demand for petroleum products by using import fees and excise taxes to increase price. It is expected that these programs will increase petroleum prices by about $.10 per gallon and cut demand substantially. These demand reductions are based upon economic studies of the historic reduction in demand as price in creases. For all products taken together the FEA estimated that the aggregate demand for petroleum will fall by one percent in response to each ten percent increase in price. While this is considered to be a very low short term elasticity, some have felt that no reductions in demand would result. To help assess this question the attached technical analysis compares 1974 actual consumption against forecasts with and without the assumed price elasticity. The table below summarizes the consumption data by quarter. As indicated in the table, price effects were expected to cut demand by about 500,000 barrels in the first quarter and rising to about 800,000 barrels per day by the end of 1974. Actual consumption was substantially below both forecasts in the first quarter due to the embargo. In the last 3 quarters, actual demand was substantially below the estimate if there are no price effects and quite close to the forecast assuming some conservation from higher prices. The difference be tween the forecasts and actual demand are summarized below. In each quarter the forecast including price effects was closer to actual demand. The attached Technical Report presents the results of differentiating between price and other effects upon petroleum demand and extrapolates these effects into 1975 in the context of the President's program. COMPARISON OF FORECASTS OF PETROLEUM PRODUCT DEMAND ILLUSTRATING THE EFFECTS OF PRICES AND OTHER FACTORS Introduction The energy program announced by the President in the State of the Union Message on January 15, 1975, includes a number of proposals designed to reduce demand for petroleum products through price increases. The effectiveness of these programs has been estimated using FEA's short term petroleum forecasting model' The quantity expressing the relationship between changes in price and changes in quantity demanded is termed the "price elasticity of demand ̈* The sensitivity of demand to price varies across the different petroleum fuels and products. For all products taken together it is estimated that the aggregate de 1 A documentation of the forecasting procedure is given in National Petroleum Prodert Supply and Demand, October 1974 through 1975, Technical Report 74-5 FEA Novem ber 1974 For 1975 the base case forecast given in TK 74 5 and the "series III fre cast presented here are analoge Slight differences are due to changes in the underlying mucroeconomie forecast provided by Da'a Resources Incorporated which is updated Met! 1.ly • To la quantity is measured as the percentage change in demand which corresponds to a mand for petroleum will fall by one percent in response to each ten percent increase in price. This estimate of price sensitivity has been incorporated in the FEA forecasting procedure implemented throughout 1974 and was used to trace the impact of the President's program on petroleum product demand in 1975. This technical report presents a number of estimates of demand for motor gasoline, distillate and residual fuel oil, and all petroleum products taken together derived under a set of assumptions designed to display the effect upon demand attributable to price changes and other important factors (i.e., the level of economic activity and the weather). Inspection of data describing actual consumption during 1974 reveals that consumption fell below expected levels due to the embargo related shortages, reductions in demand due to mild weather, or the downturn in economic activity. In addition the sharp increases in price in 1974 compared to pre-embargo levels has dampened demand. The comparisons that follow differentiate among the various factors influencing demand and project the results of extrapolating these price effects into 1975 in the context of the President's program. The Assumptions The time series describing the consumption demand associated with four different sets of assumptions were determined using the protroleum product forecasting procedure (documented in Technical Report 74-5). The assumptions separate income and weather effects from price effects from the end of 1973 through 1975. Actual data is used for all the time series for all periods prior to the fourth quarter of 1973. The particular assumptions follow. Series 1: Pre-Embargo Forecast This series projects consumption demand for the fourth quarter 1973, and for the years 1974 and 1975 under the assumption that the severe economic downturn did not occur, that the relative price of petroleum products did not increase, and that normal weather prevailed. The macroeconomic forecast assumed was prepared in December 1973, Series II: Income and Weather Effects This series simulates consumption demand from fourth quarter 1973 through 1974 using observed values for the macroeconomic variables and the weather. Normal weather was assumed for 1975. The macroeconomic forecast for 1975 was prepared in November 1974. The differences between Series I and II are attributable entirely to income and weather effects. The relative price of petroleum products was held at its third quarter 1973 level. Series III: Price Effects Series III differs from Series II in that the effects of the increase in petroleum prices are incorporated in the simulation. For 1975 the relative price of petroleum products was assumed to remain at its present level. For 1974 Series III represents "expected consumption" as determined by the forecasting procedure. For 1975 Series III is the current "base case" forecast without accounting for the President's program. Series IV: Actual Consumption for 1974, the President's Program in 1975 The consumption estimates for the first nine months of 1974 are from the Bureau of Mines; October, November, and December 1974 are FEA estimates. The President's program includes a number of measures influencing demand. Those considered are: Natural Gas-All increments to petroleum demand due to natural gas curtailments are deleted after May 1, 1975. The deregulation of new natural gas at the wellhead is assumed. Coal Conversion.—The relaxation of clean air standards and the consequent fuel switching from petroleum to coal is assumed to lead to a reduction in petroleum demand of 98 thousands bbls/day by the end of 1975. Price Elasticitics.— The aggregate demand for petroleum is assumed to decrease by approximately one percent for each ten percent increase in price. This assumption was also incorporated in Series III. Product by product detail is given in Technical Report 74–5. Fees and Deregulation.-The following fee structure is assumed : a $2 fee on imported crude petroleum on March 1, 1975; a $1.20 fee on imported products on April 1, 1975; and a reduction of the import tariff to $2 on all imported petroleum and natural gas liquids and the decontrol of crude petroleum prices on May 1, 1975. The Comparisons The following tables and figures present recent consumption experience and forecast consumption for each of the assumptions given above. For each of motor gasoline, distillate and residual fuel oil, and all petroleum products taken together: the four time series are illustrated for the period 1969-1975 and separately for 1974 and 1975 on a larger-scale; the four time series are expressed in percentage terms with Series I=100%. The three remaining series are plotted in percentage terms with respect to Series I; a table with yearly average consumption figures in thousands of barrels per day and a table giving year to year percentage changes. For 1974 actual consumption fell below those levels which were anticipated before the economic downturn and higher prices (as given in Series I). Even when higher prices and lower income are taken into account, first quarter demand is still lower than "expected" due to the embargo. In the summer of 1974 a surge of post-embargo "pent up" demand may be noted. However, in the last quarter of 1974 demand returns to "expected" levels determined by the forecasting procedure. |