The Imperfect Price-Reversibility of World Oil Demand*

Abstract

lhis paper examines the price-reversibility of world oil demand, using price-decomposition methods employed previously on other energy demand data. We conclude that the reductions in world oil demand following the oil price increases of the 1970s will not be completely reversed by the price cuts of the 1980s. lhe response to price cuts in the 1980s is perhaps only one-j?ih that for price increases in the 1970s. i’his has dramatic implications for projections tqf oil demand, especially under low-price assumptions. We also consider the effect on demand of a price recovery (sub-maximum increase) in the 1990s-due either to OPEC or to a carbon tax-spect@cally whether the effects would be as large as for the price increases of the 1970s or only as large as the smaller demand reversals of the 1980s. On this the results are uncertain, but a tentative conclusion is that the response to a price recovery would lie midway between the small response to price cuts and the larger response to increases in the maximum historicalprice. Finally, We demonstrate two implications of wrongly assuming that demand is perfectly price-reversible. First, such an assumption will grossly overestimate the demand response to price declines of the 1980s. Secondly, and somewhat surprisingly, it causes an underestimate of the effect ‘of income growth on future demand.