Standard economic principles have demonstrated that price is a function of supply and demand. The same is true for the recent  oil prices fluctuations we have witnessed over the last few years, namely the equilibrium between supply and demand. However, the following conundrum has not been resolved: are oil prices high due to greater demand or too little supply? This ambiguity allows for vastly divergent interpretations of the same data and depending on the agenda you are trying to push, will easily support either. 

Lately, the concept of "Peak demand" has been suggested in a multitude of recent articles that unfortunately do not qualify their analysis of the status quo. Some suggest that we are willing to and capable of moving away from oil. Are we?

A few years ago, some analysts lectured us about the effect of oil prices on the creation of new oil supply. Now that this argument has clearly failed, they have decided over night that we don't need oil anymore. In this debate, it is important to distinguish between demand (what you want or need) and consumption (what you get based on your ability to buy). Following this logic, consumption is "satisfied demand". Conversly, we can define the "unsatisfied demand" or "excess demand" that has been suppressed. Below the fold, I'll show that the key driver behind the price increase since 2002 has been excess demand combined with unresponsive supply.

The above diagram shows that the pattern of growth in oil consumption has varied greatly for different groupings of countries. Oil consumption in China and India has continued to grow, whether or not oil prices rose greatly. Oil consumption also continued to grow in the "Others" category, which includes many of the oil producing nations. Oil consumption in the Former Soviet Union also followed a pattern somewhat independent of world oil prices. It was only the OECD whose consumption changed significantly as world oil prices changed.

Based on this comparison, it seems to me that OECD consumption is far more affected by oil price changes than the consumption of other countries. Based on data shown in this post, it seems to me that OECD economies can only absorb a price increase of US$10 per barrel in a year, without experiencing slowdowns in their economies and a reduction in oil consumption. Non-OECD economies (including BRIC countries) are more resilient, and are more likely to continue to show growing consumption.

Below the fold, I examine similarities and differences in oil consumption patterns of OECD and Non-OECD countries and offer my view as to what the future may hold.