Wednesday, August 24, 2005

How Big A Bite?
I see a lot of commentary about the impact of high oil prices on the economy, such as this recent article from the New York Times and a segment on CNN last night. Not much of this coverage actually bothers to quantify the impact on consumers, though, relying instead on anecdotal evidence of curtailed spending on a host of items, or WalMart's concerns about slowing sales. This tends to be balanced by reminders that oil remains below its inflation-adjusted highs of the early 1980s, and that our economy uses less oil per dollar of GDP output. How big is the impact, really, and how concerned should we be?

Following the latest gasoline price hikes, we are currently paying $1.00/gallon more than we paid on average in 2003. For the average driver, with an average car, that results in an incremental cost of about $10.50 per week. For a household with two cars, that results in a fuel bill that is higher by $92 per month. You'll pardon me for thinking that this doesn't translate into many foregone Broadway tickets, as the Times suggests, but in a zero-net-savings economy, it is clearly money that consumers would have spent on something else, be it staples at WalMart or Lattes at Starbucks. When you aggregate $10/week across 200+ million cars and light trucks, the impact starts to become noticeable, even in a $12 trillion economy.

It's worth noting that even though gasoline demand remains at record levels, the result has been high prices, rather than the kind of gas lines we had in the 1970s. By contrast, we see China holding the price of gasoline artificially low, but running short of product, with drivers reportedly queuing for hours for a fill-up.

But as visible as the price of gasoline is--probably the most transparent price in our entire society--we have to remember that this is only one aspect of an across-the-board increase in energy prices. Wholesale heating oil and natural gas prices are more than double their historical averages, and electricity rates are going up, as the cost of the coal and gas that fuel most of our generating capacity rises.

Overall, this country consumes 100 quadrillion BTUs (quads) of energy each year, and the cost of 85% of it (the fossil fuel component) has gone up by roughly $4/million BTUs. That's a $320 billion/year drag on the US economy, with about a quarter of that applied to imports that contribute to our trade deficit. When you add this to the ongoing cost of a war, it's hard to imagine that we won't eventually get a recession, inflation, or both.

If there is a positive side to all this, then perhaps it is that we now live in the world that advocates of higher gasoline taxes have wanted for years, in order to hold down demand and curb emissions. Unfortunately, the lion's share of the revenue being collected--beyond energy company profits that get recycled via dividends, stock buy-backs and M&A--is going to the Middle East, rather than paying for alternative energy R&D or reducing the deficit. It will be instructive to see whether the growth in our energy demand stalls before the economy does.

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