According to a recent article in Runner’s World, it doesn’t matter how many miles you jog. Keep stuffing down doughnuts and pizza, and eventually you’re likely get heart disease. There’s a similar dynamic at work with the price of oil and gasoline, at least in the short term. We can’t produce more oil fast enough to make prices lower. The only solution is to use less oil.
As Robinson Meyer points out in his excellent piece in The Atlantic, new oil production can’t happen fast enough to increase supply sufficiently during periods of sudden demand or market disruption, so prices rise.
The only sure way to lower prices is to reduce demand.
For one example, rapidly putting more electric vehicles on the road will result in cheaper gasoline. Working from home in your pajamas also makes gas cheaper.
Analyzing the dynamic fluctuations between oil demand and prices over the last 50 years, Skibo Energy has developed the concept of Rapid Substitution. Briefly, as a host of initiatives, such as a significant increase in the number of electric vehicles replacing internal combustion engines, rapidly drive down the demand for oil, the price of oil will crash.
Clearly, over the last few months the price of oil has risen rapidly and to dramatic new highs. That doesn’t disprove Rapid Substitution. It only demonstrates that oil production of has risen more slowly than oil demand, amplified by the supply disruptions in the normal flow of world markets resulting from the war in Ukraine.
According to recent data from the US Energy Information Agency, from the 4th quarter of 2020 to the 4th quarter of 2021 global oil production increased from 92 to 98 million barrels per day. However in that time, oil consumption also increased from 94 to 100 million barrels per day. Since the oil supply is relatively inelastic, prices rose dramatically. In other words, since rapidly ramping up production is very expensive, each additional barrel of oil demand bids up the overall oil price. That was happening even before Russia invaded Ukraine, which has only exacerbated oil supply problems.
The solution is pretty obvious. To reduce oil prices, decrease the demand for oil.
The key is that demand must fall faster than production decreases. Achieving that is a challenge since oil is so entrenched in every aspect of our modern lives. Over the long-term, initiatives such as replacing gasoline-powered cars and trucks with electric vehicles, smart urban planning, and investment in public transportation are the most effective ways to sustainably reduce oil demand. Over the short-term, however, demand reductions at the scale required to lower oil prices must come from things like work from home policies, carpooling, and increased use of public transportation.
There are numerous historical precedents for this sort of rapid drop in oil demand.
In June 2008, oil prices were above $120/barrel. Oil demand dropped due to the Great Recession, and by Winter 2009 prices were below $40/barrel.
This happened again in 2020, when demand for oil tanked worldwide because of Covid 19. The average price of a barrel of oil sank to just $35 (compared to about $52 in 2019), and oil futures were trading in negative territory.
Asking oil producers to increase production won’t lower the price of oil just as running one more mile won’t make up for an extra Big Mac. The only solution is to reduce demand for oil either by switching to electric vehicles (which will take time) or cutting down on car trips by working from home.
Now is the time to reduce oil demand, not by starting a recession, but by working in our pajamas!