas prices. Extreme weather events sometimes cause this to occur. For example, hurricanes have forced unplanned closures of major refineries located along the US coast of the Gulf of Mexico.
On rockets and feathers
Have you ever noticed that the price of oil increased and observed gas prices go up immediately? And did you notice that the price of gasoline didn’t come down as quickly when the price of oil decreased? This is called the rocket and feather effect: gasoline prices follow oil prices up quickly like a rocket blasting off but fall slowly like a feather when oil prices decline.
Several factors can play a role in this phenomenon. Consumers may shop around less when prices fall, which weakens the incentive for retailers to sell at the lowest price. As well, lack of competition among wholesalers or gas stations could allow them to keep prices higher for longer.
But the feather effect is only temporary. Over time, gas prices decline along the same path as that of the price of crude oil.
The importance of gasoline prices
Everyone likes saving a few dollars, but changes in the price of gas are important for another reason. Gas and oil are used throughout the economy. When gasoline prices go up, so too do the costs—and the prices of other things. And high prices can drive inflation throughout the economy. That’s why the Bank of Canada closely watches the prices of gasoline and oil and incorporates them into its economic forecasts.
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