Falling oil prices have slowed down the rate of decline in the intensity of global oil use over the past ten years, but rising tax rates have prevented a recovery in many OECD countries. The main driving force behind oil demand is economic growth, but changes in the real price of oil affect the intensity of oil use in the economy as consumers change their behaviour, invest in new equipment, or switch to alternative fuels. Although the intensity of oil use has continued to fall in the more developed OECD countries, where taxes have boosted consumer prices, intensities have been rising in developing countries where tax rates are lower.
Apart from fuel oil - which is fighting a losing battle with natural gas in the power generation market - the demand for other oil products such as gasoline and middle distillates showed clear signs of responding to falling oil prices over the past decade, providing grounds for optimism if oil prices happen to remain low in real terms over the next ten years. Although oil demand appears to be relatively unresponsive to price changes in the short run, its long-run price elasticity is probably quite close to unity, giving prices a key role in shaping the future demand for oil.
This CGES article looks in detail at changes in the intensity of oil use by product type in the main consuming regions of the world and assesses the long-run sensitivity of gasoline demand to changes in pump prices across a sample of 39 countries. The study shows that gasoline demand in the long run is highly sensitive to changes in income and price, and that the long-run elasticities for both income and price are statistically indistinguishable from unity.
If the long-run price elasticity of oil demand as a whole is indeed unity - or very close to unity - any attempt by OPEC to increase oil prices in real terms is ultimately self-defeating. This lesson should have been learnt by OPEC after the disastrous impact on demand of the massive price rises of the seventies and early eighties, but appears to have been forgotten in OPEC’s rush to boost short-term oil revenues after last year’s price collapse. If the Organisation succumbs to short-term revenue pressures and succeeds in keeping oil prices high in real terms over the next few years, oil demand will suffer in the long run.