PRICE-ELASTICITY.md — Oil Supply & Demand Price Responsiveness
Compiled for: oil-shock-monitor-kb | Gap 7
Sources: Federal Reserve (Quant. Economics 2023, Dallas Fed WP 2403 2024), Nature Scientific Reports (2025), web search
Status: Summary
1. Short-Run vs. Long-Run Elasticity Numbers (Cited)
Supply Elasticity
Short-run (≤ 1 year): Effectively zero.
| Source | Estimate | Notes |
|---|---|---|
| Kilian & Murphy (2014) | α ∈ (0, 0.025) | Very tight upper bound; industry consensus |
| Braun (2023, Fed Reserve Quant. Econ.) | αqp ≈ 0 (posterior near zero) | Non-Gaussian SVAR identification; "short-run price elasticity of supply is indeed zero" |
| ScienceDirect (2023 replication) | Confirmed: short-run elasticity = 0 | Energy Economics journal replication |
Long-run (multi-year): Low but non-zero.
| Source | Estimate | Notes |
|---|---|---|
| Kilian (2008/2009) | ~0.05–0.1 | Allowing for investment response |
| Newell & Prest (2019) | ~0.1–0.2 | U.S. shale supply elasticity |
| Caldara, Cavallo & Iacoviello (2019) | Up to 0.2–0.3 | With weaker prior assumptions |
Key insight: The disagreement in the literature between "supply barely matters" (Kilian school: <10% of price variance from supply) vs. "supply matters a lot" (Baumeister & Hamilton: up to 37%) stems almost entirely from prior assumptions about the short-run supply elasticity. Under weakly informative priors, supply elasticity could be as high as 0.1; under tight bounds (0.025), it approaches zero.
Capital-Oil Substitution Elasticity (from DSGE model)
From the Dallas Fed DSGE model (Kilian, Plante & Richter, 2024, WP 2403):
**σ = 0.13** (elasticity of substitution between capital and oil)
This is a critically low value — oil and capital are near-complements in production. This means:
- A rise in oil prices does not easily induce firms to substitute away from oil using more capital
- The production system has very limited built-in price stability
- Supply shocks translate more directly into output effects than into substitution
3. Demand Destruction Price Threshold
Current market signals (March-April 2026)
| Source | Threshold / Signal |
|---|---|
| Bloomberg (March 2026) | Brent surpassing **$100/bl** entering "demand destruction mode" |
| US Energy Secretary (CERAWeek, March 2026) | Prices have "not yet climbed enough to cause demand destruction" at ~$100/bbl |
| RS Economy (April 2026) | Demand destruction peaks **October-November 2026** in prolonged 3+ quarter scenario |
| Petroleum Economist (April 2026) | **$100/bl** described as "psychological and structural threshold" |
Academic thresholds
- **$100–$130/bbl range:** Initial demand destruction begins; fuel switching and efficiency improvements start dampening demand
- **$130–$150+/bbl:** More significant demand destruction; "demand shocks become less important" as destruction cuts into consumption
- **Historical analog:** 1979/80 oil shock — prices spiked, then demand destruction caused by economic recession brought prices back
Nature Scientific Reports finding (2025)
Supply chain model found that demand-side disruptions caused the most increase in overall supply chain cost (more than supply disruptions), because rising demand led to more volume procurement, storage, and transport. This underscores the two-way relationship: high prices cause demand destruction, which eventually rebalances the market.
5. Key Takeaways for Price Scenario Modeling
| Question | Answer | Confidence |
|---|---|---|
| Can supply respond in weeks? | No. Elasticity ≈ 0 | Very High |
| Can demand respond in weeks? | No. Elasticity ≈ −0.1 | High |
| Is $80/bbl achievable with 3–5 MMbpd disruption? | Only if disruption resolves quickly (<1 month) or demand destruction offsets | Medium |
| Is $180/bbl achievable? | Yes, if disruption is prolonged AND market prices in persistent risk premium | Medium-High |
| Does demand destruction cap prices? | Yes, but with 1–3 quarter lag | Medium |
| Is OPEC spare capacity a buffer? | Thin: ~1.5–3 MMbpd effective (vs. 5+ MMbpd headline) | High |
| Is capital-oil substitution a stabilizer? | Almost none (σ = 0.13) | Very High |