The $100 Bill On The Refining Sidewalk

On Tuesday Stephen Karlson asked why our seasonal gasoline price spikes persist:

The $100 bill left on the sidewalk is this: why does the transition from winter gas prices to summer gas prices continue to have this price spike, year after year. One would think there is some money to be made in the right kind of hedging and stockpiling. Or is the real cost of tankage so high as to preclude such strategies?

Stephen answered his own question, and correctly. The existing EPA fuel oxygenate requirements that arise from the Clean Air Act Amendments of 1990 require that all refiners deplete their inventories of winter fuel before restocking the tanks with the summer fuel (something to do with reducing the probabiilty of mixing). This requirement exacerbates the seasonality that is inherent in gasoline prices because of (1) changes in the demand for gasoline and (2) the price inelastic nature of the demand for gasoline. So now in addition to inelastic seasonal demand for gasoline, we have inelastic seasonal supply of gasoline. And politicians and “uninformed newscasters” wonder why we have seasonal price spikes …

In theory these price spikes should provide an arbitrage opportunity for some clever entrepreneurs. But the opportunity cost of inventory storage is very large; petroleum refining is a very aggressive oligopoly, so the profit margins are just not there to support carrying such a capital cost. Furthermore, constructing more tank farms is almost as much of a no-no from the aesthetic/NIMBY perspective as building more refineries (the last refinery built in the US was constructed in 1976, in Louisiana). So expanding storage is expensive and difficult to achieve.

That’s why it’s not a $100 on the sidewalk. But it is a deadweight loss from the ill-conceived and poorly implemented regulations to control the emissions from burning gasoline.

But is there a better way, you ask? I think the fuel oxygenate requirement is another entry in the list of bad input regulations to try to control outcomes. A much better approach is to say, “We’re gonna sniff the tailpipes of cars burning your fuel. If the pattern of their emissions of criterion polutants does not meet our emission standard, then you are susceptible to a fine. Now go and set your engineers to solving this problem.” No telling the refiners how to do their jobs, no technology mandates, no input mandates that ignore how costly it is to re-engineer your refining process to meet the mandate. You just have a goal, a desired outcome, and you use your local knowledge and your human capital to meet it.

I did a search of my archives, and found posts over the past two years on gasoline prices, if you are interested in seeing what I’ve written on them in the past.

6 thoughts on “The $100 Bill On The Refining Sidewalk

  1. No telling the refiners how to do their jobs, no technology mandates, no input mandates that ignore how costly it is to re-engineer your refining process to meet the mandate. You just have a goal, a desired outcome, and you use your local knowledge and your human capital to meet it.

    Unfortunately, such an approach is not particularly appealing to bureaucrats. And, in particular, when a significant percentage of the pols have no experience of business they also have no confidence in businessmen–even to look out for their own best interests.

    BTW, I haven’t been able to find your Navarro. Who carries it?

  2. Don’t know. We get it mailed to us from the winery. The joy of living in Illinois, a relatively enlightened state when it comes to interstate wine shipment!

  3. Ilinois is not a major wine-producing state, so vintners do not represent a significant lobby in Springfield, let alone one with “deep pockets.” Hence, Illinois lawmakers and regulators have little political incentive to raise “protectionist” barriers against “out-of-state competition” — there’s simply nothing in it for them!

  4. But Illinois wine wholesalers and retailers do have an incentive to keep out mail order competition.

    That they have so far failed is happyfying.

  5. California Attorney General Bill Lockyer has an interesting report (from 2000)on gas price spikes in California on his website:

    Lockyer points put that California mandates a more expensive blend of gas that’s generally made only in a few West Coast refineries. Among his points:

    –California has little spare refinery capacity or gasoline storage, so brief disruptions of refinery production very quickly cause gasoline supply shortages

    –While some Gulf Coast refieries could make California-blend gasoline, the refinery conversion time and cost of transportation make the venture risky.

    –No gasoline pipelines cross the Rocky Mountains, thus even if California-blend gasoline were available elsewhere, there is no way to quickly bring in to offset spot shortages.

    With California government dominated by liberal Democrats with a strong environmentalist component, it seems unlikely any major expansion of refining capacity or gasoline storage could be approved under forseeable circumstacces.

    I found it interesting that Lockyer, who has a reputation in California as a fairly partisan liberal Democrat, wrote a report that, as I read it, attributes most of the California gasoline supply problems to regulation failures and our own political choices.

    Except for a discussion of zone pricing in gasoline sales, there wan’t much in his report
    documenting collusion or price fixing among refiners. I seem to remember the announcement of study his got much more coverage in our local press (Los Angeles) than the actual study did when it was completed.

    It’s easy to make the unfounded charge that oil companies are gouging the public, and harder to understand that in California, we did it to ourselves.

  6. How can politicians pander for votes out here in farm country without promising increased ethanol subsidies? Concerning oxygenates, MTBE is now on the bad list, leaving ethanol as next best alternative. Interesting commingling of farm policy, environmental regulations, and energy policy. Why, a plan like that could lead to lifetime employment for multitudes.

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