The Impact of the Refiners' Discount Program on the Korean Gasoline Market

Dae-Wook Kim, Soongsil University,

Jong-Ho Kim, Pukyong National University,

Junjie Zhang, UC San Diego,

Overview

The refiners’ discount program in South Korea provides an interesting case to study the impact of the government-guided "voluntary" price reduction. As the global oil prices rose considerably in early 2011, the South Korean government pushed big oil refiners to reduce gasoline prices in order to tame inflation.Instead of cutting gasoline taxes, the government asked the refiners to take their own losses. SK Energy (SK), the largest refiner in Korea, announced unexpectedly on April 3, 2011 that it would lower prices of gasoline and diesel fuel between April 7 and July 6, 2011. The discount would be 100 won per liter (about 9 U.S. cents), or roughly 5 percent of the then retail prices. Other three major refiners, including GS Caltex (GS), Hyundai Oilbank (HO) and S-Oil (SO), followed suit under political and competitive pressures. However, the public is cynical about whether the program eased the pain at the pump since it is difficult to verify whether these refiners walked the talk or just talked the talk.

Our first empirical question asks how much refiners reduced their wholesale gasoline prices. Similar to some voluntary environmental programs (Khanna1999), the discount offered by the refiners was not out of self interests but rather under the pressure of the government. To avoid a harsher regulation on the gasoline market, the refiners participated in the program universally. Although the refiners claimed to offer the same amount of discount, the compliance could differ since there was no enforcement. In addition, refiners used different marketing strategies. The market leader SK offered direct cash back to consumers using credit card or membership card. The other refiners lowered their wholesale prices at the same amount. Therefore, we expect that the discount program had a heterogeneous effect on the wholesale gasoline prices because of differing compliance and discount strategies.

Secondly, this program enables us to estimate the fraction of the discount passed on to consumers. The discount offered by the refiners might be seized partially or fully by retail gas stations. The rate of pass-through depends on the price elasticities of demand and supply as well as the market competitions (Fullerton2002). This paper is related to the emerging empirical literature on gas tax incidence (Doyle2008; Alm2009; Marion2011). Although the discount program may achieve the same effect in reducing gas prices for consumers as the suspension of gas taxes, they have different distributional effects. Gas tax moratorium can benefit both consumers and suppliers (refiners and gas stations) while the refiners’ discount can only benefit consumers and retail stations.

Last but not least, we are interested in the impact of the wholesale discount on the retail gasoline price dispersion. Gasoline is sold at different prices in the same market. Price differences may be attributed to heterogeneous convenience and amenities provided by gas stations. In this case, gas stations have local market power and they can price discriminate customers with high switching costs (Borenstein1991; Chandra2011). The gas stations with higher local market power can retain a larger fraction of the discount, which increases price dispersion. In this case, consumers can be better off by increasing searching for low-price gasoline.

Methodology

We have assembled a unique data set for the empirical study. First, the station-level regular gasoline prices are collected by the Korea National Oil Corporation (KNOC). The prices were recorded monthly, weekly or biweekly from May 2008 to February 2012. We focus on the 729 retail gas stations in Seoul, in which a random sample of 443 stations are geocoded in order to spatially define markets for each gas station and its competitors. Second, weekly wholesale gas price for four major refiners are also obtained from KNOC. The wholesale price data set covers the same time span. Third, the observable station-specific attributes, such as ownership, services and land prices, are obtained from the Korea Gas Station Association (KOSA). Finally, crude oil prices are reported by the Mean of Platts Singapore (MOPS) that is the most relevant driver to the Korean oil market.

This paper employs a Regression Discontinuity (RD) design to evaluate the impact of the refiners’ discount program on the gasoline market. Regular gasoline prices, margins and dispersion for retail gas stations or refiners are compared before and after the program. The gap at the cutoff is the causal effect of the discount program. Because the discount program was temporary, the starting and ending of the program created two treatment variables. Time is the assignment variable. The refiners and gas stations could not precisely manipulate the timing of the program for the following reasons. First, because the discount was under the pressure of the government, the timing was totally unexpected so it was not tied to the market condition. Second, refiners could not predict the exact oil market trend and game this information.

The RD design addresses the endogeneity concern by considering an arbitrarily narrow window of time around the cutoffs under mild assumptions (Hahn2001). The sharp RD can identify the treatment effect as long as the conditional mean of the unobservables is continuous. In our case, the determinants of gasoline prices before and after the cutoffs were evolving "smoothly" except for the discount program. In particular, we control for crude oil price since it is the dominant driver of the gasoline price. Although Korea was the 5th largest oil importer in the world in 2011, its oil consumption only accounted for about 2.6% of the world total consumption (BP2012; Eni2012). Therefore it is reasonable to assume exogenous oil price because Korea’s impact if limited. In addition, the quantity demanded for gasoline does not change dramatically because its short-run elasticity is close to zero (Hughes2008).

Results and Conclusions

Our preliminary empirical results suggest that refiners and retail stations responded to the discount program heterogeneously. The benchmark model shows that refiners cut wholesale prices by 37-88 won/liter during the discount period at the cost of their profit margins. The market leader SK slashed its price the most. As for the retail market, gas stations increased their profit margins by 20-76 won/liter. In particular, the SK coops increased margins by 76 won. It suggests that vast majority of the discount was captured by the gas stations especially those coops affiliated with refiners. We also find that price differences widened during the discount period, which might suggest that gas stations have local market power. In addition, we also observed asymmetric responses to the starting and ending of the program, which is consistent with the finding by Borenstein1997. Given that the discount program was known to be temporary, our estimates shall be interpreted as the short-run effect. We have conducted extensive robustness checks and the main conclusions still hold well.

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