This excerpt is from a report that is available to subscribers of Stratas Advisors’ North American Refining & Products, Short-Term Price Outlook and Executive Dialogue services.

On April 7, California passed a tax increase for both gasoline and diesel by 12 cents and 20 cents, respectively. With an estimated $52.4 billion in new revenue over the next 10 years for improving California’s infrastructure, the fuel tax increase has garnered decidedly mixed reactions from various business groups.

Some are calling it a necessary step in upgrading California’s ability to move goods and people; others are calling it a “job killer.” With the increase scheduled to take effect in 2018, the potential impact on California’s gasoline demand is likely to be substantial over time.

High Prices, Big Demand

Unsurprisingly, California is the largest consumer of gasoline and diesel of any state in the US, soaking up more than 10% of U.S. demand. And while the state holds a reputation for some of the highest gasoline prices in the U.S., much of this is due to the quality and composition of California-grade gasoline and the West Coast supply chain rather than a high fuel tax alone. California’s fuel taxes are currently above the national average, but they still rank well behind states like Pennsylvania and Washington.

While Californians are used to paying top dollar for fuel, there remains a real risk that a rapid increase in the fuel tax will reduce discretionary driving over time. The chart below shows the relationship between monthly, year-over-year demand growth vs. the change in the California average retail fuel price. While the R-squared of 0.44 reflects some predictive limitations to the data, the analysis below indicates that a 12-cent increase in the retail cost of fuel could cut 7,000 barrels per day (Mb/d) in incremental annual demand out of California’s gasoline market. To put this in perspective, California’s gasoline market grew an average 20 Mb/d from 2015 to 2016.

When looking just at the first-year impacts, 7 Mb/d is marginal. But over time, higher prices are likely to cut 70 Mb/d out of the state’s total demand by 2025. To put this in perspective, the incremental demand increase for the entire U.S. in 2016 was 150 Mb/d.