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Oil Prices and Pump Prices
Industry Outlook
a report by
Nodir Adilov
1
and Hedayeh Samavati
2
1. Assistant Professor of Economics; 2. Professor of Economics, Indiana University, Purdue University Fort Wayne (IPFW)
Do petrol prices adjust more quickly to crude oil price increases than to regular unleaded petrol prices paid at the pump by US consumers.
price decreases? Conventional wisdom would have us believe that While the average crude oil prices were for week t, the average petrol
petrol prices paid at the pump by consumers respond asymmetrically to prices were for the prices paid the Monday immediately following week
changes in the price of crude oil; that is, crude oil price increases are t and included all taxes. Using the model specification first suggested
quickly passed on to consumers, but when crude oil prices drop sellers by Borenstein et al.,
2
we calculated the cumulative effect on the retail
are in no rush to adjust petrol prices downwards. The theoretical price of petrol when crude oil prices changed.
3
We calculated the
underpinning for this explanation emanates from the oligopolistic cumulative effect of crude oil price changes because our estimated
co-ordination theory. According to this theory, when input costs models showed that even though the effect of a change in crude oil
increase, sellers increase the price of the final goods because otherwise price diminishes over time, the effect continues to move petrol prices
their profit margins would decrease. On the other hand, when input up to four weeks after a given crude oil price change. Thus, since the
cost decreases, their profit margins do not decrease. Thus, a seller effect does not vanish until after the fourth week, we calculated
might want to sustain high prices until its competitors start cutting their the sum of these effects over time.
prices. This implies that the sellers might exercise short-term market
power and that prices would decrease slowly once such an implicit Figure 2 shows the cumulative effect of crude oil price increases as well
collusion starts to break down, when competitors start cutting prices. as price decreases on the retail price of petrol during the first four
In the case of petrol prices, the argument regarding the lag in the weeks following the crude oil price change. During week one, a 1%
downward price adjustment has serious policy implications because it increase in crude oil price increased the price of petrol by 0.243%,
suggests that consumers are handed a raw deal by the oil industry. In while a 1% fall in crude oil price reduced the price of petrol by
addition, as long as petrol prices rise more quickly than they fall, 0.199%. However, as suggested by Figure 2, starting from week two
consumers can be cheated even when the average price of crude oil the combined petrol price responses to crude oil price increases and
stays the same but crude oil price is volatile. However, recent data do decreases are almost equal in magnitude, and the difference between
not support the argument that petrol prices change more quickly in price response levels is not statistically significant. Therefore, these
response to oil price increases than to decreases. results do not support the suspicion that consumers get significantly
overcharged as crude oil prices vary.
Oil and Petrol Price Fluctuations
In the 1990s, although crude oil prices fluctuated, the petrol price In addition to average price data for the entire US, the US Department
adjustment pattern was of little consequence because both the level of of Energy publishes petrol price data at the state level. However, the
prices and the amplitude of price fluctuations were relatively low. state level data are available for only nine states: California, Colorado,
However, since early 2000 crude oil prices and thus petrol prices began Florida, Massachusetts, Minnesota, New York, Ohio, Texas and
to rise in terms of magnitude as well as volatility. Table 1 indicates Washington. Given that the oligopolistic co-operation theory sounds
mean and standard deviation of crude oil and petrol prices in the 1990s highly plausible – especially to a wary consumer who is concerned
and those post-2000, revealing that not only the mean prices but also about the rising price of gasoline – the issue warrants further
the standard deviations are higher for the post-2000 period, examination. This is especially true if there is evidence regarding a rise
suggesting higher prices as well as greater variations in those prices.
1
in the market power for the oligopolistic firms in the petroleum
industry. Table 2 indicates that between 1997 and 2002, sales receipts
Figure 1 presents the time plot of the weekly averages for US regular of the largest firms as a proportion of the total increased,
4
suggesting
unleaded petrol prices and West Texas Intermediate (WTI) spot crude an increase in market power for the largest firms in the retail petrol
oil prices since 1991, showing that movements in petrol prices closely market. To further examine the effect of crude oil price changes on
follow changes in crude oil prices. Furthermore, in the summer of 2008 movements in petrol prices, we estimated models for all of the states
crude oil prices peaked to around US$147 per barrel, and the average for which data were available. Our findings indicated that for most
price of petrol in the US surpassed US$4 per gallon. No doubt, should states the direct effect of an oil price change on petrol prices
the contention regarding asymmetrical price responses on the part of continued to be significant, though diminishing, up to the fourth
gasoline prices hold true, the negative implication for the consumer week after each price change. Again, we calculated the cumulative
would become staggering in the recent environment. effect of crude oil price increases as well as price decreases over the
next four weeks following the change. The calculation results are
What the Data Show presented in Tables 3 and 4. The results were interesting because we
To see whether the conventional wisdom held true, we examined the found that the cumulative effect of a price increase was higher than
post-2000 data collected from the US Department of Energy website. that of a price decrease only for California, Texas and Washington.
The data were for average weekly crude oil (WTI) and the average However, for the states of Massachusetts, Minnesota and Ohio, the
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© TOUCH BRIEFINGS 2009
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