EXPLAINING DIFFERENCES IN FUEL PRICES AMONG COUNTRIES

Gal Hochman, Rutgers University, (848) 932-9142, gal.hochman@rutgers.edu David Zilberman, University of California Berkeley, (510) 290-9515, zilber11@berkeley.edu

Overview
Although gasoline and diesel 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. What factors contribute to these very large differences? And what are their implications? The literature suggests several factors that may explain these differences, and we would like to investigate empirically their importance. First, there is an export effect: price of fuel varies between oil exporting and oil importing countries. Second, the OPEC effect: prices are lower in OPEC countries, relative to other oil exporting countries. Third, the oil reserve effect: consumers in countries with greater reserves pay less for oil than those in other countries. Fourth, the regime effect: fuel prices in democratic regimes are likely to be higher than in those in autocratic regimeswhile democratic leaders may use taxes to provide services, autocratic leaders may use fuel subsidies as a way to buy political support. Fifth, the governance effect: well-targeted redistribution wealth policies require 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 reflecting environmental 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 have lower fuel prices.

Methods
We develop a linear panel model and estimate the effects of these various political and economic factors on fuel prices throughout the world, while statistically correcting for endogeneity. Because of the unobserved heterogeneity among countries, we use techniques that permit the time-invariant component of the error term to be correlated with the regressors (Fixed- effects model) and contrast our results with techniques that assume the effects are purely random (Random-effect model). We use biennial data on gasoline and diesel retail fuel prices at the pump of more than 170 countries, for the years 1993 to 2010. While reserve data comes from the Oil & Gas Journal, the data on oil consumption and production is taken from BP Statistical Review, and data on various economic variables taken from the World Development Indicators data bank. So as to evaluate the importance of governance we use data collected by the World Bank. And to evaluate the importance of political regimes and state fragility we use Vreeland et al. (2008), the Polity IV, as well as the State Fragility Index and Matrix.

Results
One key factor that emerges for the analysis is the importance of the OPEC effect, whereby fuel prices in OPEC countries are substantially lower than elsewhere in the world. A second key factor that emerges from the analysis is the regime effect and the importance of democracy and the existence of an elected legislative body. Having a political structure that distributes power to its constituencies mitigates the leaders ability to use resources for redistributing income. Other factors, albeit secondary to the two identified above, include administrative capacity (or lack of), i.e., the governance 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 be associated with higher environmental awareness) results in higher fuel prices that are statistical significant from those 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 dependence on fuel tax revenues is not statistically related to volume of oil-imports.

Conclusions
The analysis identifies two inherent political economic factors that affect fuel prices. This suggests that the heterogeneity of fuel prices among nations will continue, and that 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: World Energy Outlook 2010), we hypothesize that cheap fuels will always be observed in some oil-rich countries, as well as in autocratic countries.