There’s Only One Solution to Rising Gas Prices: Stay Home!

Overview

There’s very real pain at the gas pump today! It seems like every time you go to fill-up your vehicle, the price of gas has gone up not just a few pennies or even a couple of nickels, but by several dimes - maybe even quarters depending on how much you drive and how big your car - and your gas tank - is! Now, more and more of us are seeing it take close to a hundred dollars - or even more if you live in California - to fill up your gas tank. And yes, gas prices have become the hot topic of conversation everywhere! And of course as we do in 2022, people are both taking out their frustrations - and showing their creativity - about the seemingly endless rise in gas prices, both on social media...

…and in TikTok videos!

There are however very real consequences also to the rising costs of fuel today. Many of us have jobs that do not have any flexibility in terms of working 4 days at the office rather than 5, working remotely, or cutting back on driving related to the job. Many of us have obligations that require us to drive to care for family, to do volunteer work, or to do any number of things that we, at least, do not view as optional. And so there is a floor for all of our personal driving that is unique to each of us - and that determines just how we cope, on a micro, micro, micro economic basis, with soaring gas prices. For some of us, we see and feel the rising prices, but they are not enough - at least yet - to really impact our quality of life. However, the rising cost of not just filling one’s gas tank, but of seemingly everything today (and yes, rising diesel prices means that the costs of all consumer goods is going up as well), is indeed leading many of us to have to make difficult choices in our personal and family budgets. It is well-documented that people react to rising gas prices - and rising prices on everything - by merely charging more to their credit cards, making a “day of reckoning” for their personal finances more likely, whether that be in a few months or a few years from their present financial pressures. But in the short-term, people are adjusting their shopping behaviors based on the rising prices around them, foregoing basics like some of their prescription drugs and grocery items to cope with rising inflation.

In this article, we first take a brief look at what drives gas prices - both historically and currently. Then, we look at how this “gas price crisis” is both the same - and different - than past price shocks that have occurred. And finally, we will see there’s only one solution to today’s gas prices - and it is rooted in basic Economics 101, as the “invisible hand” of the market will indeed balance out supply and demand - even if that might take a while and might cause some pain for all of us.

Gas Prices 101

How global energy markets work and how that translates into the price you pay at the pump is an exceedingly complex topic - that is why energy economists are in such demand today as consultants and TV expert commentators! So no, we won’t try to explain the complete history and current state of the global oil market in this article.

Rather, for the necessary level of background for you, the reader, to better understand the subject, we turn to our friends at the data analyst firm, Visual Capitalist, who have put together a very good, very concise and comprehensive explainer on what determines the price you see when you pull up to fill-up your car at the gas pump. As you can see in Figure 1 (Visual Capitalist: The Four Main Factors That Influence U.S. Gas Prices) below, there are four main factors that go into determining the price that you pay at the pump for a gallon of gas. These are:

1. Crude oil prices
2. Taxes
3. Distribution and marketing costs
4. Refining costs

As you can see, over half (54%) of the cost of filling your tank is dependent on crude oil prices, while roughly the other half of the cost is split almost equally between refining costs (14%), marketing and distribution costs (16%), and yes, federal and state taxes on gasoline (16%).

Figure 1 - Visual Capitalist: The Four Main Factors That Influence U.S. Gas Prices

Source: Visual Capitalist, “Explainer: What Key Factors Influence Gas Prices?,” June 2022

The Gas Price Shock of 2022

And today, those factors have combined to cause pain at the pump. While gas prices are soaring nationwide (exceeding an average of $5 a gallon today…and forecast to go even higher)…

…they are rocketing up in California, where today, gas prices are averaging almost six and a half dollars a gallon, and in some cases, are even seen exceeding $8 a gallon!

Now it may be of little consolation when you are watching your total on the gas pump’s digital display go past $50, $60, $70…$100 or more today, but today’s fuel prices, while historically high, are not without precedent. As Addy Bink recently wrote in a very insightful piece (“Gas Prices Are High Now, But They’ve Been Worse Before: Here’s When”) for The Hill, in inflation-adjusted terms, today’s prices at the pump are in the range of those seen in both 1981 and 2008. And if you think today’s gas prices are bad, they could get a whole lot worse! As Patrick De Haan, who is the head of petroleum analysis for GasBuddy recently observed, today’s gas prices are “a perfect storm of factors all aligning to create a rare environment of rapid price hikes. The situation could become even worse should there be any unexpected issues at the nation’s refineries or a major hurricane that impacts oil production or refineries this summer.” And yes, hurricane season just started June 1st…

Analysis

So what will cause the rise in gas prices to slow down or even come to an end and begin what will surely be a slow fall back to a “new normal” (God, don’t we all despise that term by now!)? Yes, global political leaders, including President Joe Biden, are taking steps, such as releasing gasoline from the Strategic Petroleum Reserves and quite controversially, trying to cajole, convince, negotiate, etc. for more production from OPEC (Organization of the Petroleum Exporting Countries) countries, including Saudi Arabia, to help alleviate the current oil and fuel price crisis.

Now I must say, my specialty as a strategic management consultant and professor is not - in any way - to be an oil markets and/or gas price analyst! I will leave that to my colleagues in the economics field - who are raking in the big bucks and drawing a great deal of attention these days. However, I do know a great deal about one thing, and that is how consumer behavior works. And for all the science that goes into analyzing what makes consumers buy and spend and all the ways that marketers can make that knowledge work for them, there’s one basic rule of economics that comes into play time and time again that explains consumer behavior.

This rule goes back to the "Father of Modern Capitalism," Adam Smith, and the way that the “invisible hand” works to balance out supply and demand - at least eventually. And while much of the media concentrates its attention - and with it ours - on the supply problems facing the oil industry (i.e. the Russian invasion of Ukraine and the resulting boycott of Russian oil, rising labor costs and pressure on staffing (including truck drivers) impacting the industry, rising shipping costs globally, how rising fuel costs - ironically - impact the oil industry itself, and more), what we have today is also a demand problem that will - over time - work itself out in a way that is in line with basic, Economics 101 principles.

We are beginning to hear voices out there talking about how - so far - consumers, not just here in the United States, but globally as well, are behaving in a way that is out of line with some fundamental ideas about how the law of supply and demand works. This is because even in spite of rising fuel prices, people are still doing the very things that cause demand to be high - very high - for gasoline! Simply put, people are traveling in record numbers today - everywhere around the world! In fact, 86% of Americans are planning to travel in the next year! While some are still opting to continue to have “staycations” as they did in the pandemic years of 2020 and 2021, 2022’s travel boom is being fueled by pent up demand in many of us to get back on the road, in the air, and on the sea! Consumers, many of whom have deferred travel for the past two years, are still traveling by and large, as their desire - and demand - to travel is - for now - outweighing the rising total costs of doing so due to fuel price increases. Individuals are simply paying more for gas as they travel by car, and when it comes to air travel, as a recent New York Times article framed the present situation:

"A stunning rise in the cost of jet fuel has sent airfares soaring, and industry experts say they are likely to go higher. For now, though, travel-starved consumers seem more than willing to pay up.”

And so in the short term, no, I do not believe we will see the demand part of the fuel price equation behave rationally - at least through the summer travel season. Even as gas prices - and airfares - continue to rise, consumers will simply “power through” and engage in travel in record numbers. Why? Simply because the pent up demand to get out of the house and get away is a stronger motivator today than the very real “pocketbook issue” of actually paying - at least in the present - for fueling this travel. However, as with all money issues, the bills will come due - specifically the credit card bills of those charging the increased cost of filling their tanks and/or paying for airfares right now. I do believe that by the fall we will see Americans begin to cut back on their gas consumption, perhaps in a very big way, as they really begin, in even a more severe manner than at present, feel the pinch of rising inflation throughout the economy in their own personal budgets. Last year, as the escalation in gas prices was just starting, the data analyst firm CivicScience found that, of course, rising gas prices caused those earning less than $50,000 a year to drive less than those earning above that mark. But quite interestingly, as individuals begin to feel the effects of inflation in their own lives, that’s when they begin to drive less. As the CivicScience researchers put it:

“Those who are spending less are five times more likely to also drive less, compared to those who haven’t altered their spending habits.” (emphasis in the original)

So, at what point will Americans simply “stay home?” Is there a “magic price” at which consumers will slow their aggregate and personal demand for gas and we will begin to see rationality return to the fuel markets? AAA (the American Automobile Association) thought that when the national average exceeded $4 a gallon that we would see Americans really cut back on their driving, but that has not been the case to date. And now, for the first time ever, the average price for a gallon of gasoline has reached $5 nationwide, and there’s really no end in sight - either to consumer demand or to further price escalation. I would not want to proffer a price target for the “tipping point” for consumers - though some experts have said that $6 a gallon might be just that - but, as one famous philosopher put it so well, "who knows?"

What I will say is that there certainly will be, in economic terms, an equilibrium reached where consumers, both collectively and individually, will cut back - perhaps in a really severe and life-altering way, on their driving. Now, whether that comes at $5, $6, $7… $8 (gulp) gallon gas, it is hard to say - at least at the moment! There will also be, once again, a shift to smaller, more fuel-efficient cars and trucks, and especially hybrid and electric vehicles. But vehicle design, production and marketing can’t be changed overnight, and so in the end, we may well settle into yet another “new normal” - where we will drive less - with cutbacks in travel and yes, more working from home and Zoom meetings in place of in-person meetings and conferences. And in the end, wherever gas prices “settle” over the next 12-18 months - and they certainly won’t settle at $2 a gallon - will go a long way in driving the future of how we live, travel, and work going forward.

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About David Wyld

David Wyld is a Professor of Strategic Management at Southeastern Louisiana University in Hammond, Louisiana. He is a management consultant, researcher/writer, publisher, executive educator, and experienced expert witness. You can view all of his work at https://authory.com/DavidWyld.

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