OIL'S TIPPING POINT: DEMAND DESTRUCTION AT WORK
The Philippine Star
04/11/11

If you’re not seeing oil prices hogging the headlines these days despite its relatively high levels, it’s because market forces have been healthily and actively at work in trying to curb the fossil fuels’ upward and wayward price march.

The best reason why pump price increases are not going ballistic as many had initially feared with the continuing unrest in the Middle East and Africa is the automatic pullback of consumers of their fuel use to protect personal spending budgets.

Yes, demand destruction is robustly at work, as had been in occasions in the past when oil prices surged to levels that majority of consumers had found increasingly difficult to live with. So far, this economic phenomenon is doing a swell job of keeping price hikes at a flatter angle.

People are no longer surprised to see crude oil prices at beyond the $100 a barrel mark, just as they are no longer in denial about the fact that oil is getting too expensive to burn as fuel for motor vehicles, cooking, heating, and manufacturing consumer items. Consumers are now preparing for the era of expensive oil.

Changing demand habits

When we speak of demand destruction, we refer to people’s behavior towards gasoline and diesel oil use for vehicles, which to date still accounts for a big chunk in the use of oil that is pumped out of the ground and refined.

The demand habits resurgent of late are car pooling, taking cabs or other public transportation means, and ditching (or temporarily keeping in the garage) those big SUVs that guzzle up gasoline or diesel like tap water.

We’re seeing other petroleum-related areas where spending is being curbed. Cooking fuel and electricity consumption are the next budget items that are being scrutinized by our penny-pinching housewives in an effort to stretch the household budget.

Lighting, cooling (or heating in temperate countries), and appliances that run on electricity are also being subjected to a second look as consumers become more aware of potential savings not just in terms of use but also from improved technologies.

Engines of the future

A strong push likewise that couples well with demand destruction, or changing consumer preferences and habits, is the strong support on the research and development side of technology innovations.

We’re seeing once again those econo-cars in motor shows: small, compact and fuel-efficient engines that can run miles and miles on just a liter of fuel. Recent new motor vehicles unveiled by major car manufacturers also showed a growing trend towards engines running on alternative fuels.

The underlying principle in new designs is no longer guided by maximizing consumption of gasoline or diesel fuels, but by moving away from these traditional automotive fuels. In the extreme, this could even mean radically changing the design of engines that have been around for centuries.

Technology is also marching full speed ahead in finding engines that will run on renewable fuels: the sun’s heat, the force of water, the gushing of wind, and even energy from safer nuclear reactors. The ultimate objective is to replace fossil-fueled power plants.

Electricity, after all, is no longer the exclusive domain of petroleum fuels. In recent years, as crude oil had become more expensive, alternative sources of power have become more viable. Wind power, for one, which had been hampered by the high cost of building wind turbines, are finding favor in many coastal areas.

Solar powered cells are also slowly but successfully hurdling past technology challenges. The cost of these heat converters is becoming more affordable, and the many past inconveniences that have hindered their commercial applicability are becoming less.

Future of oil

What does these all mean? Can we put our minds to rest with regards the possibility of a $150-per-barrel crude in this century?

As a principle, oil prices will always be dictated by supply and demand. The supply side crude oil stock, particularly the amount of oil and gas confirmed in existence and the continuing discovery of new commercially-viable fields, has continued to be stable.

There will be the occasional spikes in prices, which will mean that we may see the price of a barrel of crude oil breach $150 in the not too distant future, but these fluctuations will be driven largely by speculation.

On the whole, the average increase in crude oil will be primarily influenced by demand which is in a sense severely limited by the income of consumers. In other words, if consumers don’t have the money for gasoline, they will find cheaper ways of traveling – or will curb their travel habits.

This cuts the same way for other applications of petroleum-based modern conveniences. The simplest example is cooking. If LPG prices rise to levels beyond the average household budget, then we can expect a resurgence of alternative fuel-based cooking devices – charcoal, wood, briquettes.

Keeping inflation in check

Bringing this discussion to the local economy, our government should not be too worried about the rising price of petroleum products. The average price to date continues to be below inflation levels, a firm indicator that this is not going to be a trigger for runaway price hikes of basic commodities.

Oil, being a small part of food production costs, is not the main culprit should there be a radical jump in its prices. Instead, our team of economists who have P-Noy’s ear should focus on making sure that the earnings of our countrymen keep up with inflation.

A wage hike across the board has taught us in the past how much damage this has on inflation. Likewise, we have seen how increases in allowances (food, transportation, education) have helped our countrymen cope with rising food prices, but have had little impact on inflation.

With May 1, Labor Day, fast approaching, this gesture to our labor community may not be dramatic enough to earn pogi points. But a package of living cost allowance increases has seen the country survive through the worst, even as the price of crude oil has doubled in less than a decade.

Should you wish to share any insights, write me at Link Edge, 25th Floor, 139 Corporate Center, Valero Street, SalcedoVillage, 1227 MakatiCity. Or e-mail me at reydgamboa@yahoo.com. For a compilation of previous articles, visit www.BizlinksPhilippines.net