I can't honestly say I know what the oil companies would be willing to drill for. Again I think you are oversimplying. There's no guarantee that any new sources are as easy to get at as older ones. Also, all the drilling equipment in the world is booked years in advance, which means that drilling wouldn't be able to begin soon, and that sites which want to drill years from now will be in tight price competition with other sites that want to drill, which basically means its very likely going to cost more to drill than it did in the past, cutting into the margin.

Of course, oil is very expensive right now, and even with some demand destruction now, the long term demand trend will be upward with dim prospects for strong sustained supply increases, so it seems very plausible that drilling in the areas in question will have healthy margins, even though costs are higher.

On the cutting the fat/muscle issue, I don't think it works like that. Your hypothesis seems to be that there is some subset of easy demand cuts that have been already made, and that any remaining cuts will be much more difficult and long term, and that these sets are fairly discrete.

The examples you gave can show how this isn't true. There aren't easy and hard cuts, in the real diverse economy with many many players, there are just gradations. There are many different consumption changes people can potentially make, and each person has some threshold price at which they will make the change.

Cars can last many years (mine is an '88), but people can buy or sell a particular car based on fuel economy. As prices rise, people who drive more will tend to favor the more economical relatively more than people who drive less, so even with the same cars on the road, fuel economy changes in response to price. Of course, the composition of cars on the road also changes in the near long-term (months and years instead of >10 years) following a price increase. We already see this. The auto manufacturers are forced to respond by altering their production (they are doing this), and on the other end of the market, the choices people make about whether to fix or junk a used car is affected by gas price and the cars economy. I know this from first hand experience, because if gas prices weren't high, I wouldn't have made the costly suspension repairs necessary to keep my old but efficient car on the road.

We see the same thing in housing. Even without changing the houses that exist, with higher fuel prices, people will move or make a purchasing decision with a relatively greater emphasis on distance from school/work/family comp than they would with lower prices. Even with an America that basically is spread out and presently high gas prices, people don't live in an arrangement that produces optimally low fuel consumption. They consider other factors, they just consider fuel consumption relatively greater when prices are higher compared to when they are lower.

Talking about visiting relatives twice a month, that behavior too will be affected by price. Of all the people in America who drive to visit relatives twice per month, at some given price point, they will drop it to once per month, then once per every other month, then only on holidays, then not at all. Ask the airline industry if travel isn't affected by fuel prices.

At some price point, workplaces might switch to 4 day workweeks, or allow for more flex time. At some price point, workers will change jobs to one that requires less fuel use, or allows more telecommuting.

Basically, there are three things to note. One is that there are many ways to reduce fuel use, even without large scale infrastructure changes, and we certainly haven't exhausted all of them. The second is that they certainly haven't all occurred already. The third is that with so many options, and so many players in the fuel marketplace, there's no reason to believe that they will fall in some discrete dichotomy of "fat" and "muscle". It's just levels of difficulty, or rather, levels of response to any given price point and time scale

Of course, the test of any good theory is predictive ability. By your model, I guess demand reduction in response to price has already occurred, and won't continue if price stays relatively stable in the next year. By my model, it will continue to occur over the next year. We can watch and see which is correct, although I'm pretty confident that I am and we will see demand destruction continue in the US at present prices.

Now, if the world's economy declines further, that would sap demand and lower price, which changes everything. If there is a war or other major disruption that shoots price up markedly, that also changes things. But I'm expecting that increased third world demand, slightly increased supply and decreased first world demand will roughly even each other out over the next year, and prices will be sort of stable, which will provide a good test of the question of whether all the easy cuts (the fat) have already been made, or whether there are still plenty more available.