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Demand for oil products in the GCC countries
Energl Policy.Vol. 25, No. I, pp. 55-61. 1997 Copyright ¢3 1907 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0301-4215/97 $17.00 + 0.00
ELSEVIER
PII:S0301-4215(96)00122.X
Demand for oil products in the GCC countries Abdul-razak F. Al-faris Economics Department, Faculty of Business and Economics, United Arab Emirates University, PO Box 17555, A I-ain, UAE
The purpose of this study is to estimate the price and income elasticities of oil products demand in the GCC countries. Annual data spanning the period 1970-91 were fitted to a partial adjustment model to obtain the estimates. The main finding of the study is that both price and income are relatively inelastic in the short-run, and there has been a great variation in these elasticities among fuels and cross-country. Copyright © 1997 Elsevier Science Ltd. Keywords: GCC; Elasticity of demand; Oil products
Oil c o n s u m p t i o n in t h e G C C
Estimates of demand elasticities of petroleum products are an important issue for the GCC countries' economies. Price and income elasticities are important parameters in projecting energy demand and in planning the needed refining capacity to meet future domestic consumption. They are also indispensable tools for policy makers for indicating the extent of price increase required to curtail internal consumption wastages and for pinpointing the potential for market forces to achieve energy conservation. Much effort has been devoted to the estimation of energy demand elasticities in the industrial countries, and the results have been of great importance for demand management and forecasting. The demand for oil in particular has received considerable attention. These studies' major concern was to gauge the speed and degree of consumers' reactions to changes in income and fuel prices and recently to prescribe and evaluate policies aimed at protecting the environment. Perceived as major oil exporters, the GCC nations have been the focus of a great deal of modelling work related to these countries' crude oil production and pricing policies. The patterns of domestic energy demand in the Gulf countries have been rarely discussed and the demand for petroleum products in particular has attracted much less attention. Moreover, most of these studies are limited by data deficiency and by a lack of detailed information at the end-user levels. This study tries to bridge the gap by providing fresh data and evidence on the major determinants of oil consumption in the GCC countries. And its aim is to provide a set of estimates of price and income elasticities of oil products' demand in the Gulf countries and to shed some light on their implications for government policies related to energy and the environment.
The pace of development in the GCC countries accelerated dramatically during the last two decades. The sharp rise in oil prices in the 1970s transformed these countries' ability to invest in industry and infrastructure. Equipped with massive oil revenues, the Gulf countries embarked on ambitious programmes to diversify their economic structure and to improve the standard of living. This rapid economic growth was associated with large increases in per capita income, urbanization, industrialization, transportation, and electrification. Consequently, these countries' demand for energy has been growing at a much higher rate than that of developed and developing countries. Total primary energy consumption in the GCC countries increased from 18 mtoe in 1973 to 115 mtoe in 1990, with an average annual growth rate of 32%. The annualized double digit growth rates of the 1970s were followed by a slower growth rate due to the gradual decline in oil revenues since 1983. The collapse ofoil prices in 1986 had accentuated the financial squeeze in these countries and prolonged the economic slow down. Despite this, commercial energy consumption, mainly oil, continued to grow at high rates as a result of energy pricing policies. Domestic products' prices in the majority of these countries have been maintained at a constant level in nominal terms and at levels well below their counterparts in the international oil market. Trends in demand, as shown in Table 1, have not been identical for all petroleum products, nor have they been so for all the GCC countries. It is apparent that consumption growth rates of all products, except that of kerosene, increased substantially during the 1970s in the GCC countries, 55
56
Demand for oil products in GCC countries." A. E AI-/'aris
Table I Average annual growth rates of consumption of petroleum products Country Saudi 1970~80
1981-91 UAE 1970~0 198 I-91 Kuwait 1970-80 198 I-91 Oman 1971-80 1981-91 Qatar 1971~80 198 I-91 Bahrain 1970-80 1981-91
Gasoline
LPG
22.7 6.2
24.2 5.0
26.5 5.9
Kerosene
Jet fuel
Gas oil
Fuel oil
Total
-4.5
24.1
41.7
16.5
6. I
5.4
65.7 8.3
30.4 5.5
38.2 5.6
20.6
70.2 7.0
63.8 6.9
144.7 6.7
58.2
1.9
12.3 2.4
51.6 22.2
-0.02 -0.5
23.1 -I. 1
57.9 ~).2
57.9 162
22.1 0.8
40.5 9.1
I 0.1 13.8
43.5 -9.6
37.9 18.9
30.6 6.3
0.0 37
31.4 8.5
16.8 6. I
24.4 29.2
-3.8 - I 2.4
47.4 8.8
19.0 0.6
0.0 0.0
18.4 5.0
14.0 7.3
18.1 5.3
0.7 10.2
15.7 -0.4
17.5 1.0
30.9 0.0
14.7 1.6
5. I
Source: Calculated from OECD (1993).
Table 2 Shore of products in total oil consumption in the G C C countries Country Saudi 1971 1981 1991 UAE 1971 1981 1991 Kuwait 1971 1981 1991 Oman 1971 1981 1991 Qatar
Gasoline
LPG
Kerosene
Jet fuel
Gas oil
Fuel oil
27.0 15.4 16.9
3.8 1.6 1.4
6.2 0.2 0.4
9.7 5.3 4.6
22.2 30.2 29.0
22.8 25.9 33.0
39.4 16.2 15.8
2.0 2.1
7.3 0.7 0.6
10.2 18.9 20.7
41.5 43.1 38.2
1.2 18.8 21.7
52.7 23.2 13.1
4.7 1.8 2.1
5.5 0.9 0.2
15.2 9.3 3.1
19.1 27.7 38.5
37.1 42.3
19.5 34.5 37.7
7.5 1.6 2.5
1.6 1.8 0.3
15.5 20.5 23.7
55.8 41.6 34.2
1.7
1971
43.4
-
41.4 49.4
3.3 13.3
6.0 0.8 0.4
13.4 13.0
34.0 35.5 24.2
-
1981 1991 Bahrain 1971 1981 1991
-
13.7 17.6 26.6
4.1 4.0 5.4
4.1 1.3 2.9
62.2 61.5 53.1
13.1 13.4 10.6
0.8 0.4 -
Source: Calculated from OECD (1993).
and subsided during the 1980s. In every case the average growth rates o f heavy fuel oil surpassed that of total oil consumption. This product is used mainly in electricity generation, desalination, and in industry. In the 1980s, extensive measures taken to exploit alternative energy sources, especially natural gas, reduced the demand for heavy fuel. The growth of population, migrating, urbanization, and per capita income contributed to rapid growth in demand for transport fuels, gasoline, diesel, and jet fuel. The low, and in some instances negative, growth rate of kerosene is due to the switch over by consumers to LPG because this is a cleaner and safer source of energy. The variation in demand growth rates of different oil products, over the period considered, ultimately changed the composition of these countries' consumption. Table 2 presents the development of individual products' shares for
selected years. Again, this table shows very clearly that not all petroleum products behaved identically. In two countries, Saudi Arabia and the UAE, fuel oil increased its share significantly and, in 1990, it dominated with shares of 33% and 42.3% respectively. Gasoline consumption in the GCC countries increased nearly ten-fold over the period considered. In the early 1970s, gasoline accounted for an average of 35% of the total final oil consumption. Rapid structural changes in the Gulf economies during the later years boosted the demand for heavier products, and the share of gasoline subsequently dropped to an average of one-quarter. Having said this, the table shows that there have been wide inter-country differences in the share of gasoline in total oil consumption. The gasoline share, on average, has been lowest in Saudi Arabia and the UAE, where economies are more diversified, and
Demandjbr oil products in GCC countries: A. F. Al-laris
highest in Kuwait and Qatar, where per capita income is the highest and domestic absorptive capacity is the smallest. High growth rates of consumption of light fuel oil (gas oil/diesel) in the 1970s have given way to much lower growth rates in the 1980s in all the GCC countries. The largest users of gas oil/diesel are industry, transport, and agriculture. The average share of light fuel oil during the period under study changed only slightly, though shares cross-country exhibit more divergent patterns. The share of kerosene declined, while that of LPG either increased slightly or remained virtually unchanged. This reflects the pattern of structural changes in energy consumption associated with the development process. At low levels of income, kerosene is the main fuel used in the residential sector for cooking and heating. As per capita income increases, both the share of kerosene in the residential fuel mix and the share of residential sector itself tend to decline. The major beneficiary at this stage will be LPG. At higher income levels, consumers switch to electrically operated appliances, and substitute electricity for LPG.
The model Most energy demand models are intimately related to the partial adjustment model proposed by Balestra and Nerlove (1966). Houthakker and Taylor (1970) tried to relax the strictly linear form of this model to an equation which is linear in logarithms. The basic assumption of the model is that consumers only partially adjust to an equilibrium demand. The adjustment is partial because of some frictions, habit formation, earlier commitments, costs involved in replacing the existing capital stock, or lack of information. In static models, the underlying assumption is that adjustment is completed within the unit time period, that is, there is an instantaneous adjustment in demand with relation to changes in income or prices. For quite a few commodities and, especially those consumed in association with capital equipment, the static models proved to be unsatisfactory. The partial adjustment model consists of two equations. The first equation defines the equilibrium value, and expresses desired demand Q*t as a function of a vector of exogenous variables X t as follows: (1)
Q*t = XtB* + 8t
The second states that the current value of Qt adjusts to its equilibrium level only slowly: Q I - Q~I = ( 1 - 6) ( Q * , - Q,-i) + vt
(2)
Solving (1) and (2) for Qt, we have
(3)
Qt = XrB + 6Qr-i + Ut
Where: B = (1 - 6 ) B *
Ut = (1- 6)ct + vt
57
6 is the adjustment coefficient and measures the proportion by which the divergence between the equilibrium level and the actual level is bridged in period t. In the extreme case, where 6 - 1, the two quantities (derived and actual) are equalled, the adjustment is instantaneous, and we end up with a static model. The closer 6 is to one, the more rapid is the adjustment to a shock to the system, and the smaller it is, the slower is the adjustment. Equation (4) could be expressed in an estimable form: Q, = ~0 + ~1P' + ~2Yt + ~3Qt--1 +
(4)
If this equation is estimated in a logarithmic functional form, then the variables' coefficients represent the short-run income and price elasticities. The long-run elasticities are calculated as the short-run elasticities divided by (1 - ~ 3 ) , where ~3 is the coefficient of lagged endogenous variable. Two qualifications have to be made before proceeding to an estimation. The first is that Equation (4) as expressed is not exactly a Marshallian demand function, since it includes the own price (Pt) and not the cross-price relationship: Eeik Pk. Where eik is the cross-price elasticity of demand. Some energy economists argue that much of the long-term adjustments to changes in petroleum prices would arise not only from gradual efficiency improvements in energy using equipment, but also from the substitution of alternative fuels. Hence, the model formulation should explicitly include inter-fuel substitution. Setting the majority of the cross-price elasticities to zero is not an ideal solution. Price elasticities contain substitution as well as income effects. And if we assume that the former may well be zero for some unrelated commodities, there is no reason to justify setting the latter's value to zero. In a recent study, Waverman (1992) indicated, contrary to widespread belief, that energy sources are imperfect substitutes for each other. In some usages, such as transportation and lighting, there are no fuel switching possibilities and, in other sectors, substitution would entail high costs. Waverman (1992, p 23) concluded, after surveying several relevant studies, that 'the majority of CEDs (cross-price elasticity of demand) surveyed here are very low in the short-run, below 0.15 and with several significant exceptions, well below 0.10 in the long-run'. Moreover, introducing energy substitution in our model requires a disaggregated data on final fuel consumption by sectors and sub-sectors, which is not available for the GCC countries. The second qualification is related to the lag structure in the partial adjustment models. The Koyck lag model applies to a situation where a demand response to changes in prices is consistent with the adjustment process in capital equipment. Replacing the stocks of energy using appliances is costly, and demand adjustment to a price jump must be a slow process. In each time unit, a fraction of the existing durable equipment is replaced by new and more efficient equipment. Some energy saving, however, can be achieved by other means such as conservation, retrofitting etc. Using the Koyck lag structure may, therefore, lead to underestimation of the adjustment coefficient and long-run
58 Demand for oil products in GCC countries: A. F. AI-faris Table 3 Empirical estimates of gasoline demand Variable Saudi UAE P Y Qi-i R-~ DW LM
-0.09 (3.4) 0.03 (2.4) 0.72 (9.0) 0.9981 2.3 5.3
-0.08 ( I. 1) 0.28 (2.8) 0.71 ( 12.2) 0.9779 2.7 3.2
Kuwait
Oman
Qatar
Bahrain
-0.10 (1.40) 0.07 (3.63) 0.94 ( 13.0) 0.9435 2.1 8.3
-0.29 (4.6) 0.27 (10.2) 0.76 (23.1) 0.9983 1.39 6.4
-0.14 (2.0) 0.02 (1.97) 0.80 (8.3) 0.9976 2.1 9.8
-0.16 (2.9) 0.11 (3.6) 0.9 I (40.8) 0.9935 2.4 15.5
Oman
Qatar
Bahrain
-2.3 (1.87) 0.25 (0.72) 1.39 (6.1) 0.9679 1.94 2.61
-0.20 (2.46) 0. I 1 (2.66) 1.13 (13.9) 0.9579 1.38 6.20
Table 4 Empirical estimates of LPG demand Variable
Saudi
UAE
Kuwait
P
-0.22 (1.68) 0.12 (2.4) 0.74 ( I 1.1 ) 0.9568 2.57 4.31
-0.53 (2.02) 0.28 (I.65) 0.62 (6.56) 0.9808 2.36 5.77
-0.88 (2.13) 0.68 (2.24) 0.78 (7.6) 0.8147 1.92 7.78
Y Qwl R2 DW LM
Table 5 Empirical estimates of Kerosene demand Variable Saudi UAE p Y
Q,_~ R2 DW LM
-0.48 (2.14) 0.70 (3.36) 0.74 (4.57) 0.9603 1.41 4.98
Kuwait
Oman
Qatar
Bahrain
-0. I 0 (1.85) 0.01 (0.21) 0.54 (1.91) 0.6857 1.74 2.62
-0.48 (2.67) 0.24 (1.55) 0.77 (8.44) 0.9620 2.65 5.76
-0.08 (2.59) 0.07 (1.38) 0.75 (4. I ) 0.8762 2.53 10.4
-0.09 (0.78) 0.09 (1.42) 1.14 (27.0) 0.9614 2.40 4.33
elasticities. Alternatively, a polynomial lag model could be used. Preliminary experiments with the Almond lag give unsatisfactory results and this technique, moreover, has several drawbacks. The first is related to the choice of number of restrictions that should be imposed on the coefficient yi. The second is the problem of choosing the lag length, K, and the degree of the polynomial, r. Third, and probably more importantly, polynomial lag models, because they are non-dynamic, are considered to be unsuitable for modelling the energy demand (see Davidson and MacKinnon, 1993).
The empirical results Our analysis is based on a simple reduced form single equation model. Time series spanning the period 1970-91 for six categories of petroleum products in each country are employed. These products are: gasoline, LPG, kerosene, aviation fuel, gas oil/diesel, and fuel oil. Petroleum products other than gasoline have much more heterogeneous applications and, as a result, are not analysed by their particular end use. Because of great differences among these countries in terms of oil reserves, pricing policy, and availability of alternative energy, the demand for each product in each country is estimated separately instead of using
pooled time series. Pooling technique may mask the results and give misleading information about these countries' actual response to changes in prices or income. The model was estimated by using OLS. The dependent variable (Qt) is the total demand for a particular product in each country and Qt-l is consumption in the previous year. Pt is the price of the respective product per barrel and Yt is a measure of income and two proxy are used; GDP and private consumption. The variables' data of each country are expressed in their own currency to eliminate the effect of the exchange rate fluctuations. Moreover, variables are expressed in nominal and not in real terms for reasons given in Berzeg (1982), Kwast (1980) and Al-faris (1993a). Estimates for Equation (4) are displayed in Tables 3 to 8, with t-test in parentheses. R 2 is the coefficient of multiple determination, and DW is the Durbin-Watson statistic for serial correlation. Durbin-Watson d-statistic may not be a suitable test to detect first-order serial correlation in an autoregressive model like ours. The Lagrange multiplier (LM) test of serial correlation, which is based on the Breuch-Godfrey large sample test, is also given in the tables. Estimated price coefficients, with the exception of aviation fuel in Oman, have the correct sign and the majority are significantly different from zero. The inverse relationship between demand and price reflects the typical
Demand for oil products in GCC countries: A. F. Al-[aris 59 Table 6 Empirical estimates of jet fuel demand Variable
Saudi
UAE
Kuwait
Oman
Qatar
Bahrain
P
-0.20 (1.67) 0.26 (1.39) 0.54 (2.0) 0.9479 1.72 4.93
-0.20 (0.74) 0.19 (5.4) 0.82 (9. I ) 0.9682 2.79 I 1.2
-0.17 (1.35) 0.12 (4.28) 0.60 (2.9) 0.7617 2.36 4.8
0.82 (2.51 ) 0.60 (3.10) 0.44 (2.5) 0.9471 1.49 4.9
-0.20 (1.09) 0.05 (0.18) 0.28 (1.20) 0.5170 1.72 6.8
-0.10 (3. I ) 0.33 (5.4) 0.55 (7.2) 0.9879 1.8I 2.2
Y Q~l R2 DW LM
Table 7 Empirical estimates of Gas oil/Diesel demand Variable
Saudi
UAE
Kuwait
Oman
Qatar
Bahrain
P
-0.37 (1.62) 0.18 (1.1) 0.85 (7.2) 0.9751 1.53 5.3
~).88 (3.72) 1.05 (5.02) 0.21 (1.39) 0.9652 1.17 9.9
-0.24 (2.1) 0.08 (2.89) 1.02 (7.8) 0.7308 2.34 8.4
-0.26 (1.97) 0.23 (2.64) 0.72 (12.8) 0.9732 1.86 6.45
-0.05 (2.0) 0.05 (5.1) 0.54 (7.39) 0.8674 I. 1 9.3
~).12 (2. I l ) 0.28 (2.11) 0.53 (3.03) 0.9349 1.50 10.6
Kuwait
Oman
Qatar
v Q~l R2 DW LM
Table 8 Empirical estimates of Fuel oil demand Variable
Saudi
UAE
P
~).26 (1.05) 0.09 (2.24) 0.62 (3.21 ) 0.9147 1.72 3.14
~).57 (I .05) 0.23 (2.68) 0.94 (4.43) 0.9618 2.34 5.4
Y QII R2 DW LM
downward sloping demand curve. The price effect on the quantity demanded can be decomposed into an income effect and a substitution effect. The former refers to the fact that a price change implies a change in the real disposable income o f the consumer. A price rise will induce a demand reduction; in the short-run this could be achieved by conservation and increasing efficiency measures. The substitution effect works through the change in relative prices, and the c o n s u m e r s will shift to the relatively cheaper substitute. Demand elasticities o f income in all cases have the correct sign, and the majority are significant at 5%. There are, at least, three channels that link fuel consumption to income levels. First, fuels are an important input into the production process, and an increase in output will require a corresponding increase in the demand for energy. Second, a rise in per capita income will increase the fuel use through substitution o f commercial for conventional energy, extensive use o f appliances, and increased demand for energy intensive goods and services. Third, GDP growth is strongly related to capital formation and accumulation o f energy driven machinery and durable equipment. Estimated parameters o f the lagged endogenous variable have also the a priori expected sign and the vast majority are statistically significant at the conventional levels. The
Bahrain
-2.4 (I .77) 0.63 (1.53) 0.67 (1.89) 0.5856 2.38 9.5
elasticities o f lagged consumption, with the exception o f demand for LPG in Qatar and Bahrain, demand for kerosene in Bahrain and demand for gas oil in Kuwait, are greater than zero and less than unity which confinus the adjustment to be not instantaneous. The slow adjustment could be the result o f several factors: (1) the existing capital stock cannot be replaced immediately; (2) the unwillingness o f consumers to conceive the changes in prices as permanent until sufficient time has lapsed; and (3) institutional effects, such as the characteristics o f the infrastructure and control over exchange rates and its impact on imported durable goods. Table 3, which contains the regression results o f gasoline, indicates that all coefficients have the expected sign and most o f them are significantly different from zero. The average short-run gasoline price elasticity in the GCC countries is found to be -0.14, with a range o f estimates varying from ~).08 for Kuwait to ~).29 for Oman. The direct interpretation o f these results is that the demand for gasoline in the Gulf countries is inelastic with respect to price in the short-run. The pricing policies o f the G u l f countries, which maintained domestic nominal fuel prices at an artificially low level, could be a contributory factor for the small coefficients. As shown by Adams et al. (1974) and Pindyck (1979), using data where prices have changed
60 Demand for oil products in GCC countries: A. E AI-faris Table 9 Price and income elasticities of demand for gasoline in selected countries Author
Country
Period
Price elasticity SR
LR
Income elasticity SR LR
AI-Sahlawi AbdeI-Khalek Botero lqbal Houthakkeret al. Baltagi and Griffin Drollas Drollas Drollas
Saudi Egypt Mexico Pakistan USA OECD Belgium Italy Sweden
1970-85 1960-81 1960-79 196I-81 1963-72 1960-78 1955-80 1955-80 1955-80
-0.08 -0.24 -0.24 -0.10 -0.08 -0.08 -0.48 -0.41 4). 17
-0.67 -I .21 -0.77 -0.24 -I. 10 -I .62 -I .08 -0.52
0. I I 0.29 0.31 0.27 0.30 0.07 0.38 0.31 0.46
infrequently and on a smaller range may bias the elasticity estimate downward. Demand elasticities of income in all cases have the correct sign, and all are significant at 5%. The average shortrun income elasticity is 0.13, with estimates for individual countries ranging from 0.02 for Qatar to 0.28 for UAE. Income elasticities in the GCC countries are notoriously small, and this could reflect the fact that private transportation in these countries is considered a necessity by the majority of people. It would be useful to compare these elasticity estimates with those obtained by others. A1Sahlawi (1988) found a short-run gasoline price elasticity for Saudi Arabia of-0.08 and, in the case of Egypt, AbdelKhalek (1988) found a price elasticity of-0.24. For the industrial countries, Dargay (1990) indicated that short-term price elasticities ranged between -0.12 to -0.37. Income elasticity for Saudi Arabia is 0.11, for Egypt 0.29, and for the industrial countries ranging from 0.19 to 1. l 9. So our estimates of price elasticities would seem reasonable, while those of income fall to the lower end of the spectrum. Estimated price coefficients for LPG are relatively large, the average is 0.83 (see Table 4). These results seem to contradict estimates by other studies which suggest that demand for LPG is price inelastic and income elastic (Dahl (1994). Related to this and, probably more surprising, the own price elasticities of kerosene demand turn out to be relatively small, the average being -0.25. Though these results fall within the ranges of other studies, Egypt -0.23 (AbdelKhalek, 1988) and Indonesia -0.11 (Koshal et al., 1988), they appear to disagree with the hypothesis that with higher incomes kerosene becomes an inferior fuel. Kerosene is usually used in rural areas and by low income groups, and it plays a transitional role in the substitution process from wood to LPG as per capita income increases. Families tend to switch over from kerosene to LPG and then from LPG to electricity as income rises further. The lack of price variation in the GCC countries could partly explain low price elasticities. Table 6 displays the parameters for aviation fuel demand. The average price and income elasticities are -0.28 and 0.26 respectively. The estimated price elasticities are much higher than those obtained for other developing countries, -0.05 to -0.10 (Dahi 1994), and moderately higher than those for the USA, -0.10 to -0.15 (Gately, 1988). Income elasticities, except in Oman, are relatively low and in contrast to the expectation that air transport is a luxury
0.92 2. I0 2.76 2.13 0.98 0.93 1.27 1.34 1.46
Table 10 Weighted average price and income elasticities of oil products in OECD Europe 1960-85 Product
Price SR
LR
Income SR
LR
Gasoline Diesel Light fuel oil (other) Light fuel oil (industry) Heavyfuel oil (industry)
-0.25 -0.08 -0.29 -0.18 -0.25
-0.91 -0.14 -0,96 -0.72 -I .66
0,40 0.88 0.70 0.95 0.54
1.25 1.68 2.20 0.95 0.54
Source: Dargay(1990).
good. Again, in high per capita societies, such as the Gulf countries, air travel may become more of a necessity. There has been considerable variation in price elasticities of light fuel oil (gas oil/diesel) among the Gulf countries (see Table 7). Elasticities' ranges extend from -0.05 for Qatar to ~).88 for UAE, with an average o f - 0 . 3 2 . These elasticities are higher than those of gasoline, but diesel is used for other purposes outside the transport sector, such as electricity generation and agriculture. Price elasticity in Qatar is quite small, and in Kuwait has the wrong sign. This may be due to lack of substitutes or rigidity in domestic nominal prices. Estimated price elasticities of fuel oil demand are of reasonable magnitude. This fuel is used mainly in electricity generation and in the industrial sector. Higher price elasticities are consistent with our expectation that fuel demand in these sectors should be price elastic because of the availability of a strong substitute, natural gas. It would be desirable to compare our estimated price and income elasticities of demand with similar results from other studies. Price and income elasticities of gasoline demand for selected countries are reported in Table 9 and the weighted average price and income elasticities for various oil products in the OECD Europe are contained in Table 10. As far as gasoline demand is concerned, short-run price elasticity for these countries ranges from -0.08 to -0.48, whereas income elasticity is between 0.11 to 0.60. Our calculated price and income elasticities fall within the range of these estimates. Results for other products prove to be more difficult to summarize adequately. Table 10 contains weighted average price and income elasticities for some refined products over the period 1960~85. These elasticities are estimated for end user categories and based on disaggregated data (industry, transport etc.), so they are not quite comparable to our estimates. Nevertheless, it would be useful to draw some gen-
Demand./br oil products in G C C counO'ies: A. K Al:#tris
eral c o n c l u s i o n from such c o m p a r i s o n . First, short-run price elasticities do vary for the different products. Average price elasticity for g a s o l i n e d e m a n d in O E C D Europe (-0.25) is greater than that in the GCC countries (-43.14). On the other hand, price elasticities for diesel and heavy fuel in the former are smaller than their counterparts in the latter. Because o f the availability o f natural gas in the G u l f countries, there has been a greater degree o f substitution possibility away from diesel and heavy fuel towards natural gas. Second, income elasticities for the three products in the GCC countries appear to be smaller than their comparable values in O E C D Europe. Differences in income elasticities o f d e m a n d could be attributed to four major factors: types o f data, m o d e l specifications, e c o n o m i c variables, socio-political or other non-economic influences.
Conclusion To estimate price and i n c o m e elasticities o f d e m a n d for petroleum products, a partial adjustment model was developed that linked fuel c o n s u m p t i o n to own price, income and previous level o f demand. The main finding o f the study is that both price and inc o m e are r e l a t i v e l y inelastic in the short-run. However, there has been a great variation in these elasticities among fuels and cross-country. Low income and price elasticities is a common feature in most energy demand studies on developed and developing countries. The bias in income elasticities m a y be attributed to the reliance upon G D P as a proxy for income instead o f using household disposable income. On the other hand, the downward bias in price elasticities could be attributed to the nature o f fuel demand. Fuels' consumption depends to a large extent on past and not on current prices. Energy consumption is strongly tied to the existing capital stock, and adjustment to higher prices in the short-run is limited to reduction in the rate o f equipment utilization. Moreover, c o m p a r a t i v e studies suggest that the elasticities' magnitudes depend also on the size o f unit time p e r i o d chosen. Estimates based on y e a r l y data tend to u n d e r e s t i m a t e elasticities c o m p a r e d with studies employing monthly or quarterly data. Another conclusion is that income and price elasticities seem to be inversely related to the lightness o f the oil prod-
61
ucts. For the lower part o f a barrel, heavy fuels, both income and price are, because o f the existence o f strong substitutes, more elastic. As we move to the upper part o f the barrel, lighter products, elasticities become smaller,
References AbdeI-Khalek, G. (1988). Income and price elasticities of energy consumptiom in Egypt. Energy Economies 10 ( 1). Adams, F. G., Graham, H. and Griffin, J. M. (1974). Demand Elasticities for Gasoline. Another View. Dicussion Paper no.279, Department of Economics, University of Pennsylvania. AI-Faris, A. F. (1993a). The Demand [br Gasoline in the GCC Countries. The Industrial Bank of Kuwait, The IBK Papers, Series no 39, AI-Faris,A. F. (1993b). Income and price elasticities of gasoline demand in the OAPEC countries. The Journal ¢?['Energy and Development ! 7 (2). AI-Sahlawi, M. (1988). Gasoline demand: the case of Saudi Arabia. Energ)' Economics 10 (4). Balestra, P. and Nerlove, M. (1966). Pooling cross section and time series data in the estimation of a dynamic model: the demand for natural gas. Econometrica 34 (3). Baltagi, B. H. and Griffin, J. M. (1983). Gasoline demand in the OECD: an application of pooling and testing procedures. European Economic Review 22 (2). Berzeg, K. (1982). Demand for motor gasoline:a generalized error components model. Southern Economic Journal. Botero, G. (1985). Energy demand in the transportation sector of Mexico. Journal o f Development Economics.
Dahl, C. (1994). A survey ofoil product demand elasticities for developing countries. OPEC Review 18 ( 1). Dargay,J. (1990). An econometricanalysisof the demand tbr oil products. In Demand, Prices and the Rqfining h~dusoy: A Case-Study of the European Oil Products Market, R. Bacon et al., Oxford UniversityPress, Oxford. Davidson, R. and MacKinnon, J. G. (1993). Estimation and lnlerenee in Econometrics. Oxford University Press, Oxford. Drollas, L. P. (I 984). The demand for gasoline: further evidence. Energy Economies 6 ( 1).
Gately, D. (1988). Taking off:the US demand for air travel and jet fuel. The Ener~, Journal 9 (4). Houthakker, H. S. and Taylor, L. D. (1970). Consumer Demand in the United States. Harvard University Press, Cambridge, MA. Iqbal, M. (1986). Estimates of gasoline demand in Pakistan. Pakistan Journal o['Applied Economics 4 ( 1),
Koshal, R. et al. (1988). Demandfi~r Kerosene in hTdonesia. Proceedings of the Pan-Pacific Conference V: Business Economic and Technical Exchange, Singapore, 16-18 May. Kwast, M. L. (1980). A note on the structural stability of gasoline demand and the welfare economics of gasoline taxation. Sottthern Economic Journal.
OECD, (1993). Energy Statistics and Balances o['the non-OECD Cormtries. Paris.
Pindyck, R. (1979). The Structure ¢?["Worht Energy Demand. The MIT Press, Cambridge, MA. Waverman, L. (1992). Econometric modelling of energy demand: when are substitutes good substitutes. In Energ3, Demand: Evidence and Expectation, ed. D. Hawdin, Surrey University Press.
Appendix D a t a definition and sources Data on consumption refer to refined oil products actually consumed in the GCC countries. Annual data on the quantities consumed are available from three sources: U N Energy, Statistics Yearbook, OAPEC; Annual Statistical Reports and OECD (IEA); Energy Statistics and Balances of non-OECD Countries. The latter source is the most comprehensive in terms of coun-
tries and products coverage and, therefore, is used in our analysis unless otherwise stated. The IEA's data covers the period 1970-91 and provides information on the following petroleum products: motor gasoline, LPG, aviation fuel, kerosene, diesel, naphtha and residual fuel. Data on oil products prices were obtained by personal communications with
the Secretariats of the Organization of the Petroleum Exporting Countries (Vienna) and of OAPEC (Kuwait). Data on gross domestic products (GDP), exchange rates and private consumption were assembled from the Arab Monetary Fund (AMF), Annual Arab Economic Report and International Monetary Fund (IMF) International Financial Statistics.
ELSEVIER
PII:S0301-4215(96)00122.X
Demand for oil products in the GCC countries Abdul-razak F. Al-faris Economics Department, Faculty of Business and Economics, United Arab Emirates University, PO Box 17555, A I-ain, UAE
The purpose of this study is to estimate the price and income elasticities of oil products demand in the GCC countries. Annual data spanning the period 1970-91 were fitted to a partial adjustment model to obtain the estimates. The main finding of the study is that both price and income are relatively inelastic in the short-run, and there has been a great variation in these elasticities among fuels and cross-country. Copyright © 1997 Elsevier Science Ltd. Keywords: GCC; Elasticity of demand; Oil products
Oil c o n s u m p t i o n in t h e G C C
Estimates of demand elasticities of petroleum products are an important issue for the GCC countries' economies. Price and income elasticities are important parameters in projecting energy demand and in planning the needed refining capacity to meet future domestic consumption. They are also indispensable tools for policy makers for indicating the extent of price increase required to curtail internal consumption wastages and for pinpointing the potential for market forces to achieve energy conservation. Much effort has been devoted to the estimation of energy demand elasticities in the industrial countries, and the results have been of great importance for demand management and forecasting. The demand for oil in particular has received considerable attention. These studies' major concern was to gauge the speed and degree of consumers' reactions to changes in income and fuel prices and recently to prescribe and evaluate policies aimed at protecting the environment. Perceived as major oil exporters, the GCC nations have been the focus of a great deal of modelling work related to these countries' crude oil production and pricing policies. The patterns of domestic energy demand in the Gulf countries have been rarely discussed and the demand for petroleum products in particular has attracted much less attention. Moreover, most of these studies are limited by data deficiency and by a lack of detailed information at the end-user levels. This study tries to bridge the gap by providing fresh data and evidence on the major determinants of oil consumption in the GCC countries. And its aim is to provide a set of estimates of price and income elasticities of oil products' demand in the Gulf countries and to shed some light on their implications for government policies related to energy and the environment.
The pace of development in the GCC countries accelerated dramatically during the last two decades. The sharp rise in oil prices in the 1970s transformed these countries' ability to invest in industry and infrastructure. Equipped with massive oil revenues, the Gulf countries embarked on ambitious programmes to diversify their economic structure and to improve the standard of living. This rapid economic growth was associated with large increases in per capita income, urbanization, industrialization, transportation, and electrification. Consequently, these countries' demand for energy has been growing at a much higher rate than that of developed and developing countries. Total primary energy consumption in the GCC countries increased from 18 mtoe in 1973 to 115 mtoe in 1990, with an average annual growth rate of 32%. The annualized double digit growth rates of the 1970s were followed by a slower growth rate due to the gradual decline in oil revenues since 1983. The collapse ofoil prices in 1986 had accentuated the financial squeeze in these countries and prolonged the economic slow down. Despite this, commercial energy consumption, mainly oil, continued to grow at high rates as a result of energy pricing policies. Domestic products' prices in the majority of these countries have been maintained at a constant level in nominal terms and at levels well below their counterparts in the international oil market. Trends in demand, as shown in Table 1, have not been identical for all petroleum products, nor have they been so for all the GCC countries. It is apparent that consumption growth rates of all products, except that of kerosene, increased substantially during the 1970s in the GCC countries, 55
56
Demand for oil products in GCC countries." A. E AI-/'aris
Table I Average annual growth rates of consumption of petroleum products Country Saudi 1970~80
1981-91 UAE 1970~0 198 I-91 Kuwait 1970-80 198 I-91 Oman 1971-80 1981-91 Qatar 1971~80 198 I-91 Bahrain 1970-80 1981-91
Gasoline
LPG
22.7 6.2
24.2 5.0
26.5 5.9
Kerosene
Jet fuel
Gas oil
Fuel oil
Total
-4.5
24.1
41.7
16.5
6. I
5.4
65.7 8.3
30.4 5.5
38.2 5.6
20.6
70.2 7.0
63.8 6.9
144.7 6.7
58.2
1.9
12.3 2.4
51.6 22.2
-0.02 -0.5
23.1 -I. 1
57.9 ~).2
57.9 162
22.1 0.8
40.5 9.1
I 0.1 13.8
43.5 -9.6
37.9 18.9
30.6 6.3
0.0 37
31.4 8.5
16.8 6. I
24.4 29.2
-3.8 - I 2.4
47.4 8.8
19.0 0.6
0.0 0.0
18.4 5.0
14.0 7.3
18.1 5.3
0.7 10.2
15.7 -0.4
17.5 1.0
30.9 0.0
14.7 1.6
5. I
Source: Calculated from OECD (1993).
Table 2 Shore of products in total oil consumption in the G C C countries Country Saudi 1971 1981 1991 UAE 1971 1981 1991 Kuwait 1971 1981 1991 Oman 1971 1981 1991 Qatar
Gasoline
LPG
Kerosene
Jet fuel
Gas oil
Fuel oil
27.0 15.4 16.9
3.8 1.6 1.4
6.2 0.2 0.4
9.7 5.3 4.6
22.2 30.2 29.0
22.8 25.9 33.0
39.4 16.2 15.8
2.0 2.1
7.3 0.7 0.6
10.2 18.9 20.7
41.5 43.1 38.2
1.2 18.8 21.7
52.7 23.2 13.1
4.7 1.8 2.1
5.5 0.9 0.2
15.2 9.3 3.1
19.1 27.7 38.5
37.1 42.3
19.5 34.5 37.7
7.5 1.6 2.5
1.6 1.8 0.3
15.5 20.5 23.7
55.8 41.6 34.2
1.7
1971
43.4
-
41.4 49.4
3.3 13.3
6.0 0.8 0.4
13.4 13.0
34.0 35.5 24.2
-
1981 1991 Bahrain 1971 1981 1991
-
13.7 17.6 26.6
4.1 4.0 5.4
4.1 1.3 2.9
62.2 61.5 53.1
13.1 13.4 10.6
0.8 0.4 -
Source: Calculated from OECD (1993).
and subsided during the 1980s. In every case the average growth rates o f heavy fuel oil surpassed that of total oil consumption. This product is used mainly in electricity generation, desalination, and in industry. In the 1980s, extensive measures taken to exploit alternative energy sources, especially natural gas, reduced the demand for heavy fuel. The growth of population, migrating, urbanization, and per capita income contributed to rapid growth in demand for transport fuels, gasoline, diesel, and jet fuel. The low, and in some instances negative, growth rate of kerosene is due to the switch over by consumers to LPG because this is a cleaner and safer source of energy. The variation in demand growth rates of different oil products, over the period considered, ultimately changed the composition of these countries' consumption. Table 2 presents the development of individual products' shares for
selected years. Again, this table shows very clearly that not all petroleum products behaved identically. In two countries, Saudi Arabia and the UAE, fuel oil increased its share significantly and, in 1990, it dominated with shares of 33% and 42.3% respectively. Gasoline consumption in the GCC countries increased nearly ten-fold over the period considered. In the early 1970s, gasoline accounted for an average of 35% of the total final oil consumption. Rapid structural changes in the Gulf economies during the later years boosted the demand for heavier products, and the share of gasoline subsequently dropped to an average of one-quarter. Having said this, the table shows that there have been wide inter-country differences in the share of gasoline in total oil consumption. The gasoline share, on average, has been lowest in Saudi Arabia and the UAE, where economies are more diversified, and
Demandjbr oil products in GCC countries: A. F. Al-laris
highest in Kuwait and Qatar, where per capita income is the highest and domestic absorptive capacity is the smallest. High growth rates of consumption of light fuel oil (gas oil/diesel) in the 1970s have given way to much lower growth rates in the 1980s in all the GCC countries. The largest users of gas oil/diesel are industry, transport, and agriculture. The average share of light fuel oil during the period under study changed only slightly, though shares cross-country exhibit more divergent patterns. The share of kerosene declined, while that of LPG either increased slightly or remained virtually unchanged. This reflects the pattern of structural changes in energy consumption associated with the development process. At low levels of income, kerosene is the main fuel used in the residential sector for cooking and heating. As per capita income increases, both the share of kerosene in the residential fuel mix and the share of residential sector itself tend to decline. The major beneficiary at this stage will be LPG. At higher income levels, consumers switch to electrically operated appliances, and substitute electricity for LPG.
The model Most energy demand models are intimately related to the partial adjustment model proposed by Balestra and Nerlove (1966). Houthakker and Taylor (1970) tried to relax the strictly linear form of this model to an equation which is linear in logarithms. The basic assumption of the model is that consumers only partially adjust to an equilibrium demand. The adjustment is partial because of some frictions, habit formation, earlier commitments, costs involved in replacing the existing capital stock, or lack of information. In static models, the underlying assumption is that adjustment is completed within the unit time period, that is, there is an instantaneous adjustment in demand with relation to changes in income or prices. For quite a few commodities and, especially those consumed in association with capital equipment, the static models proved to be unsatisfactory. The partial adjustment model consists of two equations. The first equation defines the equilibrium value, and expresses desired demand Q*t as a function of a vector of exogenous variables X t as follows: (1)
Q*t = XtB* + 8t
The second states that the current value of Qt adjusts to its equilibrium level only slowly: Q I - Q~I = ( 1 - 6) ( Q * , - Q,-i) + vt
(2)
Solving (1) and (2) for Qt, we have
(3)
Qt = XrB + 6Qr-i + Ut
Where: B = (1 - 6 ) B *
Ut = (1- 6)ct + vt
57
6 is the adjustment coefficient and measures the proportion by which the divergence between the equilibrium level and the actual level is bridged in period t. In the extreme case, where 6 - 1, the two quantities (derived and actual) are equalled, the adjustment is instantaneous, and we end up with a static model. The closer 6 is to one, the more rapid is the adjustment to a shock to the system, and the smaller it is, the slower is the adjustment. Equation (4) could be expressed in an estimable form: Q, = ~0 + ~1P' + ~2Yt + ~3Qt--1 +
(4)
If this equation is estimated in a logarithmic functional form, then the variables' coefficients represent the short-run income and price elasticities. The long-run elasticities are calculated as the short-run elasticities divided by (1 - ~ 3 ) , where ~3 is the coefficient of lagged endogenous variable. Two qualifications have to be made before proceeding to an estimation. The first is that Equation (4) as expressed is not exactly a Marshallian demand function, since it includes the own price (Pt) and not the cross-price relationship: Eeik Pk. Where eik is the cross-price elasticity of demand. Some energy economists argue that much of the long-term adjustments to changes in petroleum prices would arise not only from gradual efficiency improvements in energy using equipment, but also from the substitution of alternative fuels. Hence, the model formulation should explicitly include inter-fuel substitution. Setting the majority of the cross-price elasticities to zero is not an ideal solution. Price elasticities contain substitution as well as income effects. And if we assume that the former may well be zero for some unrelated commodities, there is no reason to justify setting the latter's value to zero. In a recent study, Waverman (1992) indicated, contrary to widespread belief, that energy sources are imperfect substitutes for each other. In some usages, such as transportation and lighting, there are no fuel switching possibilities and, in other sectors, substitution would entail high costs. Waverman (1992, p 23) concluded, after surveying several relevant studies, that 'the majority of CEDs (cross-price elasticity of demand) surveyed here are very low in the short-run, below 0.15 and with several significant exceptions, well below 0.10 in the long-run'. Moreover, introducing energy substitution in our model requires a disaggregated data on final fuel consumption by sectors and sub-sectors, which is not available for the GCC countries. The second qualification is related to the lag structure in the partial adjustment models. The Koyck lag model applies to a situation where a demand response to changes in prices is consistent with the adjustment process in capital equipment. Replacing the stocks of energy using appliances is costly, and demand adjustment to a price jump must be a slow process. In each time unit, a fraction of the existing durable equipment is replaced by new and more efficient equipment. Some energy saving, however, can be achieved by other means such as conservation, retrofitting etc. Using the Koyck lag structure may, therefore, lead to underestimation of the adjustment coefficient and long-run
58 Demand for oil products in GCC countries: A. F. AI-faris Table 3 Empirical estimates of gasoline demand Variable Saudi UAE P Y Qi-i R-~ DW LM
-0.09 (3.4) 0.03 (2.4) 0.72 (9.0) 0.9981 2.3 5.3
-0.08 ( I. 1) 0.28 (2.8) 0.71 ( 12.2) 0.9779 2.7 3.2
Kuwait
Oman
Qatar
Bahrain
-0.10 (1.40) 0.07 (3.63) 0.94 ( 13.0) 0.9435 2.1 8.3
-0.29 (4.6) 0.27 (10.2) 0.76 (23.1) 0.9983 1.39 6.4
-0.14 (2.0) 0.02 (1.97) 0.80 (8.3) 0.9976 2.1 9.8
-0.16 (2.9) 0.11 (3.6) 0.9 I (40.8) 0.9935 2.4 15.5
Oman
Qatar
Bahrain
-2.3 (1.87) 0.25 (0.72) 1.39 (6.1) 0.9679 1.94 2.61
-0.20 (2.46) 0. I 1 (2.66) 1.13 (13.9) 0.9579 1.38 6.20
Table 4 Empirical estimates of LPG demand Variable
Saudi
UAE
Kuwait
P
-0.22 (1.68) 0.12 (2.4) 0.74 ( I 1.1 ) 0.9568 2.57 4.31
-0.53 (2.02) 0.28 (I.65) 0.62 (6.56) 0.9808 2.36 5.77
-0.88 (2.13) 0.68 (2.24) 0.78 (7.6) 0.8147 1.92 7.78
Y Qwl R2 DW LM
Table 5 Empirical estimates of Kerosene demand Variable Saudi UAE p Y
Q,_~ R2 DW LM
-0.48 (2.14) 0.70 (3.36) 0.74 (4.57) 0.9603 1.41 4.98
Kuwait
Oman
Qatar
Bahrain
-0. I 0 (1.85) 0.01 (0.21) 0.54 (1.91) 0.6857 1.74 2.62
-0.48 (2.67) 0.24 (1.55) 0.77 (8.44) 0.9620 2.65 5.76
-0.08 (2.59) 0.07 (1.38) 0.75 (4. I ) 0.8762 2.53 10.4
-0.09 (0.78) 0.09 (1.42) 1.14 (27.0) 0.9614 2.40 4.33
elasticities. Alternatively, a polynomial lag model could be used. Preliminary experiments with the Almond lag give unsatisfactory results and this technique, moreover, has several drawbacks. The first is related to the choice of number of restrictions that should be imposed on the coefficient yi. The second is the problem of choosing the lag length, K, and the degree of the polynomial, r. Third, and probably more importantly, polynomial lag models, because they are non-dynamic, are considered to be unsuitable for modelling the energy demand (see Davidson and MacKinnon, 1993).
The empirical results Our analysis is based on a simple reduced form single equation model. Time series spanning the period 1970-91 for six categories of petroleum products in each country are employed. These products are: gasoline, LPG, kerosene, aviation fuel, gas oil/diesel, and fuel oil. Petroleum products other than gasoline have much more heterogeneous applications and, as a result, are not analysed by their particular end use. Because of great differences among these countries in terms of oil reserves, pricing policy, and availability of alternative energy, the demand for each product in each country is estimated separately instead of using
pooled time series. Pooling technique may mask the results and give misleading information about these countries' actual response to changes in prices or income. The model was estimated by using OLS. The dependent variable (Qt) is the total demand for a particular product in each country and Qt-l is consumption in the previous year. Pt is the price of the respective product per barrel and Yt is a measure of income and two proxy are used; GDP and private consumption. The variables' data of each country are expressed in their own currency to eliminate the effect of the exchange rate fluctuations. Moreover, variables are expressed in nominal and not in real terms for reasons given in Berzeg (1982), Kwast (1980) and Al-faris (1993a). Estimates for Equation (4) are displayed in Tables 3 to 8, with t-test in parentheses. R 2 is the coefficient of multiple determination, and DW is the Durbin-Watson statistic for serial correlation. Durbin-Watson d-statistic may not be a suitable test to detect first-order serial correlation in an autoregressive model like ours. The Lagrange multiplier (LM) test of serial correlation, which is based on the Breuch-Godfrey large sample test, is also given in the tables. Estimated price coefficients, with the exception of aviation fuel in Oman, have the correct sign and the majority are significantly different from zero. The inverse relationship between demand and price reflects the typical
Demand for oil products in GCC countries: A. F. Al-[aris 59 Table 6 Empirical estimates of jet fuel demand Variable
Saudi
UAE
Kuwait
Oman
Qatar
Bahrain
P
-0.20 (1.67) 0.26 (1.39) 0.54 (2.0) 0.9479 1.72 4.93
-0.20 (0.74) 0.19 (5.4) 0.82 (9. I ) 0.9682 2.79 I 1.2
-0.17 (1.35) 0.12 (4.28) 0.60 (2.9) 0.7617 2.36 4.8
0.82 (2.51 ) 0.60 (3.10) 0.44 (2.5) 0.9471 1.49 4.9
-0.20 (1.09) 0.05 (0.18) 0.28 (1.20) 0.5170 1.72 6.8
-0.10 (3. I ) 0.33 (5.4) 0.55 (7.2) 0.9879 1.8I 2.2
Y Q~l R2 DW LM
Table 7 Empirical estimates of Gas oil/Diesel demand Variable
Saudi
UAE
Kuwait
Oman
Qatar
Bahrain
P
-0.37 (1.62) 0.18 (1.1) 0.85 (7.2) 0.9751 1.53 5.3
~).88 (3.72) 1.05 (5.02) 0.21 (1.39) 0.9652 1.17 9.9
-0.24 (2.1) 0.08 (2.89) 1.02 (7.8) 0.7308 2.34 8.4
-0.26 (1.97) 0.23 (2.64) 0.72 (12.8) 0.9732 1.86 6.45
-0.05 (2.0) 0.05 (5.1) 0.54 (7.39) 0.8674 I. 1 9.3
~).12 (2. I l ) 0.28 (2.11) 0.53 (3.03) 0.9349 1.50 10.6
Kuwait
Oman
Qatar
v Q~l R2 DW LM
Table 8 Empirical estimates of Fuel oil demand Variable
Saudi
UAE
P
~).26 (1.05) 0.09 (2.24) 0.62 (3.21 ) 0.9147 1.72 3.14
~).57 (I .05) 0.23 (2.68) 0.94 (4.43) 0.9618 2.34 5.4
Y QII R2 DW LM
downward sloping demand curve. The price effect on the quantity demanded can be decomposed into an income effect and a substitution effect. The former refers to the fact that a price change implies a change in the real disposable income o f the consumer. A price rise will induce a demand reduction; in the short-run this could be achieved by conservation and increasing efficiency measures. The substitution effect works through the change in relative prices, and the c o n s u m e r s will shift to the relatively cheaper substitute. Demand elasticities o f income in all cases have the correct sign, and the majority are significant at 5%. There are, at least, three channels that link fuel consumption to income levels. First, fuels are an important input into the production process, and an increase in output will require a corresponding increase in the demand for energy. Second, a rise in per capita income will increase the fuel use through substitution o f commercial for conventional energy, extensive use o f appliances, and increased demand for energy intensive goods and services. Third, GDP growth is strongly related to capital formation and accumulation o f energy driven machinery and durable equipment. Estimated parameters o f the lagged endogenous variable have also the a priori expected sign and the vast majority are statistically significant at the conventional levels. The
Bahrain
-2.4 (I .77) 0.63 (1.53) 0.67 (1.89) 0.5856 2.38 9.5
elasticities o f lagged consumption, with the exception o f demand for LPG in Qatar and Bahrain, demand for kerosene in Bahrain and demand for gas oil in Kuwait, are greater than zero and less than unity which confinus the adjustment to be not instantaneous. The slow adjustment could be the result o f several factors: (1) the existing capital stock cannot be replaced immediately; (2) the unwillingness o f consumers to conceive the changes in prices as permanent until sufficient time has lapsed; and (3) institutional effects, such as the characteristics o f the infrastructure and control over exchange rates and its impact on imported durable goods. Table 3, which contains the regression results o f gasoline, indicates that all coefficients have the expected sign and most o f them are significantly different from zero. The average short-run gasoline price elasticity in the GCC countries is found to be -0.14, with a range o f estimates varying from ~).08 for Kuwait to ~).29 for Oman. The direct interpretation o f these results is that the demand for gasoline in the Gulf countries is inelastic with respect to price in the short-run. The pricing policies o f the G u l f countries, which maintained domestic nominal fuel prices at an artificially low level, could be a contributory factor for the small coefficients. As shown by Adams et al. (1974) and Pindyck (1979), using data where prices have changed
60 Demand for oil products in GCC countries: A. E AI-faris Table 9 Price and income elasticities of demand for gasoline in selected countries Author
Country
Period
Price elasticity SR
LR
Income elasticity SR LR
AI-Sahlawi AbdeI-Khalek Botero lqbal Houthakkeret al. Baltagi and Griffin Drollas Drollas Drollas
Saudi Egypt Mexico Pakistan USA OECD Belgium Italy Sweden
1970-85 1960-81 1960-79 196I-81 1963-72 1960-78 1955-80 1955-80 1955-80
-0.08 -0.24 -0.24 -0.10 -0.08 -0.08 -0.48 -0.41 4). 17
-0.67 -I .21 -0.77 -0.24 -I. 10 -I .62 -I .08 -0.52
0. I I 0.29 0.31 0.27 0.30 0.07 0.38 0.31 0.46
infrequently and on a smaller range may bias the elasticity estimate downward. Demand elasticities of income in all cases have the correct sign, and all are significant at 5%. The average shortrun income elasticity is 0.13, with estimates for individual countries ranging from 0.02 for Qatar to 0.28 for UAE. Income elasticities in the GCC countries are notoriously small, and this could reflect the fact that private transportation in these countries is considered a necessity by the majority of people. It would be useful to compare these elasticity estimates with those obtained by others. A1Sahlawi (1988) found a short-run gasoline price elasticity for Saudi Arabia of-0.08 and, in the case of Egypt, AbdelKhalek (1988) found a price elasticity of-0.24. For the industrial countries, Dargay (1990) indicated that short-term price elasticities ranged between -0.12 to -0.37. Income elasticity for Saudi Arabia is 0.11, for Egypt 0.29, and for the industrial countries ranging from 0.19 to 1. l 9. So our estimates of price elasticities would seem reasonable, while those of income fall to the lower end of the spectrum. Estimated price coefficients for LPG are relatively large, the average is 0.83 (see Table 4). These results seem to contradict estimates by other studies which suggest that demand for LPG is price inelastic and income elastic (Dahl (1994). Related to this and, probably more surprising, the own price elasticities of kerosene demand turn out to be relatively small, the average being -0.25. Though these results fall within the ranges of other studies, Egypt -0.23 (AbdelKhalek, 1988) and Indonesia -0.11 (Koshal et al., 1988), they appear to disagree with the hypothesis that with higher incomes kerosene becomes an inferior fuel. Kerosene is usually used in rural areas and by low income groups, and it plays a transitional role in the substitution process from wood to LPG as per capita income increases. Families tend to switch over from kerosene to LPG and then from LPG to electricity as income rises further. The lack of price variation in the GCC countries could partly explain low price elasticities. Table 6 displays the parameters for aviation fuel demand. The average price and income elasticities are -0.28 and 0.26 respectively. The estimated price elasticities are much higher than those obtained for other developing countries, -0.05 to -0.10 (Dahi 1994), and moderately higher than those for the USA, -0.10 to -0.15 (Gately, 1988). Income elasticities, except in Oman, are relatively low and in contrast to the expectation that air transport is a luxury
0.92 2. I0 2.76 2.13 0.98 0.93 1.27 1.34 1.46
Table 10 Weighted average price and income elasticities of oil products in OECD Europe 1960-85 Product
Price SR
LR
Income SR
LR
Gasoline Diesel Light fuel oil (other) Light fuel oil (industry) Heavyfuel oil (industry)
-0.25 -0.08 -0.29 -0.18 -0.25
-0.91 -0.14 -0,96 -0.72 -I .66
0,40 0.88 0.70 0.95 0.54
1.25 1.68 2.20 0.95 0.54
Source: Dargay(1990).
good. Again, in high per capita societies, such as the Gulf countries, air travel may become more of a necessity. There has been considerable variation in price elasticities of light fuel oil (gas oil/diesel) among the Gulf countries (see Table 7). Elasticities' ranges extend from -0.05 for Qatar to ~).88 for UAE, with an average o f - 0 . 3 2 . These elasticities are higher than those of gasoline, but diesel is used for other purposes outside the transport sector, such as electricity generation and agriculture. Price elasticity in Qatar is quite small, and in Kuwait has the wrong sign. This may be due to lack of substitutes or rigidity in domestic nominal prices. Estimated price elasticities of fuel oil demand are of reasonable magnitude. This fuel is used mainly in electricity generation and in the industrial sector. Higher price elasticities are consistent with our expectation that fuel demand in these sectors should be price elastic because of the availability of a strong substitute, natural gas. It would be desirable to compare our estimated price and income elasticities of demand with similar results from other studies. Price and income elasticities of gasoline demand for selected countries are reported in Table 9 and the weighted average price and income elasticities for various oil products in the OECD Europe are contained in Table 10. As far as gasoline demand is concerned, short-run price elasticity for these countries ranges from -0.08 to -0.48, whereas income elasticity is between 0.11 to 0.60. Our calculated price and income elasticities fall within the range of these estimates. Results for other products prove to be more difficult to summarize adequately. Table 10 contains weighted average price and income elasticities for some refined products over the period 1960~85. These elasticities are estimated for end user categories and based on disaggregated data (industry, transport etc.), so they are not quite comparable to our estimates. Nevertheless, it would be useful to draw some gen-
Demand./br oil products in G C C counO'ies: A. K Al:#tris
eral c o n c l u s i o n from such c o m p a r i s o n . First, short-run price elasticities do vary for the different products. Average price elasticity for g a s o l i n e d e m a n d in O E C D Europe (-0.25) is greater than that in the GCC countries (-43.14). On the other hand, price elasticities for diesel and heavy fuel in the former are smaller than their counterparts in the latter. Because o f the availability o f natural gas in the G u l f countries, there has been a greater degree o f substitution possibility away from diesel and heavy fuel towards natural gas. Second, income elasticities for the three products in the GCC countries appear to be smaller than their comparable values in O E C D Europe. Differences in income elasticities o f d e m a n d could be attributed to four major factors: types o f data, m o d e l specifications, e c o n o m i c variables, socio-political or other non-economic influences.
Conclusion To estimate price and i n c o m e elasticities o f d e m a n d for petroleum products, a partial adjustment model was developed that linked fuel c o n s u m p t i o n to own price, income and previous level o f demand. The main finding o f the study is that both price and inc o m e are r e l a t i v e l y inelastic in the short-run. However, there has been a great variation in these elasticities among fuels and cross-country. Low income and price elasticities is a common feature in most energy demand studies on developed and developing countries. The bias in income elasticities m a y be attributed to the reliance upon G D P as a proxy for income instead o f using household disposable income. On the other hand, the downward bias in price elasticities could be attributed to the nature o f fuel demand. Fuels' consumption depends to a large extent on past and not on current prices. Energy consumption is strongly tied to the existing capital stock, and adjustment to higher prices in the short-run is limited to reduction in the rate o f equipment utilization. Moreover, c o m p a r a t i v e studies suggest that the elasticities' magnitudes depend also on the size o f unit time p e r i o d chosen. Estimates based on y e a r l y data tend to u n d e r e s t i m a t e elasticities c o m p a r e d with studies employing monthly or quarterly data. Another conclusion is that income and price elasticities seem to be inversely related to the lightness o f the oil prod-
61
ucts. For the lower part o f a barrel, heavy fuels, both income and price are, because o f the existence o f strong substitutes, more elastic. As we move to the upper part o f the barrel, lighter products, elasticities become smaller,
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Appendix D a t a definition and sources Data on consumption refer to refined oil products actually consumed in the GCC countries. Annual data on the quantities consumed are available from three sources: U N Energy, Statistics Yearbook, OAPEC; Annual Statistical Reports and OECD (IEA); Energy Statistics and Balances of non-OECD Countries. The latter source is the most comprehensive in terms of coun-
tries and products coverage and, therefore, is used in our analysis unless otherwise stated. The IEA's data covers the period 1970-91 and provides information on the following petroleum products: motor gasoline, LPG, aviation fuel, kerosene, diesel, naphtha and residual fuel. Data on oil products prices were obtained by personal communications with
the Secretariats of the Organization of the Petroleum Exporting Countries (Vienna) and of OAPEC (Kuwait). Data on gross domestic products (GDP), exchange rates and private consumption were assembled from the Arab Monetary Fund (AMF), Annual Arab Economic Report and International Monetary Fund (IMF) International Financial Statistics.