How changes in oil prices affect the retail prices of gasoline.

To answer that question, we use 1053 weekly observations of US retail gasoline prices from 1994 to 2014, obtained from the US Energy Information Agency. The retail price data are matched with weekly price data for West Texas Intermediate (WTI) and Brent.

We calculated the percent changes in the prices of retail gasoline, WTI, and Brent. Then we estimated a regression model where we explain the change in retail prices this week using the change in crude oil prices this week, last week, two weeks ago, and so on until ten weeks in the past. The objective is to test how a change in crude oil prices affects retail gasoline prices over time. The results are presented below. The * indicates a statistically significant effect, i.e. that we can be sure that crude oil prices affect retail prices. We start with the effect of WTI on gasoline prices:

This week: 0.16*
Lag 1 week: 0.18*
Lag 2 weeks: 0.10*
Lag 3 weeks: 0.06*
Lag 4 weeks: 0.04*
Lag 5 weeks: 0.04*
Lag 6 weeks: 0.03*
Lag 7 weeks: 0.01
Lag 8 weeks: 0.01
Lag 9 weeks: 0.00

What conclusions can we draw from these results?

• A change in the WTI price has an immediate impact on the retail price of gasoline during the same week. More precisely, a 10 percent change in the WTI price leads to 1.6 percent change in the retail price of gasoline.

• However, the effect continues for another six weeks. In fact, the strongest impact on retail prices comes one week after the change in the WTI price.

• The cumulative effect is about 7 percent. In other words, if the WTI price changes by 10 percent, the retail price of gasoline will change by 7 percent over the course of seven weeks. We arrive at that number by adding the effects during the first seven weeks. Note, however, that we add the impacts cumulatively; i.e. for example, the impact in week two comes on top of the impact in week one.

We got the same results using data on Brent. The cumulative impact of Brent price changes is about 7 percent and it takes about 7 weeks to work through the retail market.

Increasing vs. decreasing oil prices

Next, we ask whether an increase in crude oil prices is passed through to the retail prices with the same magnitude and time frame as a decrease in crude oil prices. For that purpose, we separated the data into two groups: weeks with a crude oil price increase and weeks with a crude oil price decrease. Then, we did the estimations for the two groups separately.

We find the same effect of an increase and a decrease in the price of WTI and Brent. In all cases the size of the effect is 7 percent. The only difference is that the effect of crude oil price increases is more immediate and largest in the first week of the change. In contrast, the effect of crude oil price decreases is more spread out over time. It seems that retailers make sure that the oil price decrease is permanent before passing it on to the consumer.

Stable and volatile times

Next we estimated the relationship between crude oil prices and retail gasoline prices separately for the period before 2007 and thereafter. Oil prices have been much more volatile during the 2007-2014 period and we want to test whether, during such a volatile period, crude oil prices affect more immediately retail gasoline prices.

That, indeed, is the case. In both periods, the cumulative effect is again 7 percent. However, in the period prior to 2007, the changes in WTI prices work through to the retail gasoline prices in about 7 weeks. After 2007, the changes in WTI prices have their full impact on retail gasoline prices within 4 weeks and the bulk of the impact comes in the current week and the first week after the price change. We observe the same effect for Brent. For example, a 10 percent change in the Brent price before 2007 leads to a 1.4 percent change in gasoline prices during the same week; after 2007 a 10 percent change in the Brent oil price leads to a 2.7 percent change in gasoline prices in the same week.

US compared to other countries

We did the estimations described above for three other countries: UK, Germany, and France to compare the results with the US. Similar to the US, changes in oil prices work through to the retail gasoline prices in 5-7 weeks. However, the magnitude of the effect is smaller. For example, a 10 percent increase in the price of Brent leads to a 3 percent increase in the price of retail gasoline in the UK.

The difference in the magnitudes of the effect between the US and Europe comes from the different level of taxes. In June 2014, a liter of gasoline cost about 1 dollar in the US and more than 2 dollars in the UK and the difference is explained by the significantly higher excise tax on gasoline in the UK. Otherwise, the cost of crude oil is pretty much the same for both countries. Respectively, when crude oil prices change they affect a much smaller portion of the retail prices in the UK.

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