4/16/13 Effect of a U.S. Demand Reduction on Imports and Domestic SupplyLevels

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Effect of a U.S. Demand Reduction on

Imports and Domestic Supply Levels

Paul N. Leiby, 4/16/2013

Given a particular reduction in oil demand stemming from a policy or significant technology

change, the fraction of oil use savings that shows up as reduced U.S. imports, rather than

reduced U.S. supply, is actually quite close to 90%, and probably close to 95%. This might

seem surprising to those who observe that imports are ~50% of U.S. demand and declining,

While it might seem surprising that so much of the adjustment is expected to occur in imports

rather than domestic supply, it follows from the expectation that the demand reduction leads to

a rebalancing of regional supplies and demands through the market price mechanism, and

that rebalancing occurs globally.

The intuition is as follows:

We would expect no change in domestic supply form a U.S. demand shift unless there

is a change in the price facing domestic suppliers.

We generally anticipate that global oil markets will remain integrated, and any effect of a

U.S. demand reduction on oil price would be spread globally.

Thus supplies and demands in all regions will each adjust to some extent.

What determines the share of adjustment by U.S. supply is the share it comprises in the

context of all global supplies and demands, plus the relative elasticities of various

supply and demand regions.

As a simple approximation, if all regional supply elasticities are the same, and there is

no change or response by non-U.S. demand (unlikely), then the share of U.S. supply

response would equal the share of total global supply met by the U.S.. In this case the

U.S. supply response is currently about 11%, and the import response, that is the net

response of non-U.S. producers, ~89%

Note that this “worst-case” simple approximation corresponding to the large U.S. supply

effect is also the one where the U.S. demand reduction has the desirable consequences

of a comparatively large oil price reduction effect, and no rebound effect on demand

elsewhere.

A more likely case is where non-U.S. demands also respond over the long-run, and

certain suppliers (e.g. OPEC) respond more elasticallythan the U.S.. In this case we

would estimate that the import response would be ~95%. We can caveat this based on
4/16/13 Effect of a U.S. Demand Reduction on Imports and Domestic SupplyLevels

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our uncertainty whether new“unconventional” supply sources in the U.S. are relatively

more or less price elastic than other global supply sources.

Analytics of market rebalancing for a exogenous shift in U.S.

demand

We can divide the global oil market into U.S. demand ( ), Non-U.S. demand ( ), U.S.

supply ( ), OPEC supply ( ) and Non-U.S.-Non-OPEC supply ( ). A fixed shift in U.S.

demand by amount is offset by rebalancing changes in the other supplies and

demands:

Introducing the regional supply and demand elasticities , the adjustment in each

segment/region depends on it respective supply-demand magnitude, elasticity, and the

market price change :

Since supply elasticity is positive and demand elasticity is negative, we can take absolute

values and show that all terms contribute positively (i.e. the non-U.S. demand effect, along with

all non-U.S. supply effects, further reduces the required U.S. supply response).

So the fraction of the demand change that is accommodated by U.S. supply is:

We can also divide through by the level of global supply (or demand) to highlight that each

elasticity is weighted by the share of global supply/demand that it corresponds to.

If all elasticities are identical, and there is no non-U.S. demand response ( ), then the

U.S. supply response is

Du Dn

Su So Sn

ΔDu

ΔDu = ΔSu + ΔSn + ΔSo − ΔDn

εSr , εDr

ΔP

ΔDu = (εSuSu + εSn Sn + εSoSo − εDnDn)

ΔP

P

ΔDu = (|εSu |Su + |εSn |Sn + |εSo |So + |εDn|Dn)

ΔP

P

=

ΔSu

ΔDu

|εSu |Su

(|εSu |Su + |εSn |Sn + |εSo |So + |εDn |Dn)

=

ΔSu

ΔDu

|εSu |σSu

(|εSu |σSu + |εSn |σSn + |εSo|σSo + |εDn|σDn)

εDn = 0

= = ≈ 12%

ΔSu

ΔDu

σSu

(σSu +σSn +σSo )

σSu

1.0
4/16/13 Effect of a U.S. Demand Reduction on Imports and Domestic SupplyLevels

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If all elasticities are identical, and non-U.S. demmand also responds, then the U.S. supply

response is

For reasonable elasticities, and OPEC long-run elasticites varying between 0.25 and 4.0, we

find U.S. net import response (i.e., the net response of all non-U.S. suppliers and demanders)

accounting for 93% to 98% of the original demand reduction.

= = ≈ 6.6%

ΔSu

ΔDu

σSu

(σSu +σSn +σSo + σDn)

σSu

1.0 + (1 − σDu)