Do petrol retailers really ‘price-gouge’ during oil price spikes?

Source: The Conversation – UK – By Nikhil Datta, Assistant Professor, Economics, University of Warwick

The US-Israel strikes on Iran in late February caused an immediate spike in oil prices, and volatility has only increased since then. It quickly led to fears among motorists of “price-gouging” – petrol retailers raising their prices to take advantage of consumer panic.

In the UK, Chancellor Rachel Reeves asked the Competition and Markets Authority (CMA) to remain on “high alert” for profiteering by petrol retailers. Trade body the Petrol Retailers Association quickly hit back, saying her language was “incorrect and inflammatory”.

But what does the economic evidence suggest about retailers’ behaviour at times when oil prices are fluctuating wildly? As part of our yet-to-be-published research into UK petrol retailers and large oil price shocks, we examined Russia’s full-scale invasion of Ukraine in February 2022.

The invasion led to a large and sudden increase in global oil prices, providing a valuable context in which to determine how shocks to crude oil supply filter through to prices at the pump.

The first striking pattern we found was that wholesale unleaded and diesel price changes closely tracked crude oil price changes. When oil prices rose, wholesale fuel prices increased almost immediately. Our estimates suggest that roughly 80% of changes in oil prices are reflected in wholesale fuel prices within a few days.

Retail prices, however, react quite differently. Prices at the pump adjusted more slowly and were considerably smoother than wholesale prices. In periods where wholesale prices increased sharply, retail prices typically rose by less and with a delay.

At the immediate peak of the shock in the weeks following the invasion, wholesale diesel prices rose by about 39 pence per litre, while pump prices increased by only about 16 pence per litre.

The implication is that retailer margins compressed during price spikes as the gap between retail and wholesale prices narrowed temporarily. In other words, although consumers experienced higher petrol prices, the evidence does not suggest that retailers increased their markups during these periods.

But why would retailers reduce their margins when prices spike? One explanation is that consumers become more aware of petrol prices at these times. Using data from price comparison site PetrolPrices.com, we found that when average petrol prices rose above £1.50 per litre during 2022, search activity increased dramatically. The growing number of daily searches indicated that consumers were actively seeking out cheaper filling stations when prices increased.

The crossing of the £1.50 threshold also attracted media attention, increasing people’s awareness and encouraging consumers to compare prices. By using geographically granular data on search activity, combined with daily petrol price data from nearly all petrol stations in the UK, we can causally link this increase in consumer attention with intensifying price competition.

As prices began to stabilise, we found that search intensity on the price comparison site dropped. Search activity itself did not return to pre-shock levels, but instead dropped and plateaued at a higher level than before, consistent with predictions from well-established economic models.

Correspondingly, price impacts narrow over time. At the peak of increased search activity following the Russian invasion of Ukraine, a 10 percentage point increase in search activity was associated with roughly a 2% reduction in local area petrol prices. We then found that this was driven primarily by stations that already had higher prices in January 2022. These higher-priced petrol stations cut their prices the most as consumers became more price-sensitive.

The research suggests that when oil prices increase and there is lots of media attention, consumers make more effort to search for better prices. Competition then increases and this puts downward pressure on retail prices. So retailers may actually experience falling margins when oil prices spike.

Rockets and feathers

It seems that it is not the level of prices that drives consumer attention, but whether those prices are rising rapidly. As price increases slow or reverse, consumers search price-comparison sites less intensively, reducing the sense of competition between petrol stations.

But then a clear asymmetry emerges: retail prices rise more quickly following cost increases than they fall following cost decreases. This pattern is known as the “rockets and feathers” effect: prices rise like rockets but fall like feathers.

In our study, we examined the transmission from wholesale to retail prices over a period of more than ten years. As expected, when wholesale costs fell, pump prices dropped more slowly. This temporarily increased the gap between wholesale and retail prices – meaning retailers’ profits grew.

This pattern means if wholesale prices go up by ten pence per litre and then come back down, over the entire adjustment time motorists end up paying about a penny more per litre than they would if prices adjusted evenly.

But this varied across petrol stations. For some, there was very little additional cost to consumers. For others, it was up to five times larger, meaning that the same increase and subsequent decrease would cost consumers up to five pence per litre more.

Taken together, our findings point to a clear conclusion. Petrol retailers do not appear to profiteer during periods when oil prices are rising rapidly. If anything, their margins tend to be squeezed. If concerns about excess profits are warranted, the evidence suggests that it is more likely to occur when oil prices are falling than when they’re spiking.

Nikhil Datta receives funding from ESRC, Nuffield Foundation, Research England the and British Academy.

Johannes Brinkmann does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

– ref. Do petrol retailers really ‘price-gouge’ during oil price spikes? – https://theconversation.com/do-petrol-retailers-really-price-gouge-during-oil-price-spikes-278843