The darkest hour of the energy crisis has not yet arrived

After the U.S.-Iran war broke out, Persian Gulf crude oil and natural gas accounting for about 20% of global trade volume could not be shipped out through the Strait of Hormuz. In a supply-and-demand model, this is a supply-side contraction driven by geopolitical events and caused by non-price factors.

Because the short-term supply elasticity of crude oil (this article focuses on the crude oil market; the same analysis also applies to the natural gas market) is extremely low, we cannot expect other regions of the world to quickly increase production to make up for this shortfall. When supply contracts due to non-price factors, the market must achieve a new supply-demand equilibrium by causing a significant rise in prices to “eliminate” a portion of demand.

The question is: how much does the oil price need to rise in order to eliminate enough demand? To answer this quantitative question, we must understand the crude oil’s short-term price elasticity of demand. I roughly checked the literature, and estimates of crude oil’s short-term demand price elasticity are typically between -0.05 and -0.1. It should be said that crude oil demand elasticity is very low. This is easy to understand: friends who drive to work and pick up children know that no matter how much the gasoline price goes up, in the short term you still have to go fill up the tank obediently.

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