Dave Pollard's environmental philosophy, creative works, business papers and essays.
In search of a better way to live and make a living, and a better understanding of how the world really works.

	May 23, 2007

Yet More Fun With Numbers: $7/Gallon Gasoline Chart by Stuart at Random Useless Info. For the previous 30 years, 1950-1979, price was steady at about $0.30 - 0.40/gallon before spiking near the end of the 1970s. In the last five years, the price of gasoline in North America has roughly doubled. This has created some problems for the poor, but for most people it has not caused hardship, and has not significantly affected buying or consumption behaviour. In fact, the inflation-adjusted price in 1998 and 2002 were the lowest since the 1940s. OK, you say, but aren't gasoline prices a component of inflation? That's true, but it's not a major component, and besides, the real inflation rate for the average citizen is way higher than the distorted data the government spins each month. On that basis, gasoline has never been cheaper, inflation-adjusted. Our problem, as environmentalists have said for years, is not that gasoline prices are too high; it's that they are too low. Crude oil prices have consistently averaged $20/bbl since 1950, ignoring two major spikes to $60/bbl, the first in 1979-80 and the second since 2003. In real (after-inflation) terms, crude oil prices have consistently fallen since 1950, and have never been lower. No wonder Big Oil is reaping record profits, gouging the consumer a little more each year to keep its shareholders happy with double-digit annual profit growth. So it's not surprising that, except for the Wal-Martization of the North American economy (offshoring North American jobs and importing cheap Chinese crap to replace the goods once made domestically) to offset the higher costs of energy, $3.50/gallon gasoline has not affected any corporate or individual behaviour. But suppose it were to double again, to $7/gallon, over the next few years. $20/bbl oil translates to $0.40/gallon gasoline. $40/bbl oil in the 1970s translated to $1.25/gallon gasoline. Now $60/bbl oil is translating to $3.50/gallon gasoline. Do a regression line through these relative rates and we can project the following: $80/bbl oil will translate to $5.50/gallon gasoline $100/bbl oil will translate to $8.50/gallon gasoline $120/bbl oil will translate to $12.50/gallon gasoline Would we be able to absorb these increases as easily as the increase from 2002's $1.75/gallon to today's $3.50/gallon? This article (thanks to Craig De Ruisseau for the link) argues that $6/gallon gasoline is just what we need. At first blush, it would seem to be a good idea. But what would its effect be, not just on consumer spending at the pump, but on the entire economy? Well, for a start, industry won't be able to finance further energy cost increases on the backs of North American (and Chinese) labour. China is running into a wall of skill shortages, massive suffering of its huge underclass, an insatiable demand and skyrocketing cost of all kinds of scarce resources, and environmental devastation on a scale unprecedented in human history. Except for some services, savings from offshoring to cheap nations will be more than offset by the staggering cost of moving raw materials and finished goods back and forth around the globe. So an increase in oil and gasoline costs will mean an increase in producer costs and hence in consumer costs. No more Wal-Martization room remains. And a jump in consumer costs means a jump in inflation and hence in interest rates. Now, let's look at what we buy that's made from oil. In this post, I listed the top 10 uses of oil (many are surprised to learn that the cost and energy content of oil used in agriculture exceeds the wholesale price and energy content of the food it produces, thanks to $150B in annual subsidies to Big Agriculture in North America alone). In this post, I listed the average expense budget of a North American household. Putting them together, here's how the average costs of living in North America break down, per $100 in household income: Expenses heavily dependent on oil: $52 Food $10 Transportation $22 Heating / Air Conditioning $5 Health Costs $4 Clothing $5 Furniture & Home Maintenance $3 Cosmetics & Household Products $3 Expenses dependent on interest rates: Housing $24 Other expenses: $28 Taxes $15 Insurance, Child Care and other service $13 Total expenses per $100 of household income: $104. Altogether, North Americans now spend $104 for every $100 they earn. Now what will happen if, say, oil prices rise to $90/bbl and gasoline prices consequently double to $7/gallon? Let's assume, conservatively, that a doubling of gasoline prices means just a 50% increase in the $52 of expenses heavily dependent on oil. That would increase average household expenses by 26%. With no room for further cost cutting, producers would pass on their cost increases fully to consumers -- after all, their shareholders expect them to continue their double digit annual profit increases -- the stability of the stock market depends on it. Obviously, individuals cannot afford to spend $130 ($104 + $26) for every $100 they earn. The overspending in recent years has been made possible only by a sea of irresponsibly-granted consumer credit secured by overheated house prices. It can't continue when house prices are falling, and when essential living expenses jump 26%, demand for houses, and house prices, will plummet, meaning credit will be reined in, further reducing consumers' ability to pay these increased costs. If you've been following the news, this has already begun, and a bunch of the more reckless lenders are teetering on the edge of collapse as bad debts soar. Wage demands will soar as workers insist on earning enough to provide for their families. We saw this in the 1970s, as costs of living jumped sharply. What happened next? Inflation, fueled by rising costs and wages. And then, a spike in interest rates, which more than doubled in two years in the late 1970s, to the 15% range. If inflation jumps to double digits (to reflect the 26% increase in costs), interest rates will go higher than that, since investors need to earn more than inflation just to break even. Anyone remember what 15% interest rates did to the housing market in the early 1980s? Inflation and interest rate jumps will further erode house prices and will double the cost of mortgages as they come up for renewal (and immediately for variable-rate mortgages). So now the $24 housing cost per $100 of household income becomes $48. I think you get the idea. Consumers will have no choice but to buy much less. Corporate profits will plummet. The stock market will do likewise. Foreclosures, already jumping by leaps and bounds, will soar. Fortunes made in real estate and the stock market will vanish, along with the entire net worth of most North Americans. And the interest rate on the US government's staggering debt, and more staggering trade deficit, will become crushing. The bottom line is that, while $3.50/gallon gasoline was a cakewalk (just a catch-up after decades of after-inflation price decreases), $7/gallon gasoline will be nightmarish. Not because we can't afford to pay $140 to fill our gas tank, but because we can't afford to pay twice as much for the oil we eat, the oil we wear, the oil that drives our entire economy. And our economy is stretched so tight, and is so over-extended and over-leveraged, we have no room to manoeuver. This is the incredible bind we've gotten ourselves into: Coping with global warming and the End of Oil (before the nightmare outlined in The Long Emergency befalls us) demands a large increase is the price of energy to dampen our appetite for it. But that large increase could easily plunge the world into another Great Depression. There is no way out of this mess. This is what happens when you crank economic systems to their fragile limit and find yourself with no resilience, no room to maneuver. A responsible response would be to own up to our recklessness, launch a major austerity and conservation program (including limiting corporate mark-ups and ROIs to levels commensurate with risk), and invest mightily in public transportation and renewable energy. The Bush & Harper doctrine is instead to publicly deny global warming and Peak Oil, privately acknowledge we're fucked, and shove the whole massive problem into the laps of future generations. So the real problem is not that gasoline prices are too high, or that they are too low, it's that we think the price of gasoline is the real problem, and that changing that price will solve it. Category: Understanding Economics 7:15:15 PM  trackback []  comment []

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