Ellison Chair in International Floriculture
Ellison Chair in International FloricultureTeaching, Research, Extension and Service

How Gasoline Prices Affect Consumer Purchases

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From today’s WSJ:   A dollar is a dollar. So if rising prices cut into our purchasing power, textbook economics suggests that we’d carefully weigh all our buying decisions to determine where to cut back, and by how much.

Of course that’s not really the way most people budget. Rather, we put different items in different budget baskets – here’s one for movies, here’s one for clothing, here’s one for gassing up the car. So if clothing prices go up, we’ll cut back on clothing purchases first before cutting back on other things.  But even though anecdotal and laboratory evidence suggests this is how we operate, economists have had little success finding evidence of how this works in the real world. Until now.

Economists Justine Hastings at Brown University and Jesse Shapiro at the University of Chicago’s Booth School of Business got data on purchases of gasoline from a large grocery chain covering January 2006 through March 2009. As gasoline prices rose sharply in late 2007 through the summer of 2008, fewer and fewer people opted to buy higher octane midgrade and premium gasoline for their cars, and bought less expensive regular instead. (When prices fell in late 2008, the trend reversed, in spite of the worsening economic climate.)

But what about other purchases? Because some customers held retailer loyalty cards with the grocery store, Hastings and Shapiro were able to track them, too.

Specifically, they looked at purchases of half-gallon cartons of orange juice. The grocery chain carried five brands – four national ones and its own private label. They found that while rising gasoline prices led more people to buy regular, they didn’t prompt people to buy less expensive orange juice brands in an attempt to make back the money they were losing at the pump. “If anything, the direction of our estimates suggests that higher gasoline prices tend to increase the demand for higher-quality orange juice brands,” they write.

An aside: The economists also point out that “Consumer Reports” and others have disputed the wisdom of buying anything but regular for anything but a sports car. With regular averaging $3.86 a gallon in the U.S., versus $4.00 for midgrade and $4.13 for premium, it’s a bit of a mystery why many people would pay up for the questionable benefits of a higher octane grade. But the latest data from the Energy Information Administration suggests that’s what 13% of us still do.

New Age of Natural Gas

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The Energy Information Administration released new data yesterday showing that natural gas production in the U.S. reached an all-time historical monthly high in March of 2.313 trillion cubic feet, breaking the previous record of 2.28 trillion cubic feet set in March of last year by almost 33 billion cubic feet (see graph).

As Mark Perry has reported previously, the U.S. is now the world’s largest producer of natural gas, having surpassed Russia’s production last year to become the new “Saudi Arabia of natural gas.”  It’s all because of a breakthrough in drilling technology, involving the use of three-dimensional seismic imaging and hydraulic fracturing of shale rock, so that huge amounts of natural gas are being produced in New York, Pennsylvania, Texas, Louisiana and other states.  In 2000, shale gas accounted for only about 1% of our natural gas supply, but now about 20% of gas comes from advanced shale drilling, and that breakthrough is responsible for boosting gas production to record high levels.

The abundance of natural gas in the U.S. was completely unexpected as recently as seven years ago when Alan Greenspan in 2003 warned that shortages of natural gas could hurt the U.S. economy.  We’re now in a new age of natural gas because of advanced technologies, and it’s going to be a real game-changer. Will this have an impact on how greenhouse growers decide to heat their greenhouses in the future? Duh.

Mark Perry’s full post here.

90-year supply of natural gas at current consumption rate

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From MIT Technology Review (click here):

Experts now believe that the country has far more natural gas at its disposal than anyone thought three or four years ago. The revised estimates are largely due to advanced drilling techniques that make it economically feasible to extract the fuel from shale. And while the Marcellus is the most recently discovered and possibly the largest shale-gas deposit (covers PA, NY, VA and OH), others are scattered throughout the country.

The U.S. consumes about 23 trillion cubic feet (TCF) of natural gas a year, according to the Department of Energy’s Energy Information Agency (EIA). The Potential Gas Committee (PGC), an organization headquartered at the Colorado School of Mines, put the country’s potential natural-gas resources at 1,836 TCF in a biennial assessment released in June. That’s 39% higher than its estimate of two years earlier. Add to that the 238 TCF that the EIA has calculated in “proved reserves” (the gas that can be produced given existing economic conditions) and the PGC pegs the future supply at 2,074 TCF.

In other words, there is enough natural gas to supply the country for 90 years at current consumption rates. Even if we used natural gas to totally replace coal in generating electricity, domestic supplies would last for 50 years.

Natural gas offers advantages over other fossil fuels. It burns cleaner than coal, producing much less carbon dioxide. Since coal-fired power generation is responsible for a third of U.S. carbon dioxide emissions, replacing at least some of that coal with gas could significantly reduce such pollution. And using natural gas to replace gasoline and diesel fuel in vehicles could reduce the country’s reliance on foreign oil.

“It doesn’t matter what the exact number is,” says Mark Zoback, a professor of geophysics at Stanford University. “The numbers are all so big it means we have an extremely large domestic resource that is going to play a significant role in the country’s energy future.”

The availability of vast natural-gas resources in the Marcellus shale and similar sediments around the United States has changed energy calculations in a fundamental way. The discovery of this large and seemingly economical new source of fossil fuel has surprised even geologists who have spent their careers studying the shale. Little wonder, then, that policy makers and politicians are just beginning to try to figure out what the discoveries mean.

Latest energy outlook report released

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According to the early release of the Energy Information Administration’s (EIA) Annual Energy Outlook 2009 (AEO2009), the latest projections expect virtually no growth in U.S. oil consumption for the first time in more than 20 years.

EIA said that the combination of recently enacted CAFE standards, requirements for increased use of renewable fuels, and an assumed rebound in oil prices as the world economy recovers will reduce oil consumption. U.S. net dependence on imported liquids will decline dramatically over the next 20 years as the use of biofuels is expected to grow.

After averaging $101.46 in 2008, EIA projects a barrel of crude oil to average $63.53 in 2009, $82.09 in 2010, $91.59 in 2011 and $102.52 in 2012. In fact, after a nearly $40 drop in price projected for this year, it does not predict it will fall year-over-year again through 2030, the date the projections end.

EIA projects a sharp increase in the sale of unconventional vehicle technologies such as flex-fuel, hybrid and diesel vehicles, with plug-in hybrid vehicle (PHEV) sales projected to grow to 90,000 vehicles annually by 2014. In addition, they expect ethanol use for gasoline blending to increase to 12.2 billion gallons and E85 consumption to rise to 17.3 billion gallons in 2030.

Total number of miles traveled by freight trucks is expected to decrease slightly in 2009, EIA said, falling from 231 billion miles driven in 2008 to 226 billion miles in 2009, before increasing to 232 billion in 2010 and 244 billion in 2011.

Gas Price Update

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National Average: $1.89 (lowest price since February 2005)
National Low: $1.35 in Kansas City

Mark Perry estimates the annualized savings to be $317.4 billion, based on the drop in gas prices from the peak of $4.12 per gallon in July to the current $1.89 ($1.4235 billion annual savings for American consumers and businesses per penny decrease in gas prices, see calculations here).

Falling gas prices act almost like a tax cut

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According to the most recent data from the Federal Highway Administration, the total traffic volume over the most recent 12-month period (through July 2008) was 2.944 trillion miles. According to data from the EIA, the average fuel efficiency for all vehicles in 2006 (most recent year reported) was 17.2 miles per gallon. That means that the amount of gasoline required for the traffic volume over the most recent 12-month period was 171,216,860,465 gallons (2.944 trillion miles driven divided by 17.2 miles per gallon).

Therefore, every penny decrease in the price of a gallon of gas would equal more than $1.71 billion in consumer savings over a year (171.216 billions of gallons X $0.01). In that case, the $1.10 per gallon decrease in gas prices from $4.12 in July to $3.02 this week (data here), would represent annual consumer savings of $188 billion from the fall in gas prices just so far over the last three months (compared to a scenario where gas stayed at $4.12 per gallon).

An alternative calculation is to use the EIA estimate of 390 million gallons consumed per day in the U.S. times 365 days per year, or 142,350,000,000 gallons annually. For each penny decrease in the price of gasoline, consumers would save $1.4235 billion annually according to this approach, and will save $156.6 billion over the next year from the $1.10 per gallon decrease in gas prices since July.

If gas prices continue to fall over the next month (which seems likely), it could be like a $200-$300 billion tax cut for the economy.

Of course, it does beg the question of why have we not invested more in fuel efficiency of our vehicles? 17.2 miles per gallon seems ridiculously low.

Fuel costs continue to influence driving behavior

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The Federal Highway Administration reported that travel during June 2008 on all roads and streets in the nation fell by -4.7% compared to June last year. June marks the eighth consecutive month of traffic volume decline compared to the same month in the previous year. Travel YTD through June in 2008 fell by -2.8% compared to 2007.

Now that gas prices started falling in July and August, will consumers continue to reduce driving, or will they revert back to their old driving patterns? We’ll know in about a month, when the July traffic volume report is released.

Gas falls below $3.50 in Kansas

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Dorothy is probably happy since gas prices fell below $3.50 in Topeka today. In my May 31 post, I referred to the EIA’s (Energy Information Agency) projection that gas prices could fall below $3.50 by the end of the year. Friends scoffed at the notion. Hmmm… Now to see what impact the backed-up traffic jam on the Mississippi River is going to have.

Better benchmark for gas prices

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Warren Meyer added a twist to Mark Perry’s analysis of what 1,000 gallons of gas costs as a percent of per-capita disposable income (click on graph for larger image). The key for households, Warren maintains, is not how much it costs to buy 1000 gallons, but how much it costs to buy the gas required to drive their typical annual miles. Using 15,000 as an average driving miles per year per person, he gets the result above. So, while I too think paying $4 for gas is not my favorite way to dispose of my income, in terms of average household pain created, gas prices are quite far from their historic highs.