As gas prices soar to record levels, economists and strategists say so-called demand destruction – where high gas prices weigh on gas consumption – is about to set in. But conventional wisdom could be wrong, with far-reaching implications for the US economy.
With average US retail gasoline prices up about 30% since the start of the year, analysts at RBC Capital Markets used geolocation data from around 135,000 US retail gas stations to monitor foot traffic. While it costs an extra $32 to fill up the top-selling Ford F-150 compared to last year, analysts are noting demand is slowing and say it likely won’t be anytime soon. That’s because analysts at the Wells Fargo Investment Institute, for example, have priced demand-sapping gas at $4.67 a gallon. Data from automaker AAA shows that the average price of regular gasoline is already above that level in seven states, with California topping the list at $5.92 a gallon.
“The idea of demand annihilation is something we play on Wall Street quite a lot,” but there’s no sign of it, says Michael Tran, head of digital intelligence strategy at RBC. That fits the story. Trans Team found that of the 39 times over the past three decades that monthly gasoline prices have risen by more than 30% year over year, gas demand has fallen by 2% or more only 12 times.
If anything, rising prices will lead to 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. As dollars travel less far, drivers are fueling up 22% more frequently compared to last year. This suggests that gas demand is more inelastic or less price sensitive than investors might think.
It also suggests that higher prices for gasoline, not to mention other staples like groceries, are stealing demand from other parts of the economy. When gas prices rise, many consumers can reduce spending elsewhere before curbing gas demand, Tran says. Given that gasoline accounts for almost double the share of total spending for the bottom income quintile compared to the top quintile, and given that the former group has a higher propensity to spend, it’s fair to assume that broader consumer spending is being hurt by high gasoline prices will.
As Tran puts it, demand destruction will still happen, but destruction will happen beyond the pump.
There are other potential macro outcomes of rising gas prices. Falling demand in more discretionary areas may push down core inflation metrics that exclude energy and food. This would effectively mask the inflation felt by many American households as economists and policymakers favor core inflation measures over headline inflation readings. Tran says there’s a more optimistic possibility that lower demand for non-essential items amid new lockdowns across China in response to rising Covid-19 infections could help unfreeze supply chains at a time when they threaten to deteriorate . This, in turn, could help ease overall price pressures as overall consumer prices are up 7.9% yoy.
Either way, rising gas prices are hurting consumer sentiment. A Gallup poll released on Tuesday shows inflation has become the top public concern, with 59% of respondents saying they’re very concerned about rising prices and 24% saying they’re quite concerned about inflation To worry. The current mention of inflation as the nation’s top concern is the highest Gallup has recorded since 1985, says Gallup’s Lydia Saad. She says concern isn’t as great as it was in the early 1980s, but inflation is more in focus than it has been in the past 30 years and is weighing on economic confidence, Saad says. To this point, the poll shows Americans’ outlook for the economy is now roughly in line with the worst since the pandemic began in April 2020.
With fears of soaring prices growing, it’s no surprise politicians are proposing plans to ostensibly ease the pain. Therein lies a joker when it comes to playing off the economic impact of rising gas prices. California Gov. Gavin Newsom has proposed sending direct payments of $400 to all vehicle owners in the state, regardless of income level, and capping at two vehicles per person. That would account for around $9 billion in direct payments.
Given what Tran and his team have found about gas consumption — that demand isn’t overly price-sensitive — such payments could boost demand in other parts of the economy and worsen the inflation problem they’re designed to alleviate. If Newsom’s plan goes through, investors can expect other governors to try to repeat it.
Write to Lisa Beilfuss at [email protected]