explaining differences in fuel prices among countries - United States ...

EXPLAINING DIFFERENCES IN FUEL PRICES AMONG COUNTRIESGal Hochman, Rutgers University, (848) 932-9142, gal.hochman@rutgers.eduDavid Zilberman, University of California Berkeley, (510) 290-9515, zilber11@berkeley.eduOverviewAlthough gasoline and diesel is a traded commodity, there are very large differences in fuel prices among differentcountries. For example, in 2006 the price of super gasoline in Turkmenistan was $0.02 per liter, while at the sametime in Eritrea it was $1.90. What factors contribute to these very large differences? And what are theirimplications?The literature suggests several factors that may explain these differences, and we would like to investigateempirically their importance. First, there is an export effect: price of fuel varies between oil exporting and oilimporting countries. Second, the OPEC effect: prices are lower in OPEC countries, relative to other oil exportingcountries. Third, the oil reserve effect: consumers in countries with greater reserves pay less for oil than those inother countries. Fourth, the regime effect: fuel prices in democratic regimes are likely to be higher than in those inautocratic regimes—while democratic leaders may use taxes to provide services, autocratic leaders may use fuelsubsidies as a way to buy political support. Fifth, the governance effect: well-targeted redistribution wealth policiesrequire adequate institutional and administrative capacities, and countries that lack this capacity subsidize energy.Six, the income effect: consumers in richer countries may pay more for fuel, because of taxation reflectingenvironmental concerns and more awareness for public goods that have high income elasticity, And finally seven,the state fragility effect: countries whose share of crude oil revenues to public spending or GDP is large will havelower fuel prices.MethodsWe develop a linear panel model and estimate the effects of these various political and economic factors on fuelprices throughout the world, while statistically correcting for endogeneity. Because of the unobserved heterogeneityamong countries, we use techniques that permit the time-invariant component of the error term to be correlated withthe regressors (Fixed- effects model) and contrast our results with techniques that assume the effects are purelyrandom (Random-effect model).We use biennial data on gasoline and diesel retail fuel prices at the pump of more than 170 countries, for the years1993 to 2010. While reserve data comes from the Oil & Gas Journal, the data on oil consumption and production istaken from BP Statistical Review, and data on various economic variables taken from the World DevelopmentIndicators data bank. So as to evaluate the importance of governance we use data collected by the World Bank. Andto evaluate the importance of political regimes and state fragility we use Vreeland et al. (2008), the Polity IV, aswell as the State Fragility Index and Matrix.ResultsOne key factor that emerges for the analysis is the importance of the OPEC effect, whereby fuel prices in OPECcountries are substantially lower than elsewhere in the world. A second key factor that emerges from the analysis isthe regime effect and the importance of democracy and the existence of an elected legislative body. Having apolitical structure that distributes power to its constituencies mitigates the leader’s ability to use resources forredistributing income.Other factors, albeit secondary to the two identified above, include administrative capacity (or lack of), i.e., thegovernance effect, and that countries that export oil charge a lower fuel price, on average, than those that import oil,i.e., the export effect. The results also suggest stable differences among gasoline and diesel prices across countries,differences that are statistically significant.Two interesting observations emerge from the analysis: (i) we cannot show that higher income (which may beassociated with higher environmental awareness) results in higher fuel prices that are statistical significant fromthose observed in low income countries, i.e., the income effect is not statistically important, and (ii) countries that

import more oil do not necessary have higher fuel prices, suggesting that the fiscal fragility effect and dependenceon fuel tax revenues is not statistically related to volume of oil-imports.ConclusionsThe analysis identifies two inherent political economic factors that affect fuel prices. This suggests thatthe heterogeneity of fuel prices among nations will continue, and that increases in crude oil prices will translate tohigher prices in some countries but not in others. This diversified outcome will result in a differentiated approach toenergy conservation and adoption of alternative fuels. This prediction stems from the notion that adoption occursonly when a critical indicator, in our case fuel prices, reach a threshold level above which adoption of alternativesare worthwhile.Indeed, countries that invested in research and development of alternatives to fossil fuels experienced large increasesin fuel prices during the last decade, while countries that had low and very stable fuel prices did not invest much inrenewable technologies and are not diversifying their primary energy sources.To conclude, our work suggests that with the increase in crude oil prices we will observe a transition away fromfossil fuels in some countries but not in others. The composition of primary energy will shift away from fossil fuelsin oil-importing countries, but will result in the oil-exporting countries consuming relatively more of these domesticfossil fuel resources. Although many countries have eliminated or at least reduced their fuel subsidies (IEA 2011:World Energy Outlook 2010), we hypothesize that cheap fuels will always be observed in some oil-rich countries, aswell as in autocratic countries.