Saturday, April 15, 2006

The Paradox of Consumer Sensitivity to Fuel Prices



I have had a theory about consumer sensitivity to fuel prices for a few years. My theory is this: people will protest gasoline prices significantly more often than they will protest natural gas/heating prices. Sensitivity to gasoline prices is greater than heating fuel prices because consumers pay for gasoline more frequently than they pay for heating fuel.

I fill my tank about 1.3 times per week, every week of the year. That means my awareness of gasoline price changes is reinforced through ~ 5 refuelings per month. This is 60 events per year. As a result, I will have a finely tuned sensitivity to the rise and fall of gas prices and so do you. We will notice minor fluctuations, especially increases.

Now, consider heating fuel prices. There are three factors that diminish our sensitivity to natural gas prices:
- we only pay the bill once a month
- we only pay during the 4-5 months of cooler weather
- there is a 7 - 8 month span of time where we don't pay a heating bill

So, we have 5 months during which we pay once a month and after winter, we have 7 months where we aren't reminded of winter heating costs. For these reasons, we aren't as sensitive to heating costs as we are to gasoline costs.

The question though, is: Which fuel has the greater impact on our finances over the course of a year?

For auto fuel consumption, I make the following assumptions:
- Avg. fuel economy: 23 miles/gallon
- Avg. Miles driven/year: 15,000 (~1250 miles/month)

So, if gas during Month One is $1.86 and Month Two increases to $2.40, we get these values:

Month One Cost: $101.09
Month Two Cost: $130.43

So, gas for Month 2 only cost $29 more than Month 1. Suppose that gas rose uniformly by the same dollar amount from month to month over the next 11 months, the total extra dollars spent would be 11 months * $29/month = $319.

For natural gas consumption for a typical winter:
One CNN Money page reports that natural gas costs will increase 64% over last year to heat the average home for an average winter. Last year, it cost on average $957 to heat an average home during the winter. This year, the estimated total will be $1,568.

This is $611 more than last year.

So, not only will average home owners pay $611 more to heat their homes during the winters, they will pay that extra $611 over the course of 4 - 5 months.

Contrast this with gasoline, with the outlandish assumption of uniform prices increases month to month.

+$29/mo for gasoline ------------------------------- ~+$130/month for natural gas
+$319 for a whole year of gasoline --------------- +$611 for 5 months of natural gas

And this is the paradox of consumer sensitivity to energy prices. We complain about gasoline prices to the point where it is considered a factor in people's judgment of President Bush's effectiveness yet we completely ignore the cost of natural gas!

To review, consumers have greater sensitivity to gasoline prices than they do to natural gas prices, even though the greater total cost and impact to a household budget is with natural gas. The frequency with which people refill their tanks sensitizes them to fluctuations in gas prices. People consider a 10 cent jump in price per gallon significant, even though it has minimal impact on their budget. In contrast, people have little sensitivity to natural gas prices because they pay once a month, they pay for a few months out of the year and there is a large amount of time that passes where significant gas bills aren't paid. Yet, the greater meaningful cost increase is with natural gas.

And nary a peep of protest is heard from people.

Fascinating.