Saturday, August 9, 2008

Oil Demand To Fall

We often hear oil bulls describe oil demand as inelastic. The argument is as follows: No matter what the oil price is, people still have to fill-up to be able to go to work, companies still need to transport their products, and industries still need energy to produce products. As such, the oil price will continue to rise and those of us who don't produce oil will lose more and more of our disposable income. While this may be true in the short-run, it is not true in the long term. Over time, as SUVs get phased out for fuel-efficient vehicles, and as companies adopt new technologies to reduce their oil usage, oil consumption will drop, resulting in a long-term oil price much lower than it is today.

Rather than merely discussing these issues anecdotally, however, let's look at some data. Below is a chart depicting the cost of oil since 1973, along with its consumption pattern from OECD countries.
Notice a price spike in the late 70s led to a continued reduction in oil consumption for a period of several years. But it does take time. Even though the price started rising in 1979, consumption only bottomed in 1983. As the price of oil stabilized in the late 80s, people once again took the cheap price for granted and likely made business and personal decisions with little regard for fuel-efficiency. Once again, we are in a period where, over time, consumers and businesses alike will reduce these excesses of consumption, and we see the first signs of this having occurred in 2007.

Certainly, emerging markets will add to demand, but even they will improve their efficiencies as oil subsidies are reduced and new technologies emerge. The drop in consumption we saw from peak to peak in OECD countries during the 80s was on the order of 20%. As excesses are gradually phased out, there's no reason to believe a drop of this magnitude can't occur again, resulting in a level of oil prices far lower than they are today.


William said...

As analytically as we are, I think we're talking and walking with blinders on. Do you see anyone car pooling to conserve gas? Most of the gas consumption is due to people driving to work everyday, that hasn't changed, in fact, demand has probably increased.You also have to take into account of all the G1 driver's licence being handed out each week, there's literaly thouands. I think we lived in times of profit gouching.

Saj Karsan said...

Hi William,

Demand for oil has dropped sharply since this article was written six months ago! No doubt much of it is due to the recession, but you are undoubtedly seeing structural changes (e.g. a shift to high fuel mileage vehicles) that will keep it low until people forget the price can go up (likely not for several years).