Smashing the 'Perpetually Growing Oil Demand Myth'

If you believe that demand from India and China will send the price of oil and commodities to “infinity and beyond” you’ll end up losing your shirt and your sanity.

Already car sales are falling in both India and China. For India, this is already the second month in a row. For China, this is just the first. For both, things are about to get much much worse.

The per capita income for China is about: $5292 (IMF, 2007 est.)*
The per capita income for India is about: $2659 (IMF, 2007 est.)*

Cars are unaffordable luxury items for all but the richest percentiles in these countries, and that’s with state subsidies. That is rapidly changing.

In Oil drops on Subsidy Cuts in China, India, Malaysia, Taiwan I argued: “This is the catalyst that will finally burst the oil bubble. India, Malaysia, Indonesia and Taiwan have increased fuel prices and reduced subsidies this year. This will have an immediate effect on fuel consumption in these nations because they really are marginal consumers and are therefore the most price sensitive.”

Since then oil specifically and commodities in general have gone into cliff diving mode…

In Dollar Smile, Global Decoupling, Oil Super Spike and Yields I argued:

“Increased demand from developing nations won’t drive oil much higher. Developing nations are the new marginal consumers. That is to say they are the most price sensitive elements of oil demand. For first world nations oil demand is very inelastic. For developing countries oil demand is far more elastic. That means for every $1 increase in oil, more demand will be choked off in developing countries than in first world countries.

Translation: Long before high oil prices cripple the SUV driving commuter making $48 201 (2006 US median annual household income) the Chinese factory worker making about $7 700 (2006 Est.)* or the Indian worker making $3 800 (2006 Est.)* will have given up on certain consumer amenities.

It is a serious mistake to assume that commodity prices at these levels won’t have a serious affect on these developing nations.”

China August Car Sales Fall, First Decline in 3 Years (Update2): “China's passenger-car sales fell in August for the first time in more than three years as the Beijing Olympics and a slumping stock market prompted drivers to delay purchases.

Sales of passenger cars, sport-utility vehicles and multipurpose vehicles totaled 451,300, the China Association of Automobile Manufacturers said in an e-mailed statement today.

Demand for cars in the world's second-largest vehicle market cooled as inflation neared a 12-year high and a stock market slump reduced consumers' spending power. Carmakers including General Motors Corp. and Toyota Motor Corp., the world's two biggest automakers, have set up factories in China to offset slumping sales in the U.S., Japan and Europe.”

India Car Sales Fall for 2nd Straight Month on Rates (Update2): “India's passenger car sales declined for the second month in August as higher loan rates hurt demand for hatchbacks made by Maruti Suzuki India Ltd. and Tata Motors Ltd.

Sales in August fell 4.4 percent to 94,584 from 98,893 a year earlier, the Society of Indian Automobile Manufacturers said in a statement in New Delhi today. Car sales in India declined for the first time in more than 2 1/2 years in July, according to data compiled by Bloomberg.

Inflation near a 16-year peak and loan rates that have almost doubled in the past five years have squeezed consumer spending in India. The automakers group last week cut its growth forecast for the year to 10 percent from as much as 13 percent it predicted earlier this year.”

Even at $100 a barrel, prices have the effect of crowding out the marginal consumer. In this case, the cost of oil rises just high enough such that it becomes unaffordable to the marginal consumer. The marginal consumer happens to be almost everybody NOT in the first world. Basically prices will settle just high enough to wipe out any consumer surplus for these consumers and thereby severely limit demand to the highest socio-economic echelons in those countries. That level is most assuredly below $100 a barrel.

Below are a few of the important economic concepts that should prevent you from falling for all the hype about “perpetually growing demand” and “constantly rising prices”:

Marginal Demand
Elasticity
Income Elasticity of Demand
Price Elasticity of Demand
Cross Elasticity of Demand
Price Elasticity of Supply
Supply and Demand

* Astute readers may notice a discrepancy in my ‘per capita income numbers’. They are from two different sources, one from the IMF and the other from the CIA Factbook.