supply and demand - AND PRICE
July 30, 2008
Everyone knows that "supply-and-demand" sets the price in a free market. What's really interesting however is how steeply the price can change as the supply and demand thresholds cross each other.
The U.S. Dept. of Transportation just reported that U.S. drivers logged 9.6 billion less miles in May as compared to May '07. Similarly, the U.S. Dept. of Energy reported that demand for oil in the U.S. dropped by 891,000 barrels/day in May '08 compared to May '07. ("Oil hits 7-week low on demand worries, dollar gain") This drop in demand has sent shock waves through the oil markets, with the price dropping $25/barrel in just two weeks.
It really gets interesting when you put these numbers in perspective - consider :
1. Adding 891,000 barrels/day excess supply vs. demand to the U.S. markets drops the price from $145 to $120 per barrel. This represents a 17% drop in price per barrel.
2. Adding 891,000 barrels/day to the U.S. market represents a 4.5% increase in supply since we use about 20 million barrels/day.
So think about this, adding 4.5% excess supply drops the price %17. This means that if the oil producers voluntarily added 4.5% extra capacity to the supply, they would see their price per barrel drop %17, with the net effect of their total revenue drop by about 14%. The oil companies are run by nice people, but why would anyone want to produce 4.5% more product to get 14% less total revenue!
As noted, the excess 891,000 barrels/day of extra capacity wasn't created by excess production, but by decreased demand, but it's all the same. When supply gets tight, prices can spike - and vice-versa. Kind of reminds me of real estate in CA!
-- Greg