“What?” you may be saying “Gas prices are lower than they have been in a long time.” That’s true, even in California, but that just reflects the collapse of world oil prices. And only partially. You see, while oil prices have been falling across the country, the gap between California gas prices and the rest of the U.S. has climbed to higher levels for a longer stretch than at any time in the last 20 years.
Why? I don’t know, but some people claim to, from consumer advocates arguing it’s collusion to industry representatives saying that it’s just a shortage of supply for California’s special cleaner-burning blend, known as CARB gasoline.
The figure above shows the difference between California’s average gas price and the U.S. average going back to 1995 when the state started requiring CARB gas. For the decade from 2005 to the end of 2014, California’s retail price averaged about 31 cents above the national average. That differential lines up well with the fact that our gas taxes were about 20 cents above the nationwide average during that time and making CARB gasoline adds about 10 cents a gallon to the cost.
On January 1, 2015 transportation fuels came under California’s Cap-and-Trade (CaT) program for greenhouse gas (GHG) emissions, as I discussed before. It is now widely accepted that the CaT program should have, and has, increased gas prices by about ten cents a gallon. Add that in, and we’d expect the differential between California and the rest of the country (where GHG emissions are still free) to average around 40 cents per gallon.
That’s about where things were for the first month and a half of 2015, but then on February 18 a fire at Exxon’s Torrance refinery near LA shut down the plant’s gasoline production. That refinery normally produces about 10% of the state’s CARB gasoline. Since then, California’s gas price has averaged about 82 cents per gallon higher than the national average. The extra 42 cent premium since February 17 totals up to nearly $4 billion in extra payments – more than $150 for every licensed driver in the state – and still growing. As of yesterday, the average California price was 71 cents above the US, according to AAA.
The problem is worst in Southern California, where prices since mid-February have averaged 26 cents higher than in the North. In the previous decade, the North-South differential averaged around one cent.
High prices don’t necessarily mean that anyone is profiting unfairly or doing anything illegal. Scarcity of a product drives up prices even in the most competitive markets.
Events like the Torrance fire have caused price spikes in California before, but they generally have disappeared within 4-6 weeks, because that’s how long it takes to import CARB-specification gasoline from the many other refineries in the world that can produce it. In 2012, when the Chevron refinery in Richmond had a major fire, prices jumped 50 cents for a couple weeks, but within a month that excess differential was gone. As the figure above shows, previous spikes have never before lasted nearly as long as the current one.
So, this spike does suggest that something is amiss in this market. Why is this spike so long lasting? And what, if anything, should the state do about it?
Some consumer advocates point to increased concentration among in-state producers of CARB gasoline in the last few years and allege these firms are now colluding to reduce competition. But the evidence presented so far is thin, mainly just that refineries are making a boatload of money. That could indeed be due to producers restricting the quantity they sell in order to boost prices, but it could instead just reflect refineries having insufficient capacity to replace the lost production capacity when one of the largest producers shuts down unexpectedly. Either could cause the price to jump. In a 2004 paper that Jim Bushnell, Matt Lewis and I wrote, we discussed competitive and non-competitive causes of high gasoline prices, how difficult it is to tell them apart, and policies that might address them.
Critics also point to the fact that California refineries have been exporting gasoline despite the high prices at home. But not all of the gasoline made in our refineries can meet the strict specification for in-state sales. Non-qualifying gasoline is regularly shipped from California to Nevada, Arizona, Mexico and other places with lower standards. So, exporting gasoline doesn’t seal the deal on anti-competitive behavior. Now if California refiners were exporting CARB-specification gasoline since February – or making a choice to produce less CARB gasoline — that would be much more difficult to reconcile with competitive behavior.
Nonetheless, while consumer advocates have not proven their case, their suspicions have merit. With prices very sensitive to even a slight shortage, and with two companies producing about half the state’s CARB gasoline supply, it seems quite possible that firms might be able to make more money by making less CARB gasoline. This could be particularly true when a supply shock like a large refinery fire has already tightened the market. That doesn’t prove they are doing it, but it does – as the lawyers say – go to motive.
In the past, one response from the industry has been that such output restriction would just create an opening for imports of CARB gasoline that would steal their market share. But that leads us to perhaps the biggest puzzle of the current price shock: where are the imports? With California’s prices this high – regardless of whether due to real scarcity or insufficient competition among in-state producers — it seems there is ample money to be made bringing in CARB gasoline from afar, as has happened during past spikes. Why isn’t that happening this time, or happening in sufficient quantity to bring California’s prices back in line with the rest of the country?
More than one of my environmentalist friends has responded to my concerns by asking what’s so bad about high gas prices. After all, we need to move away from gasoline and this will help. I think there are a couple reasons that this isn’t the way we want to get off gasoline.
First, high gas prices hurt lower-income working families, so if we were imposing high prices with, say, a carbon tax policy, I at least would want to pair it with some other tax relief for that group to help offset the higher cost of fuel. This isn’t a government tax policy, just higher profits flowing to private companies, and there is no offsetting tax reduction.
Second, because California is a leader in all things enviro, our energy policies are scrutinized worldwide. If our fuels policy is viewed as causing inexplicably high gasoline prices, that will undermine political support for similar policies in other jurisdictions.
A year ago, I was named a member of the California Energy Commission’s new Petroleum Market Advisory Committee, five industry experts charged with examining the state’s high and volatile gas prices, and suggesting policy responses. Three weeks ago, I was appointed chair of the committee. Working with CEC staff, I hope very soon to hold a workshop at which we can hear the views of all stakeholders – refiners, importers, retailers, consumer groups and others — and ask them detailed questions. Such an open discussion will, I hope, bring more insight and common understanding than we have gotten from the media-targeted rhetoric that usually accompanies discussions of gas prices.
 If you buy a house just before the market rebounds and then sell it a few years later at a tidy profit, is that unfair?
Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.