Question

Given the large negative demand shock to oil in recent months due to Coronavirus, what actions would you recommend to oil companies to help mitigate the damage of the temporary negative demand shock?

Answer 1

Demand shock in oil markets results in falling prices of oil, taking other things constant. This is because aggregate demand curve contracts, supply is in excess of demand , those who own oil commodities or stocks will start selling to reduce risks of holding. This will drive down oil prices.

In short run even if supply is cut to reduce impact of negative demand shock, equilibrium prices will adjust at a lower level than before. This will reduce total revenue for oil producers. In order to mitigate the impact of oil demand shock due to COVID, oil producers will have to bear impact of temporary adjustment in oil markets where prices adjust at lower levels.

Of course if there is a temporary exogenous effect on supply curve much larger than demand shock then supply curve will shift inwards, thereby causing oil output to fall with oil prices rising.