Demand Destruction?
Before Trump tripped and fell over Netanyahu’s putter into Iran oil was around $60. I am just lumping together Brent, WTI, North Sea, Murban, etc.
Today, oil is trading at ~$100 on the futures market. That is an increase of 66%.
The total amount of oil missing to the world economy, if you assume that all the ships turning off transponders and magically reappearing beyond the blockade are not carrying oil, is about 20 mb/d. This is about 1/6th of total world consumption of oil.
Does a 1/6th drop in supply equate to a 2/3rds increase in price?
There is a rather obscure framework in economics called the Marshallian Demand Function which predicts how prices move to changes in the supply/demand function.
For a 1/6 drop in supply Marshall’s model predicts that the based on assumed elasticity the price should move as follows:
Elastic demand: ~5–7%
Inelastic demand: ~10–12%
Very inelastic demand: ~13–17%
That’s the theory.
We have been in this situation before though so we can look at actual reality.
In 1973, oil supply dropped 7% (~4.5 mb/d) and the price of oil moved 300% in a very inelastic market. I don’t believe oil today is that inelastic. Rare Earths sure but not oil. The US and Norway are produces now. And countries now have oil reserve. The US’ strategic petroleum reserve wasn’t created until 1975. And the economy (including cars and planes) is much more full efficient today than in the 1970s. The oil shock of the 1970s is one of the reasons the Concord was grounded.Those planes burned two tons of fuel just taxiing.
But, let’s pin that as the worst possible case. That would predict a barrel of oil could reach $180. This is just one way of looking at this. You could say 20% is larger than 7% and therefor the price per barrel of oil should be up 900% but people will stop needing oil long before that price could ever be reached.
During COVID housing demand surged and prices moved ~40%. In this case price adjustments were very localized as people moved around the country. So let’s assume this is the best elastic case. That would predict a barrel of oil would reach $84. If you look at the oil futures curve you will see the market is pricing $82 at the September contract point. And this is why the market is pricing $82/barrel because the market is seen to be pretty elastic. It’s also why, in the US, rigs are being taken offline more than being added.
But, taking both numbers as possible, that puts an average expected value of $136/barrel. You have what the market thinks and what every paranoid sensualist social media user thinks.
Does $136/barrel oil in 6 weeks matter to the consumers? Probably. Six bucks a gallon of gas is definitely going to change habits in the class of people who are already struggling. But, in the class of people who aren’t. They already have a third car that is an EV already. I have an electric bike and barely drive anymore.
I am more concerned with food production at this point than oil. But, if one ship confirms there are mines in the Strait by finding one and running into it, my opinion would change.
But, does it oil really matter to the market? Now that’s the real question. SpaceX and OpenAi, to quote Margin Call, are “odorous excrement” and need to liberated onto retail investors as quickly as possible.
The market can’t be let to crash is the rallying cry here I feel. Market participation can’t falter either - or a lot of investment banks and investors are in deep, deep … well shit. So the market has to stay buoyant and retail traders can’t be skinned alive because they are necessary to provide liquidity in those IPOs.
It’s almost like the market itself is now too big to fail when there are potentially multiple trillion dollar IPOs for companies that haven’t turned a profit, likely can’t turn a profit, and are only afloat because of accounting tricks and manipulations.
I don’t think the Iran conflict has really change the calculus here. It has just increased the costs to Wall Street to keep thing humming until they can get out of this future-tech debt hole.
-AJ