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Forbes.com

 

$3 Gas? We'll Shrug It Off

May 09, 2005

By Peter W. Huber

PRINTER FRIENDLY

If living 10 miles farther from your job saves $5,000 a year in carrying costs on the house you want, that translates into a dollar a mile in savings.

If your car ran on unrefined $42-a-barrel crude and got 20 miles per gallon, fuel would cost you a nickel a mile. But add in the cost of turning crude into gasoline and gasoline into miles--i.e., the amortized cost of refinery and car, plus taxes (which pay for the highway, among other things) and insurance--and the mile runs you 30 cents to 50 cents. The IRS lets you expense 37.5 cents per mile for business travel in your own car. The American Automobile Association estimates that it cost an average of 56 cents per mile to drive a new car in 2004. Or to put it another way, driving would be only 15% cheaper, at most, if crude oil were free, or if your car engine delivered 1,000 miles per gallon.

Grumble though we may at the pump, drivers buy miles, not barrels. And when the price of crude doubles--rising from, say, $28 a barrel to $56--the price of the average mile rises only 10% to 15%. That just isn't enough to impel most of us to change our behavior very much. People who drive expensive cars that burn lots of gas are the least sensitive to rising fuel costs. Most of the cost of quality miles lies in fancy leather and such--what surrounds the gas tank, not what gets pumped into it.

Similarly, the higher the fuel taxes, the less drivers notice or react to any change in the price of crude. Taxes add 45 cents on average to the cost of a gallon in the U.S., and as much as $2 in Europe and Japan. These taxes of $20 to $80 a barrel lower consumption, but they create economic rigidity. Oil producers see little change in demand for crude when they kick up the price by $10 or $20 because consumers see only a small change in the price of gasoline.

The most cogent economic rejoinder is that while the costs of the hardware are real, they're also sunk--once you've bought the car, the marginal cost of the mile is mainly the cost of fuel. That's correct, up to a point--higher fuel prices should indeed deter some discretionary driving and encourage some carpooling. But when you're deciding what kind of fuel economy you want in your next car, you are looking at all the costs, and that gets you right back to cents per mile that just don't depend much on dollars per barrel.

The length of your daily commute is the other key factor that strongly affects how much gas you burn. But if living 10 miles farther from your workplace saves you $5,000 a year in property taxes and other carrying costs on the house you want, that translates into a dollar a mile in savings. If it takes an oversize gas-guzzler to make those extra miles bearable, or even pleasant, you'll buy it.

Wal-Mart makes similar calculations and passes the savings on to its customers. The retailer sharply lowers its costs by setting up shop out in the middle of nowhere. Its customers happily jump in their cars to take their cut. Even at 50 cents a mile it doesn't take much of a discount on the television or fridge to pay back 10 miles on the highway.

You're a lot more sensitive to fuel costs if you drive a truck or run an airline, because the ratio of fuel costs to equipment amortization is much higher here. Truck and jet engines are expensive, well maintained and built to last. Once again, that creates a lot of economic inertia. Over the long term, however, these industries and their suppliers have worked hard and successfully to boost fuel economy, year after year. Same with people who drive mopeds in Shanghai or ancient Fiats in New Delhi. They stuff in cargo and passengers and thus tie their payload-miles a lot more tightly to the price of crude. But they account for a relatively small share of global demand.

Some analysts point to the experience of the early 1980s as evidence that automobile demand for oil is more elastic--that is, more responsive to price hikes--than we might think. OPEC slashed its output in 1979, and the price of crude soon peaked above $90 per barrel (current dollars). By 1985 U.S. oil consumption had dropped by about 15%. But utilities supplied about two-thirds of the savings by shifting from oil to coal-fired facilities; industrial users accounted for almost all of the rest.

All of these factors collapse into a single economic metric: The demand elasticity for crude is very low among the ordinary drivers whose behavior is most reviled by people who think they know better. In the short term low elasticity means consumers can't easily change their habits--they are stuck with the car engine and the commuting pattern they had yesterday. In the long term it means that when you buy a car, and the house you've always wanted, the capital costs you are incurring are so large that alongside them the oil is almost too cheap to meter.

Original Source: http://www.forbes.com/columnists/free_forbes/2005/0509/100.html

 

 
 
 

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