Effect of floating pricing policy: An application of system dynamics on oil market after liberalization

Upon the implementation of the floating price mechanism, Taiwan's gasoline and diesel prices returned to market mechanism, which terminated the phenomenon of the public paying for the losses of the state-owned oil company—Chinese Petroleum Corporation, Taiwan (CPC). Furthermore, the relatively low production costs of the privately owned Formosa Petrochemical Corporation (FPCC) disclosed the pricing mechanism of CPC, which inspired FPCC to adopt pricing strategy in order to increase the market share. This study aims to establish a system dynamics model to analyze the effects of the floating price mechanism on Taiwan's gasoline and diesel markets. This Model is divided into four sub-systems. The model of this study passed several validation tests, and hence, is able to provide a “virtual laboratory” for policy-makers to conduct simulation and scenario analysis. The simulation results indicate (a) feedback mechanism of expected revenues and pricing strategy could efficiently simulate the FPCC pricing mechanism, (b) price competition strategy could increase FPCC revenues, although the effect on market share is not remarkable, and (c) FPCC has a higher gas-station growth rate. Scenario analyses found (a) lowering oil security stockpile would not change FPCC's pricing strategy and (b) FPCC prefers to follow CPC pricing when it has more gas stations.

► System dynamics model analyzes the effects of oil markets' floating price mechanism.
► Feedback mechanism of expected revenues could efficiently simulate pricing mechanism.
► Price competition strategy could increase FPCC revenues.
► Lowering oil security stockpile, FPCC's pricing strategy would not change.
► FPCC prefers to follow CPC pricing when it has more gas stations.