Varying effects of the domestic gasoline price

Energy and Macroeconomics Department, King Abdullah Petroleum Studies and Research Center (KAPSARC), Riyadh, Saudi Arabia ABSTRACT: The paper investigates gasoline consumption in case of oil-exporting country applying Time-varying Coefficient Cointegration approach to the data from 1980 to 2017. Empirical estimations show that long-run income and price elasticities are not constant and are responsive to price and income fluctuations in the period considered. The income elasticity of gasoline demand increased until 2014, peaking at 0.151, following growth in disposable income, before declining to 0.136 in 2017. However, consumers do not stop driving when their disposable incomes fall, resulting in a less elastic response of gasoline demand to income. Price elasticities sit in the range of −0.31 to −0.05, becoming less elastic when prices are low and vice versa. The findings of the study may be useful in successful implementation of energy price reforms and implementation of environmental policies. Introduction: After the drop in international oil prices in 2014, oil-exporting countries started to launch new policies to develop their economies. It is important that policymakers involved in energy and economic development understand how economic agents respond to increased energy prices and how the latter affects the demand for different fuels. Saudi Arabia is the biggest oil-exporting country and is currently undergoing many socio-economic reforms. The success of these reforms requires accurate assessments of the country’s energy indicators. The growth path of gasoline demand, a key strategic fuel, has important implications for oil security, oilrelated carbon emissions, and refinery investment (Dahl 2012).

As such, understanding how fluctuations in income and gasoline prices could affect the demand for oil in Saudi Arabia allows policymakers to assess what drives gasoline demand over time and the likely future development of oil demand. This knowledge can help demand-side policymakers control oil demand more effectively through the use of measures such as tariffs and taxes, among other instruments. It can also help supply-side decision-makers develop more accurate data on the oil supply needed to meet the anticipated demand and plan refinery investment accordingly. Having a clearer picture of future oil demand could also help the Kingdom to develop the necessary carbon dioxide (CO2) mitigation measures ahead of time, enable government entities to plan transportation services with more certainty, and help car manufacturers project their anticipated sales. After the fall of global oil prices, many oil-rich countries deployed energy price reforms (EPR) to raise government revenues, while encouraging more rational consumption of energy (see Gonand, Hasanov, and Hunt 2019 for further discussion). The responses of economic agents in oil-exporting countries to changes in the international and domestic economic systems gives useful insights to domestic and international policymakers. Regional and global stakeholders are currently looking to Saudi Arabia, the biggest exporter of oil, for insights into the possible development paths of their economies. A significant focus is placed on the impact of Saudi Vision 2030 (SV2030), and its various initiatives. For example, the number of female drivers in Saudi Arabia is projected to be around 3 million in 2020 (PwC 2018), following the lifting of the ban on women drivers in the country in 2018 as a part of the SV2030 women’s empowerment policy. This might increase gasoline demand in the near future through direct and indirect channels (such as women driving). PricewaterhouseCoopers (PwC) (2018) also projects car sales will increase by 9% annually up to 2025, against the 3% annual increase between 2013 and 2017. The analysis presented in this paper is of particular value for Saudi Arabia as it allows policymakers to quantify the impact of SV2030 targets and initiatives, including the possible impacts of price, income, and population on energy demand. These initiatives include the Fiscal Balance Program (FBP), the National Transformation Program (NTP), and the energy price reforms (EPR).

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The Vision’s goal of energy efficiency, for example, depends on having a clear picture of the numerical impacts of drivers on gasoline demand. Evidence from data and empirical studies (Algunaibet and Matar 2016, inter alia) show that price elasticity might vary over time. We use disposable income as an income proxy, which is taken from Mikayilov et al. (2020b), and measured in million SAR at 2010 prices. Looking at the development path of the Saudi economy, the response of gasoline demand to changes in the disposable income level is most likely not constant in the long run as the latter has changes significantly over the different developmental stages of the Kingdom’s economy as discussed in the Data section. As mentioned above, even in an environment of increased prices, some factors might increase demand by canceling out the effect of price increases. This phenomenon needs to be investigated further through appropriate theoretical and econometric methods. As is well known, it is important for policymakers to understand the price effect, as it has implications for fuel tax policies and policies to mitigate environmental degradation caused by fossil fuels. Given the development stages of the variables described above, the nature of price and income elasticities of gasoline demand in Saudi Arabia might not be constant, or at least their stability should be tested. In light of all the factors mentioned above, this study investigates possible time-varying effects of economic and demographic factors on gasoline demand in Saudi Arabia. The study contributes the following insights to the literature. First, to the best of our knowledge, this is the first study to have used the time-varying coefficient cointegration approach to assess the pattern of gasoline demand in Saudi Arabia. Second, only a few papers have modeled the demand for gasoline demand in the Kingdom and other oil-rich countries. The pattern of gasoline demand found in this study can be used as a general pattern to understand gasoline demand in similar economies. Third, we show that disposable income appears to be a better measure of income than overall gross domestic product (GDP) or non-oil GDP when modeling gasoline demand in the Kingdom. This measure can also be used to model the demand for other sources of energy. Fourth, estimating price and income elasticities could help decision-makers implement effective policies in the interests of achieving SV2030 targets, particularly EPR. The test for the long-run relationship concluded that there is a common trend. The empirical estimation used a time-varying coefficient approach and found the significant long-run time-varying income elasticity was less than 0.15. The long-run price elasticity was found to range between −0.31 and −0.05. Moreover, the speed of the adjustment coefficient is found to be −0.77, meaning that any short-run deviation can be corrected to the long-run equilibrium path in under 1.5 years.

The estimation results revealed that income does not have a significant impact on gasoline demand in the short run. The estimated short-run price elasticity is −0.13. The following policy insights can be derived based on the findings of the study. Periods of higher prices result in a higher negative impact on gasoline demand and long-term price increases might cause demand to decrease severely. Besides, short-run disposable income variations do not have a significant impact on gasoline demand. This suggests that income support policies for the private sector, if required, should be designed considering their long-run impacts. The findings of the study can be useful in the successful implementation of EPR and environmental policies. The statistically significant negative and time-varying effects of the domestic gasoline price are of particular use in this regard. The structure of the remaining part of the paper is organized as follows: section 2 reviews the related literature, section 3 summarizes the theoretical framework of the study; sections 4 and 5 discuss the methodology and give the data; section 6 details the study’s empirical results; section 7 discusses the study’s findings, and section 8 presents the conclusion. Conclusion: Saudi Arabia, the biggest oil exporter is currently undergoing many socio-economic reforms including EPR. The success of these reforms requires better understanding of energy and macroeconomic linkages. The current paper investigates gasoline consumption, employing a time-varying coefficient cointegration approach. This approach allows us to analyze the varying responses of demand to income and price levels. The following policy insights based on the findings of the paper can be pointed out. Gasoline price increases, when prices are already high, cause larger negative impacts on gasoline demand. Policymakers may consider how this finding can inform energy efficiency measures: Price increases in higher price regimes could produce energy efficiency gains by curtailing gasoline demand. Additionally, consecutive long-lasted price increases might cause demand to decrease severely. This finding could be useful for policymakers, depending on their objectives. For example, if they wish to increase energy efficiency, they could gradually increase prices over the long-term. Moreover, the short-run income variations do not have a statistically significant impact on gasoline demand. This suggests that income support policies for the private sector, if required, should be designed considering their long-run impacts. Overall, the policy insights mentioned above may be useful in the successful implementation of EPR and environmental policies.

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