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What’s the Matter with California’s Gasoline Prices?

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.

 

Post230109Fig1One 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.

Post230109Fig2But 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. 

 

Post230109Fig3Part 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.

Post230109Fig4When 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?

I’ve joined Mastodon and am now posting most days on energy topics @severinborenstein@econtwitter.net

Keep up with Energy Institute blog posts, research, and events on Twitter @energyathaas.

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 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.

15 thoughts on “What’s the Matter with California’s Gasoline Prices? Leave a comment

  1. Severin has posted a very interesting comment. However, he has left out several parts of the story. .

    First, the ownership of refiners in California has changed. At one time refiners were owned by integrated companies – Exxon, Mobil, Texaco, Unocal, Shell and Chevron. Now they are owned by Valero, Marathon, PDF, Phillips 66 and Chevron. Only Chevron is integrated. The FTC pushed refinery divestitures to “promote competition.” The divestures had the reverse effect.

    The FTC tired to paper its mistake over in the “Midwest Gasoline Investigation” of a 2000 price spike when it noted “one company which ‘increased its summer-grade RFG production substantially and, as a result, had excess supplies of RFG available and had additional capacity to produce even more RFG at the time of the price spike. It thus found itself with considerable market power in the short term. This firm did sell off some inventoried RFG, but acknowledged that it limited the magnitude of its response because it recognized that increasing supply to the market would push down prices and thereby reduce the profitability of its overall RFG sales.’”
    https://www.ftc.gov/news-events/news/press-releases/2001/03/ftc-issues-report-midwest-gasoline-price-investigation

    From SEC filings it is clear that the company was Marathon Petroleum. One can also note that Marathon entered the California market in 2018. Since he acquisition has been completed Borstein’s MSG seems to have been higher. As the FTC noted, some refines use their market power.

    Now I have testified in several gasoline antitrust suits as an economic expert. In no case has a conspiracy been shown. Also I do not recall an appearance by Severin. I also prepared testimony for Exxon in the Torrance matter. Again, Severin was not a party.

    What seems clear from my 50 years of writing on oil as an academic and at non profit institutions is that the independent refiners in California understand that they can extract large rents from California consumers without fear of legal consequences. The US Supreme Court ruled in 1988 that states have the right to impose price controls. The 8-0 opinion was authored by Antonin Scalia. Some states ae exercising the right. Perhaps California should join the club.

  2. Your assertion that refinery capacity is not at the heart of the MGS is contradicted by your own chart, which shows that the surcharge shot up after the refinery fire in 2015. No way that the this fire instantly created the “excessive control of the retail market by companies in the concentrated refining business upstream.” MGS sure smells of cartel profits.

  3. I think you’ve identified the key problem, that we often see in other oligopolistic industries–vertical integration through contracts that lead to excessive pricing. To answer Brad Neff, this is not a normally functioning market that is settling at the competitively efficient equilibrium–it has a major market failure. And using Occam’s Razor, the straight forward solution that doesn’t require much more analysis is to end contractual vertical relationships of these types and only allow simple long term fuel purchase agreements. Further, it might be time to force divestment of retail outlets to increase competition. Breaking up the economic power of corporations is almost always the better solution.

  4. I have studied motor vehicle fuel costs since my days in the 1970’s on the staff of the Washington State Senate Transportation Committee. I am skeptical of Dr. Borenstein’s repeated analysis showing that California gasoline prices are inappropriately high.

    Dr. Borenstein does go through the calculations of crude oil, gasoline (road) tax, sales tax, cap-and-trade, and low-carbon fuel standard. He does not address other cost differentials between California and other states, in particular the differences in gasoline formulation, plus higher costs of operating gasoline businesses in high-cost and high-tax areas in California.

    West coast states have a different gasoline product than much of the country — oxygenated fuel. California regulates more chemicals in gasoline than do adjacent states. That is an additional cost he has not measured in Dr. Borenstein’s calculations. The Washington Post discussed some of these differences in a recent article. https://www.washingtonpost.com/business/2022/06/20/gas-prices-by-state-explained/

    Much of California’s gasoline sales are in dense urban areas, where the cost of real estate is much higher than in most of the country. Yes, it’s also true in other major cities like Boston, Washington DC, and Seattle. But, here in Olympia we fear the market impact of people in California selling their homes, and arriving here with mountains of cash from the proceeds, driving up real estate prices here.

    The companies owning the mini-marts pay income tax and payroll taxes in California; those in Oregon and Washington pay much lower income taxes and payroll taxes.

    I also have some recent anecdotal experience with these prices. I drove from Olympia to Los Angeles and back over Christmas, returning December 26 – 28. We filled the Kia Niro PHEV only three times on that trip (it gets about 48 MPG running on gasoline). The first time in Southern California, for $3.99/gallon. The next day south of Sacramento, for $3.69. The day after in Southern Oregon (a lower gas tax state), for $3.39. I filled in Olympia, on return, at $3.59 (less my Fred Meyer gas rewards — a net of $2.99!). All of that was in a 72-hour period, so not a lot of time for market prices to move.

    We experienced a $.60/gallon difference between SoCal and Oregon, and $.30 difference between Central CA and Oregon. If Dr. Borenstein’s calculation of a $0.70/gallon “actual cost” differential is accurate, and we experienced $0.60 and $.30 difference, it seems to me that the California gasoline was UNDERPRICED not OVERPRICED relative to that actual cost differential. In each case, we relied on Gasbuddy to direct us to lower-cost stations in the areas where we filled. I do have a preference for major truck stops, partly because they have

    It’s quite easy to do real-time price comparisons at different points in California using GasBuddy or other gasoline pricing apps. As I write this, an ARCO station in Torrance is charging $4.01, while an ARCO station in Woodland (north of Sacramento) is charging $3.85. My guess is that the higher cost of real estate and other high costs of doing business in the LA urban area explains this difference. You find similar differentials even among Costco gasoline prices: $3.89 today in Torrance, vs. $3.75 today in Woodland, about the same as the ARCO difference. Torrance is urban, with a higher cost of doing business. Woodland is north of the Sacramento airport, amidst agricultural land. So perhaps Dr. Borenstein needs an urban/rural split in his analysis to reflect higher costs of doing business in the major urban centers that dominate California gasoline sales.

    I continue to believe that the majority of the difference between California gasoline prices and other gasoline prices on the west coast is explained by actual differences in the cost of the differentiated product, the differences in taxes and fees, and the very significant differences in the cost of doing business in urban California versus Oklahoma or Indiana.

    But the weather is nicer in SoCal. There is a reason 25 million people live there, and no so many here. If you want to save a few cents per gallon, spend the winter in Bismarck, North Dakota.

  5. Great article – I hope it gets a lot more attention. I would also want to look at restrictive land use in California, which prevents new entrants from entering the market – specifically, high land prices, permitting requirements which pose barriers to new retailers entering the market.

  6. Sev,

    Isn’t possible that Californians are more dependent on vehicle travel and better able, on average, to pay higher fuel prices than in other states? Your article gets right to the heart of pricing anything. I tell my kids that the price of anything is what someone is willing to pay for it. Obviously, Californians are willing to pay a higher a price for gasoline than elsewhere in the country. What more is there to explain?

    Europeans have been paying much more than Americans for gasoline for decades. Why is that? Why should gasoline prices be set any differently than prices on toilet paper, microchips, or eggs? Why should I, as a consumer, expect to pay less than I’m willing to pay for gasoline if I have not made plans for and supported solutions that I can use in place of gasoline when gas prices exceed what I’m willing to pay. Artificially holding down gas prices will only make us more dependent on gasoline use, what we really need are viable alternatives to satisfy our transportation and energy needs.

    You’ve been harping on CA gas prices for years, but I still don’t understand what you don’t get about the economics at play here or why you think gasoline should be given special treatment–other than, energy is your chosen field of expertise and you see an opportunity to be part of a multi-million dollar study to get to the bottom of an issue you are obviously very curious about. Is it that you think oil companies are making too much money or that drivers are paying too much? Isn’t each making rational economic decisions? Why do we need you to step in and explain how those decisions work out to benefit both parties in the transaction?

    Maybe your answers could be found in broadening your aperture to include other countries and other commodities to understand if California gas prices really are the anomaly you think they are, or if they truly reflect the underlying economics that one would expect in any market under similar circumstances–you may need look no further than college tuition bills to see equally egregious examples of “price gauging,” “mysterious premiums,” “windfall profits,” etc.

    And if governments should set out to define the appropriate profit margins for fuel producers, should it not also define the appropriate profit margins for economic experts? Which leads me to a hairy question I’ve been contemplating for years; is it possible to solve global environmental issues, like climate change, within a capitalistic economic system? In other words, can we price in all the externalities of each of our economic decisions to sufficiently drive individuals to do what is best for society, at the broadest level? This doesn’t seem to be related to the question specific questions you are asking, but I think the two lines of thought converge in a “so what” question? How will answering these questions and setting the right policies to address them make the world a better place for you and me??

    Oh ya, and thank for the thought-provoking article.

  7. Indeed the MGS is $1.10

    Big brands only: today-now.
    University Ave in Berkeley $4.39 to 4.98
    A mile radius of my office. $4.73-5.45
    Costco $4.14
    Upstate NY $4.29
    Difference between Albany Ca and Albany NY $1.10

  8. A barrel of crude oil contains 42 gallons of crude oil, but a barrel of crude oil does not produce 42 gallons of gasoline ( https://www.eia.gov/tools/faqs/faq.php?id=327&t=9). In the US, a barrel of crude produces 19-20 gallons of gasoline and 11-12 gallons of diesel fuel. Therefore, dividing $81/bbl of crude oil by 42 to arrive at the raw material cost of gasoline is not correct

    • That’s right. That’s why one has to do empirical work to estimate the pass-through. The empirical work linked in the blog shows that the pass-through is indeed the price of crude divided by 42.

  9. OMG! You’re just a muckraker! The oil companies are suffering because of the lame excuse that climate change is going to kill us all. They’re going to go out of business once EVs and alternate energy take over. Is it not their God given capitalistic right to make as much profit as possible, despite any of this imagined damage their doing?

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