To develop effective solutions, policymakers must first understand the problem.
The rest of the US may have moved on from fretting about gas prices, but California is starting 2023 with a special legislative session on the subject. In December, California prices averaged $4.32, while the average was $3.09 elsewhere in the US. In California politics, that $1.23 difference is like a Rorschach inkblot test.
Those on the right look at the gap and see wasteful government regulation and excessive taxation in California. Those on the left see price gouging by refiners and oil companies. And because each side is confident they know what the problem is, they are already prepared with their favorite solutions.
One of the Rorschach inkblots (obviously an elephant reclining on a tree stump)(Source)
My mother was a psychologist, and I still remember the fascinating inkblots that she used in some of the testing she did. Still, I veered off into economics. Which may be why when it comes to California’s high gas prices, I think we need data and analysis, not a collection of personal feelings about the cause. So, here’s a breakdown of what we know and what we don’t know about the price of California gasoline and its difference from the rest of the country.
Piecing together the price difference
Decomposing pump prices starts, of course, with crude oil. While some crude is produced in California, the marginal source (which is what sets the market price) comes from elsewhere. Once crude is on a tanker, the price doesn’t differ much whether it is being delivered to Japan, France, China, India, New York, or California, so this doesn’t really explain the price difference. Lots of research suggests that changes in the price of crude eventually pass through to gasoline pretty much completely. That means the December average crude oil price of $81 per barrel accounted for about $1.94 per gallon of the retail gasoline price (because a barrel of oil contains 42 gallons), both in California and elsewhere in the country. Likewise, there is a federal tax of 18.4 cents per gallon that is the same across the country. Crude fluctuations have driven much of the gasoline price roller coaster this year, but not California’s premium.
Small government advocates, oil producers, and refiners argue that the price difference is due to higher taxes and environmental fees in California. That is indeed a lot of it. Once you take California out of the national average, the average gas tax elsewhere in the country was about 29 cents per gallon in December. California is a whole different story: there is the gasoline excise tax, 54 cents; the sales tax, averaging about 14 cents in December; and the environmental fees – cap and trade, about 21 cents; low-carbon fuel standard, about 8 cents; and the fee for abatement of leaking underground storage tanks, 2 cents. All that adds up to 99 cents, or 70 cents more than the average elsewhere in the US. That said, much of those funds go for things drivers like, such as roads and bridges, things that society needs, such as R&D on low carbon technologies and support for low-income households during the energy transition, and a small share for things that are more controversial, such as high-speed rail.
But that still leaves a difference of 53 cents per gallon that is not explained by higher taxes and fees. Some of that shows up in the spot price of gasoline – the price for large bulk transactions (at least 1 million gallons) among refiners and distributors. These prices can be very volatile, depending on the short-run local supply/demand conditions, but in recent years California’s spot price has averaged around 20 cents more than the average of the two other major spot markets, New York and the Gulf Coast, as shown in the graph above. Part of the difference is the cost of making California’s cleaner burning gasoline. Opinions vary somewhat, but the cost difference is somewhere around 10 cents per gallon.
Part of the Torrance refinery after the 2015 fire (then owned by Exxon) (Source)
The Mystery Gasoline Surcharge
So, about 70 cents of California’s difference is taxes and environmental fees, and about 10 cents is the cost of making our cleaner burning gasoline. But the graph below shows the retail price premium has exceeded that difference in every month since February 2015, when it shot up following a fire at a refinery in Torrance, CA. In December 2022, this Mystery Gasoline Surcharge (MGS) was 43 cents per gallon. It averaged 65 cents over all of last year.
When you multiply by the approximately 40 million gallons Californians consume every day, that starts to look like real money. It is. Since the February 2015 refinery fire, the MGS has totaled about $48 billion, or nearly $5000 for a California family of four. As this graph demonstrates, in the 15 years prior to February 2015 – despite a number of refinery fires and other disruptions – the MGS was practically nonexistent.
None of the MGS is in crude oil and only a small share is going to the refinery end of the business. The vast majority of Californian’s excess payments for gasoline – above what is directly attributable to taxes and environmental fees – is showing up in marketing, transportation, and retailing in the downstream sector.
What’s causing the MGS?
That doesn’t let the California refining companies off the hook, however. These companies do not operate many gas stations, but they have complex contracts with most branded retailers, which include fixed monthly charges, per-gallon pricing, quantity incentives, and volume discounts that are customized to the individual station. These allow the refiners to extract much of the downstream profits. A far higher share of California’s gasoline is sold through such sophisticated contracts with major brand outlets than in other states.
And a far lower share of California’s gasoline is sold through off-brand stations that buy the same quality gasoline at large commodity distribution points, called racks, at which a brand of gasoline is sold to all buyers at the same posted prices. All of this suggests that California suffers from a lack of retail gasoline competition, possibly due to excessive control of the retail market by companies in the concentrated refining business upstream. But it only suggests that’s the problem, and it doesn’t really show us what policies might address it.
What to do about it?
Importantly, this means that the unexplained premium we pay for gasoline is unlikely to be addressed by policies aimed at refinery production: a California gasoline reserve or inventory requirement, temporary waivers of California clean-gasoline requirements (which I have supported at times), increasing refining capacity, or implementing a windfall profit tax on refinery operations. Nor would eliminating taxes or environmental fees address the MGS; it would just undermine funding for reducing pollution and building needed infrastructure.
That’s why last year, I asked Santa (and some folks in state government) for a serious, well-resourced, gas price investigation staffed by expert economists, lawyers, and industry specialists (probably no psychologists, sorry Mom) that would undertake a full-time, intensive, study of why the MGS appeared in 2015 and has continued ever since. Not the all-volunteer state advisory committee that I chaired for most of its 2014-2017 life, which met 3-4 times per year, had no authority and almost no staff support. That committee ended up issuing a final report that said a much deeper study was needed.
Sure, a serious investigation would take many months and cost millions of dollars. And, sure, it’s not as satisfying as proposing quick-fix solutions that really aren’t solutions at all. But now that the MGS has cost drivers almost $50 billion in eight years, isn’t it time to find out why?
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Suggested citation: Borenstein, Severin, “What’s the Matter with California’s Gasoline Prices?”, Energy Institute Blog, UC Berkeley, January 9, 2023, https://energyathaas.wordpress.com/2023/01/09/whats-the-matter-with-californias-gasoline-prices/
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.