The impact of lower gasoline prices

In recent months we have seen gasoline prices in our area drop from around $4 per-gallon to roughly $3 currently. This drop in price is clearly having an impact for the car driving public.

Some people realize that gasoline prices do tend to decline at this time of the year due to a shift to the cheaper winter blend of fuel. However, this year the decline in prices goes far beyond the normal seasonal pattern.

The magnitude of the potential savings from lower gasoline prices can be quite significant. If someone drives 10,000 miles per year and gets 25 miles per gallon, the yearly savings from a $1 decline in the price of gas is $400. If there are two drivers, who each drive 15,000 miles the annual savings become $1,200. This assumes of course that prices stay down for an entire year.

This decline in gas prices is helping to boost auto sales. November auto sales came in at an annualized pace of 17 million units on a national basis. This is a sales level well above what we have seen in recent years. Also, the mix of sales is increasingly going toward light trucks, and away from small cars.

What consumers need to do is determine whether this decline in price is temporary or permanent. There is often a tendency for people to expect a current trend will continue indefinitely. For example in prior years when gasoline prices were rising, many commentators were calling for the cost of gasoline to go beyond $5 per gallon.

Individuals need to realize that the price of oil and gasoline can change significantly with relatively small changes in supply or demand. A 1 percent change worldwide in either oil supply or demand can oftentimes impact prices at least 10 percent.

Essentially what has been happening in recent months is that a variety of factors are at work. Worldwide oil demand has been somewhat weaker than expected, while supply has been increasing in the U.S., Iraq, and Libya. The dollar has been very strong, which has lowered the price of oil more in the U.S. versus other countries. Finally an expected supply cut by OPEC did not materialize.

When prices have had a major move that will impact future supply and demand. With lower prices, people will tend to drive more and purchase less fuel-efficient cars driving up demand. Supply will also tend to be reduced, as projects that made sense when oil was at $90 per barrel are no longer profitable at $65 per barrel.

These adjustments will not take place right away, but chances are that oil prices will not stay at lower levels permanently. It should also be noted that oil is produced in many relatively unstable countries, so a significant supply disruption is always possible, which could cause a future spike in prices.

What consumers should do is be conservative in their projections of the cost of gasoline in their car buying decisions. While gasoline prices may be low for a period of time, chances are that five years from now they will be higher. Therefore, if someone wants to buy an SUV, they should not count on the price of gasoline staying at $3 per gallon.

Oil production in the U.S. has increased significantly in recent years, which has helped to lower oil prices. Future production growth will be sensitive, as to where the price of oil settles down as well. Changes in supply should tend to keep oil prices in a range. That is when prices are low supply will be reduced, but when prices rise supply will increase.

As mentioned previously, new environmental regulations go in effect in California on Jan. 1, 2015, which will likely cause the price of gasoline to rise to some extent. Consumers can certainly enjoy the windfall from lower gasoline prices at the present time. However, for longer-term-planning people in California should be prepared for gasoline prices to go back to $3.50 to $4 per gallon.

Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.