Oil is a dense, convenient form of energy, an essential ingredient of the modern economy. Testimony to its importance is the value spent globally on oil, around 3% of global Gross Domestic Product (GDP) on a trend basis. While there are substitutes for oil, these must be traded against their lower energy density and inconvenience. The key linkage therefore is price. By implication if oil ceases to be cheap, at least in a relative sense, its attractiveness is diminished.
Oil cycles tend to be resilient because both supply and demand are inelastic - at least in the short term. With a lead time between discovering oil and producing of just less than a decade, many of the projects we see coming to fruition today were conceived in an environment of sub-$30/bbl oil! Further, usage of oil is so prevalent in modern society that entire manufacturing and infrastructure systems are built to deliver it. The initial response to increased prices is thrift, with secular changes only possible once there is widespread belief that these high prices are sustainable and there is regulatory intervention.
Explain why the supply and demand of oil are both inelastic in the short-term. What does this mean, practically, for consumers and/or the oil industry long-term?
