Explaining Differences in Fuel Prices Among Countries

Gal Hochman

Associate Professor,

Rutgers University (New Brunswick, New Jersey)

and

David Zilberman

Professor

University of California, Berkeley

 

Explaining Differences in Fuel Prices Among Countries

By

Gal Hochman

Corresponding author:

Department of Agriculture, Food, and Resource Economics

and Rutgers Energy Institute

55 Dudley Rd.

Cook campus

Rutgers University

New Brunswick, NJ 08901

Email: Gal.hochman@rutgers.edu

Office phone: (848) 932-9142

 

David Zilberman

Department of Agriculture and Resource Economics

and Energy and Bioscience Institute

207 Giannini Hall

University of California Berkeley

Berkeley, CA

Email: zilber11@berkeley.edu

 

April 2012

 

Although fuel is a traded commodity, there are very large differences in fuel prices among different countries. For example, in 2006 the price of super gasoline in Turkmenistan was $0.02 per liter, while at the same time in Eritrea it was $1.90 (Metschies et al., 2007).  What factors contribute to these very large differences? And what are their implications? This paper aims to address these questions.

We begin by documenting some of the variations in fuel prices, as well as reviewing some of the theories that may explain these differences. We identify factors that contribute to differences in consumer fuel prices among countries, and then report results of an empirical analysis that quantifies each of these factors. We will conclude with a discussion of implications.

First, we document some of the differences in fuel prices across countries beginning with OPEC countries. Similar to Metschies et al. (2007), we define fuel prices as ‘subsidized’ when they are below average US prices, after deducting a highway tax of 10 US cents per liter, and denote this price the US benchmark price. Table 1 depicts 2006 gasoline and diesel prices in OPEC countries compared with the US benchmark price, revealing very low domestic fuel prices in some OPEC countries.

 

Table 1. Fuel prices in OPEC countries relative to the US benchmark price

Country

Gasoline price

Diesel price

(US benchmark price equals 53 cents per liter)

(US benchmark price equals 59 cents per liter)

Angola

94%

61%

Algeria

60%

32%

Qatar

36%

32%

Nigeria

96%

112%

Libya

25%

22%

Venezuela

6%

3%

UAE

70%

90%

Kuwait

42%

36%

Iran

17%

5%

Saudi Arabia

30%

12%

 

Figure 1 depicts gasoline and diesel retail prices from 1993 to 2010, for 170 countries. While the box includes 75% of the observations in a given year, the minimum and the maximum are located at the endpoints. For some countries prices remained low, while for others they increased. And the simple average prices of gasoline and diesel increased significantly as crude oil spiked throughout the 21st century.

 

Figure 1. Gasoline and diesel prices

 

Fuel is not the only major commodity for which consumer prices vary across nations. Other examples include food and minerals. These differences among prices of major commodities have been explained as outcome of policy choices and economic factors. Thus, while attempting to quantify and explain the large differences in gasoline and diesel prices among countries, our analysis draws from the following three branches of literature: (i) literature on environmental awareness; (ii) public finance literature; and (iii) literature on political regimes.

The first body of the literature argues that high-income is associated with environmental awareness. Since consumption of fossil fuels is a source of air pollution and greenhouse gas emissions, and high-income individuals are willing to pay more for cleaner air, richer countries tend to regulate air pollution that may result in higher fuel prices. The second body of the literature argues that governments should finance public goods (i.e. roads, national defense, education, etc.) and invests in infrastructure, and thus governments may tax fuels that have relatively stable demand as a source of revenue. The other end, countries with large fuel revenues will use these revenues to finance their expenditures. Government revenues are also used to provide a social safety nest when administrative capacity of the government is rather weak, subsidization of fuel as well as food may be a simple means to transfer income. The third body of the literature argues that politicians may use national government resources to enhance their political survival. Thus less constrained, autocratic governments are more likely to employ such methods. Subsidizing fuel is a simple means to buying political goodwill and the theory predicts that democratic regimes with an elected legislative body is less likely to use it.

In the case of energy, however, there are two additional factors that affect the formation of fuel policy: non-renewability and OPEC. The Hotelling model of non-renewable resources suggest that owners of extractive resources take into account both the cost of extraction as well as the future cost of reduced reserve (which is referred as ‘user cost’) in determining their extraction level. Thus countries with lower user costs and lower overall costs for extraction may spillover to lower fuel prices for their own consumers.

Models of international trade can provide a perspective of OPEC’s behavior. In particular, Hochman, Rajagopal, and Zilberman (2011) suggest that OPEC is a cartel-of-nations that aims to maximize the welfare of both its firms and consumers in setting prices. OPEC behaves as a monopoly and it charges consumers in importing countries higher prices than they would charge their own citizens—leading to a wedge between prices in OPEC countries and the rest of the world (see Table 1).

 

Figure 2. OPEC consumption relative to the world

 

One of the implications of the cartel-of-nations model is that, when the share of production in OPEC countries is increasing relative to the rest of the world, the wedge between the OPEC counties and the oil-importing countries increases as does the share of fossil fuels consumed by OPEC countries. Over the period 2000-2010 OPEC’s share of crude oil production relative to the rest of the world increased and the wedge between OPEC and the rest of the world increased.

The cartel-of-nations model emphasizes domestic consumption within the OPEC countries. Figure 2 depicts OPEC consumption relative to world consumption. The figure illustrates that although fuel consumption in OPEC countries was very low in the 1970s (and thus predictions of the export tax model would be similar to those of a cartel model), consumption of fossil fuel in OPEC countries increased significantly during the past couple of decades, with domestic consumption in OPEC countries reaching about 10% of world consumption by 2008 (which is roughly 20% of OPEC production).

However, a closer look at OPEC suggests much variability of fuel prices among the various OPEC countries. The aforementioned literature can provide an explanation. Countries with larger reserves are likely to have lower prices and the political regime, as well as the income of the countries, matter.

We develop an empirical model and estimate the effects of various political and economic factors on fuel prices throughout the world. The results verify the predictions of the cartel-of-nations model, showing that fuel prices in OPEC countries are substantially lower than elsewhere in the world.

A second key factor that emerges from the analysis is the importance of democracy and the existence of an elected legislative body. Having a political structure that distributes power to its constituencies mitigates the leader’s ability to use resources of the state for redistributing income to various constituencies by subsidizing food and fuel prices (de Mesquita et al., 2005).

These differences among countries suggest that the heterogeneity of fuel prices will continue among nations and increases in crude oil prices will translate to higher prices in some countries but not in others. This diversified outcome will result in a differentiated approach to energy conservation and adoption of alternative fuels. This prediction stems from the notion that adoption occurs only when a critical indicator, in our case fuel prices, reach a threshold level above which adoption of alternatives are worthwhile.

Indeed, countries that invested in research and development of alternatives to fossil fuels experienced large increases in fuel prices during the last decade, while countries that had low and very stable fuel prices did not invest much in renewable 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 from fossil fuels in some countries but not in others. The composition of primary energy will shift away from fossil fuels in oil-importing countries, but will result in the oil-exporting countries consuming relatively more of these domestic fossil fuel resources. Although many countries have eliminated or at least reduced their fuel subsidies (IEA 2011), we hypothesize that cheap fuels will always be observed in some oil-rich countries, as well as in autocratic countries.

 


References:

De Mesquita, B. B., A. Smith, R. M. Siverson, and J. D. Morrow. (2005). The logic of political survival, The MIT press: Cambridge, MA.

Hochman, G., D. Rajagopal, and D. Zilberman (2011). "The effect of biofuels on the international oil market." Applied Economic Perspectives and Policy 33(3): 402-427.

International Energy Agency (2011), World Energy Outlook 2010,

Metschies, G. P., A. Friedrich, F. Heinen, J. Peters, and S. Thielmann (2007), International fuel prices 2007: 5th edition - more than 170 Countries, GTZ - ’International Fuel Prices 2007’, April.

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