Is Gasoline Too Cheap?

It's an article of faith among many observers of the oil industry that gasoline is too cheap in the US. Environmentalists and economists point to various externalities that aren't included in the price consumers pay, while carmakers and alternative energy developers need a (much) higher price to make advanced vehicle technologies and substitute fuels competitive without subsidies. When someone asks, "Too low compared to what?" the response usually draws a comparison to prices in Europe and elsewhere. Yet while perusing a clever historical price comparison tool on the Energy Information Agency's website, I was struck by how high today's gas prices are, when adjusted for inflation, compared to those that prevailed for most of my life--other than during energy crises. That's surely a factor in current weak US gasoline demand, which has been running slightly below last year's, and a full 3% less than the record levels of 2007.

In the course of searching for a standard table of historical gasoline prices, I recently ran across a handy new feature (or merely one I hadn't seen before) of the EIA's Short-Term Energy Outlook report. It allows the public to compare the nominal and real prices for crude oil, gasoline and other fuels, and electricity, over a flexible interval adjusted with a slider control. The first thing I noticed was that although today's price for West Texas Intermediate crude oil of $76 per barrel seems pretty low compared to its $145/bbl high in July 2008, it's actually higher than the inflation-adjusted price for most of the period from 1973-2006, with the exception of the aftermath of the second 1970s oil shock. Now, the Consumer Price Index might not be the most appropriate measure of inflation for crude oil, as I've described in some detail before, but it is perfectly reasonable to apply it to gasoline prices.

On that basis, this week's national average of $2.72 per gallon--$0.17/gal. more than one year ago--is higher than the $0.53/gal. average (equivalent to $2.32/gal. today) for 1974, following the Arab Oil Embargo that helped trigger a severe global recession. It's higher than the $1.17/gal. average ($2.37/gal.) for 1985, before a flood of new production from the North Slope, North Sea and elsewhere broke OPEC's pricing power for more than a decade. It's even higher the $1.35/gal ($2.20) that we paid in the final lead-up to the first Gulf War in late 1990. In fact, it's almost a full dollar higher than the $1.75/gal. inflation-adjusted average for 1986-2005.

When gas prices dipped below $2.00/gal. in late 2008 and early 2009, that provided a significant stimulus to an economy suffering from the combination of a recession and financial crisis. At today's level, however, not only are gas prices not stimulating the economy, but they must be a significant drag on it. Our consumer psychology may be anchored for the time being on $4 as the gauge of what constitutes a high gas price, but compared to the prices that were in effect when our current patterns of mobility and employment were set and the vast majority of the US vehicle fleet was purchased, $2.70 seems more than sufficiently high to inflict economic pain.

Don't get me wrong. I understand full well that a realistic assessment of the cost of greenhouse gas emissions would add at least another $0.10-0.20/gal. to gas prices, and that the current level of US motor fuel taxes is inadequate to pay for the proper maintenance of our highway infrastructure, let alone all the other transportation priorities we'd like to pursue. Other economies have adjusted to much higher gas prices, though these do not prevent the European Union from being a larger net oil importer, in aggregate, than the US is. If OPEC can keep crude oil above $70/bbl when global demand is slack, it's anyone's guess how high it will go when the global economy is actually growing strongly, again. Yet while higher gas prices may well be in our future for many reasons, we should recognize that today's prices remain at oil-crisis levels, and the view of them as "too low" is very much in the eye of the beholder.