Asymmetry In Pricing Gasoline Based On Oil Costs Using National Samples

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The relationship between oil and gasoline prices has been the subject of investigation over the last three decades, igniting certain controversies across academics and energy markets, practitioners, and policymakers. Understanding the transmission mechanism of positive and negative crude oil shocks to gasoline prices is of paramount importance for a country’s energy policymaking, the optimal energy risk hedging, and the portfolio risk management. The movement of these energy commodities’ prices can affect not only the consumption and production expenditures but also future investment decisions in the energy markets.

Many studies in literature highlight that oil firms and individual retailers respond faster to oil price increases than decreases. When refiners or retailers experience a decline in their input costs, they do not rush to accordingly decrease wholesale or retail prices, since they can take advantage of the additional profits they can make. This situation cannot last indefinitely and is kept on as long as the demand has not been altered. Some competitors, however, realize that by reducing these prices they can enjoy greater profits from the larger quantities they can sell. Eventually, all are forced to adjust prices to their new equilibrium. By contrast, agents increase their prices as soon as they can to maintain their regular profit margins and not to experience any losses. This asymmetric price adjustment is known as the “rockets and feathers” effect; prices rise like a rocket but fall like a feather.

The presence of any asymmetries dictating the pass-through mechanism from oil to gasoline prices is primarily attributed to structural distortions that hamper the effective competition in the fuel sector. This is a serious issue which the regulatory authorities have to intensely check, provided that such asymmetries reflect a behavior of potential exercise of market power by the refineries. Hence, the authorities to protect consumers from welfare loses need to take certain measures (i.e., the strengthening of the role of the wholesalers and the elimination of certain barriers to entry in the oil market), the thorough investigation of any potential merging activity in the industry, the further opening of the market to new entrants (i.e. hypermarkets or big stores), and the removing of legal or technical barriers for the establishment of new filling stations.

Furthermore, the presence of an asymmetric behavior is attributed to several reasons: i) the market power of several locally active gasoline stations can affect both the adjustment speed of the prices and the consumer search behavior, ii) the negative relationship between inventory levels and fuel prices; when oil prices increase and oil supply declines, the level of gasoline inventories decreases, leading to higher retail gasoline prices, and iii) imperfect competition, collusive behaviors among firms, and the size of the market and accounting practices could cause retail prices to respond in a dissimilar pattern to input cost changes.

This empirical work investigated the asymmetric pass-through of oil prices to gasoline prices. The analysis added to the unsettled discussion of whether retail gasoline prices respond asymmetrically to oil prices, with the empirical analysis being carried out for the US, the UK, Spain, Italy, and Greece, spanning the period 2009 to 2016. The selection of this country sample was based on the following discussion: the asymmetric behavior of pass-through is potentially due to the fact that fuel markets across countries are differentiated by the structure of retail markets (i.e., oligopolistic behavior, inventory levels, production lags, and market competition structures). Hence, the analysis considered markets that differed significantly in terms of their structure.

For instance, fuel markets in continental Europe do exhibit differentiated degrees of competition, though such competition is lower versus the US and the UK corresponding markets. Moreover, Greece, Italy, and Spain are countries that are still seriously affected by the recent economic crisis, which in turn could influence the pricing pass-through mechanisms. Their results could be compared with two of the strongest economies worldwide, the U.K. and the U.S.

The findings indicated that oil and gasoline prices provided mixed evidence of an asymmetric behavior. Short-run asymmetry was found in the case of Italy, while in Spain there was both short- and long-run asymmetry. The remaining cases (i.e., Greece, UK, and the US) illustrated an asymmetric pass-through scheme.

The issue of asymmetries in the pricing transmission of oil shocks to retail gasoline price shocks concerns the public opinion, as well as national regulatory energy authorities. They can use the results to efficiently monitor the market competitiveness of the fuels market. Evidence of symmetry might be the outcome of an efficient regulatory policy in the energy sector. However, the desirable level of competition is not ensured only by the symmetric behavior of fuel prices, but it also matters whether the profit margins of firms correspond to a reasonable level of return on capital.

In less deregulated countries (i.e., Italy and Spain), the policymakers should attempt to enhance competition by allowing a further opening of the market to new entrants, such as hypermarkets or big stores, and by removing legal or technical barriers for the establishment of new filling stations. By contrast, in strongly deregulated markets (i.e., the US and the UK), there are vertically integrated energy firms and many market players in the retail chain part.

Surprisingly, the Greek case highlights a case closer to the deregulated markets, though Greece is a market with weaker competition in various sectors. This may happen because of the country’s participation in a strict austerity program, following its recent sovereign debt crisis where the regulatory authorities undertook steps in deregulating the fuel sector.

Policymakers should be also concerned about mergers and acquisitions due to which the market concentration is increased at the expense of scale economies. The asymmetric pass-through of oil prices to gasoline prices affects not only consumers but also the investment decisions of several private firms since these fuels can be used as inputs in the production process.

These findings are described in the article entitled Asymmetric pass through of oil prices to gasoline prices: Evidence from a new country sample, recently published in the journal Energy Policy. This work was conducted by Nicholas Apergis from the University of Piraeus and Grigorios Vouzavalis from the International Hellenic University.

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