Dynamic panel data approaches for estimating oil demand elasticity

• Author: Afshin Javan,Nahl Zahran
• DOI: http://doi.org/10.1111/opec.12040
• Published date: 01 March 2015
• Date: 01 March 2015

Dynamic panel data approaches for

estimating oil demand elasticity

Afshin Javan* and Nahl Zahran**

*Modelling and forecasting analyst, Helferstorferstrasse 17, OPEC, 1010 Vienna, Austria;

PhD student, Faculty of Economics, Allameh Tabataba’iUniversity, Tehran, Iran. Email: ajavan@opec.org

**Senior Economist, Saudi Aramco, Dhahran, Saudi Arabia

Abstract

This study examines the general relationships between crude oil consumption, real oil price and real

GDP using a quarterly time series from 1993 to 2012. Specifically, the long-term and short-term

GDP and price elasticities of oil consumption per capita were estimated using dynamic panel and

pooled data regressions based on Nerlove’s oil demand model for 25 countries that represent 75

per cent of global oil demand. Price elasticities were found for most OECD countries. These esti-

mates were lowand consistent with previous estimates. According to the study results, the short-run

price elasticity ranged between −0.05 and −0.20 and the long-run between −0.11 and −0.36. Price

elasticities for most non-OECD countries were either positive or insignificant. Estimates of GDP

elasticities varied.The shor t-run GDP elasticity was between0.15 and 1.09, while the long-run was

between 0.21 and 1.54. On average, income elasticity for OECD countries wasfound to be slightly

higher than for non-OECD countries. Contrary to expectations, we found China’s income elasticity

to be 0.34 in the short run, but it was 0.76 in the long run.

1. Introduction

Forecasting long-term supply and demand fundamentals in the oil industry is challeng-

ing but crucial in assessing the requirements for capacity expansion. Robust and accu-

rate forecasts are essential, especially for an industry that is characterised by long lead

times.

One way to examineoil demand dynamics is through the concept of elasticity, defined

as the percentage change in oil demand given a percentage change in a certain economic

variable. It has been the focus of numerous studies, as it provides a useful summary of

demand responses, forms the basis for forecasting oil demand and supply and helps policy

makers in designing policies aimed at regulating consumption.

Many studies have focused on estimating income elasticities, as oil demand is pri-

marily underpinned by economic growth, and price elasticities, because of their impor-

tance in explaining consumption behaviour and deciding the appropriate levelof taxation,

and the subject of fuel prices has been a contentious issue among consumers and

53

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politicians. However, the literature in that area is vast, and numerous estimates exist.These

differences arise from the way oil demand is defined (consumption by consumers or

demand for crude oil by refiners), the oil product mix examined, the sectoral and country

aggregations considered, the price measure used, and most importantly the econometric

technique employed.

Using quarterly data from 1993 to 2012, this study estimates the income and price

elasticities of 25 countries that represent 75 per cent of global oil demand by using a

dynamic panel data approach that is based on Nerlove’s oil demand model.

2. Oil demand: a historical perspective

Many factors underpin oil demand, but without doubt, economic growth represents the

single most important driver. Figure 1 below plots the relationship between oil demand

per capita and GDP per capita for the 25 countries considered in this study from 1993 to

2012. The patterns of growth are differentamong countries due to their varying degrees of

development and prosperity.The developing countries show continuous growth,while the

advanced countries show stagnation or even decline. However, taken all together, the

graph shows a clear linear relationship between GDP and oil demand.

Figure 1 Relationship between oil demand and income (logarithmic scale). Sources: OPEC and

Oxford Economics Databank.

Afshin Javan and Nahl Zahran54

OPEC Energy Review March 2015 © 2015 Organization of the Petroleum Exporting Countries