The darkest hour of the energy crisis has not yet arrived

After the outbreak of the US-Iran war, approximately 20% of global trade in crude oil and natural gas could not be transported through the Strait of Hormuz. In the supply-demand model, this represents a supply-side contraction driven by geopolitical events and caused by non-price factors.

Due to the extremely low short-term supply elasticity of crude oil (this article focuses on the crude oil market, though the same analysis applies to the natural gas market), one cannot expect other parts of the world to quickly increase production to fill this gap. When supply contracts due to non-price factors, the market must significantly raise prices to “eliminate” a portion of demand in order to reach a new equilibrium between supply and demand.

The question is, how much do oil prices need to rise to eliminate enough demand? To answer this quantitative question, we must understand the short-term price elasticity coefficient of crude oil demand. I roughly checked the literature, and estimates of the short-term price elasticity of crude oil demand typically range from -0.05 to -0.1. It should be noted that the elasticity of crude oil demand is very low. This is easy to understand; friends who drive to work and pick up kids know that no matter how much gasoline prices rise, they still have to fill up in the short term.

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