So just how elastic *is* oil demand, anyway?

[jducoeur]

The meme of the day seems to be that the news media have finally noticed that, what with revolution spreading across the Middle East, oil supplies might be threatened. Breathless reports along the lines of, "Oil might hit five dollars a gallon!" are all over. And I confess, my reaction is, "Only five dollars?"

The thing is, the laws of supply and demand are cruel taskmasters. When the issues are simple ones -- it costs more to produce X -- then a rise in those costs simply means that X costs that much more. But when the problem is that the supply of X is only so much, and we're already *using* all of it -- well, then, things get a lot more interesting.

So far, things haven't hit any of the *really* big oil-producing nations yet. But when folks talk about it possibly spreading to Saudi Arabia and the like, I get the feeling that they're engaging in wishful thinking when they talk about $5/gallon, because oil demand doesn't seem all that elastic. That is, demand slackens only fairly slowly when prices go up -- which means that, if supplies are suddenly cut, prices have to go up a *lot* before supply and demand equalize again. Of course, in the long run there's elasticity: lots of things *can* switch to processes other than oil, and it's likely that some countries can ramp their production up further. But it's a slow matter, ranging from months to decades depending on what you're talking about. In the short run, we just plain *depend* on a lot of oil, and prices are likely to stretch until some of those dependencies just plain give way.

Right now, things have spread to Libya -- something like 2% of world oil production according to the ever-reliable Wikipedia. Even that is enough to send speculative ripples through the supply chain. But Saudi Arabia? That's over 10% of world production. If political disruption takes that out, you've got *serious* competition for what's left -- competition that will send prices way up.

Mind, I'm just guessing here, and I'm only an armchair economist. (And I'm not passing judgement on the revolutionary movements, which are clearly well-intentioned and may well turn out quite well in at least some cases.) But prices have been rising for a while simply because of gradually increasing world demand, especially as China modernizes. Suddenly contract supply by that much, and it feels to me like *only* doubling the price of gasoline in the short run is kind of optimistic...

Comments

[wsmith.livejournal.com]

Given a massive contraction of the supply, we're less likely to see huge gas prices and more likely to see regulated prices and gas lines. In a very real way, gasoline *is* our transit infrastructure. If the government lets prices get too high, we'd have serious problems.

Another thing to consider is that we get little to none of our oil from the middle east from what I understand. That means that most of the competition for supply will be indirect as Europe and Asia turn to the sources that we use i.e Russia, South America, etc.

[jducoeur]

On oil sources: may be true, but it's probably largely irrelevant. With a fungible commodity like oil, it mostly trades as a single world stockpile. (National trade barriers can affect that, but probably only make things worse for the US.)

Price regulation: could be, but that would only make things worse for the average consumer. At that point we'd get hoarding, panics, blah blah blah -- the cure's likely to be worse than the disease. I can't say that the government wouldn't do it, but I suspect it would backfire.

That said, the government probably *would* somewhat open the taps of the strategic oil reserves, now that I think of it. That's a stopgap at best, but could help to absorb a few months of shock while the situation stabilized. That could actually be fairly effective for a short-term crisis, if managed with care...

[wsmith.livejournal.com]

As odd as it sounds, I actually hope they do not open up the strategic reserves. Those are there for a specific purpose, a non-economic one. Better for gas to cost $7/gallon than the strategic reserve be depleted. Without the reserve we would be unable or less able to either respond to emergency situations or project force as we might need to for purposes of defense. I think most of our defense budget is overblown, but the strategic reserve is one thing I'm pretty well behind.

As for prices, I think I'd rather see rationing and gas lines than super-expensive gasoline or companies gobbling up the entire supply and leaving individuals SOL.

As far as our supply, I believe a large portion of our oil comes as a result of negotiated treaties, not simply open market access, though I could be mistaken. That said, a major oil shortage may be just what we need. The last time we had an oil crisis, it resulted in a shift to more efficient machines and alternative power sources.

Responses to the last spike

[andrea habura (from livejournal.com)]

Our last major upshift in gas prices was over the spring and summer of 2008. I thought I remembered that when gas crossed the $4.50/gal. mark, a lot of people radically changed their consumption patterns, and this NYT article seems to bear that out (http://www.nytimes.com/2008/11/21/business/economy/21oil.html).

It's true that oil demand is not perfectly elastic, but I suspect the average American household could cut consumption of oil by 10-15% without major disruption, and by 20% or more if seriously motivated (and yes, I'm counting in the cost of oil used to deliver food to the grocery store). Make oil nosebleed expensive, and more people will carpool, switch from oil to natural gas heat, and so on. They won't enjoy it, but they'll do it. Multiply it by people in other countries doing the same thing, and that has the potential to push down aggregate demand by a fair amount.

Re: Responses to the last spike

[jducoeur]

Hmm. I confess that I wouldn't expect consumption patterns to change by as much as 10% until something more like $6-7, at least not quickly -- it's *hard* to cut that much, requiring real behaviour changes, and I suspect that some of the belt-tightening from last time hasn't yet returned to its previous peak. (That is, some of the fat has already been cut, so making additional cuts of 10% requires more significant changes.)

OTOH, price rises of that level would probably cause the economy to crash again, and that would do much to reduce demand. At some level, the problem clearly is self-correcting.

So I dunno -- obviously, I'm guessing here. The real question is how easily people (and perhaps more importantly, companies) change consumption patterns. We may or may not get some hard empirical data...

Re: Responses to the last spike

[andrea habura (from livejournal.com)]

Hey, I'm just guessing too. But I'm thinking the reduction won't be 10% for every household.... more like 5% for some and 20% for others.

For example: We heat with oil. We consume about 1000 gallons of heating oil a year, which is about 40% of all of the petroleum we buy as fuel. (We have efficient cars and short commutes.) At current oil prices, it isn't worth the money to trash a perfectly good oil furnace and replace it with one that burns another fuel. If heating oil goes to $6 a gallon, it will be. Boom: Chez Fisher reduces fuel oil consumption by 40%. Even if we decided not to switch over the furnace, we might well look at an electric flash water heater and space heaters, dropping our oil consumption by 10-15%. And that's without changing how we drive or how warm we keep the house.

Another household which already heats with natural gas can't get this kind of reduction, of course. But they don't need to for the consumption changes to have an effect on the economy.

[corwyn-ap.livejournal.com]

Oil demand is elastic enough that back in 2008 when it was $4.50 a gallon, it caused a drop in consumption enough to bring the price back to $2.50 or so.

On the other hand, any government change is going to want to keep their cash cow alive and functioning.

[fenicedautun.livejournal.com]

This. The biggest worries is not that production will be impacted, as most oil production in that region is already well guarded by the 3rd party companies in charge of the extraction (think Niger Delta, which has been seriously disrupted); and whoever is trying to take charge will attempt to keep those guards in place. Especially since none of the revolutionary movements so far have been talking about expropriation of assets.

More worrying are the transmission pipelines and ports for the tankers. The Economist did a review of that because of the Suez Canal, which is already in danger from Egypt, and they pinpointed 3 spots that were in danger in that area. But even with that, if we assume the disruption is short lived (<30 days), the US holds stocks of that much oil.

[mindways]

Oil demand is elastic enough that back in 2008 when it was $4.50 a gallon, it caused a drop in consumption enough to bring the price back to $2.50 or so.

No argument re: the elasticity - but the causality of that drop probably had a lot more to do with the timing (ie, the economic meltdown) than entities going "oh, gas is expensive" and cutting back on usage.[1] Not saying the latter wasn't a factor - it was certainly happening - but at least at the time, the prospect of global economic slowdown was cited as one of the major factors behind the precipitous decline in oil prices.[2]

[1] = Maybe also with a side order of "coming out of summer, when gas prices are higher", dunno.

[2] = Economic activity evidently correlates with oil usage - for reasons I can't articulate beyond "people are Doing More Stuff, much of which requires petroleum products", but it's taken as given in a wide variety of economic articles I've read.

[corwyn-ap.livejournal.com]

I rather think the timing of the economic meltdown had a lot to do with the price of oil. So there you go, circular.

[meiczyslaw.livejournal.com]

Sadly, I didn't save the link, but I remember the consumption of gasoline actually went up when the price rose, around 2%.

We Americans are weird.

[corwyn-ap.livejournal.com]

Depends on what time frame you are talking about. If one thinks one is in a high inflation period, then it makes sense to stockpile as much as one can. For most consumers that means a full tank. If everyone fills up when at 1/2 a tank rather than empty, that is another ~7.5 Million barrels.

[calygrey.livejournal.com]

1.53 is the lowest price I got it for. It was under 2$ for a little while.

[camilla-anna.livejournal.com]

For the record, gas up here in vermont is already 3.30-ish a gallon. Five dollars a gallon isn't doubled. Awful, but not doubled.

I hate when sensible people make sense about these issues. :D

[learnedax.livejournal.com]

I have been under the impression that the supply side of oil is somewhat artificially manipulated. If it is intentionally constrained by the suppliers in order to target what they consider the most profitable price, then the effective supply is likely to be somewhat elastic if the actual supply becomes constricted.

On the other hand, as has been said revolutionaries are likely to want to get the oil infrastructure running again quickly.

With any luck, though, the instability, or potential instability, of the supply will encourage us to invest more in transitioning away from oil.

[negothick.livejournal.com]

The past doesn't offer much "luck" in the transition: after all, the major "oil shocks" of the 1970s which resulted in the tripling of gas prices almost overnight led briefly to government investments in solar energy--which vanished, also overnight, when the administration changed.

The threats to the oil supply since then, Iran, Iraq, the upheavals in the Niger Delta, and many many more, have led to nearly endless wars but not to major changes in American consumption patterns--or to a major migration to the alternative technologies.

Even electric cars require significant quantities of oil in their manufacturing process, not to mention oil-fired electrical plants to charge their batteries (which depend on rare-earth metals most of which come from China. . .).

[hudebnik.livejournal.com]

I think for U.S. consumers, the rate of price rise matters more than the magnitude. Prices jumped from $2.xx to $4.xx immediately after Katrina, and I think it really did get people to economize in ways that they wouldn't have done if the same jump had been spread over several years.