U.S. Gasoline Is Still a Great Bargain (Really!)
by Arthur L. Smith, CFA, Chairman and CEO
and Nicholas D. Cacchione, CFA, Senior Vice President
John S. Herold, Inc.
Perhaps because gasoline prices are displayed in foot-high numerals on
every street corner in America, increases in gasoline prices provoke more
consumer "sticker shock" rage than any other commodity. By way
of comparison: the Atkins diet craze has led to sharply higher prices
for protein foodstuffs. Where are the newscasts depicting irate consumer
protests against alleged price gouging by bacon and egg producers?
With the average price of gasoline exceeding $2 per gallon across the
United States, John S. Herold, Inc. has examined this price in the context
of other consumer expenditures – the seventh time we’ve conducted
such a study in the last 15 years. And for the seventh time, we’ve
come to the same conclusion: Gasoline is still a great bargain, as the
following four points attest, relative to other purchases in a typical
consumer market basket.
1. Believe it or not, U.S. gasoline price increases have been moderate.
While the costs of crude oil and gasoline have soared over the past year,
both of these commodities are relatively inexpensive in historical terms.
In fact, if the prices of gasoline and crude oil had kept pace with the
general rate of inflation since the early 1980s, the price of these commodities
would have been close to $4 per gallon and $90 per barrel. Since the early
1980s, the rate of nominal escalation in gasoline prices was about one-half
the rate of inflation in postal rates, only one-third of that of airline
fares and about one-eighth of the rate of college tuition increases.
2. For motorists, U.S. gasoline price escalation has been dwarfed by increases
in maintenance and insurance. While gasoline out-of-pocket expenses are
the most visible operating-cost component of running an automobile, fuel
expenditures pale in comparison to the enormous run-up in maintenance
and insurance costs over the past six years. The cost of gasoline/oil
has increased about 9 percent to slightly more than 7 cents per mile driven,
compared with a 46 percent increase in maintenance expenditures to 4 cents
per mile driven, a 29 percent increase in tire costs to roughly 2 cents
per mile driven and a 30 percent increase in aggregate insurance costs
to $1,102 per year. Insurance costs have soared in recent years to now
account for the largest share of total driving costs; at nearly 9 cents
per mile, insurance costs exceeded gasoline expenditures last year. Only
financing expenses have become less burdensome to the consumer over the
recent past. Actually, gasoline costs in real terms as a percentage of
all automobile operating expenses have trended downward – albeit
irregularly – over the past 24 years since the peak in 1981 (see
Figure 1).
3. U.S. gasoline is extremely cheap compared with European countries.
Even with the recent run-up, domestic gasoline still costs less than half
the amount it does in most European countries (see Figure 2). Why? Taxes.
European countries have adopted political policies to discourage oil consumption
and promote conservation.
How? With taxes equivalent to more than $2.50 per gallon. (That’s
more than 100 percent of the total cost of today’s "outrageous"
$2 per gallon U.S. retail price). Note that our great ally, the United
Kingdom, has decided to highly tax petrol, although it is self-sufficient
in both oil production and natural gas production.
4. Gasoline provides great relative value compared with other consumer
staples. Herold’s research continues to support the conclusion that
U.S. consumers continue to benefit from – even at $2 per gallon
– tremendous value in purchasing gasoline compared with other consumer
products found in the average shopping cart.
Even at today’s two bucks a gallon, the cost of domestic gasoline
is 20 to 50 percent cheaper on a per-barrel basis than many household
products (see Figure 3). One could easily spend $300 filling up his or
her tank with items like beer or wine.
This year we decided to substitute Poland Spring for Evian water in our
consumer shopping cart analysis (see Figure 4). Domestically produced
Poland Spring is marketed at $1.19 per 1.5 liter bottle, equivalent to
$126 per barrel or approximately $3 per gallon. Evian water has fallen
sharply in consumer interest but still fetches – among the Francophiles
– an amazing $1.99 per liter or $211.01 per barrel. Bottled water
is getting cheaper due to intense competition.
But let’s talk about milk, aka "moo juice" – the
kids’ version of gasoline. We found milk priced at $2.19 a half-gallon,
or about $184 per barrel. This seems like a good deal – it’s
reasonably priced, helps your bones, helps your kids grow stronger and
provides energy to fuel their activities. But gasoline is still a much
greater bargain.
So If Gasoline Really Is a Bargain, Why Does Paying at the Pump Hurt So
Much?
Gasoline is easy to hate: North American consumers of energy – we
include our northern Canadian and southern Mexican neighbors in this pickle
– are addicted to cheap and easily available fuel and can’t
do without it. To use a formal economic term, the price elasticity of
demand (the change in demand for a product due to a price delta) for gasoline
in the short run is virtually nil. In other words, we can’t change
our gasoline consumption habits in the short term just because it suddenly
becomes relatively expensive.
People must still drive to work, pick up their kids and go shopping whether
gas is $1 per gallon or $2 per gallon or, heaven forbid, $5 per gallon
as it is in Europe today. And outside of the major industrialized cities
in the eastern United States, there are virtually no substitutes to vehicular
gasoline-fueled options (mass transit) available.
Let’s face it: Gasoline is a necessity for everyday life. We didn’t
get around to calculating alternatives like ownership cost for a horse
and buggy, but if one contemplates the going boarding rates at Fairfield
County equestrian facilities, it seems clear that maintaining a horse
is certainly a luxury item!
Changing Consumer Habits Should Provide Relief
Over the long term, consumers can, and will, change their gasoline consumption
habits. Back in the late 1980s the introduction of mandatory fuel efficacy
standards helped to brake domestic gasoline consumption markedly. Econometric
analyses confirm that the price elasticity of demand for gasoline is much
higher in the long run – although still low compared to most items
– as consumers do make such adjustments as buying more fuel-efficient
cars and moving closer to places of employment.
Figure 5 puts into historical context the cost of gasoline, the efficiency
of the domestic car fleet and the world events that have affected each.
The efficiency of the domestic car fleet was in decline from the 1940s
until the 1973 Arab oil embargo and the subsequent OPEC oil price hike
that led to gasoline shortages in the late 1970s. Those events shook American
consumers and led to a 50 percent increase in fuel efficiency from 14.4
miles per gallon in 1979 to over 22 miles per gallon in 1992. That same
leap in fuel efficiency tempered the upward pressure on petroleum demand
and prices. Meanwhile, brutally competitive markets in the downstream
sector promulgated consolidation, a renewed offensive in fierce marketing
practices to combat the new "hypermarket" challenge. Consumers
of cheap petrol all benefited as the downstream sector embarked on a vicious
and competitive "fight to the death" that crushed retail at-the-pump
marketing margins while providing motorists with cheap supplies of gasoline.
Ironically, it is the past 20 years of very cheap gasoline prices that
have promoted lax driving habits and contributed to the rising cost of
gasoline today. Over the past decade, consumers have been able to indulge
in ever larger, more comfortable and less fuel-efficient cars, given the
inexpensive price of gasoline we have enjoyed. Having long been addicted
to incredibly cheap and abundant gasoline, Americans have witnessed the
fuel efficiency of U.S. cars decline some 10 percent in recent years to
20.4 miles per gallon (mpg) for the auto fleet. The culprit: rising demand
for SUVs and luxury cars.
But Habits May Be Changing Again Toward Conservation
The most recent domestic automobile sales data indicate that larger, less
fuel-efficient cars and SUVs are seeing waning demand and drastic price
reductions on unsold vehicles. Autodata, an automotive research provider,
reported that during April 2004 prices of "large" SUVs fell
1.5 percent compared with a 2.4 percent increase for compact cars. The
report also noted that in April, sales of Ford Expeditions fell nearly
34 percent, while Chevrolet Suburban and Hummer H2 sales dropped 21 percent
each. Edmonds.com, another automotive research company, reports that incentives
currently offered on "large" SUVs are the highest among all
vehicle classes. In fact, a recent purchase of a Hummer H2 by a colleague
yielded a 10 percent price break compared to paying sticker price a year
ago and included attractive 2.9 percent financing and an above-average
trade-in value. Anecdotally, we note that recent radio ads for Memorial
Day sales at SUV dealers promise large discounts and 0 percent financing.
Future Gasoline Costs Will Depend Upon Cost of Oil as Well as Demand
Downstream 101: There are five components to the price of gasoline: (1)
the base of crude oil, (2) gathering and transportation, (3) refining
and processing, (4) marketing and (5) federal, state and local taxes.
Figure 6 depicts the amount per gallon and the proportional cost of these
components. Virtually all of the retail increases in gasoline consumer
costs over the past three years can be traced to escalation in the refiner
cost of crude oil. Although the cost of gasoline rose 25 cents per gallon
and the cost of crude rose 23 cents per gallon, taxes were unchanged while
refining and marketing combined earned 2 cents per gallon more. With oil
prices currently at roughly $40 per barrel, the $2 per gallon gasoline
prices now reflect an added 20 cents per gallon in crude oil cost. (The
math is easy: with $42 per barrel crude oil prices at the wellhead, the
raw material now represents $1 per gallon.)
If crude costs continue to rise, gasoline prices will increase to a
more painful point. Until then, try to smile when you’re at the
pump – you’re still getting a bargain.
Arthur L. Smith is the chairman and chief executive officer of John
S. Herold, Inc. Mr. Smith’s previous experience was in oil industry
analysis and corporate finance with Argus Research, First Boston and Oppenheimer.
Mr. Smith acquired control of John S. Herold, Inc. in 1984 when John Herold
sold the company. He earned a B.A. from Duke University and an M.B.A.
from New York University Stern School of Business. Mr. Smith holds the
Charter Financial Analyst (CFA) designation and is a former appointee
to the National Petroleum Council.
Mr. Smith is a member of the Independent Petroleum Association of America
(IPAA), the American Petroleum
Institute (API), the Texas Independent Producers and Royalty Owners
Association (TIPRO), the Association of International Petroleum Negotiators
(AIPN), the International Association for Energy Economics (IAEE) and
the Houston Society of Financial Analysts (HSFA). He currently serves
on the board of directors of two public energy companies, Evergreen Resources
and Plains All American Pipeline, LP, and one nonprofit board, Dress for
Success© Houston. Mr. Smith also serves on the Board of Visitors
of Duke University’s Nicholas School of the Environment and Earth
Sciences.
Nicholas D. Cacchione is senior vice president and codirector of the
Equity Research division of John S. Herold, Inc., and has been director
of Equity Research since 1997. He is responsible for all of the research
produced within the Company Insights and Industry Insights modules as
well as the Private Oil Company Database. He joined Herold in 1995 as
a member of Herold Consulting, assisting public and private companies
in valuation, competitor intelligence and litigation support issues. Mr.
Cacchione’s prior experience includes more than 10 years with the
Amax Inc. organization, where his areas of experience included mergers
and acquisitions in the mining, metals, and energy industries and energy
risk management.
Mr. Cacchione earned a B.B.A. in accounting and an M.B.A. in finance
from Iona College. He holds the CFA designation and is a member of the
CFA Institute and the New York Society of Security Analysts (NYSSA).
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