Demand Destruction: A Natural Cure For Peak Oil
By Rick Buckingham
Marine Atlantic recently announced that they are tripling the price for the fuel surcharge for all vehicles bound to and from Newfoundland. The surcharge will increase on July 1, 2008 from 9.9% to a hefty 27.7%. Increased rates and fuel surcharges have been the norm on a month over month basis for the better part of one year.
From a manufacturers perspective and eventually the consumers, affordability has to becoming into play. When does it become uneconomic to ship to Newfoundland? This also begs the question for shipping anywhere involving long distances where freight charges start to affect the economics of shipping.
Air Canada announced on June 7 that they were eliminating 2000 jobs or eight per cent of its workforce and eliminating seven per cent of its capacity. On the American side of the border it has been discussed at length that most airlines domiciled in that country can't make money with the price of crude over $100 per barrel at today's ticket prices, even with the fuel charges they have implemented.
The resultant effect of this will be higher air travel costs, as the carriers in the U.S. cut back on routes and employees to try to break even by way of financial performance. One would logically surmise that in order to offset these higher input costs all you have to do is raise rates. The flaw in this thinking is that they can't because consumers won't pay for the cost pass through.
"Demand destruction" is a term widely used in literature referencing peak oil hypothesis and the impact of rising oil and gasoline prices on consumption. Basically in lay terms, demand destruction is the reduction of demand for oil and oil derivatives. In other words at a certain price level for oil, or any other product for that matter, people will start parking cars, turning off air conditioners and cutting back on air travel. They will curtail their spending around everything affected by high oil prices and buy essentials.
Arjun Murti, an energy analyst with Goldman Sachs, recently stated that gas at the pumps in the United States may have to hit $5.75 per gallon before consumption cools off enough to take the heat off of oil prices. Although, there is evidence North American consumers are being effected negatively. In his vies oil supply growth is being constrained and conversely global growth has gone on unabated. He also stated there was a distinct possibility the world could see $150 to $200 per barrel oil over the next six to 24 months.
On the supply side Mr. Murti stated there are no apparent issues as Saudi Arabia, Iraq, Iran, Venezuela, and Russia all have large recoverable oil supplies but aren't on track to grow them significantly because there is no monetary reason to do so. The rationale from their perspective is that they don't need incremental revenues by way of volume and they don't need western capital to build infrastructure to build out more reserves. In other words they are happy with the present scenario in which they have never made more money.
Consumer behaviour will be the catalyst to change the demand for oil products. If current behaviour deems that the status quo is acceptable then nothing changes if consumption patterns are sustainable. The problem is that this line of thinking isn't practical. All we have to do is look at the plant closings at General Motors to validate this. People are going from SUVs to smaller more fuel efficient cars. Discretionary income is the most important aspect or driver in this thesis. After consumers pay for all their essentials what's left over is what they can afford. It is at this point that consumers vote on what they will pay for with their wallet. Consumers have choices and we are now at the point where something has to give.
Rick Buckingham is president and CEO of Canadian 2 for 1 Pizza Inc. based in Fredericton. He can be reached by e-mail at firstname.lastname@example.org. His column appears Tuesdays.