How Higher Gas Prices Could Lead to an Increase—Not Decrease—in Demand

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As gas prices surge to record levels, economists and strategists say so-called demand destruction—where high gas prices weigh on gas consumption—will soon kick in. But the conventional wisdom might have it wrong, with broad implications for the US economy.

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With average US retail gasoline prices rising by about 30% since the start of the year, analysts at RBC Capital Markets used geolocation data around roughly 135,000 US retail gas stations to monitor foot traffic. While it is costing an extra $32 compared with last year to fill up the top-selling Ford F-150, the analysts find that demand isn’t waning and say it probably won’t soon. That is as analysts at Wells Fargo Investment Institute, for example, have pegged the demand-impairing price of gas at $4.67 a gallon. Data from the auto group AAA show the average price of regular gas is already above that level in seven states, with California topping the list at $5.92 a gallon.

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“The demand-destruction idea is something we on Wall Street play out quite a bit,” but there is no sign of it, says Michael Tran, RBC’s head of digital intelligence strategy. That jibes with history. Tran’s team found that over the 39 instances in the past three decades where monthly gasoline prices jumped over 30% year-over-year, gas demand fell by 2% or more just 12 times.

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If anything, rising prices are prompting more visits to the pump. Tran says the idea, which may sound counterintuitive, is that the average driver spends about $28 per gas-station visit, regardless of the price of gas. Because dollars are going less far, drivers are refueling 22% more often compared with last year. That suggests gas demand is more inelastic, or less price-sensitive, than investors might appreciate.

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It also suggests that higher prices for gas, not to mention other basics like food and, are stealing demand from other parts of the economy. As gasoline prices rise, many consumers can reduce expenditures in other areas before cutting gas demand, Tran says. Given that gasoline comprises nearly double the share of total expenditures for the lowest income quintile versus the top quintile, and given that the former group has a higher propensity to spend, it’s fair to assume broader consumer spending will be affected by higher gas prices.

As Tran puts it, demand destruction will still happen, but the destruction will occur beyond the pump.

There are other potential macro upshots of rising gas prices. Falling demand in more discretionary areas may push down core inflation metrics, which exclude energy and food. That would effectively mask the inflation felt by many American households, given that economists and policy makers favor core inflation metrics over total inflation readings. Tran says there’s a more optimistic possibility that lower demand for nonessential items could help supply chains thaw at a time when they are about to worsen, given new lockdowns across China in response to rising Covid-19 infections. That, in turn, could help cool broad pricing pressures as overall consumer prices are up 7.9% from a year earlier.

Either way, though, rising gas prices are affecting consumer sentiment. A Gallup poll released Tuesday shows inflation has emerged as the top public concern, with 59% of saying they worry about rising prices a great deal and 24% saying they worry about inflation a fair amount. Current mentions of inflation as the nation’s most important problem are the highest Gallup has been recorded since 1985, says Lydia Saad of Gallup. She says concerns aren’t as high as in the early 1980s, but inflation is more top-of-mind than it’s been in over 30 years and is taking a toll on economic confidence, Saad says. To that point, the polls shows Americans’ outlook for the economy is now about tied with the most negative it has been since the early days of the pandemic in April 2020.

Given growing anxiety over rising prices, it’s not surprising that politicians are proposing plans to ostensibly ease the pain. Therein lies a wild card in gaming out the economic implications of rising gas prices. California Gov. Gavin Newsom has proposed sending $400 direct payments to all vehicle owners in the state, regardless of income level and with the payments capped at two vehicles per person. That would amount to roughly $9 billion in direct payments.

Considering what Tran and his team has found about gas consumption—that demand isn’t all that sensitive to prices—such payments may spur demand in other parts of the economy, worsening the inflation problem they are meant to alleviate. Should Newsom’s plan pass, investors can expect other governors to look to replicate it.

Write to Lisa Beilfuss at [email protected]


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