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Gasoline in California


Tags U.S. EconomyPolitical TheoryPrices


From Mike Davis:

With the rise of gas prices above the $3 a gallon psychological level, and the record quarterly profits of Exxon Mobil, accusations of price fixing, price gouging and profiteering abound. Big-oil CEO's have been called before a congressional committee to answer for this "obscene greed". In a television interview following hurricane Katrina, Senator Schumer, one of the usual mouthpieces, opined — "I don't see why California gas prices should go up because refineries in the Gulf are shut down".

This is not the first time that this issue has come up. In March 17th 2003, gas prices in California rose above $2 a gallon for the first time. A California Congressman wrote a letter to the Office of Oil and Gas of the Energy Information Association (EIA), an independent statistical and analytical agency within the DOE, requesting an investigation. The full text can be found here:

While this report is about something that happened more than two years ago, it makes some excellent points, showing that the price movements were driven entirely by market and regulatory forces and not by "price gouging" following the invasion of Iraq. Here are some of the key points (some taken verbatim from the report):

Gas prices can be broken down into various components: crude oil prices, refining costs and profits, distribution/marketing costs and profits, and taxes.
The crude oil price, a global market factor, should be subtracted out. With the price of oil removed, the price spikes were no greater than those observed historically.

The major contributing factor to the price run-up was legislation mandating the partial phase-out of the carcinogenic and water supply polluting additive methyl tertiary butyl ether (MTBE) from California gasoline, and its replacement with ethanol, The following local factors contributed to the shortage: 

  • The California refinery system runs near its capacity limits, which means there is little excess capability in the region to respond to unexpected shortfalls;
  • California is isolated and lies a great distance from other supply sources (e.g., 10 days travel by tanker from the Gulf Coast), which prevents a quick resolution to any supply/demand imbalances;
  • The region uses a unique gasoline that is difficult and expensive to make, and as a result, the number of other suppliers who can provide product to the State are limited.

Originally, California was scheduled to ban MTBE starting in January 2003, but a number of factors caused Governor Gray Davis to delay the ban for one year. However, many California refiners chose to switch from MTBE to ethanol in January 2003. As a result:

  • The market became segmented into two non-fungible products, since ethanol-blended gasoline cannot be mixed with other gasolines during the summer, to assure compliance with emission requirements.
  • The price increase in crude oil occurred about the time California refiners were changing from winter-grade gasoline to summer-grade, which is harder to produce and, when using ethanol, requires a change in procedures or timing to assure that uncontaminated summer-grade product is located at terminals on time.

The MTBE changeover had much more severe implications:

1. The MTBE formulated gasoline contained 89 % gas and 11% MTBE. The winter grade ethanol based fuel contained %94 gas and 6% ethanol. Thus, refineries operating near capacity were faced with the prospect of producing another 5% after the changeover.

2. The summer grade refined gasoline component had to be further refined to eliminate volatile hydrocarbons such as butanes and pentanes. Thus in the summer, the baseline refined gas output was 10% short, (and the refining costs were increased).

3. More refinery downtime, due to unscheduled maintenance and modification.

There are many more interesting discussions going into the market segmentation produced by separate MTBE and ethanol-based refineries.

The report shows that the internal workings of the market can be very complex and that there is no basis for the simplistic price gouging accusations.

From an Austrian perspective, the notion of price gouging does not exist — the gasoline is the gas station owner's property and he/she is under no obligation to sell it for any particular price, nor am I, as a consumer, obligated to buy. (In fact, I often buy 89 octane gas instead of 91 — I don't notice a sufficient difference in engine performance to warrant the 20 cent a gallon differential.) Even among those who agree in principle with market based pricing, the price gouging mentality has gained a foothold — even conservative radio talk show hosts have caught the disease. 

The concept most people, seem to have most difficulty with is the replacement cost argument — the refinery or gas station bases it prices on what it expects to pay for its next delivery and not to recoup the cost of the last one. People understand that nobody will sell them 1000 shares of Google for 10% above last January's price, or a Pacific Heights apartment for 20% above its 2000 price, and consider that this is perfectly reasonable.

Yet the same people expect a gas station owner, who paid $2.50 a gallon for the gas now selling at the pumps, to be morally bound (and in some states legally bound) to sell it for a "fair price", $2.58 a gallon, even though the cost of the next shipment from the refinery will be $2.75 a gallon.

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