Energy Transitions and Price Elasticity

A term in economics called price elasticity measures the degree people will continue buying something when the price goes up, and at what point people either stop buying or switch to something cheaper. It is known with gasoline consumption, that in the short term people have high elasticity - meaning they either won't or can't modify their driving due to price increases. Over longer time frames this will be less true.

When gasoline price increases started accelerating in 2006 and 2007, there was a lot of complaining by neighbours, colleagues, and media. Actual changes in driving behaviour were slower. By the end of 2007 and into the first half of 2008, when oil prices kept relentlessly going higher, there was a drop in total vehicle miles driven in the U.S. This is a crude measure of gasoline consumption and doesn't take into account gains in vehicle efficiency etc.

This is a chart from the guys at Calculated Risk blog:
This drop is clearly demand destruction, but the US economy has also been rapidly slowing. Notice that there have been only two instances in the last 60 years where the U.S. has shown declining annual gasoline/oil consumption. From the EIA website:

Only after the two supply 'oilshocks' of 1973 and 1979 was there a drop in gasoline/oil consumption. Both these periods were times of economic recession and real efforts at energy conservation. They didn't last.

Will the latest oil shock of 2008 result in a longer lasting effort to transition off our addiction to oil? The price collapse of recent months doesn't bode well for the correct price signal for end users to change their behaviour. The Ford/GM SUV model that was supposed to take them to nirvana is now dead. Overall though, I have little faith that humans will decrease their discount rates enough, with regards to energy consumption, especially with a price of oil that is under $100.

Peak credit is also now past us, but this may well have the effect of keeping more legacy SUV's out on the roads because of sunken costs and inability to get credit for new vehicles. Peak credit will also impact the oil and gas industry and large projects like the oil sands will face higher discount rates and thus higher hurdles before initiation or completion. This will have the effect of delaying new projects but this is a topic for another post.

The article I wanted to bring attention to is about the lead times it takes to transition from one energy to another. This is usually measured in decades because of the amount of infrastructure that needs to be built. The oil and gas industry is quite remarkable if you think about how that oil gets from beneath the ocean and all the steps in between before finally getting to our tank in the form of gasoline! The infrastructure that allows this took an enormous amount of capital as well as time to build. I'm a great fan of hybrids and electric cars, but the ability to power a fleet of these cars is still a while away. Just like solar and wind are important sources of energy in the future, it will take time before they make a significant impact.

The article does a better job explaining: Article from The American

My bottom line is that infrastructure especially relating to energy will still be a good place to invest. The recent market plunge has created buying opportunities in some impressive companies like SLB, BHI, ESV, NOV, OIH, HAL, ABB, FTI, NBR. For higher risk, I also like some of the Canadian oil and gas producers.