Are we close to the oil price peak?

Are we close to the oil price peak?
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First Published: Wed, May 28 2008. 11 39 PM IST
Updated: Wed, May 28 2008. 11 39 PM IST
Data on miles driven and oil products consumed in the US suggest price elasticity of oil is around 16%. If that applies globally, $200 (Rs8,580) per barrel oil would cause a drop of 12 million barrels per day (bbl/day) in consumption. Speculators who tried to hold the price at $200, like King Canute holding back the tide, would need to purchase the global consumption shortfall. Just as Canute’s feet got wet, they would run out of money and be forced to allow prices to drop, incurring huge losses.
Oil prices can rise rapidly and stay there only if price elasticity is very low, in which case price rises cause only a slight decline in consumption. However, recent demand data suggest that even short-term oil price elasticity is substantial. US vehicle miles declined by 4.3% in March 2008 compared with the previous year, while gasoline prices rose 21.5%, suggesting a price elasticity of 20%. For oil products as a whole, US consumption was down 3.7% in February, while prices were up around 27%—suggesting a lower but still substantial price elasticity of 13.5%. From those data points, an average of 16% looks about right.
World oil consumption is currently around 87 million bbl/day, but that data is some months old and so reflects prices around $100. If prices rose to $200, and global price elasticity was 16% as in the US, demand would fall by 12 million bbl/day to 75 million bbl/day, which is 10 million less than current supply. Such a drop in demand would almost certainly be accompanied by a major worldwide recession.
For prices to stabilise at $200, speculators would need to purchase the 10 million bbl/day excess of supply over demand, which at $200 per barrel would cost $2 billion a day. Even for the global hedge fund community, that burden could not be borne for long. Hence speculators would be overwhelmed, and oil prices would drop back down.
However, if speculators can’t sustain oil at $200 per barrel, it’s unlikely it will reach that level in the first place, particularly if measures are taken to increase margin requirements and otherwise dampen speculative frenzy. We may therefore be close to the oil price peak.
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First Published: Wed, May 28 2008. 11 39 PM IST