Rapid Substitution predicts a rapid decline in oil prices once EVs reduce oil demand by 5%. However, oil prices are skyrocketing in 2022. Does that mean Rapid Substitution is wrong?
Oil prices are skyrocketing for the same reason that they will decline once EVs take off. Inelastic oil supply. Since it’s so difficult to start and stop oil production oil supply is relatively constant in the short-term. If oil demand increases by a few percentage points due to economic growth or if a war reduces oil supply by a few percentage points there is very little oil producers can do to increase supply. Oil buyers then bid up the price of oil.
On the other hand, when EVs start taking off the opposite will happen. Oil demand will decrease. Oil producers won’t be able to stop production fast enough and oil buyers will have the upper hand.
The same thing is happening in oil refining. Since there is more demand for refined oil than there is refining capacity, buyers are bidding up the price of oil and refiners are making lots of money. Once demand drops then refiners will be searching for buyers driving down the price.
It seems gloomy right now with gasoline so expensive, but once EVs takeoff we’ll have cheaper transportation for EV drivers and gasoline-users.
The sooner this happens the better!