Saturday, October 25, 2008

Oil Demand Elasticity

Some data on oil price elasticity are starting to arrive.

Gasoline demand in the US has fallen relative to year-earlier numbers for 26 consecutive weeks, with demand last week being 6.4% below the same week last year.

According to the EIA, and as reported by Forbes, US petroleum product demand fell in the last four-week period by 8.5% relative to the same four-week period last year.

Not sure what percent change in price to use to calculate a rough elasticity. If we use a 100% change in price, which is excessive, we get an elasticity of -.085 which is not too bad. I have always thought that an elasticity of -.20 was reasonable for a period of 2-3 years. I expect we are to see more "demand destruction" even though prices have come way down -- and many of these changes will be irreversible.

Some people might say that we are not observing price elasticity but income elasticity -- as the economy slows, oil demand drops. To some extent this is true -- to the extent that the slowing economy is due to non-oil factors. But we should expect some of the demand reductions to show up as GDP decreases. That is, some economic activity is no longer undertaken at high oil prices, and that shows up as a reduction in GDP. The decline in demand for oil should be attributed in that case to price increases, not to income falling.

1 comment:

michael said...

We have yet to see much of a price drop at the pump in Alaska, perhaps Exxon is holding a grudge? At the rate oil is dropping we will soon see a barrel of oil being worth less than a gallon of gas. It wasn't too many years ago that one small sockeye salmon was worth more than a barrel of Alaskan oil. As the poet said, there are strange things done in the land of the midnight sun.