During the week of October 2nd, gas prices in the Los Angeles area nearly reached the $5 per gallon mark, the highest it has been in five years. Since 2007, the average annual increase in gas is about 30 cents. The cost of gas is determined by a number of factors including supply and demand, geopolitical tension and a person’s location, among other things. So, what are the consequences of increased gas prices for the economy and how do these consequences affect consumer behavior?
Gas prices are known to generally fluctuate over the course of a year due to regulations that require different gasoline blends for different seasons. During the summer, beginning in the months of March and April, the Environmental Protection Agency (EPA) requires that a special blend of fuel be created which contains about 1.7 percent more energy than a winter blend, making it more expensive to make as production takes longer and yield per oil barrel is lower, an increase that is ultimately passed down to the consumer. Normally, gas prices come back down during the fall beginning September 15 when retailers are allowed to switch from summer-blend fuel to winter-blend fuel, but that isn’t necessarily the case for the West Coast, particularly in California where state and city regulations require the summer-blend months to extend until the end of October. On top of this, California also has some of the nation’s strictest gas-production policies that require refineries to create a cleaner gas blend with fewer emissions, a requirement that only a limited number of refineries are able to meet. The result is clear: California gas prices are consistently higher throughout the summer and winter months as compared to other states in the US. This is highlighted by the fact that during the week of October 4th this year, the average California price for a gallon of regular reached $4.18, compared to a national average of $2.65, and an average Texas price of $2.305, according to data compiled by AAA.
***The chart above, taken from the California Energy Commision, highlights the differences in gas prices between California and the US from 2005 to 2018. For each year, the price of gas has remained consistently higher in California than in the US in general.***
To better understand the impact of rising gas prices on the average Californian, the California Energy Commission released an analysis on gas prices in California this year at the request of Gov. Gavin Newsom. Their analysis found that California consumers have a gasoline preference for higher-priced brands such as Chevron, Shell, and 76, and are willing to pay higher prices to continue using these brands when gas prices rise. This indicates that consumers in this state prioritize the advertised quality of their preferred brand over the price of gas, despite having a multitude of options when it comes to choosing where to fill up that empty gas tank. Their report also found that Californians aren’t as concerned with gas prices as their non-western counterparts.
Despite this general preference for quality over price, not all Californians can afford to spend the extra money on presumably high-quality gas. The lower class faces a regressive tax when gas prices go up, while for the upper class, this difference barely (if at all) creates a dent in their wallets. According to researchers at the Brookings Institute, rising gas prices tend to have a pronounced adverse effect on low to moderate income households in particular. For example, in 2010 when the average price of gas was $2.80 per gallon, US households with an annual income under $50,000 drove an average of 10,000 miles and spent roughly $1,500 on gasoline. Such households have had to front an additional $530 per year for every dollar increase in price, assuming the miles driven has remained the same. For higher-earning families, the increase may not have a direct effect on their purchasing power, but for lower-earning families who already spend most of their income, the impact is far more dramatic. Having no alternative, low to moderate income families are then forced to either cut back on other expenditures or fall further into debt just to keep up with the price of gas.
This is especially true for families that live paycheck to paycheck as is often the case for low-income households, particularly those that fall below the federal poverty level. A family with an annual income under $25,000, which represents roughly 25% of US households, would end up spending an extra 2% of their income on gas. This percentage is even higher for households with more family members, as a household of four with an annual income of $25,000 already directs about 8.6% of their earnings towards gas, according to data compiled by the Urban Institute. For a family with an annual household income of $100,000, however, the extra money spent on gas amounts to about 0.5%. These households are less likely than their less affluent counterparts to spend all of their income and more likely to have savings to dip into if necessary. While the difference might not seem so meaningful, a family that typically spends all of their income cannot afford to redirect an additional 2% of their funds towards gas, while the 0.5% might already represent a surplus for families on the higher-end of the earning scale. With a poverty rate of 15.1% in California, many households could certainly see themselves affected by rising gas prices as families struggle to adjust gas expenditures on their budgets.
An increase in gas prices isn’t just unfortunate for lower-income consumers, it may have mixed effects on the economy as well. When almost 10% of a person’s income must be directed towards gas, there is little surplus left for spending on other goods. Retail stores along with the rapidly-growing ecommerce businesses may find themselves affected by high gas prices because many consumers simply have less money to spend on goods. As an immediate response to higher gas prices, lower-income households will cut back on discretionary spending such as eating out or purchasing luxury items and try to minimize unnecessary driving because they can’t do anything else to alleviate the situation. That is, they can’t simply move closer to work or switch to a more fuel-efficient vehicle. However, data released by the Commerce Department indicates that buying trends remain similar even when gas prices hit an all-time high, so long as consumer confidence is high. Consumer confidence may remain high even when gas prices rise due to a combination of factors such as low unemployment rates and tax cuts that make discretionary spending still seem favorable and financially safe.
One important industry that does find itself largely affected by increasing gas prices is the automobile sales industry. When gas prices are high automobile retailers sell fewer SUVs and large vehicles because consumers would rather not purchase vehicles that require premium gas or that will require them to spend more on gas. According to the Automotive Network, there is a correlation between fuel prices and auto sales, such that when gas prices are low, many people are more likely to purchase a larger car or performance vehicle. This is illustrated by the fact that large, gas-guzzling pickup trucks and SUV sales were up almost 10% in 2015 when gas prices were comparatively low, and the sales of the fuel-efficient Toyota Prius’ were down roughly 12% from the previous year. Unfortunately, gas prices don’t stay low forever, and those people who bought gas-guzzling cars realize they cannot afford to keep up with the costly maintenance of paying for premium gas.Businesses such as UPS, FedEx and other package delivery services are also affected when gas prices increase because their cost of operations becomes more expensive, also known as a ground fuel surcharge. This added expense is then passed on to the consumer, who now has to pay more for shipping: “Fuel surcharges allow for UPS and FedEx to keep its base shipping rate while making the necessary changes to cover any increase in fuel price” (Gibbs).
In response to these rising gas prices, business owners and employers have been forced to develop innovative ways to help their businesses and their employees save money. Some businesses have adopted work-from-home or carpool programs to help alleviate the financial burden caused by high gas prices on commuters. Unfortunately, some businesses find it harder to evade the tax-hike effects. For example, drivers for Uber and Lyft are usually unable to escape the increase because their jobs rely solely on driving. Independent contractors must then funnel more money out of their pockets to bring in the same income, forcing them to work more or make less, especially for those who have no direct control over their rates. This might be enough to take away the appeal of being self-employed as a ride-share driver. To address the potential loss in employees, Uber and Lyft both implemented programs to incentivize drivers to opt for electric cars. A company in New Jersey, MMW group, created incentives to help with the rising gas prices by allowing customers to work from home two days a week and try to cut their employee’s transportation costs in any capacity they can.
Gas price fluctuations have more of an impact on our daily lives than we think. The poorer working class woman who has to spend over two hours in traffic daily to save money wherever she can, now has to worry about the little money she has left going towards gas. The car dealerships begin to worry about meeting their monthly quota because people don’t want to purchase as many vehicles. Gas prices aren’t just prices; they impact the decisions people make on how they want to spend their money and how much they want to drive, especially for lower-income drivers.
Sources:
Gibbs, Brian. “How FedEx and UPS Fuel Surcharges Affect Shipping Rates.” Refund Retriever, 8 Mar. 2019, www.refundretriever.com/Fuel-surcharges.
Isidore, Chris. “Low Gas Prices Boost SUV and Pickup Sales.” CNNMoney, Cable News Network, 4 Dec. 2015, money.cnn.com/2015/12/04/autos/gas-prices-suv-pickup-sales/.
Marketing. “The Effect of Higher Oil Prices on ECommerce & Retail Spending.” The Effect of Higher Oil Prices on ECommerce & Retail Spending, www.rakutensl.com/post/will-higher-oil-prices-impact-ecommerces-bottom-line.
Nedlund, Evelina. “California Gas Prices Soar above $4, Reaching the Highest Price in Five Years.” CNN, Cable News Network, 8 Oct. 2019, www.cnn.com/2019/10/08/business/california-gas-prices/index.html.
Rocco, Matthew. “Why Surging Gas Prices May Not Stop Consumers from Spending.” Fox Business, Fox Business, 10 Oct. 2018, www.foxbusiness.com/economy/why-surging-gas-prices-may-not-stop-consumers-from-spending.
Sawhill, Isabel V. “How Higher Gas Prices Hurt Less Affluent Consumers and the Economy.” Brookings, Brookings, 28 July 2016, www.brookings.edu/opinions/how-higher-gas-prices-hurt-less-affluent-consumers-and-the-economy/.
Shinn, Lora. “4 Ways Employers Can Cut Commuting Costs.” Bankrate, Bankrate.com, 24 Nov. 2008, www.bankrate.com/finance/personal-finance/4-ways-employers-can-cut-commuting-costs.aspx.
Unrau, Jason. “The Correlation Between Fuel Prices and Auto Sales.” CBT Automotive Network, CBT News, 17 May 2018, www.cbtnews.com/the-correlation-between-fuel-prices-and-auto-sales/.