NZ petrol prices reflect input costs not price gouging, says NZIER

By Kirdan Lees*

Often motorists complain that petrol companies are quick to raise petrol prices at the pump but then conspire to drop prices slowly when international oil prices fall.

Like in any efficient market, changes in the cost of oil - both up and down - should be passed on to consumers rapidly.

We run the numbers and find no evidence of opportunistic gouging. Petrol companies pass on oil price decreases to consumers just as quickly as they pass on increases in prices.

The good oil on petrol prices

The price of petrol is mostly made up of taxes and levies that retailers can do little about.¹

Figure 1 shows that, without these taxes, levies and the cost of the Emission Trading Scheme, weekly petrol prices roughly match weekly movements in the New Zealand dollar price of Dubai crude (using data from April 2004 to June 2013, available from the Ministry of Business, Innovation and Employment (MBIE)).²

At first glance, it appears that changes in oil prices are passed through to petrol prices relatively quickly. But whether the price response to increases in costs is the same price response as decreases in costs (the New Zealand price of Dubai crude) is not immediately obvious. Fuel prices could well be sticky downwards.

Some argue that when the cost of Dubai crude falls the old price offers a natural focal point for oligopolistic sellers who wish to preserve margins (see Borenstein et al. (1997), for example).

In many other countries, there are concerns that domestic petrol retailers have enough market power so that increases in costs are passed on more quickly than falling costs (see for example Australia, Canada, the United Kingdom and the United States).³

So we need to dig deeper to uncover whether New Zealand companies have market power over the retail price of petrol.

Running the ruler over pump prices

Our test for whether consumers pay too much at the pump looks at whether cost rises are passed on as quickly as cost falls. We take the percentage change in the Dubai oil price data in Figure 1 and construct a cost increase variable, that takes the change in price for all price increases but is 0 when the price falls.

That is:

If cost increases drive more rapid increases in prices at the pump, then our variable should help explain movements in petrol prices above and beyond changes in oil prices.⁴ That makes our regression for market power:

We also add lags of the variables as appropriate to our market power regression. Table 1 below shows our results for both petrol and diesel there is no evidence of price gouging in this way. Our cost increase variable  is unimportant in explaining price movements at the pump

cost increases have similar impacts to price decreases.

Are market dynamics improving over time?

We can expand our market power test to see if the degree of market power is changing over time. If market power is increasing over time, we expect oil price increases to lead to higher and longer increases at the pump relative to price decreases. To test for changing market power, we allow the parameter on our cost increase variable regressions to change or vary over time. This same test for changes in market power could be used more broadly in other markets.

Figure 2 shows the parameter on the relative responsiveness to cost increases has not changed much over recent history. So there is little to suggest changes in market power for either petrol or diesel.

1) The last 3c - a - litre increase in excise tax means the price of petrol is about 60 percent taxes and 40 percent determined by the cost of importing fuel.
2) See the weekly price monitoring information here: http://www.med.govt.nz/sectors - industries/energy/liquid - fuel - market/weekly - oil - price - monitoring.
3) See Bacon (1991), Deltas (2008), Noel (2009), Valadkhani (2010), Bermingham and O'Brien (2011), Clerides (2010), NZIER (2011) and Douglas (2010).
4) See Douglas (2010) and Valadkhani (2010) who use a very similar methodology.

*Dr. Kirdan Lees is a senior economist and head of public good research at the New Zealand Institute of Economic Research.

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