The case for more uniform fuel standards

Problems in the U.S. wholesale gasoline market have played a relatively minor role in the
gasoline price increases of the last few years. But this is one part of the problem that we
created all by ourselves and can fix all by ourselves.

As a result of the Clean Air Act Amendments of 1990, the EPA developed several
programs
for the nation’s most polluted areas. The reformulated gasoline program was
designed to reduce ozone and toxic emissions, and the oxygenated fuels program reduces carbon
monoxide. Since the cleanest burning fuels are also the most costly to produce, the programs
were only mandated for the most severely impacted communities. Less impacted communities were
allowed to develop separate, less restrictive standards to achieve some of the benefits of
cleaner fuel without the full cost.

Source:
Exxon-Mobil
boutique2.giftd>

The above map shows the nature of the resulting proliferation of fuel standards. It
indicates that you could drive through 7 contiguous counties in Arizona, California, and Nevada,
and be required by law to put a different formulation of regular gasoline in your vehicle in
each one.

The proliferation of standards raises refining costs and introduces logistical challenges in
keeping the different formulations separated at each point of the distribution and storage chain
before the product gets to the final consumer. By reducing the available supply that could be
legally provided to any given locality, it also makes the price in local markets much more
volatile in the event of any unexpected changes in either local supply or demand.

An even bigger concern may be the effect that this market segmentation has in combination
with two other developments. The first is the fact that over the last quarter century, half the
refineries in America have shut down and no new ones have been built. The second is the number
of mergers and acquisitions that we have seen in the petroleum industry over the same period.
The result of the three developments together is that there are substantially fewer suppliers of
wholesale gasoline available to any particular local market.

The claim that reduced competition in the wholesale gasoline market has raised the price to
consumers should not be interpreted as suggesting that all or even a major part of the gasoline
price increases over the last few years is due to price gouging by the oil companies. Certainly
the rising cost of crude is by far the most important reason that prices of gasoline at the pump
have gone up. Notwithstanding, a study last
year by the General Accounting Office
concluded that reduced competition raised the price to
consumers by one cent a gallon on the east coast and seven cents a gallon in California.

Though the problem in southern California in particular has been going on for some time, it
is only recently getting the attention it deserves from the Los Angeles Times. In part of an
ongoing series, the Times noted correctly this weekend
that “California refiners are simply cashing in on a system that allows a handful of players to
keep prices high by carefully controlling supplies. The result is a kind of miracle market in
which profits abound, outsiders can’t compete and a dwindling cadre of gas station operators has
little choice but go along.”

It is interesting to note who’s complaining and who isn’t about the present system. The
National
Association of Convenience Stores
and the Society of Independent Gasoline
Marketers of America, whose members make their livelihood in part by finding cheap
suppliers to help them undercut the market, have been protesting loudly, as, understandably, has
the
American Trucking Association
. By contrast, the National Petrochemical and Refiners
Association
argues that the current system seems to be working reasonably well.

Identifying the problem is much easier than fixing it. Imposing a uniform fuel standard
everywhere in the U.S. that is somewhere in the middle of the current system would raise
pollution in some communities and raise costs in others. However, some have argued that overall
gains in efficiency could outweigh either of these. A recent
study
by Ujiyant Chakravorty and Celine Nauges concluded that the potential efficiency gains
were sufficiently large that, even if we required all consumers nationally buy the highest
quality reformulated gasoline, consumers in some states would still see the price they pay fall
on average as a result of the more favorable competitive structure produced by standardization,
despite the fact that the reformulated gasoline is more costly to produce.

Fortunately, we are likely to get at least some improvements in the present system in the
energy bill currently being debated in Congress. Exactly what form that will take and how much
relief that will bring remains to be seen.

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14 thoughts on “The case for more uniform fuel standards

  1. Hal

    This next article from the L.A. Times – http://www.latimes.com/business/la-fi-calprice19jun19,1,6659437.story – talks about the use of zone pricing. This is one thing that has always puzzled me about gas. It is not unusual to have wide variations in gas prices over a relatively small area. Even when gas stations are on the same corner they sometimes differ in price by five cents or more. And if you go a few blocks or a couple miles away you can often find 10 cent differential.
    The Times article talks about zone pricing as evidence of market power. But what really determines market power is inability of consumers to choose low prices. Yet it seems that gasoline is a commodity where finding low prices should be relatively easy. The prices are posted by the road. And gas consumers are highly mobile, by definition. It may well be worth their while to drive a mile or two in order to save two or three dollars on a fillup.
    Frustratingly, the article didn’t discuss the issue of how and why consumers choose where to buy gas. They quote one guy, briefly, who is buying gas at the expensive station. He said that he was almost out and didn’t have time to drive to a cheaper place.
    No doubt that happens sometimes, and there may be other cases where drivers don’t have the time or information necessary to find cheaper gas. But surely for the bulk of the market, consumers would be highly price sensitive, especially with gas as expensive as it is today. Indeed, in my experience expensive stations have much less business than cheaper ones.
    One possible explanation is that it is in fact a form of product differentiation – some consumers may prefer to pay more in order to avoid the crowds at the cheaper gas stations. But again this would not seem to provide a very big market.
    There are web sites now where you can find

  2. Mike

    Professor Hamilton,
    I’ve got access to some interesting, historical mileage / gas usage data from hybrid car owners that I’d like to use to consider some elasticity questions — are you aware of any historical datasets of average gasoline prices, say by county or state?

  3. Matt

    Mike–
    There is a great dataset available from the Energy Information Administration of gasoline prices by month for each state, with weekly prices for select areas. It comes in a pretty useless format, but I did all the dirty work to convert a large portion of it into Excel/Stata format a while back for my honors thesis, and if you’re interested, I’d be happy to send it to you. All I’d ask is that if you extended the data set in any way, that you send me a copy of the extended set. Otherwise, you can find it at http://www.eia.doe.gov

  4. Chris Wuestefeld

    It’s notable that the oxygenated gas (which I believe covers certain types of reformulations, e.g., in NJ) is pretty much obsolete, and kept around only due to corporate welfare.
    Back in the days of carburetors, the car couldn’t adjust to varying needs based on atmospheric changes. However, in today’s cars with O2 sensors and computer-controlled fuel injectors, the car can automatically sense the need for changes in the air/fuel mixture and adjust accordingly.
    So the only benefit we’re getting now is, well, higher prices and poison from MTBE.

  5. Bob V

    If the logistical and change-over costs of complying with multiple standards were sufficiently bad, wouldn’t refiners choose of their own accord to follow the more restrictive standard? To the degree that we do not see this happening, having multiple standards is not causing that much damage.
    Incidentally, would we not *prefer* that price gouging occur in the places that you describe? If those are the places that have the most pollution problems, higher prices in these areas ought to restrict consumption right where we would like.

  6. Barry P.

    Chris:
    Why do you call MTBE “poison”?
    The oxygenate requirement was pure corn-belt rent-seeking. It’s still around because no politician has an incentive to change it. You are correct that modern automotive technology has rendered oxygenated gas largely obselete, but that’s a separate issue to that being addressed by Congress.
    Note that the new iterations of the energy bill do not make reference to generic “oxygenates” like the CAAA (1990) did, but instead make specific reference to Ethanol. Back in 1990, the corn-belt pols assumed that ethanol would fill the oxygenate requirement – imagine how horrified they were when the refiners chose a cheaper, technically superior option.

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  9. JDH

    Bob V and SA: I agree with you that if the only benefits from more uniformity were the efficiency gains, then refiners would naturally on their own choose to produce the most stringent formulation, if that truly was cheaper. If one of the social benefits is greater competition, however, then more uniformity is not something you’d expect them to implement on their own.

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