2005 June 24 Friday
US Oil Demand Grows Through Price Rise

As prices of oil price keep rising...

It was not the first time the August crude contract traded above $60 a barrel _ that happened back in April and again on Monday, when prices hit $60.02. But Thursday's milestone is significant because August is now the front month contract, meaning it is the next to expire and is generally the most actively traded. The July contract expired Tuesday.

Oil prices are 58 percent higher than a year ago, though still below the inflation-adjusted high above $90 a barrel set in 1980.

...so does demand:

These fears have been exacerbated by rising demand for gasoline and diesel fuel in spite of soaring prices. In the U.S., unleaded gasoline averages $2.16 a gallon at the pump, more than 40 percent above year ago levels, yet consumption has been up by 2.5 percent over the past month, compared with a year ago.

Where is this going? Is the decrease in demand just delayed? Is the demand for gasoline that inelastic? I'd love to see gasoline consumption by income. Are upper class people just buying even bigger vehicles while lower class people retrench? Or is the price of used SUVs dropping so that lower class people can compensate for higher gasoline prices by buying cheaper yet fuel inefficient vehicles?

I came across a post on another blog (Walter's Brain on Sustainable Mobility by car industry economist Walter McManus) with numbers on rebates offered by big car makers on SUVs. McManus argues that the car companies have been compensating buyers for higher gasoline prices by lowering prices enough to pay for a few years of higher gasoline prices.

The surprisingly rapid decline in SUV sales appears to be a real portent of more concern about fuel economy in the future. I have tracked average new vehicle fuel economy versus the price of fuel for several years. I saw very little movement over the last three years and I concluded that the people who buy new vehicles were not affected.

It turns out that what should be called the SUV Price War (that GM initiated in October 2001 and that lasted until about September of last year) more than offset the effects of rising fuel prices. During this period, the Detroit-based manufacturers lowered prices (through cash and cut rate financing to consumers) disproportionately on SUVs.

My examination of the sales and pricing data reveal that SUV sales would have fallen in 2002, 2003, and 2004 had prices not been reduced by the Price War.

In the graph the blue bars show the switch from SUVs (down 0.8 pp.) to passenger cars (up 0.9 pp.) that would have occurred between 2002 and 2004 had the increase in the price of gasoline from $1.54 to $1.96 not been offset by the Price War. The yellow bars show the Price War offset.

Did Detroit win the SUV Price War?

See his May 9, 2005 and May 11, 2005 posts at that link for the details.

The car companies can drop prices only so far to compensate for higher gasoline prices.

Demand for gasoline can be reduced in a number of ways. Why aren't people slowing down to raise their fuel efficiency? McManus also argues that lowering fuel economy by driving fast is cost effective for most people.

Driving 55 miles per hour means that each mile takes 1 minute and 6 seconds. If gasoline costs $2.00 per gallon, and I get the average 1997 fuel economy in the linked table(32.4 mpg), then I will burn just over 6 cents of gas in that 1 minute and 6 seconds. At 55 miles per hour, I would burn about $3.40 worth of fuel per hour.

Now, suppose I speed up to 70 miles per hour. How much more per hour does it cost me in fuel? A paltry $2.65 per hour. I earned $2.65 per hour (which was below the then minimum wage) in the summer of 1974 as a highway construction laborer. So, as long as an hour in a stationary state (at home or work, but NOT A TRAFFIC JAM, at least not until I get my in-car computer installed) is worth more to me than $2.65, it pays to speed.

Note: As someone pointed out in the comments the correct calculation is how much dollars in extra fuel do you have to spend per hour reduced from driving time. But even with that adjustment the cost per hour saved is still less than what a large fraction of the population earns per hour worked. Plus, for someone who is speeding while working the likely benefit is even larger to the employer.

The higher incomes rise and the more fuel efficients cars become the more inelastic demand becomes to price rises.

McManus writes some great posts. McManus also argues that the hybrid Prius is mostly a marketing and public relations gimmick.

Question: Toyota started advertising the Prius recently. Why advertise a car when many shoppers are going to be disappointed to discover they will have to wait for delivery? The wait was the number one complaint about the new Prius in its first year, so why advertise and give more shoppers a reason to complain?

Answer: The Prius has increased showroom traffic. With supply constrained, many Prius shoppers end up buying a Corolla, Camry, or other Toyota model. Some could even end up with a Tundra Pickup that is cheaper than the Prius but gets 16 mpg in the city and 18 on the highway. The equivalent Chevrolet Silverado gets 16/21, so you had better hope the frustrated Prius buyer goes to the Chevrolet store if he decides to go with a pickup. And if you are thinking, "Prius shoppers would never consider a Tundra," I feel your pain. The contra-positive is "Tundra shoppers would never consider a Prius," or, to generalize, "PICKUP shoppers would never consider SMALL CARS." Welcome to my world. People have different needs and wants they are trying to satisfy when they buy vehicles. And not everyone who shops at Toyota, not even everyone who visits the store because of the ads for the Prius, shares your values. Watch out when the Highlander is in the showroom drawing in SUV shoppers. They might just buy a 15 city/18 hwy Sequoia. Pray that they don’t but the 13/17 Land Cruiser. I leave it as an exercise for the reader to find the GM, Ford, and Chrysler equivalents with higher MPG that should make environmentalists wish they had never elevated Toyota to infallibility.

Question: If hybrids were not a good idea then why would the world’s most profitable automobile producer want to be the hybrid leader? Profit is a clear sign that they are smarter than the other companies, so anything they do has to be smart, doesn’t it?

Answer: By selling hybrids, Toyota is given a pass by environmentalists to reduce the fuel economy of their new vehicle fleet relative to GM, Ford, and DaimlerChrysler without protest. I posted data comparing Toyota and GM last week. Have the environmentalists become apologists for Toyota, overlooking their move into gas-hungry SUVs and pickups? Toyota sold twice as many Tundras as Priuses in 2004 and has been building pickups in America for years. Toyota will build hybrid Camrys in Kentucky soon, and some environmentalist should find out whether American taxpayers are being asked to subsidize investment by the world’s most profitable automobile producer to do what is supposed to be a smart thing. Are there grounds for concluding that environmentalists are acting toward Toyota like the mainstream media act toward the Democrat party?

Now, you might be thinking that McManus is too cynical. Well, hear it from the horse's mouth: Kazuo Okamoto, who is taking over as head of Toyota research and development, says that hybrids are just cost justifiable in the US car market.

“When you just use the argument of fuel efficiency, the purchase of a hybrid car is not justified. But this car has other interests, for instance environmental protection.”

Another Toyota executive was more blunt in his analysis: “Buying a hybrid is about political correctness, it is not about the money,” he said.

Hybrids are projected to be about 2% of all the cars on the road in the United States in the year 2011. So don't look to hybrids to have a big impact on total gasoline fuel demand any time soon.

Will a continued rise in oil prices eventually bring on a global recession? How is the rise in oil prices going to play out on the macroeconomic level?

Share |      By Randall Parker at 2005 June 24 11:04 AM  Economics Energy


Comments
ed said at June 24, 2005 12:57 PM:

I have to disagree with you about the value of the McManus blog.

His calculations that you cite about the efficiency of driving fast don't make any sense. The relevant question is not how much more it costs PER HOUR to drive 70, it's how much it costs you PER HOUR THAT YOU SAVE by getting there sooner. The extra cost per hour of driving that he gives is completely irrelevant. (Not only that, but his calcultions are mistaken, being based on 75 mph, not 70 mph like he states, as I found when I replicated the analysis.) The correct calculations would show that it costs you $3.31 per hour saved if you decide to drive 70 instead of 55, and $3.90 per hour saved if you drive 75 instead of 55.

Next, scroll down and check out the graph in his post from May 6, "Ford Escape Hybrid and Toyota Prius Are Top Fuel-Saving Hybrids." The graph claims that most hybrid cars would save well over 1,000 gallons of gas in 15,000 miles of driving. That's quite a feat, since most cars get better than 15 mpg, so they DON'T EVEN USE 1,000 gallons per 15,000 miles to begin with. You couldn't save that much if the car ran on water!

In short, McManus is not to be trusted as an analyst.

Randall Parker said at June 24, 2005 2:08 PM:

Ed,

Okay, so he makes mistakes. But McManus not only corrects his mistakes, he's even posted in a post of mine that linked to him and told me of a mistake he made.

Randall Parker said at June 24, 2005 2:21 PM:

Ed,

I just sent him a couple of emails pointing out the problems in his posts. I'll let you know what he says in response.

Stephen said at June 24, 2005 9:27 PM:

My guess is that the reason demand isn't slowing is because fuel doesn't actually cost that much compared to the other lifestyle choices we regularly make. In other words, our pool of discretionary spending is so much larger than it was a generation ago, so we now have a lot more tolerance for price increases. I'd like to see a graph showing the retail price of car fuel as a proportion of average weekly earnings - my guess would be that the trend line over the last 25 years would be heading downward.

Stephen said at June 24, 2005 9:40 PM:

A confession. I'm about to trade my speedy but fuel efficient little Alfa Romeo for a 4wd dual cab pickup truck.

Do I need it? not remotely. Do I want it? yes. Do I care about the extra price for petrol? not particularly.

Invisible Scientist said at June 25, 2005 9:55 AM:

The popularity of the hybrid cars is a reginonal phenomenon. At Berkeley, in every street, you can see that there is a parked hybrid Toyota Prius or a hybrid Honda Civic. But these are still foreign made cars, and unlike California, they are not that popular in the Republican states. Also, these hybrid cars are quite expensive to make, since they are simultaneously an electric car and also a regular internal combustion engine car.

But in a few years, when the gas mileage of the hybrid cars is raised to 95 miles per gallon instead of 50 miles per gallon, and when the manufacturing cost of such cars is reduced, so that these can be bought for $12,000 instead of $20,000, then everybody will buy these cars, since many of these will be made in the U.S.

However, given that the demand for oil in China will skyrocket in a few years then even hybrid cars will not be enough to keep the price of oil under $100. In China they are just building the highways comparable to the United States, they have not filled these highways with cars yet.

It is definitely a good idea to focus on battery research, because electric cars charged by coal fired plants and nuclear plants, will be the only realistic solution in the long run...

Randall Parker said at June 25, 2005 1:10 PM:

Ed,

Walter McManus got back to me: The chart with the hybrid energy savings has an error on the X axis scaling. It is off by a factor of 10. He even sent me the Excel spreadsheet he used to do the calcs and explained where he added in the factor of 10 erroneously.

I checked the Honda Accord numbers with a calculator using EPA mpg data I got off the web and his adjusted figure of approximately 150 gallons saved makes sense.

Also, he agrees with your method of calculating the cost in dollars per hour saved.

Randall Parker said at June 25, 2005 1:35 PM:

BTW, For the hybrid versus regular Honda Accord you therefore save 100 gallons per 10,000 miles driven which at $2 a gallon is $200 per 10,000 miles. Well, that poses a problem for hybrid advocates. The hybrid Accord costs $3400 more. You'd therefore have to drive 170,000 miles to justify the extra cost. Ouch.

Even at $3 per gallon you'd have to drive about 113,333 miles before breaking even. At $4 per gallon you'd get a payback in 85,000 miles.

Also, that above ignores the cost of money. You'd have to pay more upfront and gradually get it back. Plus, the hybrid probably costs more to maintain. More parts to break.

BTW, the hybrid version weigh 400 pounds more and is 14 inches longer too. It has 15 more horsepower but needs it to move the extra weight.

To make hybrids workable we need better battery technology. The batteries need to weigh less more amount of energy they store and also to cost less. Then the weight and size gain on the car would be reduced and less cost would come from the batteries. But that requires advances in electrochemistry research.

So that makes clear that we need not just cheaper batteries

Randall Parker said at June 26, 2005 8:19 AM:

Ed,

Walter McManus has made two new posts correcting his earlier posts on cost per hour of speeding and hybrid fuel savings.

John Thacker said at July 1, 2005 6:29 AM:

Interesting posts about whether hybrids are worth it, but don't forget the special US tax breaks for buying a hybrid. The $2000 tax deduction knocks a few miles off how far one has to go to earn back the difference personally. (Depending on one's tax rate.)

remo williams said at July 1, 2005 8:37 AM:

Even though there may only be 2% hybrids by 2011, Id be curious what the projection for 2015 is. That could be significantly higher than 2%, and Id guess as high as 10%.

Randall Parker said at July 1, 2005 9:26 AM:

John Thacker,

When tax deductions make something more affordable it isn't really more affordable. Rather, other people are paying for it.

Also, right now a lot of hybrids are selling for above sticker price. Whereas their non-hybrid equivalents are selling at a discount. So while the difference before tax break between the non-hybrid and hybrid Honda Accords is, according to Honda, about $3400 at the dealer it is probably more.

If we accept the $3400 figure as the Accord hybrid price premium then you have to drive somewhere between 100,000 and 200,000 miles to pay back the hybrid price premium (depending on the price of gas). I keep meaning to do a post on this that lays out the calculations. Haven't gotten around to it yet.

Remo Williams,

I've posted projections on future hybrid use in a previous FuturePundit post from a month or two ago. Check my May and April 2005 archives or go into the Energy Policy and Energy Tech archives.


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