Low-Energy Fridays: Will California’s new refinery law lower gasoline prices?
California Gov. Gavin Newsom recently signed a new law that imposes additional regulatory requirements on oil refiners in the state. The law intends to reduce gasoline prices and prevent what Newsom calls “price spikes,” commonly known as price gouging.
Just days later, Phillips 66 announced a planned closure of its Los Angeles-area refinery, denying any connection to the new law. Newsom and other supporters of the law argue that refiners take advantage of captive customers by charging higher prices, while industry argues that regulation is behind the rising costs. So, which is it?
Newsom’s assertion that refiners are gouging customers is tenuous for two big reasons. The first is that, in the United States, gasoline is bought and sold in a competitive market. Surely, if a refiner were to participate in price gouging, they would lose business to another refiner. Instead, U.S. refiners are operating mostly at capacity. This is due to a scarcity of refinery capacity, which has led to higher prices that reflect that scarcity—thereby explaining Newsom’s “price spikes” more readily.
It’s also worth noting that terms like “price gouging” don’t carry much weight with economists, as prices are a product of supply relative to demand. Price gouging typically occurs when supply is low and demand is high. Whatever politicians call it, increased prices under those conditions are a normal function of the market rather than a market failure that can be remedied through regulation.
The second reason is that a large portion of the higher price Californians pay for gasoline stems from taxes and other governmental policies. At the time of this writing, the average retail price of gasoline in the United States is $3.10 per gallon; California has one of the highest state averages, at $4.33 per gallon. One reason for this is that California’s gasoline tax is $0.68 per gallon—the highest in the nation. Another is that state regulations require specific, costlier gasoline formulations to reduce air pollution. Because it’s regulatory in nature, this requirement does not fit the conventional definition of price gouging.
California’s new law will require refiners to disclose more of their business activities to the state and to hold supply in reserve to prevent “price spikes.” In practice, this will impose new costs on refiners by increasing their regulatory and paperwork burdens while preventing them from selling reserves when it would be profitable to do so (which, ironically, prevents prices from falling by increasing supply when it’s most scarce). These new regulatory requirements don’t address the root causes of heightened gasoline prices in the state. The fundamental issue is a lack of supply exacerbated by refiner scarcity, which—when combined with governmental policies like regulations and taxes—raises fuel costs.
The likely outcome of California’s new law is that the costs of operating a refinery in the state will increase, with those costs passed on to consumers through higher gasoline prices. The alternative view informing the new law is that refiners are engaging in some sort of political brinksmanship wherein they selectively adjust their prices to resist the state’s climate policies, even at cost to themselves. Generally, it is more reasonable to assume that refiners, like other producers, are profit-motivated and simply respond to the market. This more politically driven view lacks evidence, and if California politicians are wrong in their assumption, then residents will pay the price.
As a rule of thumb, policymakers should ask themselves “Why are prices high?” followed by “Does this policy address the reason for these high prices?” Given that this law seems more about accountability for oil companies than addressing scarcity, I’m inclined to think higher gasoline prices are in California’s future.