Transportation Oil Demand Consumer Preferences and Asymmetric Price Responses: Some UK Evidence

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1 SEEDS Surrey Energy Economcs Dscusson paper Seres SURREY ENERGY ECONOICS CENTRE Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Davd C. Broadsock, Alan Collns and Leser C. Hun Aprl 2010 SEEDS 126 ISSN Deparmen of Economcs Unversy of Surrey

2 The Surrey Energy Economcs Cenre (SEEC) consss of members of he Deparmen of Economcs who work on energy economcs, envronmenal economcs and regulaon. The Deparmen of Economcs has a long-sandng radon of energy economcs research from s early orgns under he leadershp of Professor Coln Robnson. Ths was consoldaed n 1983 when he Unversy esablshed SEEC, wh Coln as he Drecor; o sudy he economcs of energy and energy markes. SEEC underakes orgnal energy economcs research and snce beng esablshed has conduced research across he whole specrum of energy economcs, ncludng he nernaonal ol marke, Norh Sea ol & gas, UK & nernaonal coal, gas prvasaon & regulaon, elecrcy prvasaon & regulaon, measuremen of effcency n energy ndusres, energy & developmen, energy demand modellng & forecasng, and energy & he envronmen. SEEC research oupu ncludes SEEDS - Surrey Energy Economc Dscusson paper Seres (deals a as well as a range of oher academc papers, books and monographs. SEEC also runs workshops and conferences ha brng ogeher academcs and praconers o explore and dscuss he mporan energy ssues of he day. SEEC also aracs a large proporon of he deparmen s PhD sudens and oversees he Sc n Energy Economcs & Polcy. any sudens have successfully compleed her Sc and/or PhD n energy economcs and gone on o very neresng and rewardng careers, boh n academa and he energy ndusry. Enqures: Drecor of SEEC and Edor of SEEDS: Leser C Hun SEEC, Deparmen of Economcs, Unversy of Surrey, Guldford GU2 7XH, UK. Tel: +44 (0) Fax: +44 (0) Emal: L.Hun@surrey.ac.uk

3 Surrey Energy Economcs Cenre (SEEC) Deparmen of Economcs Unversy of Surrey SEEDS 126 ISSN TRANSPORTATION OIL DEAND CONSUER PREFERENCES AND ASYETRIC PRICE RESPONSES: SOE UK EVIDENCE Davd C. Broadsock, Alan Collns and Leser C. Hun Aprl 2010 Ths paper may no be quoed or reproduced whou permsson.

4 ABSTRACT The am of hs paper s o () esablsh he role of asymmerc prce decomposons n UK road ransporaon fuel demand, () make explc he mpac of he underlyng energy demand rend and () dsaggregae he esmaon for gasolne and desel demand as separae commodes. Dynamc UK ranspor ol demand funcons are esmaed usng he Seemngly Unrelaed Srucural Tme Seres odel wh decomposed prces o allow for asymmerc prce responses. The mporance of sarng wh a flexble modellng approach ha ncorporaes boh an underlyng demand rend and asymmerc prce response funcon s hghlghed. Furhermore, hese feaures can lead o dfferen nsghs and polcy mplcaons han mgh arse from a model whou hem. As an example, a zero elascy for a prce-cu s found (for boh gasolne and desel) mplyng ha prce reducons do no nduce demand for road ransporaon fuel n he UK. The paper llusraes he mporance of jon modellng of gasolne and desel demand ncorporang boh asymmerc prce responses and sochasc underlyng energy demand rends. Keywords: Gasolne; Desel; Asymmery; Prce; Underlyng Energy Demand Trend (UEDT)

5 Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence $ Davd C. Broadsock a, Alan Collns b and Leser C. Hun a a: Surrey Energy Economcs Cenre (SEEC), Deparmen of Economcs, Unversy of Surrey, Guldford, Surrey, GU2 7XH, UK. b: Correspondng Auhor, Deparmen of Economcs, Porsmouh Busness School, Unversy of Porsmouh, Rchmond Buldng, Porland Sree, Porsmouh, Hampshre, PO1 3DE, UK., Emal: alan.collns@por.ac.uk, Tel: Inroducon The overall demand for ol used for road ranspor connues o rse n he UK leadng o pressng envronmenal concerns. any sudes have sough o esmae ranspor fuel demand elasces, he resuls of whch are summarzed n Goodwn e al. (2004), Graham and Glaser (2004) and Brons e al. (2008), ner ala. However hese (and prevous) valuable revews only brefly dscuss he ssue of modelng ranspor ol demand as opposed o desel and gasolne separaely. oreover, hey gnored sudes ha aemp o ncorporae a sochasc Underlyng Energy Demand Trend (UEDT) wh a Srucural Tme Seres odel (STS) when esmang ransporaon fuel demand (e.g. Hun and Nnomya, 2003) and faled o dscuss he possble mporance of modelng Asymmerc Prce Responses (APRs) (e.g. smlar o ha used n Gaely & Hunngon, 2002). Therefore, hs paper assumes ha gasolne and desel are dsnc producs offerng dfferng servce qualy characerscs o consumers [1] and presens a general modelng framework ha encompasses boh a UEDT and APR usng he Seemngly Unrelaed Srucural Tme Seres unobserved-componens framework for UK road ranspor ol demand. $ Acknowledgemens We would lke o acknowledge useful commens receved from an anonymous referee on an earler verson of hs paper. All errors and omssons reman he responsbly of he auhors. Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 1 of 12

6 2. odelng Approach Harvey s (1989) Srucural Tme Seres odel (STS) framework s used o esmae UK road ransporaon gasolne and desel demand funcons as follows: A ( L) e p ~ 0, 2 NID (1a) B ( L) y C ( L) ~ NID0, e (1b) 2 1 ~ NID0, (1c) = g, d Where g s gasolne, d s desel, e s he naural logarhm of UK road ransporaon consumpon of fuel, y s he naural logarhm of UK GDP, p s he naural logarhm of he real ransporaon prce of fuel, and, he error erm for equaon (1a). A (L), B (L), and C (L) are polynomal lag operaors [2] so ha B (L)/A (L)= and C (L)/A (L)=, whch represen he long-run ncome and prce elasces for respecvely. P Y The process produces sochasc rends (he UEDTs) for boh gasolne and desel demand, he shapes of whch are governed by,,, and he hyperparameers 2, and 2 (whch are muually uncorrelaed whe nose dsurbances wh zero means and varances). Equaons (1b) and (1c) represen he level and slope componens of he rends hus allowng wo mechansms for sochascy. Ths allows he rend erms o be more flexble han f a sochasc slope componen was omed. [3] However, n he lmng case when he hyperparameers are equal o zero, he rends collapse o deermnsc rends, dencal o convenonal leas squares regresson; see, for example, Iqbal (1984) for one example of a dynamc energy demand funcon esmaed usng leas squares mehods, wh a deermnsc rend. Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 2 of 12

7 Esmaes are obaned by maxmum lkelhood n conjuncon wh a Kalman fler usng STAP 6.3 (Koopman e al., 2000), assumng all dsurbance erms are ndependen and uncorrelaed wh each oher. A general-o-specfc mehodology s employed removng nsgnfcan varables and hyperparameers ensurng a range of dagnosc ess are passed, [4] and models conform o economc heory. Gven poenal nerconnecons beween he gasolne and desel markes, a jon model s also esmaed by a Seemngly Unrelaed verson of he STS (SUSTS). The equaon specfcaons beng he same as above bu also allowng for covarance beween cross-equaon errors va he covarance erm. [5] g d Equaon (1a) assumes symmerc prce responses, bu o consder APRs, smlar o Gaely and Hunngon (2002), p s decomposed as follows: p p 1 p p R p c Where: p 1 s he value of he prce n he frs perod o.e. hs varable s a consan akng he value of he frs observaon n he sample; p s he cumulave ncreases n he log of maxmum hsorcal prces o.e. he frs perod s se equal o zero ( p 0 ) gven p 1 capures 1 he frs maxmum bu hereafer a me perod he prce s Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 3 of 12

8 compared o he maxmum observed prce pror o ha perod. If s greaer.e. p max p p 1,..., 1 added/accumulaed o he curren value of he varable;., hen s value s R p s he cumulave sub-maxmum ncreases n he log of prces o.e. he frs perod s se equal o zero ( p 0 ) and hereafer a 1 me perod he curren prce s compared o he prce n he prevous perod. If ncreases.e. p p 1, hen s value as added/accumulaed o he curren value of he varable f and only f remans below he hsorcal maxmum observed pror o ha perod.e. p p 1. If hs condon s no me (.e. p p 1 ), hen he ncrease s already capured n p and should no be ncluded agan here (o ensure double counng s avoded).; C p s he cumulave decreases n he log of prces o.e. agan he frs perod s se equal o zero ( p 0 ) and hereafer 1 a me perod he curren prce s compared o he prce n he prevous perod. If decreases.e. p p 1, hen s value as added/accumulaed o he curren value of he varable. If hs condon s no me (.e. p p 1 ), hen he nformaon regardng prce behavour s already capured n eher p or R p and should no be ncluded agan here (o ensure double counng s avoded). Thus p s replaced n Equaon (1a) by p, R p, and C p o gve he followng asymmerc specfcaons: A ( L) e ) (1a ) R R C C B ( L) y C ( L) p C ( L) p C ( L p Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 4 of 12

9 Wh he long run prce elasces replaced by he decomposed long run prce elasces; C ( L) / A ( L), P C R ( L) / A ( L) R and P C C ( L) / A ( L) C P represen he long-run prce-max, prce-recovery, and prce-cu elasces for respecvely. 3. Daa The energy daa (gasolne and desel consumpon n housands of onnes, and he weghed nomnal prces of gasolne and desel) are derved from he Dges of Uned Kngdom Energy Sascs (DUKES). GDP n m a 2005 marke prces and he mplc GDP deflaor 2005=100 (daa seres ABI and YBGB respecvely) come from he UK Offce for Naonal Sascs (ONS). The real gasolne and desel prces are calculaed by deflang he nomnal prces by he GDP deflaor. [6] Ths gves annual daa for 1960 o The fuel daa and her prces are presened n Fgure 1 and he decomposed prce daa n Fgure 2. Fgure 1: UK Road Transpor Fuel Consumpon and Prces ln(energy consumpon, housand onnes) ln(prce, ) eg ed pg pd Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 5 of 12

10 Fgure 2: UK Decomposed Road Transpor Fuel Prces ln(prce, ) pm^g pr^g pc^g pm^d pr^d pc^d 4. Resuls Table 1 gves he preferred esmaon resuls showng ha all specfcaons f he daa well wh almos all dagnosc ess passed. The only slgh ssue s ha he desel equaon, wheher esmaed separaely or jonly, forecass well n he pos esmaon perod up o 2007 bu no 2008 when desel consumpon fell by jus over 2% afer growng by nearly 4½% per annum from 2000 o However, s no surprsng ha he equaon esmaed up o 2002 does no manage o predc he oal mpac of he recen severe recesson. In all probably hs would need an nervenon o ensure he normaly of he auxlary resduals (rregular, level and slope) f esmaed up o and ncludng 2008 gven hese generally provde nformaon abou mporan breaks and srucural changes a ceran daes whn he esmaon perod, such as a severe recesson (Koopman e al., 2000). For gasolne, hs s no a problem gven ha consumpon fell by abou 2¾% per annum from 2000 o 2007 so ha, alhough he declne n 2008, a abou 5¼% was faser, was sll par Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 6 of 12

11 of he general downward rend durng he 2000s and hus capured adequaely by he equaon esmaed up o The resuls ndcae ha he UEDT and APRs are complemenary gven hey are boh reaned n he preferred models. Furhermore, he long-run gasolne and desel APRs are n lne wh expeced nuon gven P R P C P, hence, hey are plausble boh concepually and emprcally (whch s no always he case n such APR models). I can also be seen ha n he long-run desel demand s somewha more responsve han gasolne demand o a prce rse above he prevous maxmum. However, he esmaes sugges ha boh gasolne and desel demand respond smlarly o a prce recovery below he prevous maxmum and boh do no respond a all o a prce cu. The ncome elasces porray an neresng sory suggesng ha n he long-run rsng ncome wll lead o a slghly hgher rse n he demand for desel han for gasolne, moreover, n he shor run desel s sgnfcanly more responsve han gasolne o ncome changes. A smlar sory holds for he prce elasces, wh desel beng generally more responsve han gasolne n boh he long run and he shor run. Ths may, n par, be due o he naure of demand for he dfferen fuel ypes and ha hsorcally hey have refleced non-homogenous ypes of auomobles.e. desel beng used for busness and fregh purposes, whle gasolne had been more wdely used by he general publc. As such he economerc resuls mgh mply ha busnesses reduce demand more rapdly han consumers who may well be more deeply locked n o her consumpon paerns. Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 7 of 12

12 Table 1: Esmaon Resuls ( ) Preferred specfcaons STS Asymmerc Prces SUSTS g d g d Varable y 0.675*** 1.193*** 0.688*** 1.182*** y ** 0.400*** p ** * p *** *** p R * *** * *** Inervenons Slp1982*** Slp1982*** Lvl1986*** Slp1997*** Lvl1986*** Slp1997*** Slp2000*** Slp2000*** Hyperparameers σ 2 ε x σ 2 η x σ 2 ζ x Long run Elasces Y P P R P C Resdual dagnoscs Normaly H (12) r (1) r (2) r (3) r (4) DW Q (8,6) R d 2 Auxlary resduals Irregular -normaly Level-normaly Slope-normaly Predcve ess Falure ( ) Falure ( ) *** *** Noes for Table 1: ***, ** and * represen sascally sgnfcan a he 1%, 5% and 10% levels respecvely. Normaly s he Bowman-Shenon es, approxmaely dsrbued as χ 2 (2). H(n) s he es for heeroscedascy, approxmaely dsrbued as F (n,n). r (1), r (4) are he seral correlaon coeffcens for lags 1-4 respecvely, approxmaely dsrbued as N(0,1/T). DW s he Durbn Wason sasc. Q (8,n) s he Box-Ljung Q-sasc based on he frs n resduals auocorrelaon; dsrbued as χ 2 (n). R d 2 s he coeffcen of deermnaon based on dfferences. Falure ( ) s he pos-sample predcve falure es, approx. dsrbued as χ 2 (5); Falure ( ) s he pos-sample predcve falure es, approx. dsrbued as χ 2 (6). Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 8 of 12

13 The UEDTs, gven n Fgure 3, show ha n he frs half of he sample perod he esmaed UEDTs for gasolne are rsng almos connually unl he md 1980s, bu generally falls que sharp hereafer. Ths suggess ha he exogenous facors ncreased he demand for gasolne over he early par of he sample bu reduced demand over he laer par perhaps reflecng greaer vehcle effcency. However, for desel he esmaed UEDTs are generally rsng hough he sample oher han a slgh declne durng he 1970s and a sharp declne n he lae 1990s. These dfferen esmaed exogenous mpacs (n addon o he dfferen esmaed elasces) hghlghs he mporance of modelng gasolne and desel separaely (unlke Hun and Nnomya, 2003). Fgure 3: Esmaed Sochasc UEDTs for UK Road Ol Transpor Demand, APR-SUSTS ln(gasolne consumpon, housand onnes) ln(desel consumpon, housand onnes) Gas Gas (SURE) Desel Desel (SURE) Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 9 of 12

14 5. Dscusson and Concludng Remarks The elucdaon of consumer responses as measured hrough he UEDT s a crcally mporan exenson o he more radonal mehods used o model fuel demand elasces. The ncluson of such feaures, combned wh APRs, arguably provdes more dealed polcy relevan nformaon han models whou such feaures. oreover, evdence s provded here o sugges ha he wo fuels are no vewed n he same way by consumers, and n parcular, n recen decades consumers have followed que dvergen underlyng rends. Ths herefore suggess ha aggregaon of he wo fuel ypes no a sngle commody mgh lead o he consderaon of blun polcy nsrumens ryng o allevae o a happy medum for wo conflcng markes. Dfferences are found n he shor-run and long-run dynamcs of he wo fuel ypes, boh for he ncome and he prce elasces, and s furher found ha APRs preval over more convenonal symmerc responses. Perhaps mos neresngly, s found ha he mpac of prce decreases are sascally nsgnfcan, herefore ceers parbus, prce reducons do no nduce demand for road ransporaon fuel n he UK. Ths could be sympomac of a number of ssues, such as rsng congeson, reduced on-sree parkng (and wh hgher parkng coss) ec., whch hemselves would be refleced n he UEDT, albe mplcly. From a polcy perspecve, he mplcaon of a zero prce cu elascy s ha he prce of fuel could poenally be reduced, ergo reducng he overall servce cos of ransporaon and hence generang an ndrec ncome boos o he economy, whou leadng o dermenal growh n he demand for hese hghly pollung fuels. Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 10 of 12

15 Noes 1. Due o () real servce-cos dfferenals and () dfferng raes of echnologcal progress n auomove echnologes for gasolne and desel; an assumpon renforced by he subsequen emprcal analyss. 2. Wh a lag of four years. 3. There s a wde and rapdly growng leraure relang o sae space modellng of me seres processes. For an accessble nroducon o such processes n economc analyses see for example Commandeur and Koopman (2007). 4. In addon, mpulse dummes are ncluded where here s some evdence of nonnormaly of he auxlary resduals followng Harvey and Koopman (1992). 5. We noe ha he presen sudy s prmarly concerned wh () he srucure of he demand funcon and () hghlgh he poenal role of he UEDT whn. any sudes ake alernave approaches o analyss and consder ner-fuel subsuon elasces, for example Wesoby (1984). However, hese sudes are normally based upon facor-share based relaonshps, and whle of sgnfcan mporance n her own rgh, are less concerned wh denfyng ndvdual fuel demand relaonshps. 6. Nong ha as gasolne demand s made up of a number of separae grades of gasolne he prce seres for gasolne s defned usng a quany-weghed average ncludng he followng componens: 2 Sar ( ), 3 Sar ( ), 4 Sar ( ), 5 Sar ( ), Super Premum Unleaded ( ) and Premum Unleaded ( ). Nong ha a number of he fuel ypes of he perod eher/boh enered or lef he marke for varous reasons. Unque prce seres are no avalable for 3 Sar and 5 Sar fuel, herefore s assumed ha hey have he same prces as 4 Sar fuel, whch s much closer n qualy han 2 Sar fuel. Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 11 of 12

16 References Brons,., Njkamp, P., Pels, E. and Reveld, P., (2008), A mea-analyss of he prce elascy of gasolne demand. A SUR approach, Energy Economcs, Vol. 30, pp Commandeur, J. and Koopman, J., (2007), An nroducon o sae space me seres analyss, Oxford Unversy Press, New York, USA. Gaely, D. and Hunngon, H. G., (2002), The asymmerc effecs of changes n prce and ncome on energy and ol demand, The Energy Journal, Vol 23, pp Goodwn, P., Dargay, J. and Hanly,., (2004), Elasces of road raffc and fuel consumpon wh respec o prce and ncome: A revew, Transpor Revews, Vol. 24, pp Graham, D. and Glaser, S., (2002), The demand for auomoble fuel, Journal of Transpor Economcs and Polcy, Vol. 36, pp Harvey, A. C. and Koopman, S. J., (1992), Dagnosc checkng of unobservedcomponens me seres, Journal of Busness and Economc Sascs, Vol. 10, pp Harvey, A. C., 1989, Forecasng, Srucural Tme Seres odels and Kalman Flers, Cambrdge Unversy Press, Cambrdge, UK. Hun, L. C. and Nnomya, Y., (2003) Unravellng Trends and Seasonaly: A Srucural Tme Seres Analyss of Transpor Ol Demand n he UK and Japan, The Energy Journal, Vol. 24, pp Hunngon, H. G., (2006), A Noe on Prce Asymmery as Induced Techncal Change, The Energy Journal, Vol. 27, pp Iqbal,., (1984), Resdenal Energy Demand: A Case Sudy of Paksan, Journal of Economc Sudes, Vol. 11, pp Koopman, S. J., Harvey, A. C., Doornk J. A. and Shephard N., (2000), Samp: Srucural Tme Seres Analyser, odeller and Predcor, London, Tmberlake Consulans Press. Wesoby, R., (1984), odels of Inerfuel Subsuon n he UK, Journal of Economc Sudes, Vol. 11, pp Transporaon Ol Demand Consumer Preferences and Asymmerc Prce Responses: Some UK Evdence Page 12 of 12

17 Noe: Ths paper may no be quoed or reproduced whou permsson Surrey Energy Economcs Cenre (SEEC) Deparmen of Economcs Unversy of Surrey Guldford Surrey GU2 7XH

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