Bustamante’s Proposal To Regulate Gasoline As A Utility

Where to begin …? With this Contra Costa Times article and this Sacramento Bee article.

The political theater that is the California recall election is certain to elicit some very bad policy ideas from candidates, and the prize thus far goes to Cruz Bustamante. On Thursday Bustamante advocated regulating the gasoline industry as a utility. According to the Contra Costa Times,

“Gas prices in California are the highest in the nation,” he said at a news conference in front of a Sacramento gas station. “Californians are being gouged and, under current law, we are powerless to do anything about it.”

Bustamante recommends a constitutional amendment to apply utility regulation to sales of gasoline, by simply adding “gasoline” to the list of regulated industries in the state. Leaving aside for the moment concern about the ease with which politicians can exercise arbitrary power in such an environment, let’s work through what would happen in that case. First, the California PUC would have to determine whether they would use price cap regulation at the pump, or rate-of-return regulation on the refiner.

If they chose price cap regulation, the PUC is almost certain to get the price wrong, because demand fluctuates, sometimes pipelines need repair, and world crude oil prices will probably fluctuate more than the regulated prices would allow. The likely consequence of such a price cap is that customers would see periods of shortage when costs go above the price cap – so instead of being able to get gasoline to drive to work at a high price, customers would not be able to buy gas at all, because it would not be available at the regulated price. When costs are below the price cap, then there would be plenty of gas available. So maybe customers could buy extra when it’s cheap and store it in their garages, right?

But wait. Not only is gasoline highly flammable and dangerous to store in your garage in large amounts, it also has different formulas between summer and winter, and between locations within California, because of federal and state environmental regulations. So if people stored gasoline and used it in a different season, it would be harmful to air quality. So the state EPA would probably outlaw such storage of gasoline, to prevent the deleterious effects on air quality of consumers trying to insure themselves against shortages of regulated gasoline.

Thus under price cap regulation the consumer would get stuck between economic regulation of gasoline prices and environmental regulation of air quality. The inability to get gasoline when consumers want it would be a costly inconvenience, and while it may set the hearts of command-and-control environmentalists singing to think of all of these people being unable to drive when they want, it is an appalling intrusion on the personal and economic liberty of a supposedly free people in California.

What if the PUC imposed rate-of-return regulation on refiners? That’s the model by which electric utilities have been and are regulated, and Californians above all people should recall the consequences of such regulation up through the early 1990s. One reason why electricity restructuring occurred in the 1990s was the overinvestment in expensive generation capacity that occurred in the regulated electricity industry. So perhaps refiners, seeking to increase their profits by increasing the rate base on which they earn their rate of return, would build more refining capacity than is really needed, and that cost would get reflected in gasoline prices.

But wait. The last refinery built in the U.S. was in 1976, and particularly since 1990 the environmental regulatory barriers and NIMBY barriers to new refinery construction have kept it that way. So the attempts of refiners to build new capacity would probably meet with regulatory and community resistance, much as they do today.

Thus under rate-of-return regulation the consumer would get stuck between economic regulation of petroleum refining rates of return and environmental regulation of demand. Refining capacity to serve California would continue to be very close to capacity, and price spikes would still occur.

Two important facts will enable us to see through Bustamante’s demagoguery. First, the 36-cent increase in gas prices over the past two weeks that inspired his proposal was the consequence of an unusual event – a burst pipeline in Arizona. Second, to meet federal air quality regulations, Phoenix and southern California both use the same oxygenated fuel formula, so the first place that would feel price increases from gas being sent to Phoenix to increase their supply would be southern California. If federal environmental regulations did not fragment gas markets in this way, prices would be less volatile and less variable across markets, so a supply disruption in Phoenix would not just draw gas away from California.

Cruz Bustamante’s proposal to regulate gasoline as a utility indicates that he wants consumers to sit in line and wait for gas, like consumers do in Baghdad, instead of being able to buy gas when convenient, albeit at higher prices. In advocating such an ill-advised policy, Bustamante reveals one dimension in which he does not differ from Governor Gray Davis – his complete and utter lack of understanding of how markets give us the best available signals and opportunities about how to use our scarce resources. Davis’s leadership failure in the electricity crisis contributed to his current predicament. Hopefully Cruz Bustamante will see the parallels, retract his populist proposal, and avoid being hoist by the same petard.