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California’s Mystery Gasoline Surcharge Continues

It’s time for lawmakers to make the $3 billion per year puzzle a priority.

It’s not going away. Back in October, I blogged, and published an op-ed about California’s mystery gasoline surcharge. In case you instead chose to fill up those memory cells with the plotline from The Walking Dead, here’s a refresher: The state’s Petroleum Market Advisory Committee in its final report last September voiced deep concern about the abnormally high price premium that California drivers have been paying since early 2015. But, the PMAC (which I chaired) concluded that it did not have the authority or resources to do a full investigation of the cause.

                             Source: Patch.com

The response of a few legislators and other policymakers was roughly, “huh, someone should look into that.” But since then, the topic has disappeared from the news and the halls of the Capitol. That got me thinking about whether this is just small potatoes — not enough money to rise towards the top of public policy priorities — or a hot potato that policymakers just don’t want to touch.

To jog your memory, the chart below shows the difference between California’s gasoline price and the average price in the rest of the U.S. after adjusting (month by month) for the differentials in taxes and environmental fees (including our cap and trade program and low carbon fuel standard), and the higher cost of producing California’s cleaner burning gasoline. (The data and the calculations are in a spreadsheet here.)

From 2000 until the Torrance refinery fire in early 2015, California’s price differential from the rest of the country went up and down, but on average there was no premium above what you would expect from tax differences and those other costs. That changed drastically in February 2015, and three years later it has not returned to the normal relationship of the previous 15 years. The price premium in 2015 was the worst, but 2017 was still more than twice as large as any year prior to 2015.

The extra payments since February 2015 have cost California drivers about $15 billion. And if the differential continues at its current level, which shows no sign of abating, it will cost Californians about $3 billion in 2018. Is that small potatoes?

For comparison:

  • The gas tax increase that went into effect last November – leading to protests, a recall effort against one state senator and likely a ballot initiative to repeal the increase — will cost California drivers a little under $2 billion this year. And that money will go to fixing roads.
  • The state’s entire revenue take from the cap-and-trade program will be about $3 billion this year.
  • All the natural gas that California households will use for home heating, cooking, and hot water will cost them about $5 billion this year.
  • The state government’s entire contribution to the University of California will be about $3 billion this year.

So, it’s hard to see how $3 billion disappearing into the gasoline supply chain – about $300 for a typical California family of 4 — is small potatoes, even in the context of statewide expenditures.

As the PMAC’s final report pointed out, the persistent differential does not necessarily mean that California gasoline producers are acting anti-competitively. The PMAC heard from some industry participants who said that logistical and regulatory barriers to importing gasoline had increased substantially in the previous few years. Impediments to importing gasoline mean that when an in-state refiner has a hiccup, the supply from outside the state can’t quickly meet the resulting shortage.

Unfortunately, such tight markets, particularly for products for which consumers are not very price-sensitive, also put sellers in a better position to exacerbate price spikes by reducing supply. From the outside, it’s not easy to tell if a price spike is primarily due to logistical/regulatory frictions or to sellers intentionally restricting supply. Whichever is the cause, the problem shows no signs of going away. The final numbers aren’t in for February yet, but so far the premium is on track to be back above 20 cents per gallon.

And, if anything, we are likely to need more of those imports in the future, because California consumption is on the rise.  It bottomed out in 2012 and has gone up every year since. Maybe electric cars will turn that around in a few years, after we have paid another $10 or $20 billion to feed the mystery surcharge.

What should California do about the mystery surcharge? First, set up a commission with real resources to investigate the cause. Give them the funding necessary to hire (or borrow from other parts of state government) the very best experts in the oil and gasoline supply chain, and in market economics and competition policy. Then give them the authority to examine all the confidential data from companies that city, county and state offices collect.  And compel the executives at those companies to meet with this commission – not the trade association representatives or outside consultants they sent to PMAC meetings — and answer questions, behind closed doors if necessary to protect confidential or competitively-sensitive information.

Every firm in California’s gasoline supply chain must get permits to operate in the state. Those permits allow companies to do business in the state, but require them to do so responsibly. Accepting a permit should also oblige companies to responsibly cooperate when something goes wrong in the market.

Since 2015, something has gone multi-billion-dollars wrong in California’s gasoline market. It would be reassuring if lawmakers would show as much enthusiasm for uncovering the cause as they have for protesting tax increases or spending cap-and-trade revenues.

I’m still tweeting energy articles/research/opinions that grab me @BorensteinS

Suggested citation: Borenstein, Severin. “California’s Mystery Gasoline Surcharge Continues.” Energy Institute Blog, UC Berkeley, February 26, 2018, https://energyathaas.wordpress.com/2018/02/26/californias-mystery-gasoline-surcharge-continues/

Severin Borenstein View All

Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.

35 thoughts on “California’s Mystery Gasoline Surcharge Continues Leave a comment

  1. Why not advocate that consumers vote with their pocketbook? That is, buy their fuel where the price is lowest. The formulation of CA reformulated gasoline is tightly regulated by ARB; the blendstock is the same from refiner to refiner. The only difference, as I understand it, is in the additive. People should be advised to buy their fuel where the cost is lowest, with cost defined to include wait times if there is a line.

    • Gary, do you have data that says that customers have brand loyalty over price? I think it’s pretty minimal given the lines I see at low-price stations across the street from a brand name.

  2. I’m glad you are continuing to press this issue. As with you, the obvious gasoline surcharge in California has troubled me for years, and I have a couple of layman’s thoughts:

    –Because California is a gasoline “island” with no pipelines from the east and a small number of in-state refineries, we are likely seeing a classic case of oligopoly pricing where each refinery operator absorbs pricing signals from other operators and everyone works–without explicit collusion–to limit supply and set prices high. Every operator benefits in this kind of situation. The Torrance refinery fire and shutdown may, in fact, have functioned as a test case that demonstrated to the operators that surcharge pricing would not be resisted by consumers or by state regulators. So they continued this practice.

    –The California legislature’s indifference to the issue has always baffled me. You would think that price gouging by the gasoline industry would be a natural for a crusading politician. Why don’t legislators pursue it, then? Perhaps because the public seems submissive and quiescent to the the high prices (which also mystifies me). And perhaps there’s a down-and-dirty explanation: legislators, as far as I know, get free cars and free gasoline from the state. They dont pay at the pump and have no personal experience with the high prices, so they don’t sense the potency of the issue.

    –Also, I wonder if the decline of newspapers and other journalism institutions in California has left the public without a champion to help them and force a confrontation over this issue. The L.A. Times is a shadow of its former self, as are the San Francisco and Sacramento newspapers. Without the staff and resources to pursue issues like this, the issues themselves largely disappear.

    –Finally, I think there is the issue of whether a likely solution exists. If the problem truly is oligopoly pricing–again, I am talking about a pricing strategy that evolves without overt collusion–then it’s hard to picture a regulatory scheme that would fix it. The obvious economic answer is to create a larger number of refinery players and eliminate the oligopoly, but how is California going to achieve that? A pipeline from the east might also provide a solution but, as another reader pointed out, the eastern refineries usually cannot produce California-grade gas.

    I do hope you keep pressing this issue, and I will be watching here to see what happens.

  3. Get rid of our moronic California only blend of fuel. All other gasoline is fungible and shipped by pipeline to where its needed. California only fuel is not fungible, is made me 3 refineries in the state and when there is a problem since no one else makes it it can’t be shipped from anywhere else.
    It is the idiot politicians and regulators who caused this problem and now they need someone (not them or their asinine rules) to blame.
    I commute to Arizona weekly and I fuel up for the week in Arizona with their much cheaper fuel just so I don’t have to pay extra for more expensive fuel that doesn’t do anything but make a bunch of self righteous idiots feel better because they are “doing something” for the environment. All that’s doing is taking even more money out of our pockets for their rainbows and unicorn utopia.

    • Hi Tom

      A few responses:
      1. California’s cleaner burning gasoline actually does have measurable positive impacts on air quality as has been documented in a careful study by my colleagues Max Auffhammer and Ryan Kellogg. Air pollution is real, it really causes health problems, and it is really caused by human activity. Really.
      2. California’s fuel is not made in only three refineries in the state. The total number is about a dozen, though it has varied. And yes, it can be shipped from other locations. In fact it is regularly imported from Washington state, Singapore, and other locations.
      3. Yes, Arizona gasoline prices are lower. Partially due to taxes and the absence of programs to reduce greenhouse gases. But even after you account for all that, there is something else driving up California prices now that was not doing so between 2000 and 2014. Maybe it is regulations. Maybe it is refineries exercising market power. Maybe it is some logistical constraints at ports or pipelines. But if it is costing Californians $3-4 billion per year, it seems like it is something worth looking into.

      Thanks,

      Severin

  4. I also think the 10 cents per gallon estimated cost to produce CA gasoline deserves some scrutiny. My recollection is that was the mid range of the estimated cost to produce Carb Phase 2 gasoline which was introduced in 1996 and included capital recovery cost. From a refining perspective, if you have the hardware needed to produce the low distillation for current Carbob (vs Federal RBOB), I would say the actually operating cost difference to make the CARB product is minimal. In California, where refineries produce a very high percentage of their gasoline as CARB compliant, that is just how they operate. But, in California there are higher operating costs in general if a refiner purchases water, power, natural gas, among other things, as well as potentially environmental related expenses. For a point of reference, in their recent annual report Valero showed their Gulf Coast refining operating costs at about $3.40 per Barrel (of input), while in California it was about $6.00 per Barrel. http://www.investorvalero.com/phoenix.zhtml?c=254367&p=irol-newsArticle&ID=2329679
    Outside of California the cost of producing CARB gasoline is a very different question. If your refinery is not set up to produce CARB spec gasoline efficiently from prior investments (wrong distillation, high olefins or aromatics), the cost of producing it can be very high as your entire product slate needs to be rebalanced from a quality perspective (a lot of the “good” quality gasoline will become the CARB gasoline requiring “bad” quality gasoline to be sold somewhere else (and presumably for a low price). Thus the break-even cost to produce the CARB gasoline at the expense of something like Federal RBOB or CBOB might be pretty high, even if there is no real change in refinery operating cost.

    • Thanks for your comment, John. One can debate the fine points of production cost differences between California and the rest of the country. But none of that addresses why the relationship change so drastically after the February 2015 fire.

  5. EIA data shows virtually zero gasoline imports into CA between August and December of 2017. CA refinery capacity, nor import logistics, when all plants are running, is not the issue. The “average” price of course reflects all prices in the market. My observations on the street suggest that the high to low retail gasoline price spread has widened over the years, which of course will increase the average relative to the low. Has a similar changed occurred (or not) in the rest of the U.S.? Has the “low” gasoline price in CA changed relative to the “low” in the rest of the U.S.? Any analysis of this change in CA gasoline price relative to the rest of the country would need to include a deep drive into all of the competitors and prices in all of the markets (both CA and rest of U.S.).

    • Severin, Is the premium calculated relative to a production cost plus fees & taxes, or to a differential against the U.S. average? Also, have you factored in rapidly rising real estate costs for stations?

  6. You remark that “tight markets, particularly for products for which consumers are not very price-sensitive, also put sellers in a better position to exacerbate price spikes.” The fact that there’s all this hullabaloo about gas taxes suggests that CA consumers are at least visually price-sensitive (i.e. we know that prices are high and want someone to blame). Does the data show that we are not actually price-sensitive (i.e. despite high prices our behavior is unchanged)?

    CARB’s Sept 30 2014 study (https://www.arb.ca.gov/cc/sb375/policies/gasprice/gasprice_bkgd.pdf) suggested that “a durable 10 percent inflation adjusted gas price increase might cause (a) a decline in vehicle travel of approximately 0.26 percent in the short run and about 1.31 percent in the longer run, and (b) a reduction in total fuel consumption of 0.55 percent in the short run and 2.85 percent in the longer run.”

    We appear to have seen a “a durable 10 percent inflation adjusted gas price increase.” Did we see any impact in vehicle miles traveled?”

    I was going to post your blog on social media to build support for this commission, but I’d actually prefer gasoline prices to be high (for whatever reason) if that reduces GHG emissions. On the other hand, if the price elasticities are totally off, then we are basically being had, which is a different story.

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