Yet More Fun With Numbers: $7/Gallon Gasoline

US gas prices
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 thereal problem, and that changing that price will solve it.

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15 Responses to Yet More Fun With Numbers: $7/Gallon Gasoline

  1. David Parkinson says:

    Thanks for the cheery late afternoon news!! Do you have any thoughts about how we can best weather this storm? I’m already living pretty close to the ground, and getting closer as time goes on (no car, no real estate, no unneeded appliances and junk, learning to grow food, trying to find community)… am I missing anything?Funny to think that reading a post like this one even a year ago would have made me feel either freaked out or unready to really catch the message. Now I just sort of roll with the punches. I’m not sure that’s such a good thing. ;-)Isn’t it going to be a weird scene when the needle finally hits the vinyl on this implosion? The looks of recognition and almost relief are going to be coming at us from the most unexpected quarters, I suspect.Happy Wednesday,David

  2. Dave Pollard says:

    Thanks. The more I learn about the Great Depression the more I think studying it is the key to understanding what to do next. What scares me is that most of us are still so dependent on what we don’t have any control over, so lacking in self-sufficiency skills. I also worry that, where I live at least, we may have to learn to live with being constantly cold most of the year. And I’m grateful and amazed that, so far at least, the generations to follow us aren’t mad as hell at us. ;-)

  3. Gary Rondeau says:

    Dave,Thats such a nice clear statement of the problem… As I bike to work in the morning, I wonder how the hundreds of people whizzing by me in big pickup trucks with Bush/Cheney stickers on the bumper are going to react to the coming fiasco. One potential correction – If inflation dominates in the future, won’t that make our current national debt LESS of a burden in future dollars? Of coarse foreigners holding a good fraction of the debt will realize this and wish to dump it, which makes the dollar fall against other currencies. But then we can’t afford foreign goods – so China doesn’t want to pull the plug – so we all continue to pretend that nothing is amiss, until the one day some trader sneezes in Hong Kong and it all comes falling down. I think the economists and world bankers have gotten pretty good at making tweaks to the system to keep things moving along. But the dynamic balancing act is getting harder and harder to maintain as internal stresses and contradictions grow. Your scenario represents one possible unwinding.

  4. Gary Rondeau says:

    You could also argue that the first thing to go will be the frothy financial markets. A sharp “correction” turns into a panic and trillions of paper dollars lose value overnight. With millions of people suddenly much poorer – the spillover affects the rest of the economy. No one buys cars or computers – jobs are lost – people can’t pay their mortgage and that makes the housing bubble even more of a catastrophe. Foreclosures run rampant and housing prices plummet as wealth evaporates in every sector. No one has money – no one buys anything – no jobs. A true depression – but deflation not inflation is the result. I see these two scenarios somewhat equally likely – which is why there are no clear policy choices. When things break it is hard to predict just how they will break. You know what happened the LAST time, so you avoid that path, and you get a little better with the balancing act so the whole thing gets further out of balance before the correction comes the NEXT time.

  5. lugon says:

    mad at us? http://www.newfluwiki2.com/upload/UK%20pan_response2.pdf or, partly wikified (still a few pictures missing) at http://www.fluwikie.com/pmwiki.php?n=Opinion.UKpanResponse “A nation of bereaved parents”

  6. Randy White says:

    For people willing to accept reality, I offer a partial solution, so long as the Internet and electricity remain intact. It’s at lawnstogardens dot com- How to videos for urban farming- Carpool network to share rides with people that live close by- Social network to group up

  7. As you say, much of the decline in local products is due to economic factors; that is, it is cheaper to purchase offshored goods and imported food than to seek out local products and crops. As oil prices increase exponentially, though, we may see a resurgence of interest in local products–simply because it will be more economically feasible to do so.

  8. Dave and other friends, the trend of having less to spend is problably already happening. I give yu below the figure for Canada showing which areas are increasing as percenteage of costs and visa versa. Food is a lot cheaper but I do not see that continuing. Other wise what we might call consumer goods seem to be diminishing.Adjusted FAMEX Data and 2002 SHS Data1982 2002Personal Taxes INCREASE 17.7 20.0Games of Chance 0.4 INCREASE0.5Household Furnishings and EquipmentDECREASE 3.5 3.0Transportation INCREASE 11.9 14.0Food DECREASE 15.1 11.1Recreation INCREASE 4.6 5.9Personal Insurance Payments and PensionContributions INCREASE4.2 5.7Household Operation INCREASE4.3 4.6Health Care INCREASE1.9 2.6Gifts of Money and Contributions INCREASE2.1 2.4Education 0.7 INCREASE1.5Miscellaneous Expenditures 1.3 INCREASE1.5Personal Care DECREASE 1.8 1.4Clothing DECREASE6.0 4.1Reading Materials and Other Printed Matter DECREASE 0.6 0.5Shelter DECREASE 20.7 18.6Tobacco Products and Alcoholic Beverages DECREASE 3.3 2.5Total Expenditure 100 100

  9. thomas r. farnham says:

    my parents lived through the great depression , world war two, gasoline rationing , etc.does this present generation expect less of itself ?we all complain of being too fat . sorry , i will not use the term full figured . too irresponsible.there is no way people are going to move out of their plush mcmansions . the only answer is to move the places where we work into the suburbs. then we start walking or bicycling to work. in the rust belt , the only answer is to force everyone to ride public transit. at least during the winter. it aint easy to ride a bike during a buffalo or chicago blizzard. the days of the walker-texas ranger six wheeled pick up trucks are over. get used to it. gasoline rationing will be the only way to force big business to go along with the above outline. these little weekenders to the bahamas will have to end. start thinking about staying put where you live. it is time that we americans started growing up. we have been both fat and foolish for a good forty years. this present form of communication that i am using will be history in ten years. goodbye … and good luck.

  10. Good post Dave. This week, I’ve tried writing a couple along the same lines, but I think I’ll read yours instead.I added a link from the post I made today, to your article.Cheers! And thank you for doing what you are doing!

  11. Jon Husband says:

    The more I learn about the Great Depression the more I think studying it is the key to understanding what to do next.It generated socialized medicine in Canada, a greater orientation towards community, and a mentality of acquiring only what you need that was made of quality and would last .. intelligent frugality .. things like that, no ? Things we need now, but that might upset current economic models.

  12. David McElroy says:

    I appreciate the care thought put into this article. But I note the United States has not seen a new oil refinery built in 30 years and development of new oil wells is opposed. And one study noted refinery to pump costs are 48 cents per gallon in 2007. There is a problem, but it is largely contrived by those who now dominate a lucrative market and oppose any alternatives such as free energy devices that have been demonstrated but never marketed.

  13. Richard Storey says:

    A major problem with communicating difficult ideas to the general public is whether they have anything to compare it to–a frame of reference. This also involves *consensus reality*. And, of course, there’s the ever present *reality tunnels* of individual perspectives. Even then, after the gap may be bridged, there’s the analysis of the information taken, and we know that most people are not naturally analytical. The majority of the population are what David Kiersey labels as Guardians. These personalities run the day-to-day affairs of the planet. They aren’t strong in prognostication, insights, or analysis. Nor do they take kindly to persons who are strong in these areas shaking up their perspective on reality. And, of course, as already mentioned, consensus reality has a strong gripe on 99% of any given population, as an extreme few are true boundless thinkers.Therein lies the bulk of the problem of communicating the concepts of peaked world oil supplies and (so-called) reserves. Whether anyone likes it, or not, the vast majority of any population will only respond to oil shortages and loss of economic goods and services. In other words, they will wait and respond to the catastrophe as it unfolds.I realise that what I’ve written is a simplistic rendition of the topics I’ve covered, but it’s mainly meant to motivate further reflection.

  14. sheila says:

    We are all missing that 4000 lb. gorilla in the room, OVERPOPULATION !There are far too many humans on this planet thanks to the TEMPORARY carrying capacity made possible by cheap fossil resources.Now we are far beyond the earths carrying capacity and our fossil resources are in decline.Conservation, renewables and more public transportation will not solve our problem, the ONLY solution is to reduce our number to what can be sustained without fossil resources.Many organizations have been trying for decades to wake people up to the dangers of overpopulation but have mostly been ignored, now we will have to pay the awful costs that every animal has paid when they overpopulate their environment, mass death.On that happy note, I wish you good luck !

  15. Singo says:

    Perhaps you should visit the UK. At the current exchange rate, we have $9 a gallon petrol (gasoline), and the country works just fine.

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