Joint Informational Hearing
Senate Energy, Utilities, and Communications Committee
Senator Debra Bowen, Chairwoman
Senate Transportation Committee
Senator Betty Karnette, Chairwoman
April 28, 1999
1:30 p.m.--State Capitol, Room 4203
"Northern California Gas Prices at All-time High, says AAA"
"The average price of regular self-serve unleaded gasoline in southern California climbed more than 42 cents per gallon in four weeks, according to the Automobile Club of Southern California Fuel Gauge Report."
April 20, 1999 press releases from AAA and ACSC
BACKGROUND PAPER
The good old days – Almost three years ago to the day, the Senate Transportation and Senate Energy, Utilities, and Communications Committees held an informational hearing on rapidly rising gasoline prices. At the time, the public was outraged that gasoline prices had risen from $1.15 per gallon in December 1995 to $1.47 per gallon in April 1996. Yet those 1996 prices look like a relative bargain compared with recent prices as high as $1.99 per gallon.
Tight supplies? – This surge in prices has been attributed to tight supplies stemming from fires at refineries, other production difficulties and market speculation. Data compiled by the California Energy Commission (CEC) shows that gasoline production dropped nearly 12% in the week ending March 12 compared to the prior week. Yet compared with March 1998, production of California gasoline was almost 5% higher in 1999. On March 29, the Chairman of the CEC announced "There are adequate supplies of gasoline to meet consumer demand under current market conditions." Confirming this, a CEC spokeswoman noted on March 31 that the production levels don't warrant the high price for gasoline.
Basic industry structure – Most of the major oil companies do everything from exploration and drilling to refining, marketing and selling of petroleum products – in other words, they are vertically integrated. Other service stations are affiliated with, but not owned by, the oil companies. While these branded stations have varying financial arrangements with the oil companies, all are required to purchase their gasoline delivered to the station by the oil company. A third set of service stations are independently run and not affiliated with a particular oil company (i.e. Costco) and these stations purchase surplus gasoline from refineries on the spot market.
Where your money goes – It may be instructive to look at the components of the price of gasoline. The CEC has provided such a breakdown, which is included on the attached sheets. The data compares February 15, 1999, when gasoline cost $1.10 per gallon, to April 12, 1999 when gasoline cost $1.62 per gallon. Note that the cost of crude oil makes up a relatively small component of the price. Most of the increase in the price of gasoline is attributable to the refinery, which is receiving triple what it received before the recent increases, increasing from 28 cents per gallon to 70 cents per gallon. And while the price of gasoline rises, the amount of money that the retail dealer keeps has dropped from 14 cents per gallon to 9 cents per gallon.
How prices are set – The recent rapid rise in gasoline prices costs consumers millions of dollars a day. With roughly 33 million gallons of gasoline sold daily, every 10-cent increase in the price of gasoline costs consumers $3.3 million each day. How is it possible for a relatively minor supply disruption to cause a 45% increase in the price of gasoline? Consumers are quick to accuse the oil companies of gouging, while the oil companies reply that they simply respond to the market. Or as the spokesman for the Western States Petroleum Association said in 1996, gasoline prices are determined by which the market is willing to pay. So, if it is true that oil companies charge what the market will bear, the real question is, What kind of market is it? Are these prices simply the outcome of a healthy, competitive market? Or, is there an underlying weakness in the market that allows oil companies to exercise an extraordinary amount of market power and causes prices to be artificially high?
Sticky prices – While the CEC believes gasoline supplies have been adequate since the end of March, retail prices peaked in mid-April and have begun to decline slowly only for the past week or two. Wholesale prices for branded gasoline have apparently not declined at all as of early April, according to data provided by the service station dealers, yet wholesale prices for independent, non-branded stations, as represented in the spot market for gasoline, have declined significantly, almost 40 cents per gallon from their March peak. This partially explains why gasoline prices at independent stations have dropped more than prices at branded stations.
California only – California gasoline is unique because the state's poor air quality dictates specially formulated gasoline must be used to reduce air pollution. The vast majority of gasoline sold in California is produced in California by the 23 refineries in the state, and those refineries also produce non-California gasoline for parts of Nevada and Arizona. Under emergency conditions, such as supply shortages, non-California gasoline may be sold in California. The process for allowing the sale of non-California gasoline requires an emergency declaration by the CEC and the consent of the Air Resources Board.
Some have argued that California's unique gasoline makes consumers here much more vulnerable to price shocks because it limits the state's ability to import gasoline from elsewhere, as few non-California refineries make California gasoline. They propose to make it easier to permit the sale of the higher polluting, non-California gasoline, but not everyone agrees. Objections are made on both air quality and economic bases.
Fewer and bigger – Accusations that oil companies are acting anti-competitively and exercising market power will only be heightened if prices continue to rise as the merger activity in the oil industry continues. Tosco recently acquired the refining and marketing operations of Unocal, while Exxon and Mobil recently announced merger plans to create the 3rd largest company in the world. Last month, British Petroleum announced plans to buy Arco, and the Economist reports that Chevron and Texaco are also looking to find merger partners. Compare the share of gasoline sales in 1998 versus 1996 (see attached) and you'll note that gasoline sellers are becoming increasingly concentrated.
What can the Legislature do? – One’s view of the solution depends on one's view of the problem. If the concern is the improper exercise of market power by the oil companies, then current law, which prohibits anti-competitive behavior and collusion, already provides a remedy. To the extent such practices are occurring, the Attorney General is constitutionally charged with the duty of enforcing these laws and has announced plans to begin an investigation.
Other suggestions have been made to deal with the market power of the vertically integrated the oil companies, which may include barring the oil companies from owning retail gasoline outlets, and/or allowing the retail gasoline outlets to purchase their gasoline from any source of the same brand (branded open supply). These approaches were considered in 1997 but not approved by the Senate. SB 123 (Peace) contains branded open supply provisions and is pending in the Senate Energy, Utilities, and Communications Committee.
If the market is functioning appropriately, then the high prices are arguably simply a function of supply and demand for gasoline, and either increasing the supply or decreasing the demand will help keep a lid on prices. Ideas to increase the supply of gasoline have included permitting gasoline that doesn't meet California's emission requirements to be sold in the state. Finding incentives to increase refinery capacity is also possible, as is making it easier to physically import gasoline into the state.
Ideas to decrease the demand for gasoline include tax incentives for fuel-efficient vehicles, programs to support alternative fueled vehicles and car-pooling, and programs to substitute public transportation for private transportation. In San Diego, an effort was made to help gasoline buyers better know where to buy the least expensive gasoline.
Joint Informational Hearing
Senate Energy, Utilities, and Communications Committee
Senate Transportation Committee
April 28, 1999
1:30 p.m.
State Capitol, Room 4203
AGENDA
Opening Statements
- Senator John Burton, Senate President Pro Tempore
- Senator Debra Bowen, Chairwoman – Senate Energy, Utilities and Communications Committee
- Senator Joe Dunn, Vice-Chairman – Senate Transportation Committee
Presentations
- Commissioner Michal Moore, California Energy Commission
- Attorney General Bill Lockyer
- Mike Wirth, Chevron, Senior Retail Manager
- Chris Noble, Arco, Senior Vice President of Retail Marketing
- John Boles, Equilon, Vice President of Portfolio Planning
- Dennis DeCota, Executive Director, California Service Station and Automobile Repair Association
- Alan Lloyd, Chairman, Air Resources Board
- Severin Bornstein, Director, U.C. Energy Institute and Professor of Business Economics,
Haas School of Business