The literature on behavior of oil prices is filled with studies that examine the demand and supply determinants of those prices. The demand determinants are related to macroeconomic variables such as GDP growth that underpin the aggregate demand for oil. Supply determinants are related to oil production and supply distributions.[1] Recent research has shown that shocks (or unexpected news) related to the aggregate demand overwhelm the shocks related to supply in determining oil prices.

A new and rising stream of research has embarked on examining the impacts of the alternatives on oil prices. One of the alternatives to petroleum products is the electric car. Wikipedia defines an electric car as “an alternative fuel automobile that uses electric motors and motor controllers for propulsion, in place of more common propulsion methods such as the internal combustion engine (ICE).”[2] There is steady flow of news about the development, usefulness and efficiency of electric cars. Examples of such news include “Germany Jumps in the Race for Viable Electric Car” which states that German government approved a plan to place one million electric cars on the road by 2030. There is recent news that predicts that the availability of electric cars would reduce the demand for gasoline in the United States from 8.6 million barrels per day now to 2.2 million barrels by 2030. If this prediction materializes, electric cars will have tremendous impacts on oil prices. There are 800 million cars in the world today. If China, India and the rest of the world attain as many vehicles per capita as Europe and America do, which have roughly a car for every couple, we would end up with three billion cars on this earth by 2035. This would require oil reserves several times the reserves of Saudi Arabia!

One particular example of the new research on oil prices and electric cars is the study titled “Electric Cars and Oil Prices”, which is just completed by Jose Azar of Princeton University.[3]  This study examines the dynamic relationships between oil prices and public interest in electric cars. This interest is quantified by the volume of Google searches for terms related to electric cars such as “electric car”, “electric cars”, “electric vehicles”, and so on, according to Global Insights. This search tool, when given a phrase, supplies a ranking of related keywords that people search for on Google before and after that phrase. Google Trends then gives a search volume index, which in this case combined with oil price in an econometric model.

The research finds that oil prices respond negatively to shocks or news related to public interest in electric cars. Oil prices decline gradually over a period of six months to reach 5% since the inception of the news on electric cars. To put this decline in perspective, the drop in oil prices is equivalent in percentage to a drop caused by a typical shock or negative news related to oil itself.  On the other hand, a shock to oil price will also increase the interest in electric cars gradually over a period of four months.

The sensitive of oil price to long-term developments in the alternative energy markets become more important when it is related to changes in the long-run elasticity of demand for oil. Students who take Econ 101 know that the major determinant of the price elasticity of demand is the availability of viable substitutes, which more of it makes demand more elastic and the consumer is more sensitive to higher prices. There are prominent economists such as Jim Hamilton who believe that the sudden drop in the oil prices, which started in mid July 2008, is related to increases in the long-run elasticity of demand for oil.[4] This huge drop cannot be attributed to short-term factors such as oil production capacity constraints. The increase in public interest in electric cars signals increases in expectations of the availability of more alternatives in the long run. Therefore, changes in oil prices can not only be explained by macroeconomic and supply factors. Alternative energy technologies may be just as relevant.

The conclusion is that policy-makers and consumers in both oil- producing and consuming countries should keep track of the developments and the growing demand for electric cars. Some day, electric cars should rule the future and their demand would have a material negative impact on oil price.

HAPPY EID!!!