Conjectural reactions and deregulation in the Japanese oil industry

The purpose of this paper is to investigate how firms in the Japanese oil industry expect their rivals to react when the firm changes its output level. This paper focuses on an act of deregulation, the abolition of production quotas for two oil products, diesel oil and kerosene, in March 1992. Following this deregulation, oil companies could freely supply oil products. A key questions arising from this deregulation is how did the regulated industry behave in the face of this "release" from the prior production constraints. There have been several recent studies of the Japanese oil industry, but they have all focused on the impact of the abolition of the Tokusekiho, the Provisional Law relating to the Importation of Specified Petroleum Products, that restricted the importation of specified petroleum products to limited number of companies. The Tokusekiho, was abolished at the end of March 1996. However, despite this liberalization, total imports of specified petroleum products, gasoline, diesel oil and kerosene, have been very small relative to the total production of these products in Japan. This paper casts doubt on the positive evaluation of the abolition of Tokusekiho that the media has often suggested. This paper analyzes two oil products, diesel oil and kerosene. All recent studies of the Japanese oil industry have analyzed the behavior of firms and the retail price of just gasoline product despite the fact that the liberalization covered three oil products. An evaluation of the differences in the magnitudes of competition for oil products other than gasoline is necessary in order to fully analyze the effect of deregulation. Figure 1 depicts the structure of the estimation process in this paper. On the supply side, this paper assumes that the situation in the Japanese oil industry was the beginning of quantity setting competition. Using the conjectural variation approach (CVA), the paper investigates how one firm expects its rival firms in the oil industry to react when the firm changes its output level. On the demand side, a log-linear demand function is estimated. Each firm's first order condition derived from profit maximization contains the price elasticity of demand. Therefore, in order to achieve more efficient estimation, joint estimation of the supply and demand sides is conducted by using the General Method of Moments (GMM) estimator. Furthermore, the impact of the abolition of the temporary protection law, Tokusekiho, and two mergers of gasoline firms is also investigated. (Figure Presented) In stark contrast to the results obtained by Goto and McKenzie (2005) for gasoline, the results here show that firms in the Japanese oil industry almost never expect their rivals to react when the firm changes its output level. One possible reason for this outcome is that commercial customers such as bus companies and truck carrying companies, form a significant part of the demand of diesel oil. These customers may not switch between suppliers so readily. As a result, firms do not need to worry about their rival's behavior. A large part of the demand of kerosene is used by households for home heating plant. There has been a national policy to maintain a stable price of kerosene Therefore, the market may be non-competitive, and the degree of interaction among firms may be small.