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Article Excerpt
The paper presents panel unit root tests for price convergence of different petroleum products over the last decade. We distinguish consumer and producer price convergence and test for the absolute versus relative version of the law of one price. Comparing the speed of convergence as well as its development over time indicates that price arbitrage in the common EU markets is not sufficiently strong to level the price differentials, mainly caused by different excise taxation. We show that taxation alone leads to market segmentation and that discretionary national tax policy by EU member states is not (yet) threatened by the observable level of cross-border shopping.
1. INTRODUCTION
Prices for petroleum products--such as gasoline or gasoil--differ substantially between EU member states. As Figure 1 shows, the price level of 'euro super 95' gasoline in high-price countries is almost twice as high as in low-price countries. In fact, the case of gasoline and diesel fuel is striking as price differentials are sufficiently large to make cross-border shopping or 'fuel tourism' between some countries a major problem. For instance, some Italian regions bordering Switzerland and Slovenia had to introduce a markdown at fuelling stations to local households. Only these lower prices could stop the substantial revenue losses caused by fuel tourism (Banfi, Filippini and Hunt, 2005). (1) In Germany, similar measures are being discussed as fuel tourism has become a common phenomenon (Michaelis, 2004), for in most countries neighbouring Germany fuel prices are much lower. With diesel, the problem has become a Europe-wide challenge. Trucks on long-distance tours, accounting for a large share of diesel demand, have a cruising range of 1,500 to 3,000 kilometres without fuelling (EU Commission, 2002). This allows them to avoid fuelling in high-price countries.
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Arguably, one of the main reasons for the observed price differences is the different level of taxation in EU member states. Both excise and value-added taxes contribute to the existing differences. In our data set the share of taxes in retail prices ranges between about 46 percent in Portugal and 86 percent in the UK for euro super (more details will be presented in Section 2). Similar differences can be observed for other petroleum products. In fact, mineral-oil tax revenues account for substantial shares of national budgets of EU member states. The share in the budget was as high as 7 percent in the UK or Portugal in 1999, while for all EU-15 countries together the average was slightly less than 5 percent. (2) Fuel tourism therefore imposes a major threat to countries depending on high revenues from taxing these products.
Given the existence of substantial differences in both price levels and taxation for petroleum products in the EU, the focus of our paper is on investigating how the deepening of European integration has affected international price convergence between EU member states and how taxation relates to this. The process of European integration has removed barriers to the free movement of goods, services and factors of production, such as capital and labor. The Single European Act (1992) created an economic union, the Schengen acquis (1995) removed border controls, and with the introduction of the Euro as the single European currency in several EU member states in 1999 (European Monetary Union) exchange rate volatility disappeared. Finally, with the introduction of Euro coins and banknotes in 2002 transaction costs decreased even further. Without these barriers, price transparency and cross-border purchases of petroleum products in Europe, and in particular in the Eurozone, were expected to facilitate arbitrage, such that both tax-inclusive ('consumer') and tax-exclusive ('producer') prices for identical products eventually tend to converge, possibly at an increasing speed.
Taking these political developments as a starting point, we investigate whether the deepening of European integration had in fact an impact on price convergence. We will do so by first testing whether price convergence can be observed at all and, given that this is the case, how fast the speed of convergence is. Our estimates indicate a rapid convergence for producer prices. This may in part be explained by similar supply-side costs which are affected by the price dynamics of spot markets. However, despite some non-negligible, discretionary tax changes in the EU member states--such as the introduction of green taxes in Germany or tax reliefs in France at times of oil price hikes--consumer prices are found to converge surprisingly quick as well. Obviously, consumer arbitrage induced by cross-border shoppers and road haulage as well as a deepening of European integration puts some pressure on consumer prices. The speed of convergence has increased over time, indicating that the European Union's efforts were --at least in these markets--a step towards deeper integration.
Important policy implications are derived from the analysis of whether prices converge to the absolute or relative version of the Law of One Price (LOOP). We find convergence to absolute price parity only for producer prices of some products. In general, constant price differences between countries remain such that existing market segmentation, allowing for sustained price differences, can in general not be overcome. If consumer price convergence were sufficiently strong but taxes differ, there would be pressure either on tax rates or on suppliers of the products. While the first scenario would cause problems to finance public spending, the latter might end in closed fuelling stations or job losses. Our results are thus favourable for national policy-makers who will be able to continue with discretionary national tax policy. Because policy makers do not have to fear (substantial) negative international repercussions, the relative gain from introducing certain tax instruments--such as green taxes--on a national level allows them to do so more light-heartedly. Obviously, price arbitrage is not sufficiently strong to cause major restrictions to national policies; at the same time our results show that a fully integrated common market--inducing perfect price arbitrage--is far from being achieved, despite the fact that convergence has increased over time.
We extend the existing literature in several respects. To our knowledge, Bentzen (2003) is the only contribution dealing explicitly with gasoline (consumer) price convergence between countries. (3) He finds that since the 1970s some convergence has taken place in the OECD countries and in particular in OECDEurope. Our analysis adds to Bentzen (2003) by employing modern panel estimation techniques and investigating different products (euro super, diesel, gasoil and fuel oil). We elucidate several insights on the role of taxation, on differences across different products, and the speed of convergence, among others. Comparing different products is of particular interest as the products under consideration are not only taxed at different rates but differ also with respect to their ease of transportability. While private car owners can easily buy even small quantities of euro super or diesel at (almost) any time simply by crossing the border, gasoil and fuel oil have to be ordered in large quantities and shipped at specified times with trucks or even ships.
We also contribute to the literature on price convergence to the LOOP in international commodity markets--in particular to empirical studies using panel data (see, e.g., Asplund and Friberg, 2001; Goldberg and Verboven, 2005; Wieser, 2006; or Parsley and Wei, 1996). Based on panel unit root tests for price convergence of petroleum products over the last decade, our particular contribution is to give a better understanding of the role of excise taxation in the process of price convergence. We argue that excise taxation alone can introduce de facto market segmentation (allowing for relative price convergence only) in markets that would otherwise exhibit convergence to absolute price parity. Finally, our results are of interest for the discussion on international tax competition (see, e.g. Evers, de Mooij and Vollebergh, 2004, or Rietveld and van Woudenberg, 2005).
The paper proceeds as follows. Section 2 depicts the potential impact of European integration on prices for petroleum products and the role of taxation in this process. In section 3, we describe the markets of the products under consideration. The data is briefly introduced in section 4. Thereafter, section 5 presents our empirical results on convergence. We employ panel unit root tests in 5.1. Then, we estimate the speed of convergence (5.2), test for the absolute versus relative version of the LOOP (5.3) and investigate whether the speed of convergence increased over time (5.4). The final section concludes.
2. EUROPEAN INTEGRATION, THE PRICES FOR PETROLEUM PRODUCTS AND TAxATION
The ultimate goal of European integration is the free movement of goods, services and production factors in order to allow market forces to evolve freely. Consequently--and in perfect markets--arbitrage should lead to perfect international equalization of goods prices. In general, we would expect this to happen in the market for petroleum products as well. However, according to Figure 1, prices of euro super differ substantially between countries. Obviously, there are some obstacles to perfect price convergence; which shall be discussed subsequently.
If restrictions to international price arbitrage exist, local market conditions determine local prices. Without cross-border shopping, suppliers would be able to pass through taxes and possibly mark-ups more easily to the consumers. More precisely, from the perspective of suppliers, (retail) prices can be split into three components: the cost price, the seller's margin including sales promotion, and taxes (excise taxes and VAT). The cost price is mainly determined by prices for raw material such as crude oil. Since crude oil is traded in international spot markets which give the relevant price information to all market participants, the cost price is almost equal to all sellers. In fact, the underlying commodity price level is one of the reasons why we would expect (at least some) price convergence even in the case of closed economies. Balke, Brown and Yucel (1998) find that shocks to crude oil and gasoline prices are triggered mainly by supply rather than demand. However, production costs in the refineries differ, and so do transportation costs from the refinery to the buyers. (4) Generally, the specific geography of each country can cause price differences. These factors may explain existing differences in producer prices, but the pressure of market forces may erode the differences. In our analysis, we will--among other things--analyze whether arbitrage is sufficiently strong to achieve absolute (producer) price parity. When it comes to price differences 'at the pump', production costs do not appear to indicate price discrimination although they certainly contribute to regionalization or segmentation of markets for petroleum products.
Retail price differentials therefore need to be explained differently. Other possible explanations include international differences in the market structure or the price elasticities of demand. They may lead to differences in the seller's margin. In some countries markets are more competitive, e.g. there is a large number of independent fuelling stations or super markets offering fuel. Elsewhere there are few large suppliers exerting market power. (5) For several products cross-country differences in elasticities and implicit barriers to trade can actually be observed (see EU Commission, 2001), but as will be argued below compared to tax differentials they do not appear to be the dominant reason for price differentials in the petroleum products market.
According to the inverse elasticities rule (e.g., Myles, 1995, pp. 107), goods with an inelastic price elasticity of demand should be taxed at higher rates than goods with an elastic demand. With an inelastic demand, taxed goods can less easily be substituted by non-taxed goods, hence, the efficiency loss of taxation is lower. Its rather inelastic demand (see, e.g., Baltagi et al., 2003, or Pock, 2007) makes in particular (automotive) fuel an attractive source of tax revenue. Accordingly, most countries have introduced high tax rates for gasoline. In European countries, the total tax share is between 46 and almost 86 percent of the sales price of euro super (see the descriptive statistics in Table 1). These substantial tax differences are the most important reason for international price...
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