Is Oil Demand Inelastic?

Back on October 30th of 2004, I found some analysis by Bridgewater warning us of $100 to $120 oil.

How does Bridgewater arrive at $100 to $120 per barrel? It seems that the demand for oil is inelastic. It causes big increases in price to get consumers to change their behavior. Oil consumption today is about 2.7% of GDP. At its peak in the 1980’s it took consumption at 8% of GDP to curb demand and interest rates were 16% briefly. It would take oil at $120 for consumption to equal 8% which would curtail demand (and slow economic activity).

I was reminded of their spot on report when I saw this article on Financial Sense Online,

Whatever Happened to Oil Price Elasticity? by Andrew McKillop. He writes

Getting back to the narrow question of why oil demand (and world gas demand now growing at around 5%-per-year) are much less than unaffected by rising prices, but are directly increased by higher oil and gas prices, we finally call on facts.Price elasticity of anything has an underlying notion, hard to quantify, of ‘satisfaction’, and another of ‘substitution’. Neither of these have much place for the vast majority of oil and gas users. Nobody uses oil and gas ‘for the fun of it’, or at least very few persons. Equally, the famous ‘hi-tech emerging new energy’ substitutes and alternatives simply don’t exist. They may exist on the Nasdaq or in people’s heads and PCs, and in cute business video presentations, but not in the real economy.

Mckillop believes

When we go back to economic theory notions of ‘elasticity’, as mentioned above, we soon see that they don’t apply in large measure, or any convincing way to explaining what is happening.

McKillop thinks that until and unless interest rates are sharply raised to double-digit rates, oil and gas prices can go on crawling ever up.

Bridgewater thinks the market will take care of itself, thank you very much, if you let the market take its course. My money is on Bridgewater. It would be too bad if politicians short circuited the process with the unintended consequences of delaying alternatives that develop as a result of the high oil prices.

Andrew McKillop Bridgewater Oil+Inelasticity

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