Well the price of gasoline just spiked upwards across Canada and the usual media analysis has begun. Five key reasons were summarized as follows by Shawn McCarthy in the Globe and Mail: 1) Approach of the summer driving season leading to a switch to summer gas formulations which leads to a reduction in supply. 2) Higher crude prices. 3) A lower Canadian dollar. 4) Lack of retail competition in Canada and 5) U.S. exports of gasoline and diesel out of North America creating tighter demand and supply conditions. I thought explanation number three was rather intriguing.
According to explanation number three, since the dollar is off about 10 percent against the U.S. dollar and since crude prices are set in U.S. dollars, it means that Canadian refiners are paying more for oil and importers have to pay more for their gasoline. This explanation has been floated around quite a bit over the last few days. Well, that is an easy one to quickly get a bit of data on. In Figure 1, the monthly value of the Canadian dollar ($CAD per $US, noon spot rate, average) for the period 1990 to 2014 is plotted against the average regular unleaded gasoline price for 18 Canadian cities.*
Well, from 1990 to about 1999, the average gasoline price hovers around 60 cents a litre while the Canadian dollar depreciates – from 1.17 to about 1.49 CAD for a US dollar. It would appear during this period the depreciating Canadian dollar did not seem to do much to gasoline prices. The Canadian dollar depreciates further after 1999 and gas prices rise from about 60 cents a litre to 72 cents. There may be some exchange rate effect here. The Canadian dollar begins to appreciate after 2002 and hits parity for a while in 2007 but there is no drop in gasoline prices. The dollar stays strong relative to the US dollar after 2007 and gas prices continue to rise. Actually, during this period the average price of gasoline rises quite dramatically. If anything, I would have to conclude that on average a stronger Canadian dollar is associated with higher gasoline prices while a weaker dollar is associated with lower gas prices. Of course, no other confounding factors over time are being controlled for here but it was still an interesting picture.
Figure 2 takes the first difference of both series and plots them against each other and adds a linear trend. Increases in the amount of Canadian dollars needed to buy a US dollar (depreciation) seem to be inversely related to gasoline price increases. Again, a depreciating currency seems to be weakly correlated (a very low r-squared) with lower gasoline prices. Maybe there is a lag? I also plotted the first difference of gasoline prices against the exchange rate lagged three months and still got the same weak negative relationship.
So, I don’t find much support in a depreciating currency as part of the explanation for the rise in prices. As for the other factors – decreasing retail competition over time may be a better explanation for some of the rise in prices. After all, in the late 1980s there were over 20,000 gas retail outlets in Canada whereas by the mid 1990s they had shrunk to 16,500. Between the mid-1990s and 2006, they fell further to 13,772. Today, there are apparently 12,285 retail gasoline outlets. A full explanation would need to control for this change in the market and any changes in the concentration of ownership as well as the price of crude and the onset of more fuel-efficient cars. Still, cutting the number of retail outlets in half while the gasoline price more than doubles over twenty years suggests that this must be part of the explanation.
*They are: St. John’s, Winnipeg, Regina, Saskatoon, Edmonton, Calgary, Vancouver, Victoria, Whitehorse, Yellowknife, Charlottetown, Halifax, Saint John, Quebec, Montreal, Ottawa, Toronto, Thunder Bay. Source: Table 3260009 - Average retail prices for gasoline and fuel oil, by urban centre, monthly (Cents per litre). Exchange rate: v37426 Canada; United States dollar, noon spot rate, average.
APRIL 26 UPDATE
The point of the post was to simply examine the relationship between the exchange rate and the price of gasoline given the argument made in the media that a depeciating dollar was a factor driving the spike in gas prices. It was obviously too simple an examination even though I thought I had qualified matters by acknowledging other factors (including the price of crude) in the last paragraph. I have had a number of blog comments (as well as e-mails) telling me I cannot look at gasoline prices without taking the price of crude oil into account. Most of the comments have been polite and not questioned my credentials as an economist. The points are that crude oil prices are a major driver of gasoline prices (with which I agree even if the post did not explicitly state this point) and that the Canadian dollar is also driven by the price of crude oil (Well perhaps. I always thought it was commodity prices in general of which crude oil is of course an important component). Okay. I went out and got the monthly price of West Texas Intermediate. I plot two more figures below - one with the exchange rate and the price of crude over time, the other with the average price of gasoline variable I used in the post and the price of crude over time. I think the figures speak for themselves. The one plotting the exchange rate over time with the price of crude suggests that there are periods where rising crude prices move with an appreciating dollar (certainly from 2001 to 2008 the relationship looks strong). However, from 1990 to about 2001, the dollar depreciates while crude oil prices stay pretty flat. As for gasoline prices and crude? Well, the price of gasoline and the price of crude seem to move together very nicely. Let me state at this point that a full explanation would require a more methodical and sophisticated empirical analysis perhaps using some type of simulataneous regression framework to account for potential simulataneity in the relationship between crude oil prices, the exchange rate and the price of gasoline as well as other variables such as a measure of retail market concentration. As well, one might want to try a variety of different crude oil prices. I'm sure that would be a fun and interesting project.