Gas Prices & Demand Destruction

Let's talk about oil.

Provided that there continues to be enough to talk about, this may become a regular Wednesday feature. And with oil hitting $110/barrel today, there should be a lot to talk about.

Just one quick point of discussion for today: gas prices.

I paid $3.09 this morning (Denver area). How much does $110/barrel work out to? Well, there are 42 gallons in a barrel. It can't all be refined into gasoline, but that's still a good divisor because the other products produced in addition to gasoline have value as well, roughly the same as gasoline when taken as a whole. So $110/42 is $2.62/gallon. Add in roughly $1 for refining margin, distribution, retail markup, and you get gas at $3.62/gallon. Using the same math, oil at $200/barrel works out to $5.76/gallon, and oil at $300/barrel works out to $8.14/gallon. That might shock the average American, but I don't personally see significant demand destruction, even at $8.14/gallon. That's what gas already costs in much of Europe, and based on my anecdotal experience of driving a thousand miles there in December, that isn't slowing European demand in any significant way. I think most Americans frame the question incorrectly. Ask yourself (and people around you) this: IF you don't already ride the bus to work, how much will a gallon have to cost to make you do so? My commute, there and back, takes about a gallon of gas. I live right next to a light rail station, but it takes a full hour longer to ride the light rail than it does to drive (provided I leave at my usual very early time). Parking down town and the light rail ticket are essentially a wash, so an hour of my time needs to be worth less than a gallon of gas in order for it to make economic sense for me to stop driving. This calculation would change a bit if I could go entirely without owning a car, but not significantly--if I value my time at $50/hour, then, even with gas at $8.14/gallon AND the cost of car ownership, it still makes significant economic sense for me to drive. This is the result of America's huge sunk cost in suburbia, and exactly the reason why I don't see any great threat to gasoline demand, even at $8.14/gallon. Most people can give up their daily Starbucks to even out the difference between current cost and that possible, future cost--and I know which one has a greater inelasticity of demand!