Alaska North Slope crude oil price and the behavior of diesel prices in California

In this paper we analyze the price dynamics of Alaska North Slope crude oil and L.A. diesel fuel prices. We employ VAR methodology and bivariate GARCH model to show that there is a strong evidence of a uni-directional causal relationship between the two prices. The L.A. diesel market is found to bea r the majority of the burden of convergence when there is a price spread. T his finding may be seen as being consistent with the general consensus that price discovery emanates from the larger, more liquid market where trading volume is concentrated. The contestability of the West Coast crude oil mar ket tends to cause it to react relatively competitively, while the lack of contestability for the West Coast diesel market tends to limit its competit iveness, causing price adjustment to be slow but to follow the price signal s of crude oil. Our findings also suggest that the derived demand theory of input pricing may not hold in this case. The Alaska North Slope crude oil price is the driving force in changes of L.A, diesel price. (C) 2001 Elsevi er Science B.V. All rights reserved, JEL classification: Q40.