Demand for petrol/ diesel and

macro- economic determinants

Presentation to SHELL
3 May 2006

Dr. Nicola Theron

Linette Ellis
 Demand - theory

 Demand generally a function of:

 Price of product
 Price of related products
 Income
 Population
 Tastes
 Other factors (N)

D  f ( Px, Py, Y , T , N ...)

 Price elasticity of demand

 Income elasticity of demand
 Petrol/ diesel demand - literature

 Drollas - early reviews of price and income elasticity in 1984 (published

in ‘Energy Economics’).
 US studies: “[w]hile a range of estimates are found in the literature, the
consensus view is that the long run price elasticity of demand is around
-0.8 while the long run income elasticity is slightly below unity”.
(Graham & Glaister, 2002:2).
 Some studies (Blum et al, 1988) found larger ranges for some
European countries, with income elasticity varying between 0.86 and
1.90. Sterner (1990) used pooled data for OECD countries and found
long run income elasticities of between 0.6 and 1.6. With another
technique (time series data), he found the income elasticity to vary
between 1.1 and 1.3.
 Later work by Goodwin (1992) generally found that elasticity estimates
had to be revised upwards from estimates calculated between the
1980s and 1990s.
International Income Elasticity for
Fuel (Graham & Glaister, 2002:7 )
Country Income Elasticity

Short run Long run

Canada 0.12 0.53

US 0.18 1.00

Belgium 0.63 1.25

France 0.64 1.23

Italy 0.40 1.25

Portugal 0.37 1.93

Switzerland 0.85 1.54

Japan 0.15 0.77

Turkey 0.65 1.29

Summary data on price and income
elasticity (Dahl & Roman (2004))
Price elasticity Price elasticity Income elasticity Income elasticity
(short run) (long run) (short run) (long run)

DIESEL

Mean -0.13 -0.67 0.55 1.13

Standard deviation 0.22 0.75 0.84 0.82

Minimum value -0.88 -2.63 -0.93 -0.19

Maximum value 0.31 0.22 3.32 3.00

Number of studies 27 27 26 26

PETROL

Mean -0.13 -0.61 0.25 0.69

Standard deviation 0.11 0.55 0.35 0.67

Minimum value -0.46 -2.47 -0.37 -1.46

Maximum value 0.25 0.88 2.03 2.68

Number of studies 70 112 71 114

 SA and middle-income countries

 India (Ramanathan, 1999). Short run income elasticity of 1.18 and a long run
income elasticity of 2.68 – might be explained by low level of fuel consumption in
India and the gradual increase in economic growth.
 South Africa:
Source Short term price Long term price
elasticity elasticity

S.A. Cloete & E.v.d.M.Smit (1988) -0.25 -0.37

S.D. Ngumeni (1994) -0.1 to -0.2

Bureau for Economic Policy Analysis (BEPA, 1989) -0.31

Bureau for Economic Research (2003) Petrol: -0.21 -0.51

Diesel:
-0.18 -0.06

Income elasticity (BER) (2003) Petrol: 0.15 0.88

Diesel:
1.3
 Philips curve (inflation vs.
unemployment – US (1960s))
US – 1970-2000
US – Inflation (more persistent)
Expectations augmented Philips
curve (US 1970-2000)
 SA – Structural changes
 Stable Macro economic environment
 GEAR
 ASGISA;
 Monetary policy – Inflation targeting regime
 Fiscal policy – Fiscal discipline
 Deficit as ratio of GDP: 2006/07 (-1,5%); 2007/08 (-1.4%); 2008/09 (-1.2%).
 More funds available for service delivery and infrastructure provision.
 Trade deficit 2006Q1 = R14,6 bn, 2005Q1 = R4,7bn – Is this a problem?
 Higher imports – driven by consumption expenditure (lower interest rates, lower
inflation, etc.).
 Current account deficit – dependence on capital inflows.
 JSE – R38bn in 3,5 months 2006 (R15bn last year same period).
 Risk factors?
 Commodity prices high – positive effect on exports.
 Oil – 14.2% of total imports in 2005.
 Commodities = 70% of SA exports- positive effect larger than negative oil import
effect.
GDP growth and business cycle
upswings
Real GDP growth (1946-2004)
7

5
Average growth in real GDP

0
1946-1950 1951-1960 1961-1970 1971-1980 1981-1990 1991-2000 1995-2004
 GDP growth and CPI
20.0

15.0

10.0
%

5.0

0.0

62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20

-5.0

GDP CPI
 GDP and Interest Rates (Prime)
10.0 25.0

8.0

20.0

6.0

15.0
4.0

Prim e rate
GDP

2.0
10.0

0.0

5.0

-2.0

-4.0 0.0

GDP Prime Rate

 Growth and Exchange rates (R/$)
12.0

10.0

8.0

6.0

4.0

2.0

0.0

-2.0

-4.0

GDP R/$
Forecast of Key Economic Variables –
BER vs. Reuters Consensus (Mar 06)
2004 2005 2006 2007
GDP Growth:
BER 4.5 4.9 4.5 4.2
Reuters Consensus 4.5 4.7
CPIX Inflation:
BER 4.3 3.9 4.3 4.9
Reuters Consensus 4.2 4.6
Prime Interest Rate:
BER 11.3 10.6 10.5 10.5
Reuters Consensus 10.5 10.6
R/$ Exchange Rate:
BER (eop) 6.45 6.36 6.29 (6.35) 6.92 (7.30)
Reuters Consensus 6.28 (6.35) 6.60 (6.75)
R/Euro Exchange Rate:
BER (eop) 8.01 7.91 7.76 (7.94) 8.69 (9.17)
 Business confidence (RMB/ BER
Business Confidence Index)
100

90

80

70

60

50

40

30

20

10

0
 Economic theory of demand -
restated
 Petrol - Income elasticity:
 If there is an increase in income, people earn more and they have more
disposable income, which will increase their demand for petrol, as they
buy more or bigger cars, or go on more holidays or generally use their
cars more. The data on long-term income elasticity suggest that this is
approximately a 1:1 relationship. In other words, a 1% increase in
income will lead to a 1% increase in the demand for fuel (the income
elasticity seems to be higher for diesel than for petrol, but on average
the income elasticity is around 1).
 This is therefore a positive relationship.
 The relationship between the price of petrol (or diesel) and the demand
for petrol (or diesel) is a negative relationship (indicated by the minus
sign on the price elasticities). The economic reason is simple: as the
price of a product increases, the demand decreases.
 UHAMBO EXAMPLES: Econometrix

 Demand Elasticity (1999-2004)

 Petrol: -0.23
 Diesel: -0.13
 Income Elasticity
 Petrol: 0.38 (Used GDP)
 Diesel: 1.47
 Same observations as above:
 Low price elasticity – Ed<1 = price inelastic
 Income elasticity higher (petrol – correct variable?)
 Increase in light diesel vehicle sales?
 Used three exogenous variables: $ price of Brent crude oil; Rand/$US exchange
rate; GDP growth rate.
Demand forecasts – OOC’s in Uhambo
trial
 CRA (for Sasol): Sasol’s current best estimate…demand for white fuels in the
inland area will grow between 2005 and 2015 by:
 Petrol: 1.4%
 Diesel: 3.4%
 Kerosene: 2.9%
 Uhambo business plan:
 Petrol: 1%
 Diesel: 3.5%
 Kerosene: 0.9%
 Engen (Business plan):
 Petrol: 0.2%
 Diesel: 4.7%
 Kerosene: 0.0%
 Sasol/ Engen (Uhambo)

Source: Petrol Diesel Kerosene

Uhambo Business Plan 1.0% 3.5% 0.9%

CC Submission (28/4/2005) 0.6% 4.0% 2.5%

Sasol Oil (2006 budget) 1.4% 3.4% 2.9%

Engen (Business plan 2006) 0.2% 4.7% 0.0%

Demand forecasts – OOC’s in Uhambo
trial
 DME (Uhambo)
 Petrol: 0.6%
 Diesel: 0.4%
 Petronet:
 Petrol: 0.5%
 Diesel: 2.5%
 Jet Fuel: 3.0%
 Revised later to 2.6% combined projected growth for petrol, diesel and jet
fuel.
 BP:
 Petrol: 3%
 Diesel: 6% (CRA: “outliers”)
 Caltex:
 Petrol: 2.7% up to 2006, and 3.3% beginning 2007;
 Diesel: 3.3% up to 2006, and 4.1% beginning in 2007.
 Masana (ECONEX)

Petrol Diesel

2005 5.3% 5.9%

2006 3.3% 3.7%

2007 2.9% 3.5%

2008 3.1% 5.4%

2009 3.8% 5.8%

 Shell (Uhambo)

 RBB used Shell methodology:

 Demand for petrol = (GDP - 1.5%)
 Demand for diesel = (GDP + 1.4%)
2005 2006 2007 2008 2009 2010

GDP growth 3.5% 3.7% 4.4% 3.3% 2.9% 3.0%

Petrol Demand Growth 2.0% 2.2% 2.9% 1.8% 1.4% 1.5%

Diesel Demand Growth 4.9% 5.1% 5.8% 4.7% 4.3% 4.4%

 Tribunal

 “We have been presented by bald estimates by the participants in

these hearings – many of whom appeared to rely on independent
experts – but surprisingly few have attempted to explain the
underlying basis for their estimates. A notable, if somewhat
unfortunate, exception is Mr. Swart of Sasol who indicated that
Sasol had used an observed correlation between the CPI and
petrol demand to estimate demand growth. However, there is no
discernible causal relationship between these variables…”
 “In our view, common sense would suggest a high degree of
correlation between income growth and rates of growth in fuel
consumption. It may also reasonably be hypothesised that
changes in the distribution of income would correlate with shifts in
demand for fuel products.
Sasol - Petrol (Swart)
Sasol – Diesel (Swart)
 Sasol

 Battery of statistical tests (multicollinearity, heteroscedasticity; Durbin-Watson, etc) – all

meaningless;
 There is absolutely no point in running a battery of statistical tests on an equation that, (1)
is not based on economic theory and therefore excludes the most important driver of
demand, namely consumer income or economic growth and (2) includes an explanatory
variable with the wrong sign, as was done with Mr. Swart’s petrol sales equation.
 No income variable – positive growth expectations NO effect in their model;
 (Mr. Quinton Swart (who estimated the Sasol demand functions) said in his testimony that he has
not found GDP to be a good indicator of petrol demand, (although he has found it to be a good
indicator of diesel demand);
 Sasol – monthly data?
 Used levels not percentage change
 “CHAIRPERSON: What is the theory of the connection between inflation and petrol demand?
 MR SWART: I am myself not an economist, Chair. So it’s a difficult one for me to explain. It’s
things that I have tested and found to be relevant. I cannot in economic terms explain that.” (11
October 2005).
 Sasol - testimony

 (12 October 2005): “ADV FAGAN: Yes. I understand. And that would explain also why you
couldn’t, in response to a question from the Chair yesterday, on an economic basis say why
you had chosen CPI particularly.
 MR SWART: Not being an economist, I thought about that last night and I would certainly
think that inflation would have a direct impact on consumer expenditure and that
consumer expenditure would directly influence petrol sales. I must also highlight that
it’s much easier projecting. A model is just as good as the variables that you have to
project when going into the future. If anybody can give a very good estimate of consumer
expenditure growth in the future relative to what inflation will be, I would need to see that. I
put it to you that inflation as well as GDP are two of the variables that’s mostly, together
with the Rand/Dollar exchange rate, the most projected variables in the economy,”
 Finally, on 17 October 2005: “ADV CILLIERS: Now the Chairman asked you whether you
could think of a theoretical reason for such an influence of CPI on the demand for petrol.
Can you?
 MR SWART: I again submit that the reason I can think of is that inflation would have an
impact on disposable income of the consumers and that would influence their purchasing
power as well as patterns in terms of the sizes of vehicles they purchase, money available
to them, etc.”
Correlation – Petrol and CPI (levels)
3000

2500

2000

1500

1000
82 84 86 88 90 92 94 96 98 00 02 04

PETROLVOL_NOM

140

120

100

80

60

40

20

0
82 84 86 88 90 92 94 96 98 00 02 04

CPI
Shell – Petrol (forecast vs. real)
8.0%

6.0%

4.0%

2.0%

0.0%
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
:0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0 :0
:01 :03 :01 :03 :01 :03 :01 :03 :01 :03 :01 :03 :01 :03 :01 :03 :01 :03 :01 :03
96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05
19
-2.0% 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20

-4.0%

-6.0%

-8.0%

Vol_Petrol GDP minus 1.5 (Shell petrol)

 Shell – Diesel (Forecast vs real)
15.0%

10.0%

5.0%

0.0%

00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00
0 1: 03: 01: 03: 01: 03: 01: 03: 01: 0 3: 0 1: 03: 01: 03: 01: 03: 01: 03: 01: 0 3:
: : : : : : : : : : : : : : : : : : : :
96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05
19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20

-5.0%

-10.0%

Vol_diesel GDP plus 1.4% (Shell diesel)

 Price effect
35.0%

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00 00
0 1: 0 3: 0 1: 0 3: 0 1: 0 3: 0 1: 0 3: 0 1: 0 3: 0 1: 0 3: 0 1: 0 3: 01: 0 3: 0 1: 0 3: 0 1: 0 3:
: : : : : : : : : : : : : : : : : : : :
96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05
19
-5.0% 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20

-10.0%

Vol_Petrol Petrol price (cent per liter %)

Regional effects - Regional Economic
Growth (year on year % change)
Province 2000 2001 2002 2003 2004

Western Cape 4.2 3.7 4.4 3.5 5.3

Eastern Cape 4.3 2.7 1.6 2.5 4.6

Northern Cape 2.0 -1.7 1.5 3.6 3.0

Free State 2.1 -1.1 3.9 2.0 3.9

KwaZulu-Natal 4.7 4.4 2.6 2.8 4.9

North West 1.5 0.9 1.6 4.5 4.9

Gauteng 5.9 2.3 5.1 2.9 4.4

Mpumalanga 3.1 1.3 2.5 2.7 4.2

Limpopo 0.2 6.8 4.2 2.7 2.7

GDPRSA at market
4.2 2.7 3.7 3.0 4.5
prices
 Other possible regional factors
(Intergovernmental Fiscal Review)
Western Cape South Africa Western Cape as % of SA

Area (square km) 129 370 1 219 207 10.6%

Paved km 7 172 56 431 12.7%

Gravel km 24 991 199 936 12.5%

Access km 7 822 92 160 8.5%

Total km 39 985 348 527 11.5%

Road network density (m/sq km) 309 282 109.6%

No of registered vehicles 1 188 6 949 17.1%

Vehicles per km of provincial 29.7 20.2 147.0%

road

Provincial spending on roads 391 5 089 7.7%

(2003/04)
 Other factors
NAAMSA: Local Sales: Passenger Cars - Number

40000

35000

30000

25000

20000

15000

10000

5000

0
 Other factors

 South Africa is a developing country, but has a low persons-per-car ratio among
the affluent, similar to the US at around 2:1. Yet this ratio is as high as 80:1
among poorer people. The mobilization of poorer people via mini-bus taxi’s from
1984 led to petrol growth rates of almost 10%, while traditional bus companies
saw 40% declines in passengers. The impending move of petrol mini-bus taxi’s
to diesel midi buses will accentuate the swing to diesel-powered cars, started by
the advent of diesel 4X4’s and the move to road-freight trucks as railway
efficiency declined. These structural shifts will have an effect in the medium run.
Estimation of demand equations

Linette Ellis
BER
Estimating demand equations for petrol and
diesel sales volumes

 Choice of explanatory variables

 Explanatory variables must make economic sense
 Both real price and demand variables important determinants (e.g. gdp,
income, car sales/stock)
 Positive relationship between real GDP growth and growth in petrol
sales volumes…

16%

But correlation only 17%

12% between 1983 and 2005,
even lower after 1995
Year on year % change

8%

4%

0%

-4%

-8%
83 85 87 89 91 93 95 97 99 01 03 05
Petrol sales volumes Real GDP
 Stronger relationship between growth in real disposable income of
households and growth in petrol sales volumes…

20%

16%
Correlation 38% between
1983 and 2005, 26%
Year on year % change

12% after 1995

8%

4%

0%

-4%

-8%
83 85 87 89 91 93 95 97 99 01 03 05
Petrol sales volumes Real Disposable Income
 Strong negative relationship between petrol sales and real (CPI
deflated) price of petrol

15% 40%
-73% Correlation between
1983 and 2005,
10% -64% after 1995
20%
Year on year % change

5%
0%
0%

-20%
-5%

-10% -40%
83 85 87 89 91 93 95 97 99 01 03 05
Petrol sales volumes Real petrol price
 Incorrect specification of equation can lead to non-sensical results,
e.g. positive relationship between sales and price

2900 600

500
Petrol sales (Millions of litres)

79% Positive correlation

Petrol price (cents per litre)

2600
between petrol sales and
price if level data is used 400
2300
300
2000
200

1700
100

1400 0
83 85 87 89 91 93 95 97 99 01 03 05
Petrol sales volumes Petrol price
 Strong positive relationship between real GDP growth and growth
in diesel sales volumes…

15%
67% between 1983 and 2005,
38% after 1995
10%
Year on year % change

5%

0%

-5%

-10%
83 85 87 89 91 93 95 97 99 01 03 05
Diesel sales volumes Real GDP
 Negative relationship between diesel sales and real (PPI deflated)
price of diesel, but weaker than seen in petrol

15% 40%
-19% Correlation between
1983 and 2005,
10% -13% after 1995
20%
Year on year % change

5%
0%
0%

-20%
-5%

-10% -40%
83 85 87 89 91 93 95 97 99 01 03 05
Diesel sales volumes Real diesel price
Estimating demand equations for petrol and
diesel sales volumes

 Choice of explanatory variables

 Explanatory variables must make economic sense
 Both real price and demand variables important determinants
 Equation specification
 Levels vs. % change
 Logs
 Cointegration techniques
 Interpretation of statistical results
 Coefficient sign
 Magnitude of coefficient and t-statistic
 Goodness of fit and R-squared
 Autocorrelation and Durbin-Watson
 Forecasting