Tuesday, March 20, 2007

Gasoline Island

Yesterday’s posting grew too long to include a relevant current example of the side-effects of California’s environmentally-driven de-industrialization. While retail gasoline prices across the US have jumped by 30 cents/gallon since January, prices in California are up by 50 cents, averaging $3.07/gallon for unleaded regular last week, with a few stations charging over $3.50. Before outraged consumers clamor for another investigation of collusion and gouging, though, they might consider what previous investigations have concluded: fundamental structural problems make the California gasoline market unusually vulnerable to local refinery outages. As a Marin County paper recently put it, “the state is like an island.” That was already true when I traded West Coast refined products for Texaco in the late 1980s.

Two minutes of Googling yielded a 2003 study by the Energy Information Agency of the Department of Energy, prepared at the direction of the Congress to assess that year’s California gasoline price spikes. It includes a nice graph showing that from 1995-2003, gasoline prices in the Golden State were consistently higher and more volatile than the national average. In addition to the unique problems of switching from MTBE to ethanol that year, the EIA identified the following contributing factors:

  • California’s distance from alternate gasoline supplies
  • The complexities and higher cost of producing gasoline to California’s unique, environmentally-oriented specification (CARB), especially when switching from winter to summer formulations.
  • California’s over-extended refining system, which has not expanded as fast as gasoline demand.

The last point is particularly important, because it has a strong influence on price volatility. Since normal demand keeps these facilities running near capacity, California refiners must plan carefully for annual plant maintenance, lining up supplies from outside the state to cover anticipated shortfalls. But when something unexpected happens, such as the recent fire at Chevron’s Richmond refinery, more imports are needed, and they are typically weeks away, depending on whether product is available from Seattle-area refiners, the Gulf Coast, Europe or Asia. In addition, once refinery production returns to normal, there is no large, local surplus from which to rebuild the inventories that help to dampen price swings.

While the media has generally been doing a better job of reporting these issues than they used to, NBC News’s coverage on Monday included an interview in which an official of the Automobile Club of Southern California blamed “speculators” for pushing the price up. In fact, it is this normal spot market price response that enables California to attract supplies from other, more distant markets. A refiner in Texas, for example, must recoup the cost of blending a tanker-sized batch of gasoline--worth over $20 million--to California’s stringent specifications, plus freight, plus enough profit to cover the risk that prices will have fallen again, by the time the cargo is discharged a couple of weeks later. Without a significant price differential between the California and Gulf Coast spot markets, no cargoes would be forthcoming.

All of this ultimately flows from decisions taken decades ago by state and local air quality regulators to control air emissions (plain old pollution, in those days) by tightening up on stationary sources--including refineries--and requiring carmakers to install better smog equipment and refiners to make cleaner-burning fuel. What they didn’t do was ask consumers to buy more efficient cars. As a result, California consumers routinely pay the higher cost of making CARB gasoline, and whenever local supplies are disrupted, they pay extra for the lack of a capacity cushion.

As I’ve suggested in the past, this is still not a bad deal for Californians. Before these regulations really took hold, air quality in the state’s big cities was very poor, especially in the Los Angeles Basin. California consumers sacrifice a little of their material standard of living at the gas pump—about 23 cents per gallon more than the rest of the country, on average since 2001—in exchange for cleaner air. Going forward, as I discussed yesterday, they will sacrifice a little more to address climate change, with benefits that won’t be nearly as immediate or noticeable. It will be interesting to see what happens to the level of consumer complaints.

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