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Falling Oil Prices and Fuel Economy

Sigma Investment Counselors

November 14, 2014

The average price for gasoline in the U. S. is currently below $3.00 per gallon.  Moreover, the Energy Department recently predicted that the average price of gasoline in the U. S. will be below $2.94 a gallon in 2015, a 44% decrease from their previous outlook, issued just a month ago.

That may sound like good news for consumers, and it is, but it comes with some material problems. 

Choosing a new vehicle and designing a new vehicle present an interesting dilemma.  Bigger, potentially safer, and more powerful, do not translate into less thirsty and more affordable.  In other words, you can have a big and fast vehicle, but that tends to mean greater fuel consumption and a higher purchase price.  Even worse, real fuel economy requires smaller, less powerful vehicles and a higher price, since meaningful fuel savings require significantly more complex and expensive power trains.

History suggests that consumers generally favor larger, more powerful vehicles.  The industry is more than happy to support those preferences, as larger vehicles tend to be considerably more profitable.  With gasoline below $3.00, and some expectation that even lower prices are coming, everyone should be happy.

That’s fine, but here is the dilemma.  Fuel prices may go up, perhaps right after you bought a gas guzzler, and the manufacturers are faced with meeting ever increasing, mandated fuel economy standards.  With cheaper fuel, consumers are more likely to opt for bigger, more powerful vehicles.  In order to meet mandated fuel efficiency standards, manufacturers will have to find a way to sell smaller, more expensive, less profitable, fuel efficient vehicles to potentially reluctant consumers.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®

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