The Dimensions of Demand Destruction

7/20/09 – 40th Anniversary of the Moon Landing

As you may have seen in the overview of these Points to Ponder I have listed words in groups of three that describe various aspects about energy. In my never-ending quest for enlightenment I learned on a recent vacation trip of how the Dine’ (also known as the Navaho) look at life in groups of four. The Dine’ even show how Christianity is based not just on the concept of the trinity, but on a concept of four where man must be
included or the trinity as no meaning on its own.

1st Dimension -- With that in mind I want to look deeper and ponder what drives demand destruction. We are all well aware of the role the basic global price of a commodity influences demand. If price gets too high, consumers stop buying it.

2nd Dimension --Can security of supply concerns cause demand for a commodity to decrease or for those concerned consumers to seek an alternative to that form of the commodity? While this factor is usually reflected in the basic price noted above, local security concerns can impact the market for a commodity.

3rd Dimension --Yet another price component is the political correctness price that many special interests and policy makers would hope to impose to cause and economic choice for a more PC form of a commodity. CAFE standards, cap and trade and green mandates impose such costs on some segments of the global energy economy. Of course if those costs are not imposed globally, the base price for the commodity unburdened by PC that is available to the rest of the global economy will go down and the unburdened (or as the PC elites may think, the unwashed masses) will increase consumption defeating the PC objective.

4th Dimension – This would appear to be volatility and, in the words of Alan Greenspan, irrational exuberance or speculation. Here our friends, the speculators, can be acting over the long run in a self-defeating manner. There is a general desire for consumers to seek stability in the price of their daily needs. These consumers would even pay a reasonable premium for such stability for an alternative form of that commodity.

Here speculation that leads to high levels of volatility (See The Phallacy of a Spike 7/4/09) in oil with respect to other forms of energy could lead to further demand destruction. Now I do not want to demean speculation as I have noted throughout my Confessions report and many of these Points to Ponder that speculation is a fact of life and a means to price discovery. However, the appropriate place to speculate on a future economic recovery and therefore future demand increase is in the future months of the futures. Speculation that drove oil to over $70 for the current month or spot contract would seem to be “irrational” and can trigger equally irrational political reaction.

The following is a plot of the futures for oil at the close of the market on July 17, 2009. I have added the red line that could bring oil back to a hypothetical price of natural gas in the near months to show how near term reality of supply and demand in this current recession and future speculation in economic recovery could play out without turning speculators once again into scapegoats. (See Speculation & Scapegoats 7/4/08)

Points to Ponder

  • While the various components of price are certainly the main drivers of demand destruction, can price volatility also add to the destruction?
  • Does volatility even matter when infrastructure locks global demand into specific forms of the commodity for a long period of time?
  • Is speculation in an economic recovery premature and adding to volatility?
    • Is such speculation rational?
    • Does the decoupling of prices bring extra regulatory and politicalattention?
  • Would the tribal council of the Dine’ violate the laws of economics with such investment?
  • And did man really land on the moon or was it staged in Hollywood?

Click here for more information about Confessions of an Energy Price Forecaster: A 12 Step Program to Enlightenment

Click here for John Tobin's full bio

 

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