Why $4 Gas Will Hurt Less This Time

Many drivers took precautions the last time rising gas prices wrecked their budgets

By SHARE

It's starting to seem like a spring ritual: Something goes pop in the Middle East, oil and gasoline prices surge, consumers get nervous, and the economy backslides.

Last year, the "Arab Spring" uprisings in Egypt, Libya, and several other countries pushed oil prices up by more than $20 per barrel, to a peak of about $113 in April. Gas prices hit the unnerving $4 per gallon level in May, depressing confidence and spending and triggering fears of a double-dip recession.

[See how Iran could affect your wallet in 2012.]

Now, Iran is the boogey man. Oil prices fell back below $80 per barrel in the second half of last year, as the Middle East settled down. But they're heading back up as the ongoing confrontation over Iran's nuclear weapons program intensifies. The United States and Europe are imposing a modified boycott of Iranian oil, to pressure Iran to curtail its quest for nuclear weapons. Some analysts predict a pre-emptive U.S. or Israeli military attack on Iran this year. If that happens, Iran could retaliate by attempting to shut down the Strait of Hormuz, a key oil chokepoint, or taking other measures that cause turmoil throughout the Middle East.

Those worries have produced a new "fear premium" on oil prices, which are heading back toward $110 per barrel. If shooting breaks out in Iran, prices could spike to $150 or even $200 per barrel, at least for a while. Gas prices have already risen by about 30 cents this year, to an average of about $3.65 per gallon. Since seasonal factors usually push prices up by 25 cents or so in the spring and summer, pump prices seem headed for $4 once again—and possibly $5 or even $6, if bombs fly.

Rising gas prices always take money out of consumers' pockets, leaving them less money to spend on other things. So $4 gas will undoubtedly slow the economy. But the effect might be less pronounced than in the past. Here are four reasons why:

We're getting used to it. If gas prices hit $4 this spring, it will be third time in five years they've crossed that notable threshold. When gas prices first hit $4, in 2008, it was both an economic and a psychological shock, since American drivers had never paid $4 for a gallon of gas before. Last year, $4 gas wasn't quite as startling. At some point—perhaps this year--$4 gas may even start to seem normal.

[See 6 things that could derail the economic rally.]

That's important, because the psychological impact of rising gas prices often amplifies the economic impact. Gas only accounts for 5.4 percent of the typical household's spending, but rising gas prices can depress consumer confidence faster than almost any other factor short of an unexpected catastrophe. That alone slows other types of economic activity, and it's especially true when prices cross round thresholds, such as going from $3.99 to $4.01. But the more familiar $4 gas becomes, the less shocking it is. Not long ago, $3 gas was considered alarmingly expensive. But drivers found ways to cope as such prices became commonplace, starting in 2007. Now, $3 gas seems like a bargain.

The economy is stronger now. When $4 gas first arrived in 2008, the economy was in the early stages of a recession that was about to get much worse. So the combined psychological and economic impact came at a very vulnerable moment. Last year, when gas prices briefly crested $4, the economy was still very weak, highly susceptible to financial problems in Europe and other dangers. The economy is far from bulletproof today, but jobs have slowly been coming back, consumers have been paying down debt, and companies have been strengthening their finances. That means the economy is less vulnerable to price shocks, with companies and consumers alike better able to absorb higher costs.

[Check out U.S. News Weekly: An insider's guide to politics and policy.]

Cars are more efficient. In 2008, rising gas prices led to a surge in demand for hybrids and other high-mileage cars. But choices were limited and some dealerships quickly ran out of the few models buyers most wanted. Hybrids were still considered oddball cars that made up a tiny fraction of overall sales. Many economy cars got decent mileage, but were underpowered and undesirable. The American automakers in particular had few high-mileage cars people actually wanted to buy.

That has changed. Most automakers offer hybrids these days, with Toyota alone offering five different models. Beyond that, higher fuel-economy requirements and new interest among consumers has led the automakers to significantly boost gas mileage—without cutting back on style, power, or features people want. At the beginning of 2008, the average new car got 20 miles per gallon, according to TrueCar.com. Today, the average is 22.9 mpg, and it's sure to keep going up as automakers continue to roll out better technology. At least a dozen conventional gas-powered cars now average 30 mpg or higher, including popular domestic models like the Chevrolet Sonic and the Ford Fiesta.

[See 3 numbers that will determine the next president.]

Many drivers burned by high gas prices in 2008 have also downsized since then, with sales of four- and six-cylinder models accounting for a much bigger share of sales these days, and thirsty V-8s becoming a thing of the past. That means costlier gas doesn't bite as sharply as it used to.

Obama has a strong incentive to push gas prices down. Obama administration officials have said that there are ways to offset a surge in oil prices caused by the new embargo on Iranian oil. One way would be increased production by U.S. allies such as Saudi Arabia, to make up for oil that Iran, the world's third-biggest oil exporter, isn't able to sell. If that doesn't work, Obama still has the option of releasing oil from the U.S. Strategic Petroleum Reserve, which would add to supply and also signal Washington's intent to keep oil and gas prices in check.

It goes without saying that Obama is intently focused on getting re-elected this year—and acutely aware that his chances go down as gas prices go up. So it's a good bet that the U.S. government won't stand idly by all year as rising gas prices wreak havoc with the typical family's budget. Even if it intervenes, however, Washington can't keep a lid on oil and gas prices forever, and it seems inevitable that sooner or later, $5 gas will become the new $4 gas.

  • Three holes in Mitt Romney's Tax Plan
  • Why Running For President is a Great Career Move
  • How to Reclaim the American Dream
  • Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success, to be published in May. Follow him on Twitter: @rickjnewman