There's so much outright garbage on the Internet about the price of oil, I decided to do a little crude modeling of my own to try to get a handle on this. My conclusion is that, using a trivial model and some simple historical values, it appears that oil may not get past $150 in the next year. Note that at $150/bbl, it's still not going to be soaking up more of "world GNP" than it was back in 1980, so this is interesting; it suggests near-term dislocations in the United States, Europe, and Canada may be a lot smaller than I, for one, expected.
Herewith some numbers and stuff. ======================================================= To start with, I dug around and found a claim that the price of gasoline has an elasticity of -0.2. OK, that's 1 significant digit, maybe it's kind of close. I didn't find the elasticity of crude oil anywhere, but for the time being I'll go with -0.2. That's certainly very low. (In a monopoly market, prices are "naturally" set at the point where elasticity = -1.0, for whatever that's worth; -0.2 really is 'way low according to theory and implies prices are far, far below the point at which producer income is maximized.) Elasticity = (dQ/dP) * (P/Q) where Q = quantity sold and P = total revenue. It's normally negative, at least if we use this definition, as the quantity sold normally drops when the price goes up. The next piece of information we need is the "natural" rate of increase of oil consumption. (There is enormous amounts of garbage spewed about this one!) I found a table of world oil consumption, going from 1900 to 2005. It's located here: http://www.eia.doe.gov/aer/txt/ptb1110.html Assuming it's accurate, we get our first surprise: The compound growth rate in oil consumption from 1900 through 2005 was 3.08%. The growth rate from 1995 to 2005 was 1.79%. This is far, far lower than I expected! Next we need to make some assumptions about supply. If we assume there are 100 bbl/day available now, we can scale that up or down to get supply in one year; call the first "Q" and the second "Q2". Initially, assuming we're /at/ the peak, I assumed flat supply. Finally we need some formulas. Define Q = total starting supply = 100 bbl/day P/Q = starting price = 100 dollars/bbl P = total starting revenue = (P/Q) * Q = 10,000 dollars E = elasticity = dQ/dP * P/Q Now, we're going to have a "natural" final value for Q, which is the amount demanded if the price remains flat. We define that as Q1: Q1 = final "natural" demand = 102 barrels, if we assume the "natural" demand increase rate is 2% per year. P1 = final "natural" price = starting price = 100 dollars/bbl But we're not going to allow consumption to rise at the "natural" rate; we're going to pin it to the available supply. This gives us: Q2 = "forced" final consumption value = 100 bbl/day Now we want to find P2, the final "forced" price. To do that we go back to the formula for elasticity, which we're assuming is constant: (Q2 - Q1)/(P2 - P1) * P2/Q2 = E For convenience, we'll define delta-Q = Q2-Q1 = difference between "forced" level and "natural" level of consumption Fiddling around a bit we get P2 = P1 * (1/(1 - delta-Q/(E * Q2))) I plugged that that into a spreadsheet, and found the following, for a number of values of elasticity and demand growth, but assuming flat supply in each case (unit width font, please): ---------------------------------------- Demand Elasticity Growth Final Price -0.2 2 111 *** Based on recent oil use -0.2 3 118 -0.2 5 133 -0.1 2 125 *** Based on recent oil use -0.1 3 143 -0.1 5 200 -0.05 2 167 *** Based on recent oil use -0.05 3 250 -0.05 4 500 -0.05 5 Floating point overflow ---------------------------------------- Since elasticity is a big unknown I've shown it with -0.2 (value claimed on the Internet), -0.1, and -0.05. I would guess that the last value -- 0.05 -- is unrealistically small. Note that an actual /drop/ in supply has almost the same effect as an additional increase in the "natural" demand. So, if supply actually drops by 3% while demand "naturally" would increase by 2% the result is about the same as an increase in demand of 5%. In fact my very simple model says that combo results in a final price of about $139/bbl. So, the overall conclusion from this trivial exercise is that, unless the elasticity is really, really, REALLY small, or demand goes up a lot faster than it has in the past, we're probably not going to see prices much over $150 within the next year. I was surprised -- I thought we were heading for the cliff a lot faster than this, and $200/bbl oil next year was a no-brainer. But, apparently not.
