Foreign Countries Cutting Fuel Subsidies Will Decrease Oil Demand

Indonesia has decided to decrease their fuel subsidies; thus raising the price of gasoline for consumers at the pump. The new price will rise 28.7% to a price of 65 US cents per liter or $2.46 per gallon. India also announced an increase in gasoline prices to $2.66 per gallon, an increase of about 7%. Taiwan is another country that is ending a freeze on gasoline prices.

These price increases are important to creating more elasticity in the demand for oil. If governments fix the price of gasoline at below market levels, when demand increases there and supply remains constant, the price can only go up. In economic terms, this creates a demand curve that is almost vertical. Small increases in demand with fixed supply can create huge price increases. By passing through the increased price to consumers, demand will be reduced and price will find a new equilibrium point at a lower price point. Could this create a short term top in the price of oil?

Longer term, higher oil prices are going to cause consumers to seek ways to decrease their consumption. Buying smaller cars is one way to decrease fuel consumption. Consumers are already shunning big pickup trucks and SUVs. It will take time for this ‘demand destruction’ to work its way through the economy. Demand destruction also includes switching to alternative energy sources over the long term such as natural gas, coal, and electricity for cars. In economic terms, the short term demand is not very elastic. In the longer term of years, it is much more elastic. The supply of energy is also not very elastic in the short term, but much more elastic in the long term. It takes a long time to find and produce oil.

Demand destruction sounds like a good way to decrease oil usage and maybe reduce global warming, but it depends on what energy sources are substituted. Substituting coal would be a disaster for global warming. Cutting consumption by doing without can be devastating. [Demand destruction: who gets destroyed?]

Demand destruction can be very hard on the most vulnerable people who have limited ability to cut consumption or use alternative fuels. For example, in Africa some countries generate electricity from diesel fuel. The high prices are forcing them to cut back on electric production, which is devastating to their already weak economies.

If oil production increases slowly, we may have time to move to alternatives. Alternative energy will take a long time to replace fossil fuels. In a previous article: Solar Cell Manufacturers Have Room to Grow, which shows how slowly production capacity for solar cell manufacturing is growing. Even at 300% growth, it will take many years for solar systems to even catch up to the demand for new energy sources, much less replace existing sources. If the Peak Oil theories are true, then oil production will start decreasing and we will be in a world of pain.