Price Impact on Demand

William R. Edwards* (wre@texven.com)

Now that oil prices have again risen above $100 per barrel, it is probably appropriate to question the degree to which this price level will reduce demand growth, as it surely will. Enough time has elapsed and enough data has been gathered to allow the construction of a valid curve displaying the price level of crude oil and the resulting demand growth in the United States. Over the past twenty years the price of crude has fluctuated over a range where the high has been more than ten times the low. This range is wide enough for the resulting observations to be meaningful and helpful.

 

A few points are worth highlighting. Petroleum demand established a growth rate of about 2% per year for several years as the price of crude fluctuated around a $25 level. This persisted long enough for this growth rate to become considered as “normal”. It is interesting to observe that most current thinking presumes that this rate of growth will resume in the near future as economic activity recovers. Based upon the curve shown above, however, such a rate of growth can occur only if the price of crude declines substantially, back to the $50-60 level. Conversely, if the current price range, generally thought to be “right”, is maintained, then we can expect no growth in demand going forward.

The numbers used in this assessment apply directly only to the United States, but the observations can be directionally applied to the worldwide picture. For each demand center there is a corresponding curve shaped like that shown here. Whereas the zero growth price for the United States is around $90, the zero growth point for China may be ten or twenty dollars higher. The principle is the same, however, that it is unreasonable to expect worldwide demand growth rates to recover to pre-financial crisis levels without a major drop in the world price of crude.

In developing this correlation it was obvious that a lag time of about a year exists between a given price level and the demand response. These numbers then reflect the growth we will experience a year after the price level is reached.

 

* President, Edwards Energy Consultants, 1550 Fort Bend Road, Suite 705, Katy, TX 77494, wre@texven.com, 281-392-2444.

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