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Central Banker | Fall 2006

Gas Prices: Don't Panic ... Yet

Do you find yourself watching the corner gas station to see if the price of a gallon of gas rose or dropped 10 cents overnight? While the $1 gallon seem to be long gone, real gas prices aren't the highest they could be.

During April 2006, the U.S. average retail price of gasoline increased from $2.73 to $2.97 per gallon and remained above $2.90 in May and the first half of June.1 This increase was evenly distributed across U.S. regions, leaving the historical differences in prices across regions unaffected. For example, gas is 10.4 percent more expensive on the West coast than the national average-but 2.5 percent cheaper here in the Midwest than the national average.

Analysts sometimes play down consumers' concerns about the high prices of gas by noting that in real terms (that is, relative to other goods and services) gas is still relatively cheap compared with prices in the late 1970s and early 1980s. However, the recent increases in the prices of oil and gas undermine this argument.

gas prices

Take a look at the adjoining chart. The consumer price index (CPI) for all items provides a measure of prices of all goods and services. The Bureau of Labor Statistics also publishes consumer price indices for expenditure categories, including one for gasoline. The chart tracks the real price of gasoline since 1967, i.e., the ratio of the CPI for gasoline to the CPI for all items. Even disregarding the September 2005 spike due to Hurricane Katrina, it is clear that gas has become more expensive in relation to other goods since 2003. The real gas price has not yet reached record high levels, but it is above the long-run average and comparable to mid-1980s levels.

Gasoline price inflation tracks closely with the growth rate of the price of oil. The price of oil in the week of April 21 crossed the $70 per barrel threshold, and has remained around $70 per barrel ever since.2 The high oil price is the result of sustained world demand at a time when several factors have restrained the supply of oil. The world demand is fueled by sustained growth in oil-hungry China and India, continual demand from the United States and Japan's recovery. On the supply side, the oil industry does not have much spare capacity. Any disruption would be reflected immediately in higher spot oil prices. For example: the war in Iraq, rising tensions in United States-Iran relations, civil unrest in Nigeria and so on. Futures prices suggest that the prices of oil and gasoline are likely to remain high in the medium term.

Even if the real price of gasoline is high by historical standards, and trending toward record levels, the trend will have to be sustained for quite some time before most U.S. consumers trade in their cars, trucks and SUVs for smaller and more fuel-efficient cars. The fraction of personal consumption expenditures (PCE) spent on gasoline (as shown by the orange line in the chart) is on the rise, but close to its historical average (3.7 percent) and much lower than the 6 percent peak in the early 1980s.3

So don't panic about gas prices ... yet.

Endnotes

  1. Weekly data for gasoline prices (all grades) from the Energy Information Administration: http://tonto.eia.doe.gov/dnav/pet/pet_pri_gnd_dcus_nus_w.htm. [back to text]
  2. Domestic spot market price: light sweet crude oil, WTI, Cushing. SOURCE: Wall Street Journal/Haver Analytics [back to text]
  3. See also Cashin, David and McGranahan, Leslie. "Household Energy Expenditures, 1982-2005." Chicago Fed Letter, June 2006, (227). [back to text]