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Oil Demand Should Continue to Fall

by: Saj Karsan August 10, 2008 | about stocks: OIL / USO    

Saj Karsan

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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.

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This article has 9 comments:

  •  
    Aug 10 05:25 AM
    Why would "a long-term oil price much lower than it is today" not result in a growing consumption, then?
    Reply
  •  
    Aug 10 08:39 AM
    With just the thought of a lower price of oil being "much lower", I can see the SUV owners simply parking their vehicles in the garage for a bit, and getting them back on the road if the price of fuel really does go lower. Result: progress lost. We need to work on newer and better fuels, as well as low-cost processes for converting vehicles currently on the road to make use of those fuels. Otherwise, we will be replacing greenhouse gases with huge SUV graveyards, thus using more energy to get rid of them than we create.
    Reply
  •  
    Aug 10 09:10 AM
    Not looking at semi log scales does the reader an injustice in terms of seeing any relationships. Eyeballing it, demand is up ~25%-30% while price is up 550% over 25 yrs. A 10mm b/d (20%) demand drop out of the OECD to me would imply a lot of negative aspects about exports and oil price elasticity. Not seen here is the oil supply line which if memory serves has non-OPEC ramping quite significantly shutting in OPEC capacity. That is not about to happen this cycle.
    Reply
  •  
    Aug 10 10:35 AM
    Not all OECD countries forgot the lessons of the 1970's oil price spiral. Better efficiencies through more fuel efficient autos, better urban planning, better public transportation. So most of OECD have done the large scale, easy stuff. They also pay a lot more. So price effect on demand will be lower in Europe than USA.

    One lesson from the 70s is that North America is a slow learner, slowest in its class, so there may be short-term histrionics based on price but demand reduction will likely be slow and rebound with vigor if crude prices slide.
    Reply
  •  
    Aug 10 12:08 PM
    Hi Xpert. You mean in the future? It most certainly would...this is the nature of cycles, as opposed to the "its different this time" argument we hear too often.

    Whisper, I agree. The high oil price makes research and development into alternatives viable for the time being, but if the oil price should fall, carbon taxes and other government mandates will be required to stop us from harming the environment.

    Thanks for the note Mekats. This article was simply about the demand side, the supply side will follow tomorrow. As for logarithmic charts, this article was intended to educate readers that don't analyze for a living, rather than confuse anyone with industry jargon.

    Hi Erew, the massive run-up we see in consumption since the late 80s shows that in the aggregate, the OECD does not appear to have learnt any lessons, allowing for some efficiencies to arise now that they are indeed paying attention.

    Reply
  •  
    Aug 10 06:50 PM
    The big drop in oil demand in the late '70's, early '80's was because utilities nearly eliminated their use of oil to generate electricity in reaction to the Arab embargoes. Oil used to provide somewhere around 50% of electricity; it's not 3%. That is a one time change that cannot be repeated obviously. The only other big savings potential is in fueling personal vehicles and possibly trucks. That is the issue at hand today. It may happen, but will take a long time. Don't expect the change to be anywhere near as dramatic as the earlier decline.
    Reply
  •  
    Aug 11 10:51 AM
    Jim:
    Bullseye! Your comments are 100% correct. And the other major difference between this oil shock and the late 1970s is "demographics&quo... Simply put we have added roughly a billion more people (mostly in Asia) in that time frame, many of whom will be consumers of oil. All the talk about China slowing is a bunch of crap. They shut down factories for a month to clean the air for the Olympics. Big deal. This was a TEMPORARY condition. You think they will remain shut? Not a chance. China is on a "treadmill" and the risks of major civil unrest far outweigh the environmental or cost issues associated with rapid growth. Think about this for a moment. The city in Sichuan completely devastated by the May earthquake was roughtly the size and population density of New York City. Now can you imagine the amount of concrete, cement, copper, and steel needed to rebuild a city the size of New York City? Mind boggling. And trust me they will rebuild it. 10 million people have to work and live somewhere.

    Yank
    Reply
  •  
    Aug 12 02:23 PM
    The market cycles, investment firms see to that. Oil speculators drove the price up. We need to control these people. More stability in oil prices is good for everyone. including alternative energy companies, as uncertaintly breeds discontent among investors.
    Reply
  •  
    Aug 12 06:16 PM
    Hi Jim,

    You are right, the reduction in demand is going to have to come from reduction in fuel for vehicles. It will take a while, I agree, but we do see signs of it happening already.
    Reply
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