The Asymmetric Effects of Crude Oil Prices and Exchange Rates on Diesel Prices for 27 European Countries

  - Global Business Review

Many studies have examined the asymmetric effect of US dollar-denominated crude oil prices on petroleum product prices. The ‘rockets and feathers’ argument suggests that a crude price increase raises petroleum product prices more than a corresponding decrease in crude prices lowers product prices. However, for the countries that do not use the US dollar as a medium of exchange, petroleum product prices are also affected by the exchange rates. This paper analysed the asymmetric effects of both US dollar-denominated crude oil prices and exchange rates on local currency-denominated diesel prices for 27 European countries in the short run as well as long run. The overall empirical evidence suggests that, in the short run, diesel prices react more to crude oil price increases than to a decrease, parallel to the ‘rockets and feathers’ argument. However, contrary to that argument, the long-run adjustment is the opposite. As for exchange rate shocks, again the ‘rockets and feathers’ argument holds and diesel prices respond more to exchange rate depreciation than appreciation in the short and long run.

Petroleum product prices are important because of their effects on economic performance. Therefore, the effects of petroleum product prices on economic performance have been investigated in various studies in the literature. Apart from several determinants such as transportation cost, rental cost and labour cost, petroleum product prices are mostly influenced by crude oil prices and exchange rates. Most of the earlier studies were associated with the ‘rockets and feathers’ hypothesis introduced by Bacon (1991), which posits that petroleum product prices react faster to rises in crude oil prices than to decreases in prices. Besides crude oil prices, another factor is the exchange rate pass-through to petroleum product prices that builds up price asymmetry due to exchange rate changes. Particularly, the recent volatility in crude oil prices attracts attention to the price asymmetry commonly seen in retail petroleum product markets. This study aimed to explore the asymmetric effects of crude oil prices and exchange rates on diesel prices for 27 European countries over the short and long run.

The ‘rockets and feathers’ hypothesis asserts that gasoline prices give a faster response to increases in crude oil prices than to decreases. It is suggested that companies, owing to their market power, are inclined to raise prices rapidly when faced with cost increases while behaving sluggishly to adjust their prices downwards in response to cost decreases to keep profit levels high. Some other possible explanations for the presence of price asymmetry include inventory adjustment costs, the level of competition at different stages of the distribution channel, consumer search costs, type of cost shock (permanent vs. transitory cost shock and long-term vs. short-term cost shock) and consumer response to changing prices. The existing empirical literature on asymmetric price adjustment between crude oil and gasoline prices differs by country, data set, frequency of data, the econometric model used and findings. Although the ‘rockets and feathers’ phenomenon is supported in several studies, there are also some mixed results in the literature. For instance, while Bacon (1991) found evidence for strong and rapid adjustment of UK gasoline prices to cost changes, Manning (1991) showed that price adjustment does not last long. Likewise, various results are observed in the literature, some of which confirm price asymmetry and some which conclude no asymmetry or mixed signs of asymmetry.

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