Obsolete Boutique Fuels and Failure to Arbitrage

Lynne Kiesling

Andy Morriss (Univ. of Alabama Law School) and Don Boudreaux (George Mason University) have an excellent op-ed in today’s Wall Street Journal, A Coca-Cola Solution to High Gas Prices. The punch line: environmental fuel formulation regulations balkanize wholesale fuel markets and make prices more volatile as a consequence.

This is not a new phenomenon; indeed, in the mid-2000s the boutique fuel problem was the focus of a lot of attention, as well as a lot of my posts here at KP. But it’s a problem that has persisted as the regulations have persisted, despite the fact that modern pollution control technology makes fuel formulation regulations obsolete. As Jonathan Adler notes in remarking on Andy’s and Don’s op-ed,

While most of the fuel standards were adopted in the name of the environmental protection, many are actually the result of special interest pleading. Producers of various products, ethanol in particular, sought fuel content mandates or performance requirements that would benefit their particular product. (I detailed part of this history in “Clean Fuels, Dirty Air,” in Environmental Politics: Public Costs, Private Rewards (Greve & Smith eds. 1992).) Worse, some of the content requirements are irrelevant for new cars due to modern pollution control equipment. Federally imposed boutique fuel requirements have outlived whatever usefulness they ever had.

Similarly, Andy and Don point out that

By the 1920s and early 1930s, oil companies were engaged in a vigorous “octane war” to improve quality and reduce price. This competition helped transform 100-octane fuel from a chemical that sold for $25 per gallon in the early 1930s to a mass-produced commodity selling for about 25 cents per gallon a decade later. That improvement helped win the Battle of Britain by giving the Royal Air Force a performance edge over the Luftwaffe. By 1944, Standard of Indiana alone could refine 1.15 million gallons of 100-octane aviation gasoline per day, a production rate surpassing that of the entire industry before the war.

After the war, prices continued to fall as competition drove producers to improve their fuels and expand their pipeline networks. With the gasoline market becoming national, refiners gained the scale to innovate in ways that further boosted quality and cut prices. …

From the 1920s to the 1950s, competitive markets successfully drove improvements in transportation fuels while reducing prices. We need to unleash those forces again. A good place to start is by undoing the anticompetitive regulations that keep our fuel markets small and fragmented—and making the sale of gasoline once more like selling Coca-Cola.

This is a really important point. In a very important sense, fuel performance and emissions reduction objectives are aligned — the better the fuel at delivering performance and the better the engine and the exhaust system at minimizing fuel waste, the lower the emissions per mile driven and per gallon of fuel. That also lowers the overall cost of driving, which gets us back to the Jevons effect discussion of yesterday and before.

See also David Henderson’s comments on the topic at Econlog. He accurately connects the regulation-induced price volatility to a failure to arbitrage across markets, which would happen naturally if not outlawed.