Asymmetric adjustment of retail energy prices in Europe: Analysis of structural change and exchange rate dynamics

Abstract

This paper investigates the roles of structural changes and exchange rates in the relationship between retail energy prices and crude oil costs. Using a dummy variable approach, this paper argues that once the structural change in this relationship is taken into consideration, the empirical results of studies that found evidence in support of asymmetric behavior, which is largely obscured at pump where prices include both tax and duty, no longer hold. Adopting a nonlinear Auto Regressive Distributive Lag (ARDL) framework, this paper also shows that studies that failed to account for the exchange rate as part of the marginal cost of importing oil for countries with a high oil import dependency ratio may be misleading. Specifically, the results indicate that once the exchange rate effect is taken into consideration, the possibility of rent-seeking behavior in the gasoline markets of Italy and Spain disappears, while the rockets and feathers effect in the ex-tax gasoline, diesel, domestic heating oil, and industrial fuel oil markets of France, Germany, Italy, and Spain vanishes. Finally, employing instrumental variables and generalized method of moment estimators, this paper further finds that the results are robust and free from endogeneity issues.