Familiarity breeds contempt? No. Opportunity costs.

Implications: The price of oil has not yet impinged on the cost of not using it.  It remain economically efficient.  As inflation sets in, however, there will be less and less incremental budget to be spent on energy.  This will likely fuel inflation and hurt demand.

Analysis:  

Each time the price of oil spikes, there has been a softening in demand. However, this decrease in demand has been temporary, lasting no more than a month or two. Then demand resumes its normal growth pattern. During this period, people are evaluating their alternatives and adjusting their spending patterns. This is not because people and business have accepted $70 oil.

Consumers evaluate the opportunity costs of high oil prices. In other words, “If I stop or reduce what I do that is consuming oil, am I further ahead?” For most people, the answer is no. If I stop driving to work, will I be financially ahead – no. If I cut back and only go to work four days each week instead of five, will I be further ahead? No, I’ll be able to stay home all five days and collect unemployment.

The incremental spending on gasoline, for example, is coming from other parts of the budget. This may be savings, or other discretionary spending categories. Many are dumping their Suburbans and F-150’s for Kia’s and Cooper’s. Some are able to roll these costs through as higher wages or higher prices. This begins the cycle of inflation.

The prospects for lower oil prices come from Russia and other potential producers. Russia has vast amounts of oil that have not yet found a convenient way to markets. As pipelines from the central and other remote producing regions of Russia are completed, supply will increase substantially.

Other countries, like Turkmenistan, have significant oil reserves, relatively close to major consumers, like Europe. Pipelines from other central Asian nations, bringing oil and gas towards Europe are in the engineering phase. These countries have not been willing or able to develop these resources as yet, but are likely to do so soon.

Some forecasters (I am not among them) have actually said that oil is likely to drop below $50 per barrel, once these supply hit markets. This might even set up some competition with traditional producers who can easily lower prices from current levels and still make substantial profits.

Consumers have not gotten used to $70 oil. They simply do not have a choice yet. As inflation bites into their incremental income, demand will drop. Prices are likely to find some level, lower than $70, until supply expands. Then Economics 101 takes over again.