For the last few years, Americans have enjoyed friendly prices at the pump. And in many ways consumers' lives have been shaped by these prices.
People have bought bigger cars, traveled more, and spent more money in general.
But nothing lasts forever and rising gas prices could mean big changes for the American way of life.
According to GasBuddy.com, gas prices could reach a three-year high in 2017. And in the long-term, gas prices are likely to climb back up to record levels, experts say.
"There may not be a giant hike, but I do think eventually gas prices could return to record levels, maybe not in the next year or two...but it's just a matter of time," Patrick DeHaan, a senior petroleum analyst at GasBuddy.com, told Business Insider. "Global demand is on the uptick because of low oil prices so that would tell us that demand is increasing, but oil production has not really followed to that degree."
And as gas prices continue to rise, Americans could be forced to transform how they drive, spend, and where they live.
Say goodbye to your big truck
Since gas prices began falling in the last quarter of 2014, Americans have increasingly strayed from buying more fuel-efficient passenger cars and instead opted for larger pick-up trucks, SUVs, and crossovers.
In fact, SUV and crossovers accounted for 40% of US market share in 2016 versus 34.7% in 2014, according to IHS. The market share for sedans, on the other hand, decreased from 36.2% in 2014 to 31.1% in 2016.
But if gas prices go back, it's possible we could see Americans abandon their larger vehicles for smaller cars.
"If gasoline prices are high and are expected to stay high, you are going to see more fuel efficient overall vehicles. And you see that, for example, in Canada, and certainly in Europe,"Adele Morris, a senior fellow and policy director of climate and energy economics project at Brookings, told Business Insider.
"Gasoline prices have been higher for a longer time there, so people drive smaller much more fuel efficient cars and you would expect to see similar patterns in the United States," she said.
Americans have actually made this shift before.
In July 2008, gas prices reached record highs of about $4 a gallon and almost immediately consumers made a dramatic move to smaller, more fuel-efficient cars.
"Almost overnight fuel efficiency became a very important factor in what kind of cars Americans were looking at. And that could happen again," DeHaan said.
As gas prices have inched back up during recent months, we are already seeing a small shift in what kinds of vehicles people are buying.
"What we are finding in the current environment that we are in, where gas prices are about 60 cents higher than last year, is that motorists are very slowly going back to more fuel efficient vehicles," DeHaan said.
The average fuel economy of new vehicles sold in December 2015 was 24.8 mpg. But in December 2016, it had gone up to 25.0 mpg and in January and February this year it went up again to 25.1, according to the according to the University of Michigan's Transportation Research Institute.
But trading their large car for a smaller one isn't the change people are likely to make if gas prices soar. Americans are also likely to find other areas of their life they can cut spending.
Less dining out, less shopping
One of the biggest things people quickly change when gas prices go up is their discretionary spending, Morris said.
"In the short run, when gas prices go up it, people have only a limited ability to significantly change how much gasoline they consume. Because they have the car they have, they live where they do, they work where they do, so they might be able to cut back on discretionary travel a little bit, but probably the biggest factor is changes in other expenditures," Morris said.
"So where you tend to see a decline in other expenditures are things like meals eaten outside the home, where people can on a pretty rapid basis change their consumption patterns of discretionary spending."
Lower gas prices generally translate to higher consumer sentiment, which means people feel good about the economy and generally will spend more, DeHaan said. This has been the case for the last few years.
In fact, in 2015 it was estimated that consumers spent 80 cents of every dollar saved on gas on personal consumption, according to a JPMorgan Chase report.
However, if gas prices surge, we would likely see consumer sentiment plummet, people stop spending, and businesses would likely suffer.
"When gas prices are high, very quickly we see an impact on fast food restaurants and shopping in brick and mortar stores," DeHaan said.
"The impact varies, but it can come back to hurt traffic in malls. It's likely because motorists are cutting back from their discretionary spending categories as they shell out more of their paycheck towards gas prices," he said.
In the long term, though, gas prices can change a lot more than people's dining and shopping habits.
Home prices could be impacted
As the cost of gas increases, some homes may become worth more than others.
"We find that all else equal, homes in areas with longer commutes tend to sell at lower prices when gasoline goes up and homes with shorter commutes tend to sell at higher prices when gasoline prices go up," Morris said.
In fact, according to a 2014 study done by Morris and Helen Neill of the University of Nevada, Las Vegas, a 10% increase in gas prices can mean a 2% price bump for homes closer to a city center.
Homes further from a metropolitan hub, though, saw about a 1% drop in home value, according to the study.
To calculate this correlation, Morris and Neill used data from 930,702 home sales in the Las Vegas area for a span of more than 30 years. Morris said that home prices were most likely to decline if they were located more than half an hour outside a metropolitan area.
"The pivot point in our data, for this particular city, was about a 30-minute commute. So if your house was in an area where your commuting time was less than 30 minutes you were more likely having home prices going up when house prices go up," Morris said. "But if it was more than 30 minutes, your home prices were more likely to go down when gasoline prices go up."
This area outside of suburbs, which is often referred to as the "suburban fringe," was most affected when gas prices soared in 2008 and the housing crisis hit.
"If you look at the walkable urban neighborhoods, during the great recession, the housing prices basically went flat. Maybe they went down 10%, but they basically went flat," Christopher B. Leinberger, the chairman of the Center for Real Estate and Urban Analysis at George Washington University, told Business Insider.
"The drivable suburban fringe, relying upon cheap gas prices, had by far felt the biggest impact of price declines," Leinberger said.
For example, Leinberger said that houses in the suburban fringe surrounding the DC metro area saw home values drop as much as 60% percent from peak home prices, while homes in suburban areas closer to the city saw a drop of about half that.
Of course, gas prices were not the sole factor influencing home prices in 2008. The mortgage crisis sent the housing market into a tailspin and home values across the nation fell. But high gas prices do affect peoples' preferences, and when prices at the pump are soaring, people simply don't want to live as far out.
"Over the longer run, we know that gasoline prices can shift the prices for different types of cars and even people's patterns of living and commuting," Morris said. "Prices matter and people respond to prices and if gasoline prices go up and stay up then certain consumption patterns are harder to sustain and people are going to make other choices."
Economic Impact of Rising Natural Gas Prices
Natural gas prices have risen significantly in recent months, surpassing nearly all forecasts. In December, the spot price at the Henry Hub—the benchmark for U.S. natural gas prices—averaged $6.31 per million British Thermal Units (MMbtu), more than three times the average spot price one year earlier. In California, the run-up in prices has been even more dramatic, with daily spot prices averaging $15 per MMbtu and, at times, reaching $69 per MMbtu, a national historical high.
Increased costs for natural gas have begun to show through to consumers and businesses in the Twelfth District. Heating bills and electricity rates have risen for consumers in a number of District states, and additional increases are expected for the duration of the winter. For businesses, higher energy costs have constrained profits and prompted some District manufacturers and service providers to shut down until prices have settled back.
This Economic Letter examines some of the factors contributing to the recent surge in natural gas prices, paying particular attention to the increases in California, and discusses whether this is likely to be a short- or long-term problem. Having identified the major issues, the focus shifts to describing the effects that the price increases have had on producers and consumers in the District. The Letter concludes with a discussion of how rising natural gas prices are likely to affect economic growth in the West over the next year.
Recent trends in natural gas prices
Figure 1 compares the nation’s average monthly spot price for natural gas at the Henry Hub between January 1998 and December 2000 to the average range of annual wellhead prices from 1990-1999. The average annual wellhead price for natural gas between 1990 and 1999 was $1.90 per MMBtu. The average range, computed as plus or minus two standard deviations from the 1990-1999 average, was $1.40 to $2.40 per MMBtu.
Monthly spot prices began to exceed the 10-year average midway through 1999, hitting $3.05 per MMBtu in November 1999 and averaging $2.65 per MMBtu. However, the real run-up began in June of 2000, when natural gas prices broke through the $4.00 mark and began to increase at double-digit rates. By December 2000, prices were running above $6.00 per MMBtu, more than three times the price one year earlier. While analysts had predicted an increase in the price of natural gas in 2000, recent spikes surpassed almost all forecasts.
The run-up in gas prices has been most dramatic in California. On several days in December, spot prices for natural gas exceeded $50.00 per MMBtu, more than four times the national average. Daily spot prices in cash markets in other parts of the country hit comparable levels at times in December, but prices in California have been higher than the U.S. average for a sustained period of time. Figure 2 shows the spread between average spot prices in the California market and at the Henry Hub. Market prices for California are represented by two Northern (Malin, Oregon, and PG&E Citygate) pricing points and the average price at the three points in Southern California (Southern California border). Natural gas prices in California began to deviate noticeably in September, with average differences of around $1.00 per MMBtu. In December, the spread in prices in California and the U.S. average widened dramatically, surpassing $8.00 per MMBtu.
Why are natural gas prices rising?
Natural gas is bought and sold in an unregulated market, so, like other commodities, the price of natural gas at the wellhead is determined by supply and demand. The recent surge in prices is the result of rapid demand growth combined with limited increases in supply. Winter started earlier than usual this year in the East, Midwest, and Pacific Northwest, pushing temperatures well below normal in November and December. Industry analysts estimate that during the first six weeks of the traditional winter season, the average temperature has been 21% below the 10-year average and 35% colder than last year (Natural Gas Daily). This has meant unseasonably high heating demand throughout much of the U.S. At the same time, electricity deregulation and the general move toward cleaner burning fuels have resulted in considerable growth in electricity generation plants fired by natural gas. Data from the Department of Energy indicate that natural gas demand for electricity generation increased by about 12% between 1990 and 1999, making electricity generators the third largest user of natural gas, following industrial and residential customers. Finally, rapid and continuous economic expansion during the past ten years has boosted demand for natural gas among all users, especially industrial enterprises.
While demand has been increasing, supplies of natural gas have remained relatively stable. Like other commodities, natural gas supplies fluctuate with prices. Figure 3 shows the average number of rigs drilling for gas in the U.S. and the average spot price at the Henry Hub over the past three years. Low prices for natural gas in 1998 and part of 1999 resulted in significant reductions in gas drilling, as some existing wellheads shut down and new exploration and new drilling stalled. As prices began to rise in 1999, the number of rigs drilling for natural gas also increased, rising by about 70% between April 1999 (the trough of drilling activity) and December 1999. In 2000, the number of active rigs increased another 37%, rising to 854 rigs in December 2000.
Why are natural gas prices higher in California?
California is the largest consumer of natural gas in the West, accounting for about 70% of the natural gas delivered to western states. California produces only 15% of the natural gas it uses, importing the rest from other states (50%) and Canada (35%). The state imports natural gas via five major pipelines in Northern and Southern California. In addition to obtaining gas directly from the pipeline distribution network, companies in California rely on underground facilities to store natural gas inventories. About 70% of the storage goes to large gas distribution companies, primarily Southern California Gas and Pacific Gas and Electric. The remaining 30% is used by natural gas marketers, electric power generators, and large industrial end users. These storage facilities allow companies in the state to hedge against fluctuations in price and interruptions in distribution.
Because California has a large presence in the market, a diverse group of suppliers, and the capacity to store inventories, economic theory would predict that prices in California will equilibrate with those in surrounding states. The divergence in prices in recent months, therefore, suggests that some type of barrier—physical, regulatory, or market-based—has allowed natural gas sellers to obtain substantially higher prices. While it is difficult to pinpoint the exact cause of the relative run-up in price, pipelines into California are operating at or near capacity and stored supplies in the state are well below their five-year average, suggesting that daily natural gas demand is regularly outstripping the available supply.
As in other parts of the U.S., natural gas demand has been boosted by unseasonably cold winter weather, rapid growth in the use of natural gas fired electricity generation facilities, and general economic growth. At the same time, supplies of natural gas have been constrained by ongoing distributional problems related to the El Paso Pipeline explosion. The main channel in that network was slow to come back online and, during the worst part of the crisis, California drew down reserve supplies from storage, leaving levels lower than average entering the winter season. Adding to the difficulties of the demand and supply imbalance in California has been the deterioration of the financial position of two of California’s major buyers of natural gas, Pacific Gas and Electric and Southern California Edison. Both investor-owned utilities have defaulted on debt and missed payments for electricity delivered, motivating a number of providers of natural gas to raise their prices to these firms and, in some cases, to refuse to sell on credit.
Economic effects of rising natural gas prices in the District
Rapidly rising natural gas prices have become a major concern in many Twelfth District states, particularly with electricity prices also rising. Both producers and consumers in the District have experienced large jumps in costs, prompting some businesses to close temporarily and many consumers to reduce consumption and conserve.
For agricultural producers and many non-high-tech manufacturers, the price increases have been particularly difficult. Natural gas is an important component of production costs in agriculture: It is used for fuel to heat greenhouses and to run food processing machinery, and it is a major input in the manufacture of fertilizers and pesticides. As a result, many farmers in the District have experienced significant increases in costs, with some finding it more profitable to idle their production and/or fields than to produce under current conditions. Some District manufacturers are in a similar situation. Chemical makers, paper processors, brick producers, and food processors have decided to discontinue operations until natural gas prices improve. For manufacturers with forward contracts for natural gas, it is increasingly more profitable to resell this energy than to produce their products.
District residential consumers also are beginning to feel the effects of rising natural gas prices. Natural gas is the primary fuel for home heating in the West. Unseasonably cool weather combined with higher prices for natural gas has meant increases in heating bills of between 60% and 100%. Moreover, most major utilities in the District have warned customers that natural gas bills could increase even further in coming months. While the average residential consumer should be able to weather higher heating bills for three to four months, increased heating costs will depress households’ discretionary budgets and likely temper spending in other areas.
Although rising natural gas prices have hurt some producers and consumers in the Twelfth District, there is little evidence that rising costs have significantly slowed economic growth in the region. The lack of more widespread effects is not particularly surprising. On a per capita basis, western states consume less energy than the rest of the U.S. Natural gas accounts for only about one-quarter of all energy consumed in western states and, on average, expenditures on natural gas in District states amount to less than 1% of gross state product. Thus, even if prices remain high for most of the year, the impact on the economy, measured by its share of gross state product, will be less than the Asian financial crisis in 1997. Finally, unlike electricity markets, markets for natural gas are relatively unregulated and generally well functioning. Thus, capital spending on new production and distribution capacity for natural gas has responded quickly to price increases, and most analysts expect the supply and demand imbalances to be resolved by next winter.
Prices for natural gas have risen steadily and are currently well above historical levels. The recent surge in prices is due to rapid growth in demand over the past year, combined with limited growth in supply. Although certain businesses and consumers have experienced large jumps in costs, thus far the District economy has weathered the increases fairly well. Looking forward, given the relatively small role that natural gas expenditures play in the District economy and the limited time frame for the demand and supply imbalance, the increase in price should not derail the District’s expansion.
Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.