This flies flat in the face of repeated statements recently in the press and blogosphere that gasoline demand is going down, so let’s look at it a bit more carefully. Here are the EIA’s full historical tables for gasoline demand, both week ending and 4-week average. Using the smoother 4-week average, the 2008 demand has been consistently lower than in 2007, but not by much. However, using the finer-resolution one week data, 2008 demand was higher than 2007 for the weeks ending 4/11/08, 3/28/08, but lower the weeks ending 4/4/08 and 3/21/08. For two of the last four weeks, demand for gasoline has been higher in 2008 than in 2007. This is hardly conclusive evidence of demand destruction, and completely ignores that the most recent demand figure shows a year-on-year increase.
Will we see significant demand destruction in the future? There is no clear answer to that at this time, but I think one thing is clear: it’s time to take a deeper look at the mechanics behind how demand destruction will work, if and when we see it (or, if we already are).
Does a lack of demand destruction when oil is well over $100/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 to price alone?
Figure 1: No significant demand destruction based on EIA’s gasoline demand chart… the most that can be stated definitively is that the past year has not shown appreciable
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 make more energy efficient choices based on the price of energy. 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 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.
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, possibly more importantly, homes that require less driving to commute to work. 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. After all, 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
Return on Investment Driving Demand Destruction
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 slower option over another that consumer 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. At some gasoline price level, it makes sense for any given person to arrange to carpool. 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—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 at $3/gallon, but 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 risk and the resultant correction, as I argued a few weeks ago (LINK)). At least some of the decrease in
With gasoline well over $3/gallon, and oil well over $100/barrel, there does not seem to be any significant demand destruction in the
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. We can only wait and see what happens…It's also worth pointing out that this analysis only considers US gasoline demand. Even if there is an ongoing demand destruction of 1% per year in the US, two significant factors overwhelm this: global demand growth remains strong, and net exports are falling precipitously (by 150,000 barrels per day in March alone). More on these items in future posts...