Thursday, October 11, 2012

Sacramento's Role in California's Gasoline Price Spike

How much higher were gasoline prices in California last week than elsewhere?  Enough to raise the national average price for unleaded regular by about $0.10 per gallon.  So while the rest of us were paying an average of $3.75/gal., down slightly from the previous week, gas prices in the Golden State went up by 48 cents, leaving Californians paying nearly a dollar a gallon more than other Americans.  In general the media have done a good job of explaining the direct causes for this spike: a pair of unexpected outages at large refineries in the Bay Area and L.A., combined with the difficulties of supplying the state's unique gasoline blend when local refiners fall short.  Robert Rapier does an even better job of explaining the intricacies of that blend.  But what's missing from all this commentary is an explanation for why the supply for the nation's largest gasoline market, with more than 11% of US sales, should be so tightly balanced that such disruptions would lead to economic hardship for consumers.

As I've indicated before, California is effectively a gasoline island. The product pipelines connecting it with neighboring Arizona and Nevada run out, not in, and the only routes between California and the other West Coast refining center north of Seattle travel over water.  So the principal refineries serving the California market are in California, and obtaining supply from elsewhere that hasn't been prearranged takes time for special batches of fuel to be blended up, tankers to be chartered, and for those vessels to complete their voyages from ports as far away as the Gulf Coast or Singapore.  That entails at least a couple of weeks.

In a posting I wrote in 2007 during a similar price spike in California, I referred to a 2003 study by the Energy Information Agency of the US Department of Energy, looking at an earlier California gasoline spike. (This is a recurring problem.) Among the major factors explaining the higher prices and volatility of the California gasoline market, they found,
"The California refinery system runs near its capacity limits, which means there is little excess capability in the region to respond to unexpected shortfalls."
That also means that there is typically no local surplus from which to rebuild inventories once refinery production returns to normal.  That's a crucial factor in the speed at which prices return to normal.

So much for the diagnosis, but what about the cause?  Tackling the local pollution from large, stationary sources like oil refineries, and from the tailpipes of the state's 31million cars and other vehicles has been a top priority for the state's Air Resources Board (CARB) since the 1970s, for good reason.  However, over the years, CARB's increasingly strict regulations made it harder and less attractive to operate refineries in the state, and more difficult to blend the fuel it allowed to be sold there.  As it happens, I saw much of this first-hand when I worked as an engineer in Texaco's Los Angeles refinery and later when I traded refined products, crude and feedstocks for the company's West Coast operations in the 1980s and early '90s.  I watched one small refinery after another go out of business, and the magnitude of periodic price spikes grow, as the market became more constrained and isolated. I also saw refining margins for the survivors improve relative to those on the Gulf Coast and other parts of the country.  These trends seemed related, since the state, by its actions, was turning California gasoline into a boutique product and effectively blocking competition from outside the state.

The normal response of companies operating in a market such as that, with growing demand and healthy margins, would have been to invest in more capacity--new refineries or major refinery expansions--and collectively to overshoot somewhat.  But by then the prospect of obtaining the permits necessary to build a new refinery in California had gone from difficult to impossible, and most refining investment was focused on the substantial upgrades required to keep up with the state's periodic tightening of product specifications.  And since those investments generally did little to increase output or improve product quality in ways a consumer might notice and pay a premium for, they had awful returns and dragged down the total return on investment for the entire facility. This contributed to refineries shutting down or being sold to independents with less capacity to make further such investments in the future. 

The net result of all these factors is a California refining system that today is 21% smaller than in 1982, at least in terms of crude processing capacity, but must meet gasoline demand that has grown by a third in the meantime, even after shrinking from its 2006 peak.  Now, when an unplanned refinery outage occurs, the result provides as classic and dramatic a demonstration as you'll ever see of the price response to a shift in the supply curve for a good with inelastic demand.

As an ex-Californian and ex-Angeleno there's no doubt in my mind that air quality, especially in Southern California, has improved as a result of many of the regulations imposed on industry and on fuels.  However, you'd have to ask the state's current residents whether that result is worth the high price they periodically pay at the gas pump, or whether some degree of compromise that would have allowed refineries to expand to keep pace with demand, while cleaning up the air almost as much, would have been preferable. 

7 comments:

Jim Melendy said...

Suppose CARB allowed the standard gasoline that the rest of the US uses to be sold in California, but with a fee that is ten or twenty cents per gallon higher than the cost difference between California's blend and what the rest of the US uses. That would normally preclude any significant sales of that product, but when exceptional conditions arose, it would limit the price spike to approximately ten or twenty cents. I think that would be better than the disruption we have seen here in Calif. over the last week.

Geoffrey Styles said...

You'd still have to get it there quickly; any delay contributes to the spike, because until more supply arrives, demand has to fall, and pretty sharply.

I see several longer-term solutions:
1. More local supply, which could include biofuels to whatever extent they could safely be blended in, or produced as "drop-in" fuels fully compatible with gasoline.

2. More efficient cars and/or cars running on other fuels, such as natural gas (CNG), propane, or electricity.

3. Reduced driving by various means--carpooling, mass transit, telecommuting (highly recommended), etc.

4. A pipeline from Texas, which would probably have to be subsidized by the state, because if it were attractive on its own it would already have been built (or repurposed; there are already several pipelines between CA and TX, but as I recall they are for crude oil.) That's been looked at before, and rejected: http://www.energy.ca.gov/releases/2003_releases/2003-08-20_pipeline.html

Ed Reid said...

California appears to be anxious to provide large scale demonstrations of the risks associated with a number of elements of environmental, energy and fiscal policy. I applaud California's enthusiasm; and, I am very grateful California has volunteered, rather than North Carolina. I prefer to observe from the bleachers, rather than be on the field. :-)

Geoffrey Styles said...

Ed,
And isn't that the essense of federalism? I'm pleased to watch from Virginia, though I have a bit more skin in the game via family connections. Like Germany, California is testing the boundaries of how quickly renewable energy can be adopted, and whether the net result is a cost or benefit to the measurable economy, and how large. What concerned me during recent initiative campaigns was that voters were being assured that it was a foregone conclusion that the economic benefits outweighed the costs. If only that were true.

donb said...

It would be interesting to know how much better (if any!) the special fuel formulations work at reducing NOx, hydrocarbon emissions, etc. in California. We could compare any incremental reductions in pollutants with the incremental cost of the fuels, as get a cost for the increment. I am guessing that drivers in California are paying quite a bit for a small reduction in pollutants. Looking elsewhere to make reductions might make more sense.

Geoffrey Styles said...

Don,
From analysis I saw in the '90s, the regulations passed the point of diminishing returns years ago, at least on local air pollution. After the first few iterations, each successive ratcheting down on fuel specifications ends up chasing smaller benefits at higher costs--sometimes exponentially higher costs.

50stateautoloan said...

That would normally preclude any significant sales of that product, but when exceptional conditions arose, it would limit the cost spike to about0 or0 cents. I think that would be better than the disruption they have seen here in Calif. over the last week.