Painful Lessons

Friday's record closing price for oil of $138 and change put paid to any hopes that last week's average retail gasoline price of $3.98/gallon would turn out to be the high-water mark for this summer, as the price around Memorial Day has been in some previous years. As stressful as the reality of $4 gasoline is on the economy and on individuals, though, there are good reasons not to panic. Hoarding by consumers or attempts by government to moderate prices could make the situation even worse, as we experienced in the previous energy crisis. Although we rarely think of it in such terms, reliable supply generally trumps low prices.

After a long stretch in which the price of gasoline consistently lagged the rate of consumer price inflation, it is now leading the CPI higher along with food-price inflation, which also includes a significant energy-related component. In June 2006 the average retail price of gasoline was $2.85/gal. If it had only increased as fast as overall CPI inflation--ignoring its impact on same--we would now be paying $3.04/gal. That's about what the price would be if gasoline had inflated steadily with the CPI since 1981, when it averaged $1.38/gal. We're just beginning to see the adjustments consumers must make to accommodate this sudden shift in gasoline's share of household expenses, in the absence of ready cash from home-equity loans. If these conditions persist, we will eventually learn what they mean for the value of real estate in outer suburbs that benefited from the rise of long-distance commuting.

Whatever the contribution of speculation to high oil prices--the number one cocktail-party-and-dinner question I am asked, these days--or the role of the weakening dollar, we mustn't forget that oil wouldn't be an attractive investment for commodity speculators and dollar-hedgers without the ongoing collision between global constraints on expanding its output and the rapid growth of demand from the economies of Asia and the Middle East. It would be counterproductive at this point for our government to implement policies that resulted in further increases in demand or reduced supply. Gas tax relief at the pump or a windfall profits tax on oil companies might mollify consumers and voters, but they would ultimately make markets even tighter. So would any quick reversal of the apparent trend by consumers to keep less fuel in their gas tanks.

It might seem odd to look for good news in this situation, but compared to the late 1970s, things could be worse. Gasoline inventories are still at reasonable levels in terms of the number of days of supply they represent. As a result, the only gas lines we've seen were the result of consumers capitalizing on a lag in price increases at stations serving the New Jersey Turnpike. As painful as rationing supply by price has become in this case, it works better than price controls or odd-even refueling restrictions. That's worth remembering in this election year.