Basic supply and demand economics maintain that as prices fall, demand increases, but to what extent?
The effect on oil, for one, will be negligible, according to the commodities team at Merrill Lynch.
They’re arguing that global oil demand is heading into negative territory as it recouples with GDP growth — also becoming a negative number (see the charts below). And, what’s worse, they’re not expecting lower oil prices to help boost demand much.
We estimate that a reduction of 10% in oil prices can lead to an increase in oil demand of 0.1% to 0.5% depending on the region. However, most of the benefits to consumption brought about by a lower oil price could be more than offset by the positive income elasticity of oil consumption. Broadly, we find a large, positive and significant income elasticity of oil demand for most regions and countries, other than Europe. In other words, our analysis suggests that the negative impact on consumer purchasing power of a global recession will offset the benefit of lower oil prices on oil demand in 1H2009.
That leaves ML forecasting a contraction in global oil demand of 0.5 per cent next year — or 400,0000 barrels a day. In comparison, the International Energy Agency is still predicting oil demand to grow 0.8 per cent, or by about 670,000 barrels a day.
Related link:
Safety in options – FT Alphaville
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