The Future Is Low Gas Prices

Like millions of Americans, Sam Irvani assumed higher gas prices were inevitable. "I got the Volt in May and I think I've gotten gas only one time since then," explains Irvani about his new Chevy plug-in hybrid. "My commute is about five miles either way. I had been driving a BMW 550i, but it made sense to drive something less expensive."

Conventional wisdom has fueled millions of similar car-buying decisions. By now gas was supposed to be $10 a gallon and we would all have to trade in our pickups and big powerful cars for hybrids and teeny-tiny hatchbacks.

Well, conventional wisdom was dead wrong. Gas is cheap. It's likely to get cheaper. And it's going to stay that way.

The Defeat of Pessimism
Peak oil theorists, environmentalists, Malthusian malcontents, pessimistic economists, moms, dads and virtually everyone else have long been convinced that petroleum prices were headed higher and only higher. Oil was running out, scarcity was coming and the battle for world resources would be vicious and expensive. No one was predicting this: gas prices that, controlled for inflation, are nearing historic lows.

Back in May 2014, when Irvani leased his Volt, according to the U.S. Energy Information Agency, gas was selling for a nationwide average of $3.68 per gallon — and well over $4 a gallon in Southern California where Irvani lives. By December that average price had dropped to $2.57, with California prices edging under $3 and prices in places like Texas diving down well below $2.

Prices have dropped further since then as the price of oil has plunged from about $108 a barrel in June 2014 to about $47 a barrel as this is written in early January 2015. Many, if not most, observers expect the price to go down even further.

Here's why. Supplies are up and demand is nearly flat.

Lots of Supply
Back in 1956, while working at Shell Oil's research lab in Houston, M. King Hubbert predicted that oil production in the United States would peak between 1965 and 1971, and then enter into inevitable decline. When that peak was reached in 1970, his theory was extrapolated out to production across the globe. The end was nigh.

But the development of advanced hydraulic fracturing techniques (fracking) and other unconventional technologies has recently resulted in a radical increase in American oil production. From a low of 5 million barrels a day in 2008, production has steadily increased until this past October. America produced more than 9 million barrels a day of oil, not far from the 9.6 million barrels a day peak in 1970.

Oil is a fungible commodity. So the more oil the United States makes for itself, the more supply there is for every other country to use. In 2012 for instance, the U.S. pumped 38.8 percent of what it used domestically, and imported another 15.1 percent from our friendly neighbor to the north, Canada. By October 2013, U.S. domestic oil production was greater than oil imports for the first time since 1995.

The EIA expects U.S. oil production to run at about 9.3 million barrels a day during 2015. That's not enough to meet the country's consumption, but it is enough to knock back oil imports to their lowest level since November 1994. And that in turn has led to the U.S. trade deficit shrinking, in November, to its smallest level in 11 months.

And while America is producing more oil for its own use, the rest of the world is still pumping at a furious rate. Governments in countries like Russia, Iran and Venezuela depend on oil revenues and can't afford to not export as much as they can. Meanwhile, countries in turmoil like Libya and Iraq have continued to keep their production humming despite their insecurities.

Then there's Saudi Arabia, long the lowest-cost and largest producer of crude, which has increased its production. For the Saudis, lower oil prices will starve its potential regional rival Iran of revenue and, maybe even better, make investment in further exploitation of North American shale oil unprofitable. Fracking in North Dakota's Bakken Formation with oil at $110 per barrel makes sense, but it may not pay at under $50 per barrel.

In late October 2014, the secretary-general of the Organization of Petroleum Exporting Countries (OPEC) asserted that half of shale oil production in America would be uneconomic at about $80 a barrel. "I think that OPEC is sadly mistaken," Niles Hushka, who runs an engineering and oil services firm in North Dakota, told National Public Radio. "I think...in order to discourage production, especially in the Bakken, you're going to be looking at prices down in the $40 range."

Right now, $40 per barrel doesn't look that far away.

At the moment, though, we're reaping what current investments in American shale oil have sown. There's no reason to expect a large drop in American production at least through 2015. And 2016 looks good, too.

Modest Demand
Americans consume a mind-boggling amount of gasoline. But it's not as much as it used to be.

Back in 2007 the country burned through 142,349,493,000 gallons of gasoline — just about twice what we used in 1967. But with the economic slowdown of 2008 came a significant drop in usage to 138,182,390,000 gallons. And by 2012, when economic activity was supposed to be increasing, that number had dropped down to 133,462,850,000 gallons. Consumption has increased somewhat in 2013 and 2014, but it's still below where it was in 2007.

Yes, cars have grown more efficient and continue to do so. But demographic changes in how we live are affecting demand for gasoline as well.

As the large population of baby boomers age into retirement, they use less gasoline. And younger Americans are increasingly moving into cities where public transportation is more accessible and services like Uber and Zipcar make owning your own vehicle less of a necessity. With much of current urban planning concentrating on building more densely packed housing near public transit, these trends aren't likely to abate, no matter how cheap oil gets.

Throw in slower growth in countries like China and India, and demand for oil products has slackened. That's a recipe for even lower prices.

The Future
Of course there will be price fluctuations over the next few years. There always are. But barring some unforeseen event — political upheaval in Saudi Arabia or widespread war in the Middle East, for instance — oil will find a relatively low, stable price point and stay near there.

Beyond that, there's going to be even more oil coming from new sources.

Technology has always driven oil production. The Hughes rotary rock drill bit revolutionized the industry in 1909 and vastly expanded production. Slant drilling, offshore drilling and, yes, fracking have all vastly increased production. Add in innovations like "managed-pressure-drilling" that may pay off in extending yields and life of wells across the world.

And that opens up new areas for exploration.

For instance, Algeria just began drilling for shale gas in the Ahnet Basin. There are initiatives under way to exploit the potentially huge shale oil deposits in Israel's Shfela basin. Brazil is looking at expanding exploration off its coast for new oil sources.

Your Future Car
Controlled for inflation, gasoline in America historically averages around $2 a gallon. It's getting close to that now and will likely stay around that price. Prices in some areas, like Texas and the rest of the Gulf Coast, may even approach $1.50 a gallon.

Lower gas prices stretch the payoff on alternative technology vehicles longer. Take for example the conventional, four-cylinder 2015 Honda Accord EX-L with Navigation at $31,015 (EPA rated at 31 mpg in combined driving) and its brother, the $32,875 Accord Hybrid EX-L (which the EPA rates at 47 mpg). At $4 a gallon, that $1,860 difference in cost can be made up in 2.7 years of driving. At $2 a gallon that doubles to 5.4 years — beyond the length of time many buyers will keep their cars. And that's longer than virtually any lease.

Of course it also makes relatively fuel-thirsty vehicles like large SUVs more affordable. Sales of the recently redesigned Chevrolet Tahoe are up, while those of hybrids like the aging Toyota Prius are stagnant or declining. But even buyers of large vehicles are conscious of fuel use, with the popularity of the turbocharged EcoBoost V6s in the Ford F-150 line attesting to that. Even with gas prices down, there's never a reason to waste fuel.

Lower fuel prices, however, may also open up the possibility of higher fuel taxes. Currently the federal fuel tax on gasoline stands at 18.4 cents per gallon, where it's been since 1993 and it's not indexed for inflation. With total gasoline consumption stagnant, the Federal Highway Trust Fund is teetering near bankruptcy and maintenance and improvements to infrastructure like bridges and highways is being delayed. It's been politically impossible to increase that tax with fuel prices relatively high. Even with Republicans in control of Congress, that may now be a viable — and, at least for legislators, attractive — option.

States are also looking at improving revenue from their fuel taxes, and those may rise as well. Some states, like Oregon where a pilot program is under way, are also considering mileage taxes in lieu of fuel taxes to capture revenue from cars with better fuel mileage or electric vehicles like the Tesla that currently pay no fuel taxes at all.

It's not likely that gas taxes in America will ever approach those of Europe. In Germany, taxes on fuel run €1.27 per liter: about $5.53 per gallon.

Even Expensive Gas Is Cheap Fuel
Even at $4 or $5 a gallon, gasoline is a bargain in the 21st century. Back in the 1980s, American families spent as much as 5 percent of their household budgets on fuel. Even as prices reached near their peak in 2012, households were spending only about 4 percent of their income on gas.

In a recent interview with The Detroit News, President Obama said, "I would strongly advise American consumers to continue to think about how you save money at the pump because it is good for the environment, it's good for family pocketbooks and if you go back to old habits and suddenly gas is back at $3.50, you are going to not be real happy."

But for the moment, it's hard to see from where President Obama's "suddenly" may come. After all, the United States Energy Information Agency itself projects prices decreasing slightly through 2015, then staying flat until about 2020. After that, a slow but steady increase through 2040.

That's a quarter century from now. So, the question remains: Should you let gas prices drive your car-buying choices?