Downside Risk and the Agenda

Last month I was in London, winding up a music project at George Martin’s AIR Studios; but a journalist is never off duty, and anytime I travel I also observe. I love talking to strangers if only for data; hearing others’ varying life stories helps me shape a more accurate perception of the world’s real economic state of affairs. Besides, these conversations never fail to remind me that everyone has a great story to tell — and an individual’s story is just as important as anything you’ll hear anywhere else.

And to someone in my lines of work, England’s unique story hides a warning of downside risk.

Roads Not Built for Traffic

You’ve probably heard that Britons pay extremely high prices for gasoline and even higher for diesel – and London’s famed taxis use a great deal of that distillate daily, prowling the city’s maze of streets in search of fares. Unlike ours, British news reports show active public protesting against high fuel prices; ironically, rebellious America hasn’t seen any of that. For centuries England’s citizenry had the reputation of doing any suffering in a "stoic and dignified" manner; but apparently that’s not what’s done anymore, not when it comes to fuel.

Likewise, I’ve been reporting for years on London’s "congestion charge," paid by anyone driving into Central London for work or pleasure. But comparing this trip to my last stay there, in 1999, I couldn’t see that the added tax on commuters had helped much. The individuals I spoke with seemed to confirm my analysis; no one believes that it has done a thing to lighten the traffic of automotive commuters or shoppers in their city. They all said it was just one more tax to discourage people from owning automobiles.

Outside our hotel and all across the city of London, numerous BMW billboards promoted the fact that their vehicles have automatic shutoff systems for when stoplights have you parked – a marvelous way to save petrol. But, noticing the obvious, the British could save half the gasoline they use every day if they had just one straight road in all of London. As the crow flies, our hotel and AIR Studios were only about .25-mile apart, but by road it was at least double that distance.

In 1999 Jeep Grand Cherokees were everywhere on their roads – so many that I thought the local Jeep dealer must be doing phenomenally well – but on this trip I never saw one Jeep in London. What one will see must be among the world’s most unique and varied assortments of automobiles; and I was immediately struck by how many of their compact cars would be exceptional sellers here in the States.

Back in 1999 I reported that if Renault had come back to America with only its Espace minivan, it would have been a runaway hit. After all, we were used to boxy-looking minivans, and the 1999 Renault looked something like a Hawker private jet on wheels. Even the most reluctant minivan owner would have been the envy of his neighbors with this model in the driveway.

Along with the occasional Jaguar or Land Rover, I saw numerous motorcycles and more mopeds than I’ve seen here since the sixties, all on some of the most crowded streets anyone’s ever seen. The scene differs from our roads too in that their traffic congestion always seems to be moving, where our cars tend to be sitting and idling once the density of vehicles per mile reaches critical mass.

Mobility: Precious Freedom or Luxury?

While we’re mostly unaware of it, our car market actually has us more than a little spoiled. At lunch with the musicians one day, I mentioned that often we have Zero Percent Financing available; one musician simply looked up and stared, astonished at our darned American luck.

At the BBC Broadcast House before my weekend show went on air, my engineer talked with pride about his new Toyota Prius, which had replaced his Mercedes E Class diesel. But when I asked him about the price he’d paid for his Toyota, it worked out to around $43,000 US. Yes, I know part of that is the exchange rate between our currencies – but even using the 1999 exchange rate, his Prius is still a $38,410 vehicle. Always inquisitive, I had to ask how someone on a BBC engineer’s salary could afford a luxury like this, and he responded that only by holding down a part-time job assembling customized computers could he afford ownership of any vehicle, period.

America as a Spoiled Market

The cost of fuel in Europe drives compact cars’ popularity, and therefore their sticker prices, to astronomical heights. This in turn fuels many negative comments about the American car market from automotive execs; Bob Lutz, vice chairman of General Motors, groused earlier this year that GM could make a fortune in America if it could get the same margins on its small cars here that Volkswagen gets on its products in Europe. Carlos Ghosn, head of Renault Nissan, has voiced similar complaints.

Volkswagen, meanwhile, is considering removing one of its small vehicles from this market altogether; dealers can’t get enough of them in Europe, where profits on them are high, and VW loses money selling that vehicle here because of the Dollar/Euro exchange rate. This is also why Volkswagen pulled its diesel-powered Passat from the U.S. after it was introduced a few years back – and it’s why, as of now, we don’t have the high-mileage diesel version of the new Tiguan compact SUV in this market. Why sell those vehicles here and lose money, when in Europe people are standing in line to buy them for thousands of dollars more?

With England’s traffic equation in mind, I asked local Honda motorcycle dealer Al Lamb why Honda wasn’t importing its moped-like cycles into the U.S. He said dealers have begged Honda for those bikes for some time now, without result. Again, one has to believe that blame rests on Americans’ price sensitivities for these vehicles, for the Honda Ruckus in the U.S. lists for $2,049 — but in England, the identical Zoomer costs almost twice that much.

Buy Like a European?

This story of our price structures compared to England’s carries a warning: Their much larger gross margins notwithstanding, manufacturers often have a hard time making money there because buyers are so much scarcer. Additionally, I should again mention the crowding on the roads, even though no one in London seems to have anything against taking the tube or riding the bus.

I bring this up because I came home to find that Toronto’s CIBC World Markets had published the most negative outlook for the American car market that I have ever read. Like all such reports, it’s based on where oil is going in the future; not to mention the unstated agenda that would make us more Europeans in our car buying.

CIBC says that within a couple of years oil will be at $200 a barrel and we will be paying $7 a gallon for gasoline. CIBC believes this will drive 10 million vehicles off of our highways – mostly those owned by the lower class, who will no longer be able to afford the luxury of any car ownership. The remaining vehicles’ gasoline usage will drop by 15 percent, while the large truck and SUV market will fall by half.

Now, this column’s regular readers know that I spend a great deal of my life working on downside risk issues for the American economy, which really is what either drives or diminishes new car sales. And, while the CIBC report was widely reported in the media (driving the price of oil up again that day), and the report referenced the second world energy crisis several times, I was having a hard time finding any balance in their final analysis.

Here’s why: Let’s assume the 10 million American cars going away forever each use 750 gallons of gasoline per year, or about the average today. That’s 7.5 billion gallons of gas not used, or 394,736,842 barrels of oil not needed in that year – or a demand drop-off of 1,081,471 barrels per day. Combine that with the expected 15 percent less gas everyone else uses because gasoline is prohibitively expensive, and that’s another 1,650,000 bpd not needed. Add in the first figure and the 525,000 bpd we have already cut back, and you come up with 3,256,471 barrels of oil per day that just motorists in the U. S. won’t be buying.

The CIBC report does not cover what will happen to worldwide oil demand at $200 a barrel, but the drop-off in use will surely be every bit as dramatic as ours. Which means the price of oil would collapse. This is what happened to oil demand in the early eighties — and why prices collapsed soon thereafter.

If I report more on downside risks to our economy than most anyone, I also point out that what actually happens becomes the next level of the cycle. And then I explore where that movement will take us, because that part of the cycle is every bit as important to the story.

Of course the real downside risk to us, if we do become European-like car owners, is not the gas we would save, it would be the future price of our cars.

© 2008 Ed Wallace

Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, given by the Anderson School of Business at UCLA, and is a member of the American Historical Society. He reviews new cars every Friday morning at 7:15 on Fox Four’s Good Day, contributes articles to BusinessWeek Online and hosts the talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF. E-mail: wheels570@sbcglobal.net