Why does gasoline price increase more than the oil price?

Thanks to the large stimulus programmes and active vaccination campaigns, the global oil demand boosted a lot recently, and the oil price surged more than 45% in the first half of this year. Do not be surprised if you occasionally observe the station-level retailer gasoline price rises even faster than the oil price. This phenomenon is known as the rocket effect in economics as the price hikes like a rocket. On the contrary, the price of gasoline typically falls like a feather and much less than the fall in oil price, which is called the feather effect. 

Researchers have noticed this type of asymmetric price transmission for many years, and a plethora of studies have been done to investigate this and the mechanisms behind it. While the results are controversial, studies mainly concentrate on the potential causes of asymmetry in tacit collusion, inventory capacity, station-heterogeneity, and consumer search cost.

However, since oil is the most crucial international trade commodity, the exchange rate should also dramatically impact the local gasoline price. All the above mechanisms fail to capture the local gas price response to the shock from the exchange rate. Chen et al. (2019) considered this problem. They propose to use the exchange rate pass-through (ERPT) to disentangle the effect of the exchange rate. ERPT measures the changes in import prices arising from an exchange rate shock. For example, if there is a 25% increase in the exchange rate and the imported commodity price also increases by 25%, we have ERPT equals one – a complete and symmetric ERPT. Alternatively, if the ERPT is less (greater) than unity, we have an asymmetric ERPT, and the imported commodity price may overreact (underreact) to the shock of the exchange rate. Chen et al. (2019) notice that all the past literature ignores the role of ERPT as a channel for rocket and feather effect and assumes a full pass-through. Notably, the empirical works are still correct given a country has symmetric ERPT. Yet, if the ERPT is asymmetric, the observed asymmetric response of the local gasoline price could originate from the asymmetric ERPT rather than the asymmetric price transmission. In other words, the rocket and feather hypothesis could be wrong, and the reason we observe the effect might owe to the asymmetric response to the shock of the exchange rate.

Chen et al. (2019) use extensive data in 28 EU countries to examine the above conjecture. First, Chen et al. (2019) estimate a panel error correction model with the whole sample. Consistent with the previous studies, they find evidence of asymmetric gasoline price transmission. Next, they employ a panel threshold error correction model and include the exchange rate as the explanatory variable. This way, they split the panel data into two groups: the net oil-import EU countries and the net oil-export EU countries. Intuitively, suppose the asymmetric ERPT does lead to the rocket and feather effect. In that case, we should observe a much larger and more significant impact of the ERPT on the gasoline price in the import-oriented countries than the export-oriented countries. Conversely, if we follow a similar impact level, the ERPT may fail to address the rocket and feather effect issue. Strikingly, Chen et al. (2019) find the proxy variable for ERPT is more crucial in the oil-importing country group – a 10% increase (decrease) in the level of exchange rate results in a 26.2% increase (decrease) in the local gasoline price in the short-run. Meanwhile, the impact of the exchange rate on gasoline prices is insignificant in the oil-exporting countries. These results confirm the vital role of ERPT as a mechanism for the rocket and feather effect.

Well, the gasoline station owner may not intend to charge you more money when the price surges. Instead, they may just be risk-averse over the high volatility of the exchange rate and take the cost of the risk from you.

Chaoyi Chen

Chaoyi Chen joined the MNB and the MNB Institute in 2020. He received a PhD in Economics from University of Guelph in 2019. His research interests are econometrics and applied econometrics. His research topics have included the threshold regressions,  long-horizon regressions, nonstationary time series regressions, and applications on macroeconomics.


References:

Chen, C., Polemis, M., & Stengos, T. (2019). Can exchange rate pass-through explain the asymmetric gasoline puzzle? Evidence from a pooled panel threshold analysis of the EU. Energy Economics, 81, 1–12.