Blast 'em

This Blast 'em blog is going to shine a much needed bright light on legislative shanigans. We will provide details of the wrong doing, give names of the doer, and describe the ramifications to the public. Initially we will focus primarily on consumer issues.

Thursday, May 25, 2006

THE GAS CAP - ANOTHER LOOK

The following is a speech given to The Lion’s Club by Richard Miller, Professor Emeritus and once Dean of the U of H Law School. Dick has actively worked in the public interest at the legislature for at least the past ten years.

SPEECH – THE GAS CAP
To the Lion’s Club

Carl Miura and Distinguished Members,

I’m delighted to be here to talk to you about the late, sometimes lamented, gas cap.

I am probably not the most knowledgeable person to hear from; a couple of my colleagues in Citizens Against Gasoline Price Gouging know a lot more both about the industry and how pricing of gasoline works. You should know a little more about our group: none of us has any financial interest in limiting or reducing gasoline prices other than as an auto owner. One is an auto repair guy who owns a big shop and who has a beef against Chevron, two are former executives of companies which produced and sold fuel, like PRI, one is a retired Dep. AG who was a participating counsel on behalf of the State in the antitrust action against Chevron, one is a retired accounting professor – a brilliant guy – who is retired from the Univ. of Michigan. I’m just a retired law professor and former dean at UH. I know less than any of the others. By way of contrast, it is my understanding that key members of our current state government have had strong ties to Chevron.
I got into the business of criticizing oil companies when I discovered that we in Hawai'i were paying $.30 to $50. per gallon more, on average, than the mainland and that there was no market reason why that should be so. That extra tariff, multiplied by the millions of gallons of gasoline sold each year, represented a small fortune that would leave Hawai'i every year as oil company profits, was clearly responsible in significant part for our high cost of living – not just what we pay to fuel our cars but every company we buy from charges us for the cost of gasoline they use.
The high relatively high cost of gasoline is caused only in very small part by the taxes we impose on gasoline. On average our taxes are about $.14 higher than the mainland’s. And the taxes, you will note, do not usually leave the island but are spent here, though not necessarily wisely!
The key question is: Why is gasoline so expensive? To answer that, let me step back a little. Hawai'i is a relatively small, and most importantly, a relatively isolated state. This creates a problem for several important commodities, because by virtue of our size and isolation we do not have the competition that other states may enjoy. That is true of interisland airlines – we came darn close to ending up with one airline. That is true of newspapers and newspaper advertising – came within an inch of ending up with one major Honolulu daily, owned by Gannett and called the advertiser. I was very proud, by the way, to work with Save our Star Bulletin – a Canadian newspaper publisher showed up with the desire and ability to buy the Star Bulletin; and I was also involved in insuring the continued viability of Hawaiian and Aloha, when it really looked like we would lose one of them. It is true, of course, of the electric company on this island. And it is true of health plans – HMSA has a virtual monopoly of the PPO business – something like 70% with a reserve of half a billion dollars. Kaiser has pretty much cornered the managed care business.

And of course, we have a similar situation with gasoline. We have two refineries who manufacture all the gasoline we use; that situation, which is not a monopoly but an oligopoly, involves just a couple or very few players.

In each of these areas we either have no competition or competition is weak or shaky. It is true that real competition is the best regulator of prices in the market. But with regard to the wholesale market for gasoline, there is no true competition. Chevron and Tesoro provide gasoline to Shell and all the other gasoline sellers in Hawai'i. Aloha had plans to break into our market by buying gasoline in Singapore, where it is rather inexpensive, and shipping it to Hawai'i. It built a very large storage capacity for a very large price, and when it was done, Chevron idled up to Aloha and said: Why buy from Singapore and ship to Hawai'i ???– that involves a lot of risk, from the weather, the sea, from spills, etc? We will sell it to you at the same price that you could get it from Singapore if you had to ship it yourself. That price is known as market parity. And Aloha said “Great!” So every gasoline seller who buys gasoline at wholesale from Chevron (And maybe from Tesoro, but I’m not sure) – Shell, 76, and all the rest – gets it at market parity.

There is no competition at the wholesale level. The very few sellers at that level sell pretty much at the same price, and all of them live with that very happily. So long as none of them go head-to-head with Chevron by really lowering their retail price, Chevron will continue to sell them gasoline at Market Parity. All make big fat profits; Indeed, Chevron at the antitrust trial testified that for the prior year it had made 25% of all of its profit on gasoline, nationwide, in Hawai'i.!!!

If you want to fantasize about how profitable the situation is for all of those who sell gasoline at the wholesale level, think about this: Aloha buys its gasoline from Chevron at Market Parity and then sells it to Costco, who retails it for 15-20 cents a gallon less than Chevron and most of the other dealers. Unless Costco is giving it away at less than cost as a loss leader, (and why would it do that?) everyone seems to be cleaning up. In other words, without any explicit agreement – which would be necessary to establish a conspiracy in restraint of trade – the few gasoline manufacturers can insure that most of the gasoline will be sold at pretty much noncompetitive prices, and each of the companies will clean up with fat profits.

At the Chevron’s antitrust trial, its management made it pretty clear that if Texaco or others began to seriously undercut Chevron’s prices, Chevron would shut off the tap.

Why doesn’t Chevron cut off Aloha for selling to Costco who undercuts the retail price market? Probably because Aloha, alone of the possible competitors with Chevron, has the capacity to return to its original plan of importing gasoline from Singapore at low cost. That would give Aloha the independence to really undermine the happy scheme where all generally charge similar prices. Chevron doesn’t want that to happen.

Now, if I’m correct that we have an oligopoly that can pretty well set its own prices for wholesale gasoline, what should we do about it? First, the fact that there was an oligopoly which could avoid real competition was Chevron’s principal defense at the anti-trust trial. What we have traditionally done where we have a necessity – and let us not kid ourselves – gasoline is today a necessity -- we regulate. That is what we do and have always done in the electric industry, nationwide, where a limited number of companies have cornered the market. That is what the insurance commissioner has been doing, with great positive effect, in the area of health plan rates until this session when rotten politics managed to give effect to a sunset provision in the rate regulation law. Watch what happens to HMSA’s and Kaiser’s rates. We saw what happened to electricity in California when regulation was removed – they had nothing but terrible problems of rising costs, blackouts, and you name it.
Where there is a failure of competition, as there is so often in Hawai'i, and market forces are not controlling prices, it is, in my opinion, the duty of government to protect citizens by stepping in and regulating. And that is what we tried to do with gasoline in Hawai'i.
What happened and what went wrong?

It is very difficult if not impossible to establish a competitive price for a commodity based upon what is happening within a noncompetitive market. But we do know a couple of things: 1. The market for oil and gasoline is often governed nationally and internationally. 2. The high cost of gasoline in Hawai'i was partly the result of a phenomenon that where mainland prices went up, our gasoline prices would go up very soon afterward and match or exceed the mainland increases, but when mainland prices came down, Hawai'i gasoline prices would either not come down or would come down after great delay. 3. There was no real competition at the wholesale level, but there was supposed to be real competition at the retail level. Indeed, these were findings made in court by US District Judge Mollway.

From this it was concluded that tying Hawai'i's gasoline prices to an average of several widespread places in the mainland (we discovered from the earlier bill that limiting the average prices to west coast gasoline prices didn’t work mainly because of California’s special requirements and unusual markets) would be likely to produce a fair price and would cause Hawai'i's prices to fall, as well as to rise, when mainland prices fluctuated. The three places selected were NY Harbor, the Gulf Coast, and L.A.

Adjustments for special market costs – location adjustment factor - $.04 per gallon; marketing margin factor of $.18 per gallon; mid-grade adjustment of $.05 per gallon, premium adjustment factor of $.09 per gallon, 8 zones were created to account for different conditions on the various islands and isolated spots on the islands. The PUC was directed to establish zone price adjustments for the various grades of gasoline.

Manufacturers, wholesalers, and jobbers were given the power to petition the PUC for adjustments based on changes in the costs, and most importantly, the PUC was given the power on its own, “Regardless of whether a petition has been filed and notwithstanding a determination of the adjustments made pursuant to subsection (a), the commission, in its discretion, may make such other and further adjustments deemed necessary and appropriate to establish maximum pre-tax wholesale gasoline prices that reflect and correlate with competitive market conditions.”

It was claimed that the adjustments were too high, but the PUC never acted to reduce them, though it could and should have.

Unlike the first bill, which tried to cap both wholesale and retail prices, this bill just capped the wholesale prices on the theory that that is where competition was non-existent and “conscious parallelism” existed. Conscious parallelism has been held NOT to be a violation of the antitrust laws. (That is probably why the State’s case went down the tubes, tho’ Chevron did settle for $30 million.)

Well, what happened?

Katrina and Rita hit! They, along with the Gulf war, caused the price of oil to soar. Those prices affected world markets. The averages used to calculate the baseline price also soared. (It was argued that Hawai'i's prices for oil are based on different sources and would not have increased like those on the mainland, but that is naïve. Oil is a world commodity and what happens in the Gulf or the Gulf Coast affects the world price.) A second thing occurred which we suspected. Because wholesale gasoline is noncompetitive – an oligopoly – the wholesalers could and would raise their prices pretty-much to the cap. That they could do that proved what we believed, that they represent an oligopoly and there is no competitive market for wholesale gasoline.

But what also happened is what we were hoping for: When mainland prices fell, prices for gasoline in Hawai'i would also fall. TAKE A LOOK AT THE CHART THAT CARL MIURA HAS PROVIDED. THAT WAS WHAT THE GAS CAP LAW WAS DESIGNED TO DO, AND IT DID IT. What remained to be done, What could have been done by the PUC (See 486H-16(c) – Regardless of whether a petition has been filed and notwithstanding a determination of the adjustments made pursuant to seucsection (a), the commission, in its discretion, may make such other and further adjustments deemed necessary and appropriate to establish maximum pre-tax wholesale gasoline prices that reflect and correlate with competitive market conditions) and was never done, was to adjust the adjustment factors to lower levels and to change the formula to avoid the overeffect of unusual and important events, like Katrina and Rita, on the mainland. Indeed, the new law which requires the PUC to calculate the gas cap price does both of those things, requiring the average used to create the baseline price to be the average of the lowest three locations, with Singapore being added as one of the four locations to be used. (Singapore was where Aloha was going to get its gasoline before Chevron offered them gasoline at Singapore “Market Parity” Prices.) It also makes the factors for which amounts are adjusted more realistic and, in consequence, lower.

Unfortunately, the Legislature responded to public ignorance, often aided and abetted by newspaper reporters, and blamed the gas cap for the large increases in gasoline prices. In consequence, it suspended the price cap. However, it also established a petroleum industry monitoring, analyzing and reporting program and special fund; requires the PUC to continue to calculate and publish what the maximum pre-tax wholesale price would have been if the cap had not been suspended. The call for transparency may be defeated by the industry’s ability to hide its facts on the ground that they are trade secrets. It changed the adjustment factors as I mentioned before, especially to reduce the add-ons allowed on the baseline price and to add Singapore as a forth location whose prices may be averaged if it falls in the bottom three.
One section that could be helpful sets forth and prohibits unfair trade practices by the petroleum industry. One of my former students said that he thinks that Chevron was vulnerable to state claims of unfair trade, but the California attorney representing the State would not pursue those claims, just the federal antitrust claims.
Finally, the law gives the governor “the authority to reinstate the weekly maximum wholesale gasoline price for 30 days after publishing a notice that the reinstatement would be beneficial to the economic well-being, health and safety of the people of the State.” I don’t know what is supposed to happen after the 30 days but I suppose the governor can keep on reinstating if prices exceed the price determined by the PUC or if there is a natural disaster.
It remains to be seen how this new law will work, but it sure does have the potential of putting the governor in the hot seat if prices rise above the amounts determined by the PUC.

Finally, gas caps aside, we are likely in for very bad times fuel-wise. The increasing demand for motor fuels from China and India and the view, which seems to be shared by insiders, that oil production has peaked in most places where it is produced (not to mention the anti-US views of big oil producers like Venezuela and Iran) may very well create acute shortages in the years to come with the result that gasoline prices could rise to enormous levels, creating uncontrollable inflation (or deflation) and putting a huge crimp into our economy.

When I recently was in Florida driving on I-95, I tried to get some classical music on the radio and failed. I did get public radio and heard a guy named Stephen Leeb, the President of Capital Management and an author, being interviewed. It led me to buy his book, “The Oil Factor”. This is the central point of what he said, and I quote:

. . . “We believe that we are on the verge of a historic transition away from relying on oil as our primary fuel. This transition won’t be something we choose. Rather, it will be forced upon us by the fact that oil supplies are peaking—within a very short time, oil producers simply aren’t going to be able to produce as much oil as the world needs. This will be the key big-picture trend of t he 2000s, and it will lead to a long-term uptrend in oil prices. Oil shortages and rising oil prices will be the order of the day, and they will play havoc with the economy”.
* * * *
All in all, oil prices are likely to rise to triple-digit territory -- $100 a barrel at a minimum, and probably higher—by the end of the decade and possibly sooner. Inflation ultimately is likely to reach levels well into the double digits.

In this kind of situation, capping the price of gasoline won’t work to hold down prices except marginally. So, at best, gas caps are a temporary solution. What we need to do is to develop a national bandwagon for alternative energy that, if necessary, will make the Chevrons of this world irrelevant. And we have to do it quickly.

Why is it no longer news that gas prices in Hawaii are not falling since the suspension of the gas cap law? At the time the Governor signed the Bill, Hawaii was only 36 cents above the national average. Some of the closeness is due to the fact that there is no longer an excise tax on gas, a savings that consumers were beginning to enjoy. As of today the difference has grown to 53 cents! This is the highest gap between us and the mainland in a long time and may continue to get bigger. No reporting of this is a disservice to the consumers of Hawaii as there is no one else that can put as much public pressure on the wholesalers as the media.

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