The Price and Income Responsivenessof World Oil DemandDermot GatelyProfessor of Economics, NYUNY Energy ForumDecember 11, 2007 Dermot.Gately@NYU.edu
NY Energy Forum December 11, 2007 Dermot Gately “The Price and Income Responsiveness of World Oil Demand” e-mail: Dermot.Gately@NYU.edu website papers: www.econ.nyu.edu/dept/courses/gately/research.htm Papers on OPEC and the World Oil Market: “How Plausible is the Consensus Projection of Oil Below $25 and Persian Gulf Oil Capacity and Output Doubling by 2020?" Energy Journal, 2001, 22(4), pp. 1-27 “OPEC’s Incentives for Faster Output Growth”, Energy Journal, 2004, 25(2), April, pp. 75-96. “What oil export levels should we expect from OPEC”, Energy Journal, 2007, 28(2), pp. 151-173. Papers on World Oil Demand: “The Asymmetric Effects of Changes in Price and Income on Energy and Oil Demand”, Energy Journal, 2002, 23(1), pp. 19-55 (with Huntington) “Vehicle Ownership and Income Growth, Worldwide: 1960-2030”, Energy Journal, 2007, 28(4), pp. 163-190 (with Dargay and Sommer) “Price and Income Responsiveness of World Oil Demand, by Product” (with Dargay and Huntington), August 2007, with revised version to be posted soon
Why has the price-responsiveness of oil demand been different this time? • Despite crude oil’s price tripling since 2003, oil demand has kept growing – in contrast to the demand declines that we experienced after similar price increases in the past. Why? • World income has kept growing (SURPRISE) • Price-responsiveness of demand has been small (not a surprise): • OECD: Been there, done that. • Developing Countries: except for residual/heavy oil, demand has grown almost as fast as income. • Oil Exporters consumed 1.7 mbd in 1973, now 8.5 mbd.
income kept growing; demand growth slows but no decline income growth slows sharply; oil demand falls
Why has world income kept growing? • Price tripling was gradual, not abrupt • Asia plays a much larger role in the world economy, and its growth continued strong • US economy sustained by financial institutions throwing mortgage money out the windows • OPEC was smarter in keeping a lower profile, which was less threatening than in the 1970s.
Why has world income kept growing? • Price tripling was gradual, not abrupt • Asia plays a much larger role in the world economy, and its growth continued strong • US economy sustained by financial institutions throwing mortgage money out the windows • OPEC was smarter in keeping a lower profile, which was less threatening than in the 1970s. • I’m saying this was a surprise, not that we should have expected it – bearing in mind what Graham Allison once said about Kremlinologists after the Soviet collapse: “What they once told us was inconceivable, they now tell us was inevitable.”
Reduce Oil Demand When Price Jumps?OECD: Been there, done that. • OECD demand reductions after the price shocks of the 1970s: mostly due to fuel-switching, away from oil. Been there, done that. • Did not un-do these demand reductions when price fell in the 1980s. • Cannot re-do these fuel-switching reductions in demand when price triples in 2003-2007.
Reduce Oil Demand When Price Jumps?OECD: Been there, done that. • OECD demand reductions after the price shocks of the 1970s: mostly due to fuel-switching, away from oil. Been there, done that. • Did not un-do these demand reductions when price fell in the 1980s. • Cannot re-do these fuel-switching reductions in demand when price triples in 2003-2007. Personally, I haven’t reduced my heating oil use at all in 2003-2007. In fact not since 1981 have I reduced it – to zero, when I switched to natural gas.
Crude Oil Price and World Oil Demand: asymmetric price-responsiveness, especially for Residual Oil
OECD transportation oil demand • Income-responsiveness of demand: increased vehicle ownership (but saturation in US) and larger, more powerful vehicles • Price-responsiveness of demand: • slow adjustment in usage & fuel efficiency • more symmetric than non-transport oil demand with respect to price increases and decreases
Fuel-efficiency & weight of new US vehicles, 1975-2005: partially symmetric price-responsiveness
Real Oil Price Indices, 1971-2006 (1971 = 100): G-7 countries Another reason for little response of world oil demand: although crude oil prices tripled in 2003-07, there have been much smaller increases in end-user prices including taxes.
For the past two decades, Other Oil demand has increased as fast as income in China, the Income Growers, and Oil Exporters – albeit more slowly in the OECD.
Gately, “What oil export levelsshould we expect from OPEC?” Energy Journal, 2007
Gately, “What oil export levelsshould we expect from OPEC?” Energy Journal, 2007 IEA & DOE projections to 2030: OPEC oil consumption will grow much slower than GDP 1971-2003: 7.6% annual % growth for oil demand and 5.1% for GDP: oil grew much faster than GDP
Elasticity assumptions used in our demand projections to 2030 Income elasticity of demand = % change in demand / % change in income (holding price constant) Price elasticity of demand = % change in demand / % change in price (holding income constant)
Comparison of our projections to 2030 with those of IEA, DOE, & OPEC (with constant real prices)
Conclusions • The story of world oil demand over the period 1973-2007 is a tale of two oil products. Demand for Residual Oil has fallen by one-third, while the demand for Other Oil has doubled. • Most of the reductions in oil demand were due to reductions in residual oil (and home heating oil) after the two price shocks of the 1970s – the result of fuel-switching to coal, natural gas, and nuclear for electricity generation, especially in the OECD, rather than improved technological efficiency. These fuel-switching demand reductions were not un-done when oil prices collapsed in the 1980s – strong evidence of asymmetric price-responsiveness – and thus cannot be re-done when oil prices increase again. However, the world still uses 10 mbd of residual oil (of 84 mbd total), making further reductions possible.
Conclusions , continued • Now that Residual Oil’s share of Total Oil has declined from 28% in 1973 to 12% today, future changes in Total Oil demand are dominated by what happens to Other Oil. In most of the developing world, demand for Other Oil has increased almost as rapidly as income since 1973, and half as fast as income in the OECD. • The price-responsiveness of demand for Other Oil has been much smaller than for Residual Oil, especially among the Income Growers, China, and the Oil Exporters. There has been some evidence of asymmetric price-responsiveness for Other Oil, but only within the OECD – the result of fuel-efficiency improvements that were not abandoned when oil prices fell. However, some OECD reductions in transport oil have been partially reversed by oil price declines, as consumers have chosen vehicles that are heavier and more powerful.
Conclusions , continued • Our analysis suggests – at current real prices – weaker demand growth over the next decade in comparison with IEA and DOE, but much stronger growth beyond 2015. Over the period to 2030 we project that the ratio of world oil demand growth to income growth will be 0.53. In contrast, they project that – at current real prices – this ratio will be only 0.36 (IEA) or 0.34 (DOE). By 2030, this would be a difference of 20 mbd between our projections and theirs – roughly the production of two Saudi Arabias. • Since such rapid demand growth is unlikely to be supplied, real world oil prices would have to increase substantially by 2030 in order to slow demand growth, or income growth would have to slow substantially, or both.