All Cars, All the Time

Gas Prices...When Will Drivers Crack?

As you may know the online version of the Wall Street Journal is free this week and I've been snooping around for good info. One interesting story that I found deals with Americans’ response to rising fuel costs. Basically, the article asks what is it going to take before consumption is reduced? The answer? It’s going to take A LOT, a whole lot.

The price elasticity of U.S. gasoline use is as low as 0.1. So if gas goes up by 10% then demand would drop by 1%. I would imagine that as the price continues to rise that elasticity would have to tighten somewhat: a 10% increase of $1.80 is a more palatable 18 cents as opposed to 30 cents for a $3.00 gallon of gas. But what do I know? I’m no economist.

Another economist estimates that real inflation-adjusted gasoline prices have to rise at roughly five times the rate of real income just to keep the nation's gasoline demand flat. Our incomes have been growing by 3% as of late and last quarter gasoline vaulted up 17% as compared to 2005. Gasoline demand increased only 0.3% during this same time frame so it would appear that this economist is on to something.

Exxon is predicting that fuel consumption by North American cars and light trucks will peak around 2020 and then begin to slacken. That forecast means that Exxon will not be building any brand spankin’ new refineries that the President is calling for.

So let’s recap: Substantial price increases may generate headlines and tons of sound bites from “gas pump economists” who predict dire things—but the quiet majority is simply taking the hit and not saying/changing/doing anything about it.

Will this trend continue or will prices hit a certain barrier? Well, I saw something today that gave me perspective. Last year someone photoshopped a gas station sign to show the price for regular gasoline and then ARM for the price of mid-grade and LEG for premium. The “outrageous” price regular gas shown on the sign? $2.35 Considering that today the “bargain” gas station down the street from me is a $1 higher, that $2.35 a gallon seems like quite a bargain now, doesn’t it? If we continue to adapt to higher prices at this rate, then we could be looking at higher prices for some time to come.

What I wonder about is the impact of oil on inflation. It’s one thing to pay more to fill your tank, but when everything you buy increases in cost then there could be considerable demand decrease across the board.

Original WSJ article here.