The Good, the Bad & the Ugly of $7 Gas

Back when gas was $2 a gallon, we didn’t sweat it. Our biggest concern at the pump was whether we remembered to check the oil. At $3 a gallon, we started to grouse. At $4, we can all agree, it hurts.

So imagine what it would be like at $7 a gallon, or three and a half times the price at the beginning of last year. If you can’t bear to, somebody else has. His name is Jeff Rubin and he’s spelled it out in a report he wrote at CIBC World Markets.

Here’s the grim scenario Rubin lays out. The Saudis are boosting production by 200,000 barrels a day, but most of that will be sucked up by its own booming economy. China’s cut its fuel subsidies, but gas still costs a mere $3.25 a gallon there. In fact,such subsidies around the world are giving short-term relief at the cost of longer-term pain: Demand stays high, so oil rockets ever higher, closing at $140.15 Monday.

Unless something gives, Rubin argues, oil will average $200 a barrel in 2010, which translates into $7-a-gallon gas. To keep it nasty, brutish and short, here’s what that means for U.S. residents:

  • Stagflation;
  • Driving like Europeans (15 percent less mileage, more public transportation — except Europe has pleasant public transportation);
  • Market share for SUVs/vans/light trucks cut in half; vehicle sales collapse to early 80s levels;
  • 10 million fewer cars on the road; one in five homes lose their second car;
  • Hundreds of thousands of auto-related jobs disappear;
  • Spending more per month on gas than food; diminished purchasing power compared to consumers in Europe or Japan.

Unlike the oil shocks of the 70s, which were probably steeper in terms of inflation, the rise in gas prices this time is driven by broad fundamental forces that aren’t going away. As Rubin says,

Even the temporary 1979-1981 oil shock led to huge changes in driving behaviour. The prospect of a permanent price regime of $200 per barrel oil should trigger changes that will dwarf the adjustment we saw nearly thirty years ago.

In other words, you may have bought a Datsun in 1981 and traded it in for a Ford pickup in 1993. But if you have to ride the bus in 2009, you may well be riding it in 2020.

Now the ultimate outcomes don’t sound so bad to some — fewer cars, less pollution. But the transition is going to spread the pain around to everyone. The alternative energies that this blog chronicles will eventually ease much of this pain, but more and more voices are echoing how bad that it will be in the interim.

Rubin saves his direst analysis for the report’s end: Oil will follow housing in a devastating one-two punch. An ailing housing market leaves rates low, which means more money greasing the economy. So it may not feel as bad as it is right now. But high oil forces the Fed to raise rates — an excruciating treatment for a painful condition.

The most important reason for thinking that the major hit to growth lies ahead rests on the response in monetary policy. As a number of prominent economists, including Ben Bernanke himself, have pointed out, the impact of some of the biggest oil shocks were exacerbated by aggressive Fed tightening…The U.S. economy has managed to avoid feeling the full brunt of oil prices over the last few years, but 2009 will be the year that its luck runs out.

Even now, at $4-a-gallon gas, Rubin may sound like a carbon-fuel Cassandra. But his logic is persuasive throughout the report, which should make us wonder how we’ll adjust if his outlook proves to be true.