I am flying back to Los Angeles from a visit to the Detroit Auto Show. (You can read InsideLine’s great coverage of the show here.)
It was a very different show from last year. Back then the big question hanging in the air was the economy. “Would vehicle sales continue to improve?” This year the assumption is that 2011 will show nice gains.
But there was another question hanging in the air this year. “Where are gas prices headed?”
In some ways, automakers would benefit from an orderly increase in prices as it would help shift demand to the wave of small vehicles they are dutifully introducing to market.
The trouble with fuel is that it is a commodity susceptible to “hoarding/dumping” behavior. Fuel doesn’t spoil. This means that if producers expect prices to risee in the near term, there is every incentive to hold on to supply to capitalize on tomorrow’s higher price. Even small reductions in supply can upset the balance in demand, triggering higher prices. So the expectation of higher prices can be self-fulfilling. And this is a positive feedback loop that encourages a rising price spiral to the point where prices are so high that demand noticeably drops.
This can trigger the expectation of lower near-term prices, encourages producers to dump fuel, increasing supply in relation to demand. Prices plummet.
This clearly played out in 2008. (One unanswered question from that experience is how this whipsaw in prices destabilized an already weak economy.)
In 2008, the story that contributed to the expectation of higher prices was rapid growth in the BRIC countries and an associated increase in demand for fuel.
Today, the story is similar, but also includes the expectation that demand will increase globally as economies recover.
A rapid run up in fuel prices is a real risk to the economic recovery as it will undermine consumer confidence and weaken consumer spending in other areas. (Money spent at the pump, can’t be spent on dining out, home improvements, etc.)
And while automakers have shored up their small vehicle offerings, it is next to impossible for them to shift production quickly enough to keep up with shifting consumer preferences that can change by the week.
So we need to watch gas prices closely. They are the dark cloud behind the silver lining of optimism at this year Detroit show.