Yesterday's announcement by GM to cut truck production

by: Eric B.

Wed Jun 04, 2008 at 15:00:00 PM EDT

On top of a couple of startling developments yesterday -- the Ford F-series truck failing to be the top-selling model in the U.S., and GM's plans to shutter four truck manufacturing facilities and possibly sell the Hummer brand -- came rising speculation that oil prices are reaching their peak.  That is, speculators and a weakening dollar drove up the price of crude and that things will recede, bringing down oil prices (and, presumably, gas prices).

Although yesterday's announcement by GM could actually help Michigan, that combined with the prospects that oil might get cheaper (one estimate, which I think was hopelessly optimistic, predicted $40 a barrel oil) raises the very delicate issue of market volatility.

One of the unfortunate lessons from this is that the market for new cars is, at the end of the day, primarily driven not by consumer appetite but by the price of gasoline.  That is to say when the per-gallon cost reaches the threshold of about $3.50 a gallon, people alter their behavior more and more as it becomes more expensive.  Beneath that, people buy as much car as they can afford.  Intuitive, yes, and also unfortunate that we've learned it based on recent events.

GM's decision to skip big truck production in lieu of four-cyllinder engine cars suggests that the company isn't buying the talk about an oil bubble, since plummeting oil prices would undoubtedly bring down prices at the pump and again stimulate demand for big trucks.

The question is what happens if they're wrong.  What happens if oil prices slide below $100 for several months or even a year, and the price of gasoline drops below that $3.50 threshhold that seems to cause consumers to change their habits.  Most people probably know more about the state of the oil market today than they did a year ago, but were driven to that by self interest.  We've actually been in a state of gradual increase in gasoline price since about 2005, with huge headlines during individual spikes. In between, when the price of gasoline has fallen to more manageable numbers, people have reverted to their normal state of blissful ignorance.

In previous years, those spikes haven't been long enough to actually change people's long-term behavior.  This summer appears to be the first when gas prices are up for at least the medium term, and which are actually causing changes in behavior.  But what happens in winter, if prices -- bolstered by a strengthening dollar and the end of oil futures speculation -- again fall to where they cease to influence car purchases?

A Gallup poll from last month suggests that the general public a) wants the government to institute price controls on gasoline, and b) wants to permit more drilling in Alaska and off the continental shelf.  This suggests not just that the general public is lazy and ignorant about oil (it does certainly do that), but that at the end of the day the public wishes that the world would not change.  All things being equal, the general public would rather government intervene in the market than to amend their habits to the market's realities.  They aren't changing their consumer habits willingly, but are doing so at the point of a bayonet held by the market itself.  Should prices relax for a period of time, there's good reason to believe that demand for fuel efficient cars might likewise relax and demand for gas guzzling trucks to again pick up.

This would be bad for a lot of reasons, like climate change policy and energy independence, but it could prove especially bad news for Michigan.  That third shift GM plans to add to its Lake Orion plant to make four-cyllinder engines could go away if demand for four-cyllinder engine vehicles go away.

Michigan's best interests are best served by a stabile, predictable price for gasoline.  Or, more to the point, stable, predictable demand for the cars Detroit is building.  Thomas Friedman, and this is going to scare the bejeezus out of many of you, last week called for, not a price ceiling but a price floor.  That is, if the price of gasoline ever falls below a certain point, we bridge the gap between market price and at-pump price until it hits the floor.  I leave it to you to ponder whether it's a good idea to artificially raise demand for fuel efficient cars.

I personally don't think this kind of thing is going to be necessary.  Because production is basically already topped out and new discoveries will take about seven years to hit the market and because demand is rising, I think GM's decision to pursue fuel-efficient cars was ultimately a very wise one.  It would have been wiser, of course, if they'd figured out that this was coming a few years ago, instead of squandering all that time and money trying to hold back the stream with just a pair of ragged hands.