Can We Handle $4 Gas?

A lot of things are getting better in the economy. Gas prices are not one of them.

After rising 17% since December, nationwide gas prices are siphoning enough cash out of consumers' pockets to make some worry that we could be headed back into a recession. It's a legitimate fear. "We need to look at the situation of gas prices today," Rick Santorum said last month. "We went into a recession in 2008 because of gasoline prices. The bubble burst in housing because people couldn't pay their mortgages because we're looking at $4-a-gallon gasoline. And look at what happened, economic decline." That's an incomplete, yet otherwise accurate, analysis.

But some aren't as worried this time around. Standard & Poor's published a report (PDF file, Adobe Acrobat required) last week rebutting those fretting about the consequences of $4 gas. "The U.S. Economy Can Handle $4 Per Gallon of Gasoline," it states assuredly.

How? For one, there's little sign that rising gasoline prices are causing consumers to retrench in a meaningful way -- yet, at least. Despite higher gas prices, "consumer spending on clothing and accessories was up 5.3% versus a year ago, spending increased 4.3% at sporting goods, hobby, book, and music retailers, and the food and drinking establishment business increased by 8.2% year over year," S&P wrote.

There are a few reasons for this. Nominal incomes are rising, up about 3% in the last year. That doesn't make people richer -- inflation ate away most of the gain -- but it does offset part of the rise in gas prices. People are also driving less and doing it in more fuel-efficient vehicles. And after defaulting or refinancing on painfully high mortgages, households have much more flexibility now than they did a few years ago. In 2007, debt payments made up 14% of an average household's disposable income. Today, it's 11%. That makes a huge difference.

But it was this line in S&P's report that caught my attention: "While consumers are definitely paying more at the pump, many consumers are benefiting from the lowest winter heating bills in years due to the combination of natural gas prices and the exceptionally mild winter in the northeastern U.S."

Surging gas prices could wallop consumers if you assume all else is equal. But it's not. Recent headlines that read "Home Heating Costs Fall to Lowest Point Since 2001" draw less attention than those detailing higher gasoline prices, but they're just as important to households' finances.

Natural gas -- which heats about half of U.S. homes -- has fallen 40% in the last year, with prices now near a decade low. The Energy Information Administration estimates that the average home that heats with natural gas will spend $204 less this year than they have during the average of the last five years. For a household using 60 gallons of gasoline per month, that savings offsets the entire recent spike at the pump.

Why don't we give credit to such savings? Duke economist Dan Ariely has a theory for why rising gasoline prices feel particularly miserable compared with other commodities. He explains:

For the several minutes that I stand at the pump, all I do is stare at the growing total on the meter -- there is nothing else to do. And I have time to remember how much it cost a year ago, two years ago and even six years ago. Yet I have no such memory about the prices of items in any other category. I have no idea how much milk was six years ago, how much bread was three years ago or how much yogurt was a week ago.

Or how much natural gas prices were a year ago, for that matter.

Another way to look at this is all energy consumption -- including gasoline, heating, electric utilities, etc. -- as a percentage of all consumer spending:


Sources: Bureau of Economic Analysis, author's calculations.

This chart ends in December, so it doesn't capture all of the rise in gasoline prices (or the more recent decline in natural gas prices). But what it shows is important: At best, energy consumption as a share of income is currently about average, if not a little below it.

"We are inclined to conclude that $4.00 per gallon of gasoline will not derail the U.S. economy," S&P wrote, "but acknowledge that $5.00 per gallon presents an entirely different set of risks, especially as we approach the summer peak driving vacation months."

That seems like a reasonable stance. Never underestimate the wrath caused by high gas prices -- and rising gas prices are something to be legitimately upset about -- but paying $4 at the pump might not be the nail in the coffin some presume it will be.

If you do think oil prices are bound to keep leaping higher, oil giants like ExxonMobil (NYS: XOM) and Chevron (NYS: CVX) look attractive at current prices. For more energy picks, consider The Motley Fool's free report, "The Only Energy Stock You'll Ever Need." It's free. Just click here.

At the time thisarticle was published Fool contributorMorgan Houselowns shares of ExxonMobil and Chevron. Follow him on Twitter @TMFHousel.Motley Fool newsletter serviceshave recommended buying shares of Chevron and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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