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.

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.

[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.

[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.

[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.