Reply #15: Demand destruction, prices and profits [View All]

[Terry in Austin]

Good point about profit as a constant percentage. For one thing, it helps steer the focus away from the "profit-hungry oil companies" narrative, which I think is very necessary to do in order to get to any real understanding of what's going on.

I'll offer my take on it, for those who cling to this narrative:

It ignores the fact that oil producers just don't have the power to manipulate prices. Private companies control maybe 20% of the reserves; even OPEC, at about 40%, has long since lost the power to control prices.

It also ignores the market fundamentals at work. When supply falls short, demand must be reduced, so prices rise. In the case of a very inelastic commodity like oil, the price has to rise quite a lot to achieve any significant demand destruction.

Specifically, given the price elasticity for oil of about -.07, it means that the price has to rise 100% in order to reduce demand by a mere seven percent. That's a very steep increase, and that's what we're seeing -- that's what it takes to keep oil supply and demand in balance when there's a shortfall.

As you noted elsewhere, hot commodity trading and a weaker dollar do contribute to the price increase, but they are not the reason for it. The reason for it is just plain, non-conspiratorial, impersonal supply and demand at work. Maybe someday soon we can get used to the reality of oil decline and start dealing with it.