Why Pain at the Pump Hurts More Here

by Tion Kwa

Originally published in washingtonpost.com's Think Tank Town, August 7, 2008

With crude oil tumbling to a three-month low, consumers might begin to harbor fresh hopes that prices could settle at more moderate levels after all. The problem is, oil's retreat over recent weeks had more to do with financial market instabilities in the wake of Fannie Mae and Freddie Mac's troubles than the fundamentals that have driven the acceleration in prices. The real question remains whether high prices have finally managed to reduce demand to a sufficient degree, radically altering the supply-demand equation.

In the United States, there does appear to be a discernible level of "demand destruction"—the reduction of demand for oil and oil-derived products. With gasoline prices now established above $4 a gallon, habits and preferences are changing. SUV and truck sales are plummeting, and small cars are starting to get a second look. Automobile ads on TV now often prominently display fuel-consumption figures. Indeed, people are driving less, more commuters are taking to public transport if they can and there is a missionary zeal in energy conservation.

Less apparent, however, is how much a decline in demand there has been in Europe and Asia. Because high taxes have long been a part of fuel costs in these regions, the rise in pump prices has not been as great in percentage terms as in the US. And because crude oil is priced in US dollars, stronger currencies in the rest of the world take some sting out of the rise.

Take Britain, which has one of the highest fuel costs in Europe. Current gasoline prices of around $9.50 a gallon will shock Americans long used to fuel cheaper than bottled water. But to put it in context, the price represents a rise of about 19 percent in the local currency from November (when prices broke above one pound per liter) to July. In that time, prices in America rose more than a third. Over a longer period, say between early 2007 and this July, US pump prices jumped around 80 percent while UK prices rose about 40 percent. Thus, the effect of higher crude oil prices are more acutely felt in the US than in the UK.

Rises of 19 percent and 40 percent are not insignificant, of course. And certainly they have prompted howls of protest. British truck drivers have been demanding reduction in fuel taxes; fuel is the biggest component of their business costs.

There have been changes in energy-use patterns, too. But these have not been as radical as in the United States. The reason is that being accustomed to high energy prices, Europeans are long used to the energy conservation practices at home and at work that Americans are only now converting to. So there isn't terribly more they can immediately adapt, to lower consumption still more.

One other practice in the UK and several other parts of Europe is the company car perk. In 2006, 5 percent of household automobiles in Britain were company cars. Some of these drivers even have fuel for private car use paid for by their companies, on top of fuel for commuting and business trips. Company car drivers are less likely to feel the bite of higher fuel costs and to reduce use.

In Asia, conditions vary. In developed economies like Japan, Hong Kong, and Singapore, there are many similarities with Europe. So patterns of consumption are not likely to resemble those of America in recent months.

In other parts of the region, fuel price rises are hitting hard, particularly after the reduction in subsidies. Gasoline prices are up 41 percent in Malaysia. Taiwan raised prices 13 percent. Indonesia, India, China, and others also have seen sharp rises in prices.

But this is unlikely to result in declines in demand significant enough to make a difference in global terms. Without an adequate public transport system, many people in Malaysia might still need motorcycles to get to work. Residents in Thai provincial towns may need to take three-wheeler cabs to the market. And less wealthy societies generally are going to be constrained in adopting energy-saving technology at home and in factories.

So as things stand, the most notable degree of demand destruction so far is to be found in the United States. Quite simply, America has the most slack. This just may not be enough to influence oil prices down to where most people would like to see them.

Tion Kwa is a senior writer at the Straits Times in Singapore and a Bernard Schwartz Fellow at the Asia Society.