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Thoughts on Demand Destruction: Where Is It?
Posted by jeffvail on April 28, 2008 - 10:00am
Topic: Demand/Consumption
Tags: demand destruction, Gasoline Consumption, gasoline demand, Movement on the Demand Curve, peak oil [list all tags]
Where's the Demand Destruction?
With this uncertainty surrounding the concept of “demand destruction,” it’s time to take a deeper look at the mechanics behind how demand destruction occurs. Specifically, this essay will limit its focus to two components of demand destruction in gasoline: the time-lag between high prices and reduced demand, and the need to price alternatives to each gallon of gasoline we consume. Does a lack of demand destruction when oil is well over $110/barrel mean that prices must go even higher to destroy demand? How much higher? Or is it enough that prices hold at this level for long enough to cause people to gradually make long-term purchases with this price in mind, and thereby destroy demand? How long? Finally, how much of current US demand destruction (to whatever degree it exists—even if only as a decrease in growth of demand) is due to current economic conditions, and how much can be attributed directly to the price of oil?
Time-Lag in Demand Destruction: Major Purchases Drive Energy Consumption
One way that demand destruction occurs is that, when making major energy-consuming purchases such as a car or a house, people choose more energy efficient alternatives when the price of energy is higher. These choices happen over time—everyone won’t (and couldn’t) rush out tomorrow to buy a more fuel efficient car, even if gas suddenly hit $10/gallon. How long is the time lag in these choices? Moody’s says that the average time between car purchases in the US is 4.33 years. Even if we could figure out a magic number at which every consumer will pick a new car based on improved fuel efficiency, it would take at least 4 years to affect this transition. In reality, however, no one knows what percent of people would change to a more efficient car, and how much more efficient that new car would be, based on a given price of gas. The latest data does show that sales of SUVs and pickups were down 27% and 14% respectively, compared with a general automotive sales decline of only 8% for the first quarter of '08. This suggests that current oil prices are already significantly impacting consumer car choice when they decide to purchase a new car, but that this transition will take a long time--remember, the 4 year figure to change to a higher fuel-economy automotive fleet is only valid if every new car purchase is more fuel efficient. These numbers suggest that we're moving toward greater efficiency, but not in a great hurry. The decline in overall sales also suggests that an increasing number of people are financially stuck with their present vehicle, even if it gets poor gas mileage.
What about houses? Americans move houses on average every 5 years. Well, at least they did when they were upwardly mobile in a growing economy and sub-prime credit was easy to come by. It is yet to be seen how the current economic situation will change this figure, but it seems likely that our rate of moving will slow. In theory, when we move homes, we could choose more energy-efficient homes (better insulated, better solar design), or, more germane to a discussion of gasoline demand, we could choose homes that require less driving to commute to work, shopping, etc. However, the massive sunk-cost in suburbia must be taken into account. While these homes may go down in value because of the commuting difference, they will likely remain largely occupied because, while the cost of commuting may skyrocket, the cost of ownership in the suburbs may decline to even this out. If a family currently consumes 50 gallons of gasoline per month in suburbia, and could cut this to 20 gallons per month by moving to a more central location, then at $10/gallon this would save them $300/month. If ownership costs (or rent) in the suburban location declined by more than $300/month, then (ignoring many other factors) it is more financially viable to remain in the suburbs. Additionally, when Americans make the average, once-in-5-year move, they don’t all move to a newly constructed house. The average American home is about 30 years old, and despite the promise of “New Urbanism” or downtown condo living to reduce gas consumption via commuting, the turnover of America’s housing infrastructure will take time.
ROI: Pricing Alternatives to Marginal Gasoline Consumption
Demand destruction happens in other ways than buying a more efficient car or moving to a house closer to work. It is also possible to reduce demand by choosing a less convenient, less pleasurable, or a slower option over another that consumes more gasoline. Take carpooling, for example. The passenger-miles-per-gallon of any car immediately doubles when a single commuter adds another commuter as a passenger. Four adults in a Honda Civic hybrid would average about 200 passenger-miles-per-gallon. Even four adults in a Hummer would get respectable mileage per passenger! If this is so simple, then why don’t we all do this? Because carpooling costs time, both in the time required daily to pick-up and drop off the additional passenger, time required to set-up the carpool system, and time in the form of inconvenience of people unexpectedly needing to work late, not being ready for pick-up on time, etc. How do we value this? There are no statistics that I’m aware of that track % of people who commute with one or more commuting passenger, or that track something similar, nor do I have any statistics for average “inconvenience time” per additional carpool passenger. However, at some gasoline price level, it makes sense for any given person to arrange to carpool instead of commute by themselves. At $4/gallon, however, my impression is that most Americans will still value the time saved more than cutting their gasoline bill in half. The calculations for riding the bus, light rail, walking, riding a bike, etc. are essentially the same—how do you balance the money saved on gas with value of added inconvenience and additional time? For some people the decision clearly makes sense, it may even be more convenient and save time—but those are the people most likely to already carpool, ride the bus, etc. New demand destruction doesn’t occur until the price of gasoline changes the calculus, where it didn’t make sense for a given individual at $3/gallon, but it now does makes sense at $X/gallon. How high would gas prices have to be for it to “make sense” for 50% of suburban commuters to carpool or ride the bus?
Economic Cycles and Demand Destruction
Ultimately, the kind of calculus suggested above is inextricably linked to the health of the broader economy. Rich consumers with large and growing disposable incomes are likely to value their time and potential inconveniences at a much higher rate than those struggling to buy groceries (notably, those with high disposable income are also the most able to pay now to upgrade to more efficient homes or cars, but least incentivised to do so). Another point to consider in evaluating demand destruction is the cause of economic problems. If economic problems are caused by high energy prices, then it seems accurate to consider demand destruction attributable to these economic problems as demand destruction caused by high energy prices. However, to the extent that economic problems are the result of an economic cycle, and not due to high energy prices, then the energy demand destruction that results does not seem accurately attributable to high energy prices. Our current economic troubles seem to be a function of both issues, but in my opinion more a short-term cyclical issue (inaccurate pricing of credit risk and the resultant correction, as I argued a few weeks ago). At least some of the decrease in US oil demand can be attributed to economic cycles, and not to high oil prices, but we probably cannot separate these causes and isolate the portion of demand destruction caused by economic cycles. Can we even say whether or not demand would actually continue increasing at $120/barrel IF there was no “Credit Crunch”? Does a statistic like GDP/barrel of oil consumed allow us to see through this fog? It might if we had a very accurate measure of inflation, but in my opinion the CPI certainly doesn’t qualify. For that reason, comparing the 2006 GDP/barrel consumed vs. the 2007 GDP/barrel consumed is also problematic. Furthermore, it does not necessarily follow that, in a cycle-driven recession, GDP will shift to more energy efficient paths.
Conclusion
With gasoline well over $3/gallon, and oil well over $110/barrel, there does not seem to be any significant demand destruction in the US. Reasonable people can argue that demand is up about 1% or down about 1% since this time last year, but I am defining this entire range as “not significant.” What is the boundary of “significant” demand destruction? By significant, I mean significant impact on the supply-demand equilibrium for oil. Per-capita gasoline consumption, while important from a standard-of-living perspective, at most impacts elasticity of demand, and does not fundamentally change the supply-demand equilibrium (growing populations don't impact geology), so I am focusing on absolute demand for this analysis. If a low-end estimate of the decline rate for oil production post-peak (or net oil exports at present) is 5% per year, then I think that is the boundary for “significant” demand destruction. Demand destruction of 1% per year on an ongoing basis, compared with oil production decline of 5% per year, won’t have a significant impact on the supply-demand equilibrium. Conversely, a year-on-year demand destruction of 5% compared with an oil production decline of 5% does have a significant impact on the supply-demand equilibrium because it negates the impact of the production decline rate—this is effectively what Richard Heinberg suggests in his Oil Depletion Protocol.
If this analysis tells us anything, it is that there is no easy way to calculate exactly what price point will cause demand destruction of X%. I remember when many proclaimed that $3/gallon gasoline would cause huge demand destruction. Now many of these same people proclaim that demand destruction will explode at $4/gallon or $5/gallon gasoline. Europeans, though admittedly in a very different situation, don’t seem to be driving significantly less at $8/gallon. In the end, we simply cannot know how demand destruction will unfold, and I think that is highly significant for calculating the economic impacts of rising oil prices—we have no empirical basis to either prove or disprove propositions as opposite as 1) present prices, if maintained indefinitely, will cause sufficient demand destruction to keep prices from rising significantly higher, or 2) prices will be able to at least triple before demand destruction begins to keep pace with supply declines. I know that there are nearly endless opinions on this point, but the significance of this analysis is that we cannot prove either point of view to be right or wrong.
It’s also important to highlight that this essay only considers demand destruction within the United States, while the global oil market is inherently global. What will it take (both psychologically and economically) to see 5% demand destruction per year in the US? What are the prospects for global demand destruction of 5% per year? Even if we aren’t currently witnessing a decline in global production of 5%, evidence suggests that net exports are declining at least that fast…
The latest EIA figures actually show a 0.57% increase in US gasoline demand year on year over the last week.
Something I have pointed out before is that even if the total transportation BTU demand had remained constant, volumetric demand would increase because the gasoline pool now contains fewer BTUs because of ethanol. So a very small amount of demand destruction could occur, and yet be masked.
However, in general I agree with your overall premise. And I think the reason for this is that people still think this is a temporary situation.
Europeans, though admittedly in a very different situation, don’t seem to be driving significantly less at $8/gallon.
Of course they knew that the situation wasn't temporary, since their prices were much higher to begin with due to taxes. So Europeans planned accordingly, and as a result have half the per capita energy usage of Americans.
Lending support to the comment I made in the first paragraph is this story that Leanan just posted in Drumbeat:
Loss of fuel economy from ethanol-blended gasoline hits motorists in the wallet
So even if there was a 0.4% decrease in overall BTU usage, the total volume used would still increase.
I know by the math, 10% Ethanol does not sacrifice many BTU's, however, many people I talk to say they are losing 2-4 mpg since the 10% Ethanol came to market. Personally, my Subaru Outback went from 25mpg now to 22-23 and I've been slowing my highway speeds from a common 75 to keeping it under 70. That is a significant loss in efficiency from the 10% ethanol.
I live in the London suburbs, and fuel prices are currently as follows for an Imperial gallon:-
Unleaded petrol- $10.04 (average), $10.36 (max.)
Super unleaded- $10.62 (average), $11.08 (max.)
Diesel- $10.86 (average), $11.81 (max.)
My local filling station has told me that so far there has been no
fall off in demand (this was prior to the Grangemouth refinery strike
being widely known by the general public).
For those unfortunate enough to be using US gallons:-)
1 US gallon = 3.7854 litres, so at GBP 1.20 per litre for diesel,
GBP 1.20 x 2 x 3.7854 = approx USD 9 per US gallon.
unleaded petrol is GBP 1.10 a litre.
In the UK car sales rose 2.5% last year and are expected to drop very slightly this year according to the Society of Motor Manufacturers and Traders (SMMT). So based on the UK there is still a long way to go before much demand destruction.
The government has started moving in the right direction by grading the annual car tax to hit gas guzzlers the hardest. Cars emitting more than 226 g/km pay GBP 400 and those under 100g/km nothing but there are only two diesels that make the grade.
IMHO the sale of new cars emitting more than 226 g/km should be banned from 3 months forward. The the ex-chairman of Shell, Sir Mark Moody-Stuart has also recently said the EU should ban the sale of cars that do under 35 miles to the gallon. The theory is that even wealthy people cannot get round this.
Some local authorities have also started charging more for parking permits for gas guzzlers.
Regulation is always tricky. The U.S. CAFE standards was raised on cars, but not trucks partly helped to inspire the SUV sales boom. And which is worse a minivan getting 20mpg with 6 people in it, or a hybrid with a single person in it getting 45mpg?
I don't know what will make the biggest difference, but can't imagine any regulation can beat weathy people's desire to consume - it might as well redirect their wealth to something even worse for the environment.
I've long been on the high "sin tax" approach, even as I acknowledge it is regressive, hurting those least able to change, and having little on effect on those well enough to pay "any price".
The only other alternative I know is rationing. Combining rationing and ebay could make for an interesting market! The poor can have their share if they need it, or make a few bucks for finding a way to live without a car, or driving less.
I don't know much about rationing, but would imagine coupons would have expiration dates to prevent hoarding, and limit "inflation" of value, but expirations could still excourage fuel hoarding itself, ESPECIALLY if the ration levels are decreasing. A fun game, however played.
More effective would be a tiered excise ... at a set rate for vehicles with higher fuel inefficiency (l/km, g/m) than the current fleet average, twice the set rate for vehicles with twice the fuel inefficiency or more, no excise for vehicles from the fleet average to half the fleet average inefficiency, and a subsidy at the set rate for vehicles at half the fuel inefficiency or less.
And surplus on collections over the cost of the subsidy going to buy more energy efficient running stock for public transport.
Robert -"So Europeans planned accordingly, and as a result have half the per capita energy usage of Americans."
Europeans "planned" to live in countries 50 times smaller than the US. Good "planning!"
Geographical Europe is larger than the USA. Most of our countries are similar in size to your states.
I think the key difference is more historical than it is due to population or area. The age of settlement of Europe, and the foundational infrastructure (locations of towns, distribution of farms, patterns of land ownership, etc.) creates a much more evenly distributed population than in America. Additionally, much of US built environment developed AFTER the development of the car, especially in the western US. The result is that our post-WWII population boom was able (and in some ways coerced) to locate in suburbs built many miles from work on what was formerly cheap, minimally productive ranch land or desert. Europe experienced nothing like this (at least nowhere near on the scale that it happened in the US). The result is that US built environment is much more dependent on daily human-miles of transport than in Europe...
Not only "able" and "coerced", but also subsidized ...
... utility hook-ups for property developments charged on a per-hook-up basis without consideration of the network cost of sprawl is a cross-subsidy ...
... requiring extensions of utility network capacity for electricity, water, sewerage to be born by the existing rate base while subsidizing green field projects to "attract industry" is a cross-subsidy ...
... indeed, the roll-over of capital gains on development on a dollar basis without any matching acreage requirement encourages developers that have made a big score to look for an opportunity for a greenfield development that is large enough to shelter the capital gains.
That's without even considering cross-subsidies of support services for the auto transport system.
I think the key difference is more historical
GM was convicted for restraint of trade for buying streetcar lines in order to shut them down.
Over a half century of public policy and public subsidies has supported sprawl and suburban/exurban expansion. Roads and highways, federal and state money for new schools, post-WW II VA loans could only be used for new housing and not on existing homes in established neighborhoods, etc.
Suburbia is *NOT* the result of "natural" economic forces, but of a lifetime of public policy support and subsidies.
Best Hopes for Redirected Public Policy Support and Subsidies,
Alan
If I remember right don't Chevron own some battery technology that they refuse to let anyone use for cars?
Either way, that kind of action is small potatoes compared to the effect of the systematic, ongoing, substantial subsidy for sprawl development.
In the film "Who Killed the Electric Car" they explained how the nice elderly couple who invented the great battery idea for GM was sold by GM to Chevron after they killed the EV1 in California.
Google "cobasys patent".
Cobasys has succesfully sued the major battery-makers of the world. Chevron-Texaco owns half of Cobasys, Energy Conversion Devices owns the other half. They have a very basic patent on NiMH-tech that expires in five years or so. Settlements with major battery-makers expires before that I think.
Do the EIA figures include the military and if so what percentage do they use? I can't imagine it is their first priority to reduce use and guess if their percentage is high then it will confuse the overall figures.
Carpooling:
Undoubtely someone will come along on this thread soon and state that "Americans will never carpool". Cow Cookies! I remember carpooling myself for a while during the 1970s, and of our carpool being just one of very many in the large office building where I worked, and throughout downtown. Not everyone carpooled, but a lot of people did then. They might carpool again IF the cost of gasoline goes high enough.
One barrier to higher participation in carpools: How does the carpooler get home if they get sick, or their kid gets sick, or there is some sort of personal emergency? The City of Asheville has a good solution to this problem with their Emergency Ride Home program. We need municipalities everywhere to rapidly adopt this idea.
One thing that was a big hassle back in the 1970s was getting prospective carpoolers together. It wasn't so much of a problem for very large employers with many thousands of people at the same location. For people working in smaller work groups, though, it was a real problem. Now, we've got specialized website dedicated to facilitating carpooling by matching people together. It should be much easier for people to make the transition to carpooling with such services being available.
CNN had a story on carpooling this morning. Interest is picking up, due to gas prices.
I think that this represents a huge opportunity for new new web-based services that will match drivers and passengers, allow people to rate other members, etc. One of the larger hurdles to increased car-pooling is finding someone who meets your geographic and time requirements...
Interesting idea. There are online sites that let people match up for ride-sharing, but they are mostly used by college students for occasional trips home.
A site where you can rate your fellow passengers could be a money-maker. I know I would be more willing to carpool if I knew in advance that my fellow riders didn't have any unpleasant habits. (Wears too much perfume, packs smelly liverwurst sandwiches, blasts music I don't like and gripes when I switch it to sports radio, argues forever over who has to pay the extra penny when the gas bill won't divide evenly, etc.)
I was a tax CPA, (long since retired), but in the 70's Congress passed a law to encourage car pooling. A company could buy a Van, have a designated employee driver, and that driver would pick up other employees and shuttle them back and forth to work. The company paid all of the cost, the passengers had no cost (nor imputed income) and (I believe) the designated driver could use the van for incidental mileage without tax consequences. At any rate, it was a good deal for companies and employees (and saved fuel).
If that law has expired, it sure needs to be resurrected. And, if it is still in effect, employees need to lobby their company to look into it.
For car pooling to be further adopted the legal liabilities of the DRIVER must be addressed by, in the U.S., the various 50 state legislatures. After all, there will still be accidents. Will drivers with more to lose to litigation be willing to participate as drivers in a car pool? I think they will be less inclined.
Wishful thinking, at best. I would contend that the current economic downturn is almost solely attributable to high energy prices. Credit & housing price issues, etc., are results, not causes, of the deepening recession. Furthermore, this downturn is neither short-term or cyclical. It is the outcome of the world running out of cheaply obtainable petroleum.
Do we see "demand destruction" in the junkie community when the price of heroin rises? People have to get to work and run errands. Their quality of life takes a severe hit when they can't visit family & friends. As fuel prices rise, other discretionary spending may decline, impacting retail sales & the rest of the consumer economy, but people will still drive at all costs. To be stranded means the end of income, productivity and spending. No one should be surprised that hyperinflationary fuel prices create only minimal demand destruction in a society whose infrastructure is wholly designed around cars.
"Do we see "demand destruction" in the junkie community when the price of heroin rises?" Precisely. I watch for evidence of a desire to reduce gasoline consumption on the highway. When I see folks going less than 5 to 10 mph over the speed limit I will admit that gas prices are having an effect. So far, I do not see any evidence at all.
Hi CB,
If I may speak to this point. My partner and I made it back from our road trip to Toronto earlier this morning, covering off some 3,500 km in a little over three days. We took his car even though it's significantly more thirsty than my own (5.7L V8 versus 3.5L V6) for the sole reason that we required the additional cargo room. I wasn't expecting great results, but one thing that did surprise me was just how much speed and driving style influence fuel economy. During the times when I was behind the wheel, I averaged a reported 8.6 litres per 100 km (27.1 mpg), largely by keeping my speed close to the posted limit and by anticipating changes in traffic flow so as to avoid excessive braking (under light load conditions, the engine's multiple displacement system shuts down 4 of the 8 cylinders which, in theory, cuts fuel consumption by about 10 per cent; however, these savings require one to keep speed in check and to avoid heavy acceleration). My partner, who is particularly fond of the getty-up-and-go pedal and who is just as content to hit the brakes as he is to look three car lengths ahead, averaged 10.8 litres per 100 km (21.6 mpg) -- a 25 per cent fuel penalty. A difference of 2.2 litres per 100 km in this case works out to be 77 litres and at average of $1.30 per litre, that's a $100.00 savings.
Cheers,
Paul
I assume that your partner has been informed of this delta ?
Best Hopes for Domestic Tranquility,
Alan
Hi Alan,
I assume that your partner has been informed of this delta ?
Don't worry, I'm constantly providing helpful feedback with regards to his driving behaviour but, oddly enough, it's not always received in the spirit in which it is given. Go figure, eh? ;-)
BTW, this Dodge Magnum R/T replaces the Chrysler LHS I gave him for his birthday (the one he subsequently totalled in a rear-end collision).
Best hopes for less aggressive drivers who don't speed and tailgate.
Cheers,
Paul
Edit: I'm partial to station wagons and I happen to like this one a lot. Ours is identical to the one shown here: http://www.dodge.com/en/2008/magnum/
NPR ran a story not long ago about the housing price slump claiming that the prices of housing in developments that required long car commutes was falling faster than prices in more urban settings/housing along commuter rail lines/housing close to public transportation.
Another comment is that high gas prices may cause demand destruction in other areas before it causes demand destruction in driving. Instead of driving less, people may start consuming less in other areas to free more money for buying gas. Instead of driving to the mall to shop, buyers are driving to the Wal-Mart to shop. Instead of driving to Whole Foods to buy groceries, they're driving to Sam's Club. That kind of thing.
What ever happened to the promise of telecommuting? I know of an AT&T worker who does it sucessfully, but all else I know have neither been encouraged - nor offered - by their employer to try it.
Telecommuting is uber common. People telecommute from India & China to the rest of the world every day. The name has changed, tho. Now telecommuting is called "out-sourcing."
Also:
What I have discovered is that many companies are reluctant to allow their onshore workers to telecommute but by nature of the distance are forced to allow their offshore workers to telecommute.
I have now worked at four different blue chip companies who use outsourced workers in India but who do not permit telecommuting.
At one company I asked to be able to telecommute and the response was "we have no work that can be done via telecommuting". I said, "what about the Indians?".
They said, "It is our position that we have no work that can be done via telecommuting".
My personal guess is that outsourced Indian workers are so cheap that they don't care too too much about productivity whereas with on-shore workers they are afraid they may slack off and have no way of being able to tell. Or maybe the managers are afraid they would have nothing to do if they weren't "managing".
At Global Crossing (at telecommunications company), telecommuting was a bitter issue. In the end, the telecommuters lost. Managers want control more than they want productivity or happy employees, or anything, for that matter.
The irony is that outsourcing increases the amount of air travel.
Probably because if you can telecommute, somebody in India or the Philippines or China can do your job for a fraction of the cost.
Yes, I content their is a large populace that could do their work at home. As long as our communications infrastructure keeps up the pace.
Because narcisistic sociopathic control freaks want "face time" with their employees?
Or just maybe because a survey by America Online and Salary.com in 2005 concluded that employees engaged on the Internet were frittering away $760 billion a year of their employers’ money and they think even more time will be wasted?
Oops, I better get back to work:-)
I'd suggest that demand destruction will follow a path which is aptly described by the name - destruction.
Most people consider driving as a necessity and not a negotiable factor. They will cut other areas of expense first, followed by going into debt, before they are forced, in a catastrophic fashion, to reduce consumption.
Therefore the key factor is the degree of 'buffer' they have between current expenditure and a level at which something 'breaks'. An individual that has $50 of buffer would expect at least this level of cost rise before substantial usage change would occur.
Demand destruction isn't gradual on an individual basis - its something of a series of cliff edges as chunks of demand are eliminated and where some of these eliminations have consequent effects (eg driving to work).
Obviously there is a continuum of buffer values in any country, as there are varying levels of price rise rate (taking into account taxation, exchange rates, etc.) Thus you can imagine assessing this buffer value on a country by country basis; stacking them up after after taking into account typical usage, taxation etc. to arrive at a cumulative graph of what price rises have what effect, and on which groups.
Its also important to realise that there are systemic effects where the catastrophic failure of one individual to afford personal transport has a knock on effect on the rest of societies ability to cope.
Sum that together and we have to expect that the effect of demand destruction will not be a uniform affair. Countries will be hit in order of their resilience to such change. To an extent we have seen that already with developing countries being hit as cheap oil falls out of the system.
When I attempted to do a rough and ready ordering of countries to such effects I found that the US was a relatively early hit - with minimal levels of tax buffer, a population that was in debt up to its neck, and an underclass being paid a fraction of the average. European countries, although having a lower average GDP, tended to have less of these issues and thus had some leeway in the timing of demand destruction. The rich everywhere had significant buffers, but were often dependent on the continued viability of businesses or stock market investments.
As in most areas, early adaptation at a country level to reduced dependence of societal systems on oil was the optimum action to take - before fast declines made mass action unaffordable.
Demand destruction for oil does not happen.
What happens is unemployment.
When you are unemployed you cannot afford the car payment never mind $4 per gallon.
I contend that Americans won't cut back until unemployment starts rising.
"What happens is unemployment."
Yes, this is basic, but it very seldom gets mentioned because of its self-evident nature. As people have their discretionary income reduced by rising transport fuel and energy costs, less will be spent on the services that are 70+% of the US economy. The loss of jobs will slowly accelerate until some crisis level is reached. This will also hurt state and local governments' abilities to provide services as tax revenues will also decrease markedly, which is already happening now. The spiral will enlarge to swallow businesses that supplied the services no longer being bought. Take fastfood for example, as its purveyors see demand for their products evaporate, they will order less from their suppliers and consolidate, etc. Going short Pepsico, etc., is a good investment strategy, although it's perverse/social-darwinistic to make money off of companies going out-of-business.
Demand is also inelastic in the short term. If you have a gas-guzzling car, it's value may have dropped significantly, therefore it will take time to save enough money to sell it. (sounds odd, no?) A lot of it also has to do with housing. If you don't live on a bus route or near any shopping you have no choice but to drive. The solution for that is to move. But, that takes time. It also takes money that people don't have. So, you suck it up, cut back on something else, and gas up the vehicle.
Demand destruction is happening, it's just in other goods, not gasoline. Just wait until the Christmas numbers for 2008 come in. Talk about Bah Humbug. . . .
People don't just demand oil and its products - they demand a very wide variety of stuff. Some of that stuff has a lower marginal utility and thus a more elastic demand curve than does oil (and its products). Much of that stuff is what we would call "discretionary purchases". It is these that get eliminated first when the price of oil and oil products rises. THERE is where to look to find your demand destruction. It is only when there are no more items which might compete against oil for consumer dollars, when there is nothing left with a lower marginal utility than oil, that you start to see substantial elasticity and destruction of demand with continued oil price rises. We're not there yet (collectively, although a few individuals might be just about there now), but give it time, it won't be long.
Charles Komanoff and Daniel Rosenblum, in an interesting essay on carbon taxes (see http://www.shalomctr.org/node/1243) suggest that the long-run price elasticity of fossil fuels in general is in the range of 40%; i.e., a rise in price of 10% should lead to a drop in demand in the range of 4%. Based on recent data, as discussed, there could be an existing trend in this range that wouldn't be apparent because of the noise in these data. And, of course, even if a price elasticity in the range of 40% is realistic in the current situation, it may change in a non-linear fashion as time goes on.
Thanks for the link, Globo.
I have often wondered about this issue of demand destruction, but very few people seem to have a quantitative handle on it, even in a very approximate way.
I'm glad that Jeff Vail has raised this issue in the key post as well -- great job!
I have anecdotal impressions. Here in Minneapolis, MN, USA there do seem to be more bikers -- even more winter bike riders -- every year. Transit is poor, but the new light rail has attracted many riders. At least a few of them are new to transit, with some even moving to condos, apartments, or homes right on the transit line.
Our perceptions are changing with regard to our impacts on the planet. Granted, there is a powerful backlash with people following the dangerous memes that we do not negatively impact the environment, that we (USA) keep the world safe for democracy when we invade and occupy oil-laden places, and the like. But there does seem to be a significant shift going on which may impact consumption patterns.
My own expectation is that we will not respond in ways to make for a graceful powerdown -- too little, too late. I suspect that civilization may deteriorate into chaos in the face of the environmental tsunami we have invited and also not prepared for. But one does what one can, thereby perhaps avoiding nihilistic despair and making an opening for a little bit of hope and delight in the present.
The price of gas and demand destruction seems to be somewhat mysterious. The larger picture has even more variables and more uncertainty.
As you note, the price elasticity of oil or gasoline may not be linear after a certyain point.
I think that those who claim that US gasoline demand destruction will "explode" at $4 to $5 per gallon are deluding themselves.
The price comparisons with Europe are interesting, but the reference point for pricing should really be India, which is showing no signs of demand destruction at prices well above $5 per gallon.
The idea that the US economy cannot "bear" a gasoline price that is lower than just about every country on the planet other than a handful of major oil producing countries that heavily discount/subsidise domestic prices is laughable. American consumers will moan and groan about "higher" prices - as do consumers just about everywhere else - but there's no sign of this actually translating into lower gasoline usage. Diesel prices have escalated at an even more rapid clip than gasoline prices - but there's no sign of any demand destruction there, and US aggregate diesel consumption is growing very rapidly.
The "demand destruction" that is caused by higher percentages of disposable income being spent on diesel/gasoline will be displaced elsewhere - ie in frothy/excess/frivolous consumption that is easily reduced or eliminated.
US gas prices? Still waaaay cheaper than India.
Don't mention petrol prices in poor Turkey: they charge around US$ 12 per gallon...
A personal encounter with demand destruction.
I was dosed on various cold medicines and hadn't had anything to eat yesterday, after my wife infected me with some kind of lethal cold strain, and I was on my way to get some chicken soup last night when I pulled up to an intersection, to turn left at the light, where there was a car with its flashers going.
As I was about to pull around, a woman emerged from the car, whom we used to call a dwarf, or the more PC term is Little Person, but anyway this lady said that she was out of gas and asked if I could run her down to the local gas station. Because of cold medications and lack of food, I wasn't sure if I was hallucinating or not conversing with someone who could have come straight our of the Wizard of Oz, but I said sure.
Anyway, I took them down to the gas station and bought them a gallon of gas and took them back to their car. She was recently divorced, and she said rising food and energy prices were just killing her budget. I recommended that she go to George Ure's website (Urban Survival) and buy his PDF publication on how to live on $10,000 per year. (I suppose it may be $15,000 per year by now).
As Robert noted up the thread, the problem is that people--courtesy of ExxonMobil, Saudi Aramco, Daniel Yergin, et al--are operating under the assumption that high energy prices are temporary, and they are postponing making difficult choices about downsizing.
$10 Gasolne (?) Headline From Drudge:
http://www.nysun.com/news/business/gas-price-may-soon-cost-sawbuck
Another anecdote. I pulled into a local lumberyard to get a credit on some building material and pick up some 2x4s and cinderblocks. I had to have the returns inspected before I could get a refund. Two of the yard hands came out to look at the returns, but the first thing they looked at was my Subaru wagon.
First guy: "What kind of mileage do you get with that?"
Me: "Well, when I'm not pulling the trailer, I get about 30 on the highway."
Second guy: "Those cars run for about 300,000 miles don't they."
Me: "Yeah, we have 189,000 on it and it runs like new."
First guy: "I have a pickup, and the gas costs are killing me."
(First guy notices the jerry cans I have in the trailer.)
First guy: "Those are gas cans, huh?"
Me: "Yeah, they're military surplus. I found a catalog place that sells them for $14 each."
First guy: "Next time you're in, could you bring one of those catalogs with you?"
Yo WT, glad I as not around when you were driving under the influence!
How to live on $15,000, tell that to the billion+ on $1 a day. Couple of weeks ago in Egypt people were begging food leftovers from my table in a tourist hotel.
I absolutely agree that the messages from Exxon etc. are giving the wrong signal. IMHO the government needs to give very clear simple messages, e.g. a ban on all cars emitting more than 226g/km with steadily reducing targets over the next 10 years. This would send a clear signal to people to move to more efficient cars even for Rich Bastard:-) Unfortunately since this involves bad news very few politicians have the balls for this - so more credit to Roscoe.
Just seen in the Financial Times
Opec’s president on Monday warned that oil prices could hit $200 a barrel and there would be little the cartel could do to help.
Later in the same article
Adam Sieminski, analyst at Deutsche Bank, pegs price expectations at $90-$100 a barrel, with an average of $102.50 for 2009. But points out: “Oil supply growth in non-Opec countries is struggling at a time when Opec has been cautious with its production policies.”
So Opec say $200 but the man from Deutsche bank says $90-$100, what a great mixed message!
Purely anecdotal, but in the last big bull oil market we saw West Texas intermediate rise from $3.56 per barrel in 1973 to $39.50 in 1980. World consumption peaked at 67 million BOPD in 1979 and fell to a low of 58 million BOPD in 1983 before it began rising again.
An 11-fold increase in oil price and an eventual 13.5% decrease in cosumption.
And that was when Chindia was tiny.
Disclaimer: I'm not an economist - this is my common sense analysis of the situation:
Demand destruction (or decline in demand for oil if you like) is going to be a non-linear process, likely with sudden phase-change-like behavior. Why? Think about it a little more globally. Everyone in the world puts in bids for our constrained supply of oil. The people who cannot pay the asking price drop out of the bidding. At the moment, which countries can't afford to pay $120 per barrel? The poor ones, namely the people who use almost no energy anyway. I mean, we're talking about per capita energy usage that is a factor of 10 or greater less than people in the first world. Their decline into abject energy poverty is barely a blip on the screen. (I'll keep my rants about the morality of that as limited as I can...)
As we move up the ladder we get to the first world, say, the US. And this is an interesting case, because I think the social democracies like Sweden will behave very differently to the US, but let's take the US because it is the dominant energy consumer of the planet. The US is a like a little scaled down version of the rest of the world. There are poor people and rich people. The poor people will quickly drop out the bidding for gas, but they're poor and they don't use much energy anyway. There's simply no comparison between living in a small apartment in the city and using public transport versus living in a 3000+ sqft
mansionhouse and commuting 30 miles each way to work in an SUV every day. We're talking orders of magnitude again. Again, demand destruction is negligible.But finally, one day, the middle class is going to figure out that they're paying too much for gas and then everything will grind to a halt very quickly and suddenly. Don't ask me how one figures out when that day comes. We can only keep guessing.
The lack of demand destruction or inelasticity of demand for gas is all pain and no gain. When the gas prices first started soaring, I was thinking this was great so that we can now see people driving less and switching to smaller cars. Obviously, this behavior has been minimal despite anecdotal stories in the MSM.
So, I welcomed the personal pain of higher oil prices if we could ease our overall impact on the planet and stretch out the availability of a critical resource. Now, I am not at all convinced that extremely higher prices will have much of an impact. Therefore, we are getting no reduced impact on the planet and I personally have experiencing a reduced real income. Doesn't seem like much of a tradeoff. Sure, I drive a Prius but will still experience less disposable income.
And, let's just say the U.S., which is unlikely, did something that would significantly reduce our demand. Rationing seems like the only viable solution in the face of absurdly low inelasticity. This would do very little for the planet and the slack would just be taken up by places like India and China.
There is no hope. So let's just sit back and observe the s**t hitting the fan.
But you know what really gets me? The concept of supply and demand is so ingrained into most people, that they can't even see that the rules don't really work that way when the supply is constrained. On the flip side, people still think that we're going to solve global warming with a carbon tax. It's just about as delusional as thinking that, when oil prices go up, demand should decrease nicely in response.
Too many people have been conned into believing that we can "commoditize" anything, including food, water, air, energy, education etc... and then we're surprised when consumption and production don't behave the same way as they do for little plastic toys from China. Doh.
Supply and demand works perfectly fine thankyouverymuch.
What has happened is that people fail to understand how the equations work, and that supply cannot always increase to the level of want (or sometimes even need). Innumeracy and wishful thinking FTL.
What happens when supply cannot keep up with want is that the price increases until enough people are priced out of the market that you reach demand=supply.
It isn't so hopeless as you paint it.
By adopting a lower energy profile early, your standard of living will not be impacted nearly as badly as those who fail to adapt as quickly.
You have an effectively lower income, but people without your foresight will be hit much harder leaving you relatively better off.
This gives you a much more comfortable seat to watch the waste products hitting the rotary air impeller from.
Amen.
We're on a no-win rollercoaster ride, and it won't end pleasantly. The amount of ignorance about what is going on vis-à-vis gasoline (energy), our absolute need of cars to keep the local economy moving, and the eventual financial collision of need versus availability is unbelievable. Around my parts, people still blame high gasoline prices on gouging; they also "know" that prices will eventually drop like they did in the 70's (I was there, too), and are still buying giant SUVs and pickups. Oh, also in our area, house prices are still going up.
You've inched closer to the fulcrum, but to be brutally honest, you're still on the wrong side of the see-saw. Increasing mpg 40% is hardly a change at all in the big view. Now bicylcing & fueling up on local food ... there's a big change.
It seems common sense that the poorest will be the first to have to cut back. In central London there has been a congestion tax, i.e. a tax of GBP 8 = USD 16 per day to enter central London since February 2003. For a wealthy person this is great since their limos can speed through clearer roads.
IMHO a clear message needs to be given that fuel prices will continue to increase over several years. Maybe it could be seen as patriotic to cut back and stop sending dollars or troops overseas to "protect" the oil.
"But finally, one day, the middle class is going to figure out that they're paying too much for gas and then everything will grind to a halt very quickly and suddenly. Don't ask me how one figures out when that day comes. We can only keep guessing."
So, do you assume we will all sit in our houses and wait for the bank to reclaim it because we haven't driven to work, and therefore haven't made our payments, all because we decided we'd rather live in the street than pay more for gasoline?
No, around here gasoline is prime -- NO ONE IS GOING TO GIVE UP GASOLINE USAGE UNTIL SOMEONE ACTUALLY TAKES THE GAS AWAY FROM THEM! Price doesn't matter, for now and for many more dollars in the future. The only change you might see in the near future is a movement to smaller cars -- and then only reluctantly (no one I know can afford a new car). I still see tons (pun, pun) of brand new giant SUVs and pickups around here. The only way usage can end "quickly and suddenly" would be a total collapse of the economy. That may come, but it won't be the price of gasoline that stops people from buying gasoline.
Not at all. Where did I say that? I assume at some point when a household budget is in the red, and credit cards are maxed out, that families will start searching for ways to cut back and balance the books. First they do easy things like turn the thermostat down, cook at home more and eat out less, give up some of their travel plans for the holidays etc etc. And at some point, people will start to cut back on driving, use smaller cars, public transport and so on and so forth. There has to come a point when the price of gasoline stops people buying gasoline. My point is that that time comes when people can't afford it anymore. If the monthy cost of food exceeds your monthly income, what do you do? Most people eat less. That's my point.
i misunderstood your point also, i thought you meant folks in the burbs would begin selling their homes and moving closer to work/transportation when petro soars.
What work are you going to drive to once the unemployment that will cause demand destruction starts to take hold?
My guess on getting folks out of thier monkmobiles is that it will happen only when there are shortages and rationing.
Yes, obvious isn't it.
If fuel is in plentiful supply and the price is high, everything affected by the rise in the fuel cost will rise in price too.
Of course that should include wages, profits and taxes.
That will mean a corresponding increase in inflation.
But...............
When a lack of supply sets in. Various other behaviours will become apparent.
Fuel becoming hard to get means first, a serious cut back in discretionary driving.
A move to taxi's, buses and trains. As long as they can access supply.
Small business will begin to shut down.
A shortage of fuel for delivery and services.
Hoarding and black markets appear.
Tourism will begin to collapse.
Unemployment will begin an inexorable and steady rise.
Deflation will set in.
So at the moment we should not fear the rising cost of fuel demand will always be there, the circle of price rises and wages should maintain some equilibrium.
The scarcity of fuel holds much, much greater dangers.
>Deflation will set in.
This is highly unlikely. There are many reasons why, that are well explained on itulip.com. But basically:
- The Fed will print more dollars and risk inflation/hyperinflation rather than allowing deflation
- The cost of raw materials continues to escalate
- The dollar continues to shrink in value relative to other currencies
So, we may be in for very hard economic times, but more likely akin to the hyperinflation of the Weimar republic, rather than the deflation in the US during the GD.
Morgan
Could you explain how printing money can forestall deflation in a situation of business collapse and unemployment. Maybe you have a precedent.
If the economy began to collapse due to the housing/financial bubble alone, then printing money could assist. But...........
Fuel/energy shortages is what I expect to provoke the main and chronic economic downturn.
I suspect the economy will begin deflating soon after constant queues at filling stations begin, who knows though, as I said I'm just surmising.
Printing money is no good if the workers able to earn and business able to pay, can't.
Unless of course you think the economy can proceed on welfare.
itulip.com does not conceive (could be on purpose, best self delude when there is no alternative) a collapsing economy.
Their business depends on a perceived growing economy and if that requires hyperinflation, then that is what they will forecast.
It's very unlikely any democratic government, corporation, large or small business or salary earner will admit to a likely or pending economic collapse when their livelihood depends on the opposite.
I think you have misunderstood the argument.
You don't have to have deflation for the economy to collapse - inflation at very high rates will do the job nicely.
For a precedent, look up the Weimar republic on Wiki.
Whether you have deflation or inflation depends on how much currency you print, but does not alter the underlying problem.
Where was the energy shortage in Germany?
Germany came out of the inflation period because they were able to access the energy required.
They would have been able to pick themselves up from a depression as well.
Their hyperinflation was not due to energy shortages.
A million dollars for a loaf of bread, is meaningless if the million dollars can't be earned.
I'll repeat.
As I said inflation and even hyperinflation could/should be the result of the high cost of energy, for so long as energy remains in reasonable supply.
Inflation cannot continue if business can't provide work and money for consumerism to make the merry-go-round.
It would take a government to print money and provide work via public and capital works.
That can't continue for any length of time if the energy fails to arrive in sufficient supply.
The economic situation we face is unique.
Like assholes everyone has an opinion.
My opinion is inflation followed by deflation.
I was answering the claim that deflation would be "highly unlikely" because the website "itulip" said so.
If it seemed like you had actually delved into some of the thinking at iTulip, then we'd have a basis for discussion. However, you obviously didn't spend any time there. They do not "depend on the economy growing", and you're deluded if you think that's what iTulip is about.
Regarding inflation versus deflation: for deflation to happen, the dollar has to get STRONGER relative to goods such as oil, food, houses, etc.
Now think about it. The US Gov't is sending every family a check for $1,000 or more. Is there any way that printing money and sending people checks will make the dollar worth more relative to a precious commodity like oil? No.
If oil and energy drives the economy, and if those commodities are becoming more scarce, that means they will increase in price relative to paper currency. The energy shortage scenario you predict only supports my argument. If gas costs $20 per gallon, then food is going to cost 2-3X more than it does now, and so will anything else dependent on that energy to produce or transport (e.g. appliances, electronics, solar panels, etc).
I'm not saying that some items like houses can't drop in value. Certainly, large mansions located in sprawl are likely to decline in price - but that won't translate into cheaper oil or food. And, even home price depreciation can happen by inflation. If the dollar inflates away half its value over the next 10 years, then your house is worth half of what it was in real terms (i.e. how much food you could buy if you sold it).
There have been many inflations and hyperinflations in the last century. There have been only two significant deflations. One of them, in the US, was partly due to the tie to the gold standard. That's why private gold was called in and private gold ownership made illegal, so the gov't could make more dollars (early 30's). Since then, we have gone away from the gold standard. There is NOTHING anchoring your dollars now.
Think of it this way. If you were the sole world oil producer, and someone wanted to pay you for your extremely precious resource in paper money that they printed at will, what would you do? Would you just accept their printed money without question, at the risk that they will just print more to pay you next time? Probably not, if you're smart.
Well, that's exactly what is happening now. Too many dollars, not enough oil. I see nothing on the horizon that will change that situation. It will only get more and more extreme.
No DD, just more consumption. It's like how fashionable it was to have TB in France over a hundred years ago.
Hooray Chevron:
http://www.lickmygreenballs.com/chevrontoxico-ruining-amazon-communities
Compared to the other costs of driving a car, gasoline just isn't that big of a hit. With gas at $2.25/gal (the 2006 average), a typical American car costs $0.522/mile to drive. That car gets 20.2 MPG, leading to the cost of gas being ($2.25/gal)/(20.2 mi/gal)= $0.111/mile of that. At today's average price or $3.60/gal (a 60% increase in gas prices) it costs $0.589/mile to drive, a whopping 12.8% increase in cost over 2 years. Of course you haven't seen a huge drop in auto use, there hasn't been a huge increase in price!
You are showing the change in total average cost, which includes fixed costs. The more germane comparison may be variable costs or those costs which vary depending upon miles traveled. In addition, the gas price is the most obvious variable cost since people are paying at the pump on a regular basis.
In any event, however, even the large increases in variable costs doesn't seem to be making much difference.
This is true, but these are averages.
i.e. if you're depreciating a new car over (3? 4? 5?) years, fully insuring it, etc, then these are your costs, and likely they are even higher.
If you've bought the cheapest car you can find to get to your job, and have little or no insurance, then the transport cost increase is very much higher than your 12.8%.
i.e. the middle class feels the squeeze, but it's pretty marginal. The working class?
Will people lose their jobs because they can't afford gas?
More likely they will eat less. Or lose their apartments and sleep in their cars.
You do have a point. In fact, for a poor (or frugal) person who drives a $2000 car and only caries the legal minimum insurance then gas prices have a big impact and you're likely to switch to transit or carpool or do just about anything you can to reduce your car costs. On the flip side, there are a substantial number of people for whom the reduction in traffic from having some the poor off the road will just mean that they can drive their Escalade (which is over $1/mile to operate) faster so some of the fuel savings will be lost. That's the thing about averages, they may not represent your reality even if they explain why there hasn't been a big drop in gasoline consumption.
As a side note, I would expect more of the reduction in fuel use that does eventually come to be in the form of people driving more efficient cars rather than people not driving.
Some of that reduction might also come from SUVs carrying a solo driver being converted into carpoolmobiles carrying a full load. And note that the passengers, by the way, are not driving at that moment.
In answer to one of your concluding questions - what will it take to see aggregate demand destruction in the US? - I would guess that you won't see this until there is a substantial decline in the number of registered motor vehicles in the US coupled with a substantial improvement in US vehicle fleet fuel efficiency.
You people are so fond of your complicated mathematical models you can't see the wood for the trees.
Here's demand destruction in a nutshell: UNEMPLOYMENT.
In 2002 after the tech crash I was unemployed.
My demand was destructed for me because I was flat broke. After I was forced to sell my SUV I had no choice but to take the bus.
Unemployment is the only thing that will realistically stop people from driving and even then it will have a limited effect: If I had had a cheap jalopy I would have continued driving whenever I could have afforded gas.