Many Americans are shrugging off higher gas prices

This article was originally published in The Hill on May 9, 2018:
https://thehill.com/opinion/finance/386893-many-americans-are-shrugging-off-higher-gas-prices

As the U.S. economy has slowly improved during past years, so too have fuel prices increased. The average price for a gallon of unleaded according to AAA reached $2.82 this week, the highest level in more than three years, dating back to 2014.

We’re not near the $4-a-gallon threshold we had back in the summer of 2008, but many parts of the country routinely pay well more than $3.00 now. As the global economy continues to expand, the price trend for what we Americans pay to fill our tanks will continue to track upward.

In the past year, fuel costs have increased by 21 percent, and uncertainty created by the White House’s decision to pull out of the Iran nuclear deal will likely drive more volatility.

Americans today, however, have reason to be less concerned about fuel prices. A decade ago, when the average gallon of gas cost more than $4.00, there was a rapid run up in small car sales. This time around, Americans are on a different road.

For the average vehicle, driven an average of 12,000 miles a year, the 21-percent increase year-over-year in fuel prices amounts to $324 more spent on fuel.

For the typical two-vehicle household, that’s almost $650 more fuel expense, or $54 per month. If history is a guide, this will impact consumer spending and will likely start to weigh on consumer sentiment.

But will it change new vehicle buying behavior? On that front, the data tell a more complicated story.

American consumers have shifted preferences from cars to trucks over the last 40 years. Traditional cars — the “three-box” sedan we all know well — now accounts for less than one-third of all new vehicle sales in the U.S.

The rise of the crossover vehicle — a vehicle that combines the best attributes of a traditional sedan, with the look and performance of a truck-based SUV — has seriously decimated demand for midsize and compact cars.

Ride height, greater availability of all-wheel drive and improved utility along with less of a sacrifice in fuel economy have moved consumers out of traditional sedans and into the broader truck family.

Indeed, according to sales-weighted calculations from Cox Automotive’s Kelley Blue Book, the “compact SUV/crossover” segment delivers an average of 26.4 miles per gallon (MPG) in 2018, while the “compact car” segment delivers 32.0 MPG.

That sounds like an important gap, but in terms of personal economics, it really isn’t so substantial for what you get in return.

In economist speak, improving fuel economy delivers diminishing returns. As you climb the MPG ladder, the resulting gallons and dollars saved decline exponentially, so the premium in monthly fuel costs paid for driving a less-efficient vehicle declines as the MPG is improved across all segments.

For example, the annual fuel premium for driving a compact SUV versus a compact car was over $300 in 2008. It was down to $191 last year, roughly $16 month.

Further, the incremental increase in the premium paid due to this year’s 21-percent higher gas prices is $34 a year, or less than $3 a month. Will consumers suddenly abandon ride height and greater utility for the cost of a coffee? I don’t think so.

If you think I cherry-picked the best performing segment for this illustration, you’re wrong. If I look at all trucks vs. all cars, the fuel-cost premium for a truck was $630 in 2008. Last year it was $334.

The 21-percent increase in gas prices over the past year requires the average new truck buyer today to pay $5.08 more per month for that added utility. That’s about what you’d pay for a Venti Carmel Flan Latte at Starbucks.

New vehicles have enjoyed tremendous gains in fuel economy over the last 10 years. Due to the diminishing returns from higher MPG on gallons used and money spent, the change in the last decade delivered an incredible one-decade benefit that we likely won’t see in any future decades.

The current administration is not interested in pressing for higher fuel efficiency in the nation’s fleet, despite the fact most carmakers would support regulations calling for incremental improvements.

With the California Air Resource Board digging in for an emissions battle, the auto industry, unfortunately, is likely to see more lawsuits in the coming years than real-world fuel-economy improvements.

On the up side, vehicles are more efficient than ever. So how will higher fuel prices impact consumer behavior? Ironically it could support demand for more crossovers, modern SUVs and trucks. The average age of a vehicle in the U.S. today is over 11.5 years.

The average car on the road today gets lower gas mileage than the average new compact SUV. If you’re feeling pain at the pump, you might be inclined to replace that old clunker while inventories are high, interest rates remain lower than they will be and incentives remain plentiful.

Yes, it may seem ironic, but a lot of Americans can shrug off increasing fuel costs (and help the environment) if they go out and buy a new truck.

Jonathan Smoke is chief economist for Cox Automotive. The Cox Automotive family of brands includes Autotrader®, Dealer.com®, Dealertrack®, Kelley Blue Book®, Manheim®, NextGear Capital®, vAuto®, Xtime® and a host of others. Cox Automotive is a subsidiary of Cox Enterprises Inc.