Bianco Research L.L.C. An A R T A C

Bianco Research L.L.C.

An Arbor Research & Trading Affiliated Company

Independent ¡¤ Objective ¡¤ Original

Volume 19, No. 81

1731 North Marcey, Chicago IL 60614



Commentary

Market Opinions and Topics of Interest

By Howard L. Simons (847) 304-1511

October 31, 2008

Gasoline, Productivity And Inflation After The Downturn

Much has changed since our May Commentary on

gasoline expenditures, inflation and productivity.

That document was written when crude oil was at

$125, roughly twice the recent price level, and one

week before global equities reached their post-Bear

Stearns high.

Global growth was still strong,

investment banks were still walking the earth and

Benjamin Bernanke was three weeks away from

threatening to raise interest rates to combat stillrising inflation.

thereof (thin red line, left-hand chart) against

the logarithm of implied gasoline demand

(thick blue line), we see total gasoline

demand has risen higher in an erratic fashion

for almost a quarter-century independent of

price.

If price elasticity of demand was operating as

designed, we would see a negative trend in the

scatter diagram (right-hand chart). The trend is

erratically positive. The partial contribution of

price to total demand may be negative, but it is

being overwhelmed by income- and engineeringrelated factors. Both continue to support our

original thesis that gasoline demand can rise

independently of price so long as the economic

value added by its consumption exceeds the

total cost paid.

While vehicle-miles declined 5.6% in August from

year-ago levels, a significant level to be sure and

one consistent with declines in the 1974-1975 and

1980 recessions, it is important to remember prices

are affected not by vehicle-miles but rather by total

volumetric demand. We repeat from May (original

boldface):

If we index constant-dollar gasoline prices to

July 1984 levels and map the logarithm

Where Is The Negative Price Elasticity Of Demand?

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

Productivity

Implied gasoline demand (thin red line, following

page) fell 3.0% from year-ago levels in the third

quarter; on a seasonally adjusted basis (light red

line), it fell 2.2%. Constant-dollar GDP per barrel of

gasoline consumed (thick blue line) has declined

8.75

Logarithm Of Gasoline Re-Indexed To July 1984 = 100%

0.64% before seasonal adjustment and is at a

record high after seasonal adjustment (light blue

line).

0.875

0.750

0.625

8.70

0.500

8.70

1987

-1.500

1986

8.75

1985

-1.250

-1.375

8.80

0.375

8.80

0.250

Gasoline Demand

(Right Scale)

-1.125

0.125

-1.000

8.85

0.000

8.85

-0.875

-0.125

-0.750

8.90

-0.250

8.90

-0.375

-0.625

8.95

-0.500

8.95

-0.500

-0.625

-0.375

9.00

-0.750

9.00

-0.250

9.05

-0.875

9.05

0.000

-0.125

9.10

-1.000

9.10

0.125

-1.125

0.250

9.15

-1.250

9.15

-1.375

Constant-Dollar Gasoline

(Left Scale)

0.375

9.20

-1.500

9.20

0.500

Logarithm Of U.S. Implied Gasoline Demand, MMB/D

0.750

0.625

9.25

Logarithm Of U.S. Implied Gasoline Demand, MMB/D

(Thick Blue Line)

9.25

1984

Logarithm Of Gasoline Re-Indexed To July 1984 = 100%

(Thin Red Line)

Where Is The Lead/Lag Relationship?

0.875

Bianco Research, L.L.C.

Page 2 of 4

This much seems clear: The U.S. and indeed the

global economy were able to absorb higher

petroleum prices without crisis; they have been

unable to absorb the credit crunch with similar

October 31, 2008

equanimity. Any decline in petroleum demand

produced by the credit crunch and its income

effects will exceed that of higher prices.

Rising Productivity of U.S. Gasoline Consumption

$3,500

9,500

Implied Gasoline Demand

(Left Scale)

9,250

$3,300

9,000

$3,100

8,750

8,500

$2,900

8,250

8,000

$2,700

7,750

7,500

$2,500

Constant $ GDP/B

(Right Scale)

7,250

7,000

$2,300

6,750

6,500

Real GDP Per Barrel (Thick Blue Line)

U.S. Gasoline Demand, Thousand Barrels Per Day

(Thin Red Line)

9,750

$2,100

6,250

Gasoline And Inflation

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

$1,900

1979

6,000

gasoline prices have been rising for nine years

and the CPI only recently has moved over trend,

we still find gasoline prices a poor metric for the

CPI. Of course, this may say more about the CPI¡¯s

construction than about the impact of gasoline prices

on household budgets.

We note, as before, how a simple timeline is more

than twice as robust as an explanatory variable for

the Consumer Price index (thick blue line) as are

wholesale gasoline prices (thin red line); the

comparative r2 values are .995 and .489. As

Gasoline Does Not Drive Inflation

350

220

210

200

275

190

250

180

225

170

200

160

175

2

150

r = .995

150

140

125

130

2

100

r = .489

The Consumption Link

If we blend the rising consumption noted above with

the rising price, we must get rising total consumer

expenditures for gasoline. We can proxy this effect

by taking retail sales at service stations as a

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

100

1989

25

1988

110

1987

50

1986

120

1985

75

1984

87 Octane Gasoline, USGC, Cents Per Gallon

(Thin Red Line)

CPI

(Right Scale)

300

Consumer Price Index (Thick Blue Line)

Gasoline

(Left Scale)

325

percentage of total personal consumption (thick blue

line, following page).

It leads year-over-year

changes in the CPI (red columns) by six months on

average.

Bianco Research, L.L.C.

Page 3 of 4

The last datum is for September. We noted in May

that if gasoline continued to claim a larger share of

consumer budgets in April and May, which occurred,

upward pressure on the CPI would result, which also

occurred.

October 31, 2008

consumer budgets yet; once again, consumer

spending is going to be affected much more by the

incipient recession and destruction of household

wealth than it is by gasoline prices. If all trends

currently observed persist, we should see

downward pressure on the CPI through the first

quarter of 2009.

The recent drop in gasoline prices is still too shortlived to have produced any material changes in

Gasoline Expenditures And Consumer Inflation

5.8%

6.10%

5.70%

5.50%

4.6%

5.30%

4.3%

5.10%

4.90%

4.0%

4.70%

3.7%

4.50%

3.4%

4.30%

3.1%

4.10%

2.8%

3.90%

Jul-08

Jul-07

Jan-08

Jul-06

Jan-07

Jul-05

Jan-06

Jul-04

Jan-05

Jul-03

Jan-04

Jul-02

Jan-03

Jul-01

Jan-02

Jul-00

Jan-01

Jul-99

Jan-00

Jul-98

Jan-99

Jul-97

Jan-98

Jul-96

Jan-97

Jul-95

2.70%

Jan-96

2.90%

1.0%

Jul-94

Jan-95

3.10%

1.3%

Jul-93

3.30%

1.6%

Jan-94

3.50%

1.9%

Jul-92

3.70%

2.2%

Jan-93

2.5%

Gasoline / Personal Expenditures (Blue Line)

4.9%

5.90%

Gasoline Expenditures / Personal Consumption

(Right Scale)

CPI Y-o-Y

Led 6 Months

(Left Scale)

5.2%

Jan-92

CPI PCYA Led 6 Months (Red Columns)

5.5%

Conclusion

One of the precepts of behavioral finance is pain

and pleasure produce highly asymmetric effects; the

pain of loss is roughly three times as great as the

pleasure of gain. Investors also have a hypertrophic

sense of entitlement; gains are supposed to happen

while losses are not. Journalists, we can attest, are

far less curious about 900-point gains in the Dow

Jones Industrial Average than they are about 500point losses.

The treatment of petroleum prices in general and

gasoline prices in particular is consistent with these

observations. We have written a series of Market

Facts noting the positive partial contribution of crude

oil prices to the S&P 500, and others noting the

weak and unstable contribution of energy prices to

inflation expectations, and it is safe to say neither

statistical demonstration has been embraced

wholeheartedly.

We were asked many times during the September

2007 ¨C July 2008 doubling of crude oil prices what it

would take to bring them back down and we

answered consistently, ¡°A global recession.¡± Lower

gasoline prices are of small solace in this context,

ranking just above a 2% dividend yield on a stock

whose price has fallen by 50%.

When the economy recovers, the long-term bull

market in energy prices will return and will not derail

that recovery so long as the economic value added

by energy purchases exceed their total cost.

Bianco Research, L.L.C.

Page 4 of 4

October 31, 2008

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