In Milwaukee, service-station owner Jeff Curro no longer sells gas. According to the Milwaukee Journal-Sentinel, Curro, who has been selling gasoline for 20 years, “turned off his pumps at his Shell station in Brookfield when the price he was being asked to pay was just too much.” Including taxes, the wholesale price Curro was asked to pay came to $3.44 per gallon recently. With retail prices at $3.47 per gallon, there wasn’t enough of a mark-up to justify keeping the pumps turned on. “Three cents a gallon doesn’t cut it,” he told the Journal-Sentinel. “It doesn’t pay the bills.”
Curro is not the only victim of high gas prices, nor will he be the last. Fuel is an important factor of production in many industries and, as in Curro’s case, increases in the price of fuel can undermine profitability. The hit from the pumps affects businesses both directly and indirectly. In addition to increasing direct industrial production costs for such things as raw materials and transportation of goods, rising fuel prices cut into consumers’ pocketbooks, an outcome that indirectly affects businesses. The more money consumers spend on gas, the less they have available to spend on other goods and services. It could be the beginning of the perfect economic storm: as fuel prices rise, both business profitability and consumer demand for goods and services might drop. If that happens workers around the nation might find themselves out of work.
Scarcity and Jobs
The rise in price of hydrocarbon fuels is an indication that the relative scarcity of these fuels is increasing. That a scarcity of necessities has an impact on business profits and subsequently on jobs was recognized in the 18th century by Adam Smith. Writing in The Wealth of Nations, Smith pointed out that in times of scarcity, “the high price of provisions” causes employers “to diminish rather than to increase the number of those [employees] they have.” As a result, says Smith, “more people want employment than can easily get it; many are willing to take it upon lower terms than ordinary, and the wages of servants [i.e., workers] … frequently sink” in years of scarcity.
This is what happened in the West following the 1973 Arab oil embargo. On October 6, 1973, Egyptian and Syrian military forces launched a surprise attack on Israel. The Arab states were lavishly funded in their efforts by the Soviet Union and, having taken Israel by surprise, had a decided advantage. Allowing Israel, an American ally, to be defeated by forces funded and supported by Moscow was considered unacceptable, so the Nixon administration proposed, on October 19, a $2.2 billion military aid package for the embattled nation. The Arab reaction was swift. Later that day, Libya announced an embargo on oil shipments to the United States. Saudi Arabia followed suit the next day.
The embargo resulted in a substantial reduction in the available supply of oil. According to energy analyst Daniel Yergin, writing in the book The Prize: The Epic Quest for Oil, Money & Power, the net loss “was 4.4 million barrels per day, or about 9 percent of the total 50.8 million barrels per day that had been available in the ‘free world’ two months earlier.” And, according to Yergin, the “effects were made even more severe because of the rapid rate at which world oil consumption had been growing–7.5 percent a year.” Suddenly, America entered an age of energy scarcity.
The reduced fuel supply and increasing fuel demand led to high prices but the crisis was made worse by federal policy. Nixon-era price controls exacerbated the problem and fuel shortages across the country led to economic turmoil and job loss. The price controls, said economist Thomas Sowell, “turned a minor adjustment into a major shortage.” In the United States, Yergin noted, “gross national product plunged 6 percent between 1973 and 1975, while unemployment doubled to 9 percent,” setting in motion the era of malaise that persisted through the remainder of the decade and into the first years of the 1980s.
Energy and Industry
This time the rapid rise of fuel prices has nothing to do with an embargo imposed by oil-producing nations. Instead, refined fuels are becoming increasingly scarce because of government regulation that has stifled increases in refinery capacity. No new refineries have been built in the United States since the 1970s. As a result, refinery capacity has not kept pace with demand for refined fuels. Though expansion at existing refineries has helped, other regulations mandating customized fuel blends for different regions of the country hamper production. “The increasingly complex world of stringent product requirements and other logistical issues have stretched this industry thin, and therefore, there’s insufficient capacity to deal with unexpected change, whether it be weather-related, economy-related or industrial accidents,” said Guy Caruso, head of the U.S. Energy Information Agency.
No matter the cause, the effects of scarcity will be the same today as they were during Adam Smith’s time. During the week before Memorial Day, gas prices, adjusted for inflation, neared record high levels while other refined-fuel prices stayed high. Though fuel prices may moderate somewhat over the coming weeks as refiners complete the switch from winter to summer fuel blends, the long-term trend is for ever higher prices–and that hurts the nation’s major energy-intensive industries.
To get an idea of the challenges faced by industry in the form of rising fuel prices, look no further than the airlines. Jet aircraft consume huge quantities of jet fuel, a kerosene-like substance that, like gasoline, is produced by refineries from crude oil. The massive quantities of fuel required to keep the airlines flying makes the industry profoundly susceptible to economic damage from rising fuel costs.
According to the Air Transport Association (ATA), the nation’s oldest and largest airline trade association, airlines currently consume between 19 and 20 billion gallons of jet fuel each year. As a result, even the smallest increase in fuel prices can have a dramatic effect on airline costs. According to the ATA, at the current rate of consumption, “every penny increase in the price of a gallon of jet fuel drives an additional $190-200 million in annual fuel costs for U.S. airlines. So if the price were a dollar higher over the course of one year, that would translate to about $19-20 billion more in operating expenses.”
In fact, just as drivers have paid substantially more for gasoline over the course of the decade, since 2000 the price of jet fuel has increased dramatically. According to ATA, a gallon of jet fuel cost 90 cents in 2000, not including government taxes and fees. By 2006, the average price had climbed $1.96 per gallon. Prices have continued to rise since. Until now, competition and consumer expectations have kept airfares relatively low despite the rising cost of fuel, but some airlines including Delta, Continental, and others are now looking to increase prices to cover the rising cost.
Until now, the U.S. economy has been breezing along with consumers reportedly taking little notice of the increased cost of fuel. But just as the airlines are beginning to nervously consider controversial increases in airfares, there are other signs within the economy that give reason for concern.
The effects of high fuel prices on the economy as a whole started to become noticeable last year. On August 7, 2006, Chicago Business reported that gas at $3 per gallon was “pumping $5 billion from the Chicago-area economy, a hit that could cost the region roughly 62,000 jobs” if the high prices continued. Job losses in that region included some at the Solo Cup Co., maker of plastic cups and cup dispensers. Plastic is made from petroleum products, making Solo and other plastics manufacturers sensitive to high petroleum prices. According to the Chicago Business report, higher energy costs increased “Solo’s costs of manufacturing, shipping, paper and–biggest by far–plastic raw materials derived from petroleum,” and the company announced it was cutting 400 jobs. According to Tom Pasqualini, executive vice president of operations for the company, high energy costs were “a big part of the reason” for the cuts.
The new malaise in the economy has spread from Chicago to other parts of the nation. In Arizona projected job growth figures have had to be revised downward according to state economist Don Wehbey. Speaking to the Arizona Daily Star, Wehbey warned that fuel prices will “constrain some of the economy.” According to the state economist, “The fuel prices pull money out of the economy that would otherwise disperse to or otherwise be held by the consumer and as well [as] businesses. They would otherwise have a different way of spending or investing and saving that money in the economy.” In Arizona, Wehbey warned, there would be little or no job growth in manufacturing, while the state’s construction industry would suffer a large slow down. Meanwhile, other areas of the nation–including Virginia, Ohio, Wisconsin, California, Michigan, Iowa, North Carolina, and other states–saw an uptick in unemployment rates for April.
Does this mean the nation is on the verge of a fuel price-induced recession? For now, it is too early to tell. But consumer spending, a major driving force in the economy, could very well weaken as a result of higher fuel prices. In a significant sign that this is, in fact, happening, the market research firm BIGresearch released the results of its May Consumer Intentions & Actions Survey that found that fewer Americans plan to spend money on significant purchases as a result of high prices at the pump. “Consumers underestimated how high gas prices would go and are making changes to their purchase behaviors to cope,” said BIGresearch CEO Gary Drenik. “It’s tough for customers to think about making big ticket purchases and long-term debt obligations when daily budgets are being stretched to their limits with no end in sight.”
The findings of the BIGresearch survey point in an ominous direction. Consumer spending counts for some 70 percent of U.S. gross domestic product and is one of the last remaining props supporting the U.S. economic edifice. If high fuel prices mean Americans are about to end their decades-long spending spree, it could mean that the American economy is about to run out of gas.