"Demand Destruction"

I assume we will be hearing the phrase "demand destruction" on CNBC more and more going into the summer driving season. CNBC reporters like to bandy that phrase around but they don't expound on the phenomenon. 

From wikipedia:

Demand destruction is an economic term used to describe a permanent downward shift in the demand curve in the direction of lower demand of a commodity such as energy products, induced by a prolonged period of high prices or constrained supply.

Note the words "permanent" and "prolonged." I don't know if one could call the current period of "high prices" for oil and gasoline "prolonged." However, Saudi Arabia does not see a "permanent downward shift in the demand curve" for oil."

It would be interesting to see some studies regarding "demand destruction" in the mainstream media or on the business pages. I have not seen any objective, quantitative studies.

Taking the summer vacations out of the equation, and limiting the discussion to the 44 to 48 weeks of using a car for work, errands, and pleasure, I would assume that below $2.00/gallon, folks don't worry a whole lot about their driving habits.

I would also assume the "demand destruction" curve is a typical college biology 101 "S" curve. As the price of gasoline increases, folks cut back on their driving, but at some point, they feel they can cut back no more. They need their car for work and/or school and essential errands.

Let's say folks can cut their driving to 70 percent of "normal" or baseline consumption. Pick your number. It may not be 70 percent, but at some point folks feel that is all they can cut. Let's say, then for argument, the "demand destruction" for a typical, individual driver is about 30 percent.

At $2.00/gallon and a baseline of 100 gallons, that is $200. Let's say the oil industry cost is $150/100 gallons, and thus the oil industry makes $50/100 gallons.

At $3.00/gallon, one might think about cutting back on gasoline, but my hunch is that any cutback is minimal. The big reason: most folks either pay with a credit card and those paying with cash have already cut back some. So, 90 gallons at $3.00/gallon --> $270.The cost of producing the gasoline has not gone up enough to make a difference in back-of-the-envelope calculations. $270 - $150 --> $120 to the oil industry.

At $5.00/gallon, "demand destruction" is serious, and now folks have cut back to 70 gallons (70% of baseline). 70 x $5 --> $350. The cost to the operator is the same. $350 - $150 --> $200 to the oil industry. The increase to the consumer at the pump is 2.5 times (from $2/gallon to $5/gallon) but the oil industry sees in increase in margins from $50 to $200, or 4 times as much.

Again, I am well outside my comfort zone trying to understand the consequences of "demand destruction" and would prefer to link to an expert analysis. But I have to start somewhere.

Most concerning to state and federal governments will be significant loss of taxes at the gasoline pump, as folks cut back to 70 percent of baseline with "demand destruction."(It should go without saying that coal-powered cars have been contributing to this loss of revenue for several years now.)

If the cost to the operator was driving the cost of oil/gasoline up, the consequences would be different. But the price of oil is up because of the weakness of the dollar. And the weakness of the dollar is due to ......

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On a different note, I think supply and demand, global economy, and Mideast concerns affect the price of oil between $60 and $90; but the weakness / strength of the dollar affects the price of oil above $100.

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Monday morning, April 25, 2011, CNBC: first pundit to mention "demand destruction" and related it to a downward pressure on GDP.