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Page added on May 3, 2018

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Will Higher Oil Prices Destroy Demand?

Consumption

Oil prices have dipped a bit this week, but still remain at their highest levels in nearly three and a half years. The reasons are by now familiar to most readers who pay attention to the daily whims of the oil market: OPEC cuts, falling inventories, geopolitical unrest and strong demand growth, to name a few.

But at what point do higher prices start to destroy some of that demand, erasing one of the most significant bullish factors influencing the market right now? As John Kemp over at Reuters points out, there isn’t a magical threshold in which demand is humming along swimmingly and then suddenly drops off a cliff. There isn’t a binary response in that way.

Consumers respond in different ways to different prices, and the duration of high prices also matters quite a bit. Auto fleet turnover takes time, and people don’t rush out and buy a more fuel efficient car immediately when prices spike. And as John Kemp rightly argues, demand will likely take a hit before we can detect it in the data.

Nevertheless, demand is sensitive to prices, which is to say it will slow or even decline if prices rise high enough. A brief look at recent history bears that out. Crude oil prices saw a historic run up in prices in the years preceding the 2008 record high spike and subsequent meltdown. That rally essentially ended a century-long upward trend in demand, which hit a high above 21 million barrels per day (mb/d) in the U.S. in 2006-2007. The financial crisis, a terrible economy, more efficient cars and a somewhat saturated auto market led to a temporary peak in oil demand, which was followed by several years at lower levels.

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When oil prices rose back to $100 per barrel in 2011 following the Arab Spring, demand dipped even further.

Only when prices collapsed in 2014 did the U.S. start to see a revival in demand. U.S. consumers enjoyed more than three years of cheap oil, causing them to fall back in love with SUVs and pickup trucks.

However, we could be on the verge of another shift in the cycle, with WTI at a three-year high, sitting just shy of $70 per barrel. More importantly, the OPEC cuts, the prospect of supply outages in Iran and Venezuela, and the depletion of inventories down to average levels promise to push prices even higher. We haven’t seen any discernable change in demand just yet, but again, these things take time to show up in the data.

The IEA projects oil demand will rise by a robust 1.5 mb/d in 2018. The agency believes total demand will outstrip supply for the rest of this year, with the supply gap growing as time passes. That, of course, is predicated on the assumption that demand does indeed grow at that projected rate of 1.5 mb/d. But, at some point, if demand exceeds supply by enough, and inventories fall below average levels, prices will spike to much higher levels

(Click to enlarge)

At that point, say, $80 or $90 or $100 per barrel, demand will have to start taking a hit. To reiterate, forecasting the precise price level, and the magnitude of the demand response, is tricky. But, suffice it to say, the oil market won’t see consistently high levels of demand growth – at 1.5 mb/d – year after year if prices are approaching triple-digit territory.Then there is the matter of the short-term versus the long-term. Demand destruction might not occur instantaneously. It will take an extended period of high prices before consumers start really cutting back in a big way. But if prices stay high for several years – and there are plenty of reasons why that might not occur – the hit to demand could have more permanent consequences.

In other words, this time could be different. Unlike a decade ago, electric vehicles are increasingly competitive with traditional gasoline or diesel-fueled cars and at some point in the 2020s will reach cost-parity without subsidies. Higher oil prices tilt that equation in favor of EVs and could shift that timeline forward. A sustained period of high prices could accelerate the energy transition that most analyst see as inevitable.

By Nick Cunningham of Oilprice.com



6 Comments on "Will Higher Oil Prices Destroy Demand?"

  1. dave thompson on Fri, 4th May 2018 2:04 am 

    Will Higher Oil Prices Destroy Demand?

    No but it will be a blessing for all the folks that sell the stuff.

  2. Outcast_Searcher on Fri, 4th May 2018 3:06 am 

    Just looking at the chart, one can see that the demand correlation is very weak compared to price. Oil demand is quite inelastic in relationship to price. People really need what they NEED to get to the grocery store, work, etc. Whether the price is $5 a gallon or below $2 a gallon.

    The strength of the economy is a bigger factor. Just look how much consumption dropped during the financial crisis (with a VERY weak economy), even as prices plunged by over two thirds.

    And the trend of the consumption the last couple years is just like the couple years before. Whether prices were low and dropping or moderate and rising, overall consumption was rising overall, though quite volatile in the short term.

    If the global economy continues to expand at a decent clip, total oil consumption will grow. Unless the supply of oil can increase faster than expected, that should have a general upward pressure on prices.

    After all, $70 oil isn’t high, looking at the past 13 years (range on the chart), especially considering inflation.

  3. Antius on Fri, 4th May 2018 9:40 am 

    “Will Higher Oil Prices Destroy Demand?”

    Yes. There is an energy intensity to GDP. Ultimately, more wealth diverted into energy production means less wealth left over to invest in other things. That is why high oil prices cause recessions. Rising interest rates cause recessions for the same reason.

    When recession hits, there are lots of poor unemployed people who cannot afford cars or manufactured goods produced and transported using oil. Hence, demand declines. Rising inequality is a clear sign of system stress leading to demand destruction.

  4. Cloggie on Fri, 4th May 2018 12:55 pm 

    Toyota iRoad, for city 1-person transport:

    https://www.youtube.com/watch?v=rGuN-ozC5cY

    https://en.wikipedia.org/wiki/Toyota_concept_vehicles,_2010%E2%80%9319#i-Road

    One charge has a range of 50 km (31 mi) and a top speed is 45 km/h (28 mph(.

  5. Cloggie on Fri, 4th May 2018 12:57 pm 

    Europe aspires to become fossil fuel free by 2050.

    Denmark in 2045:

    https://cleantechnica.com/2018/05/03/largest-opposition-party-in-denmark-has-way-more-ambitious-plans-than-current-governments-energy-initiative/

    On the double:

    https://cleantechnica.com/2018/05/04/volkswagen-doubles-ev-battery-order-to-48-billion/

    “Volkswagen Doubles EV Battery Order To $48 Billion”

  6. kanon on Sat, 5th May 2018 9:39 am 

    Keep in mind that there is a virtual monopoly for motor vehicles in transportation in most of the U.S. and many other places. Thus, there is a captive market for fossil fuels and the response to higher prices is limited to less driving (or less of something else).

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