Out of Control Policy Blog

The Myth of $10 per gallon gas

Thankfully, the hysteria over sky-high fuel prices is moderating, thanks in no small part to the moderation of fuel price inflation as retail gas prices fall to under $4 per gallon in most places. Nevertheless, this hasn't kept some forecaster from claiming we will see $10 gas prices ($200 per barrel) by the end of the decade. I doubt this will happen.

We may well see $5 per gallon gas by 2010, but this would represent relatively modest increases over the next two years compared to what we have experienced over the last two. We'll adjust.

The real kicker will be the BRIC countries--Brazil, Russia, India and China. The unsettling of energy markets in Russia and former satellites creates uncertainty that could trigger upward pressure on prices if it continues for several months. But the real issue will be whether India and China continue their rapid growth. On their current trajectory, their demand for oil will outstrip their supply, even if China begins tapping into its known reserves in western regions of the continent. More importantly, world oil supply is not longer replacing oil at a rate sufficient to keep pace with demand. (Yes, we've hit "peak oil" in this respect.)

Still, I doubt we will see bumps much above $5 per gallon in the US because of the following:

1. I don't see congress upping the fuel tax to the point we would add more than a $1 to the overall price, and keeping us well below European gas prices (and fuel taxes);
2. Our economy is in a much stronger position to adopt new technologies, so the upward pressure on prices will be muted significantly within the next decade if retail gas prices continue to approach (or exceed) $5 per gallon.
3. US households will adjust to keep travel expenditures within about 10-12 percent of their overall budget. Over the past 12 months, they've accomplished this by simply not driving (hence falling VMT): longer term households will adjust their routines and adopt new technologies to reduce the budgetary impact
4. 4-5 years is long enough for new supplies to be brought on line at higher retail prices to mute the worst effects of high retail prices in the US.
5. Uncertainty in the current retail price will be reduced by an increasingly visible commitment to alternative technologies to substitute for oil, most importantly nuclear. While these technologies will not be on-line for 15-20 years, the investment commitment will quell a lot of uncertainty.

Of course, all this crystal ball gazing goes up in smoke if Russia (or Iran or Iraq or Venezuela or North Korea or.....) uses the Bomb.

Samuel Staley is Research Fellow

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