Gauging gouging

COMMENT: This is quite lengthy. Skim if you like. It contains two news items; one each about two reports which were issued in February examining retail gas pricing in Alaska. Both reports conclude it's mainly market forces at work, but the House Judiciary Committee report figures someone is still "hiding the ball," but it just couldn't find where or how.

By Brendan Joel Kelley
Anchorage Press
Wednesday, February 11, 2009

After last summer’s extraordinarily high gas prices, which peaked around $4.70 a gallon, then-Speaker of the House John Harris (R-Valdez) tasked the House Judiciary Committee with investigating why our prices didn’t drop when the rest of the nation’s did, and to prepare a report with solid recommendations for legislative action during this recently begun session.

The report came out February 2, authored by Judiciary Committee Chair Jay Ramras (R-Fairbanks), but it didn’t contain any definitive answers to why our prices remained high. From 2002 to 2007, retail gasoline cost an average of 17 cents per gallon more than in Seattle; in October of last year, the difference was 71 cents per gallon. Ramras’s report suggests that the two in-state refineries that produce automobile gasoline needed to make up for losses in the jet fuel market—Flint Hills Resources in North Pole and Tesoro Alaska in Nikiski produce primarily Jet A fuel, which accounts for 60 percent of their sales, while auto gas makes up only about 10 to 15 percent of their production.

The Attorney General’s Office of Consumer Protection is due to release a similar report any day now, looking into whether there was price fixing or collusion by the refineries. Lawmakers point out that, unlike the House Judiciary Committee’s investigation, the attorney general’s office had access to proprietary information, and may have more answers than Ramras’s report.

Ramras’s conclusion was “meddling in the free market is likely to produce negative consequences with lasting effects on Alaska’s economy and employment.” It suggested that legislation such as house bill 68 and senate bill 54, which would prevent Alaska refiners from selling gas wholesale for more than 10 percent of what refiners in Washington sell for, could have unintended consequences and possibly be disastrous for the Alaska refineries.

Ramras, who authored the report and then asked other legislators on the Judiciary Committee to weigh in via addendums, told the Associated Press that his findings were based on “intuition.”

“I got hammered a bit for that word,” Ramras says. “But I’m not sure what else you would call it, you know? We just kind of have a working idea, we think, of what’s going on, and it’s not fair.”

“There must be a better answer,” the report reads. “Somebody must be playing ‘hide the ball.’ But we could not find it.”

“If the committee used layman’s language to describe how Alaskans feel, the profanity would be much too graphic and would compromise the professionalism of this report. Suffice it to say, Alaskans feel taken advantage of,” Ramras wrote.

“Alaskans feel like they’re getting screwed,” Ramras says. “And I should have left that in [the report], because it captures the sentiment.”

The two Democrats on the Judiciary Committee, Lindsey Holmes and Max Gruenberg (both of Anchorage), issued dissenting addendums to Ramras’s report disagreeing with Ramras’s conclusions. “I haven’t heard all of the evidence yet,” Gruenberg, one of the co-sponsors of HB 68, says. “I think we need to have some hearings on this price gouging legislation. We haven’t even had a hearing on the bill.”

Gruenberg’s dissenting addendum concerns procedural and substantive issues with Ramras’s report. He believes the report was premature, since the attorney general’s report hadn’t been published yet. There was no opportunity for discussion and debate, Gruenberg wrote. The findings are incomplete, and the conclusions unsubstantiated, according to his addendum.

“Despite the directions by Former Speaker John Harris to prepare a report with solid recommendations for legislative action, the report fails to recommend a solution to the problem presented,” the Gruenberg addendum reads. “The report is authored from a laissez-faire point of view—that, if the government remains hands-off, the best result will be achieved. Alaskans are depending upon our state government to help find a solution.”

“The people who wrote that report are from that mindset, that if government interferes it causes problems,” Gruenberg says. Indeed, the report and the dissenting addendums reflect a fundamental difference between Republicans and Democrats: Republicans preferring the free market approach and Democrats interested in exploring regulation. Ramras agrees, “but without animosity,” he says. “We have an extraordinarily warm and collegial point of view with [Gruenberg], so it’s hard to find fault. We just simply disagree.”

Ramras also defends the process—his writing the report himself, then asking other Judiciary Committee members to weigh in via addendum. “Down here where you have philosophies at battle, I don’t know that you could achieve better than a generic point of view to agree on, where we’d sit down and try to edit things together, when you have such a breadth of points of view, political and philosophical,” Ramras says. “We thought it was very constructive to offer members the opportunity to do their own addendum, and I read [Gruenberg’s] addendum, and I thought it was very fair. I thought it was inbounds and I thought it was very fair criticism.”

So the questions remain: Why didn’t our gas prices drop at the same rate as in the Lower 48, and should the legislature enact laws to prevent price gouging by the refineries?

Lawmakers are hoping that the attorney general’s report will answer the former question to a better degree than the Judiciary Committee’s investigation. As for the latter, “I think we need to do something,” Gruenberg says. “I think we need to take some action. [The public] can understand if we do X; they can understand if we do Y, but I think [Ramras] is a big target out there if he doesn’t do anything. People are gonna say it’s a lot of hot air.”

bjk@anchoragepress.com

Alaska Gasoline Pricing Report

CONCLUSION (excerpt)

Economic Drama Meets High School Economics
Our Conclusion

[The report concludes that any action on the part of the state to regulate retail gas prices in Alaska increases the risk that one or both of the refineries in the state will be sold, or close down. The refineries main product is jet fuel, sold on the international market. Gasoline is incidental to that, but the revenues from gasoline are a make-or-break factor in the economic business case for the refineries.

But the House Judiciary Committee didn't completely surrender to the arm-twisting. It still suspects that someone is "hiding the ball." It just couldn't find out how or where it was being done.]

Do Alaskans want price parity with Seattle gasoline prices, or do they want the opportunity-cost driven, sometimes erratic, pricing of Alaska’s refined gasoline that comes with 10% of Alaska’s jobs and Gross Domestic Product? This, in the Committee’s opinion, seems to be the multi-billion dollar question.

It is the dilemma of economic drama. Do we want the Alaskan roller coaster or the Seattle merry go-round, plus .15 cents per gallon more, in perpetuity? Which ride do we want to put Alaskan consumers on, given that jet aviation fuel is the mother’s milk of much of the Alaskan economy? The recent economy has shown us that during some petroleum cycles, Alaskan consumers subsidize the volatile and extremely competitive global market of jet aviation fuel through their consumption of retail gasoline. On balance, the Committee chooses the free market and robust economic drivers. The Committee recommends it is a worthwhile tradeoff for a little more price volatility at the pump in exchange for the most promising value-added industry Alaska has been able to create since the onset of the TAPS era.

This conclusion not withstanding, the Committee, after meeting in September, October, November, and January, shares the cynicism of the Alaskan public. There must be a better answer – somebody must be playing “hide the ball.” But we could not find it. This report attempts to find it. This report attempts to lay out the most likely, plausible theory as to why gasoline price-parity with the Seattle market has been lost since March of 2008, and why we have seen periods of intermittent lost price-parity as well as inverse price-parity with Seattle, which has resulted in Alaska having better pricing than the Seattle rack rate.

Finally, the Committee also uncovered disturbing price patterns in Southeast Alaska that have not been fully incorporated into this report. The committee recommends that the Speaker of the House of the 26th Legislature direct a joint effort by the House Judiciary Committee and the House Resources Committee to explore inconsistencies in pricing patterns that affect this vital and vulnerable region of the state.

Read the full House Judiciary Committee's report here
http://housemajority.org/ramras/pdfs/26/gasoline_pricing_report_20090204.pdf (15 MB)

No evidence of illegal activity behind high Alaska gas prices

JUNEAU — Two investigations into high state gas prices found no illegal activity but are offering ammunition for people for and against legislation that would prevent price gouging by setting profit margin caps.

At the same time, spokespeople for the state’s two gasoline refiners, Flint Hills and Tesoro, say government control of prices and profits could drive them to do business elsewhere.

“It’s the uncertainty,” Tesoro spokesman Kip Knudsen said. “We have opportunities to invest in other markets without that intrusion.”

Jeff Cook, spokesman for Flint Hills Resources Alaska, forecast fuel shortages and other dire consequences should lawmakers approve anti-gouging or price cap bills.

He said lawmakers might have good intentions in protecting consumers but are playing a “dangerous game” considering price control.

“Government intervention in prices ultimately creates far more harm than good,” Cook testified at a Senate Energy Committee hearing Thursday on Senate Bill 54. “It would be a very serious threat to the future of the North Pole refinery.”

Flint Hills officials said the company may sell, shut down or seriously modify the North Pole refinery within a few months. The state stepped in, and Flint Hills now is discussing possible assistance with the state. Options have ranged from a state buy-out to breaks on royalty oil prices.

Two separate committees on Thursday addressed gas prices investigation reports and legislation aimed at price gouging. Senate Bill 54 is sponsored by Anchorage Democrats Sens. Bill Wielechowski, Johnny Ellis and Hollis French and Fairbanks Sen. Joe Thomas. House Bill 68 also is sponsored by a coalition of Democrats, including Rep. Scott Kawasaki of Fairbanks and Anchorage Reps. Pete Petersen, Les Gara, Chris Tuck and Max Gruenberg. Tuck and Petersen are members of the House Energy Committee that compared details of the two investigation reports.

One report was released Thursday morning. The much-anticipated investigation by the state attorney general’s office found no evidence of illegal activity in Alaska gas prices.

“Our investigation did not reveal any evidence that this kind of illegal collusion or price fixing has occurred among the refiners, distributors or retailers of gasoline in Alaska,” the report found.

Economic realities in Alaska likely explain the high prices, the report stated. Those factors include small market demand and low competition and dramatic and unpredictable changes in the price of crude oil through 2008.

“It’s the market at work, and it’s not a very perfect market, that’s for sure,” said Ed Sniffen, a state attorney who handled the investigation. “Competition here isn’t that great.”

Many Alaska consumers are puzzled why pump prices are so high when the resource, oil, comes from so near. In particular, a de-coupling of retail average prices in Alaska and Washington state has stymied some who wonder why Alaska’s prices have remained so high when those Outside have dropped.

The attorney general report stated gas prices reached record highs across the country in 2008, driven by high oil prices. Alaska’s market takes longer to react, which at one point created a wider spread than usual in prices. However, the attorney general report noted the Anchorage-Seattle price spread is narrowing as oil prices stopped falling.

Gov. Sarah Palin, who directed the state attorneys to investigate, had no comment on the report, spokesman Bill McAllister said.

Rep. Petersen is a sponsor of anti-gouging legislation. He said the wild swings of the market amplify the need for consumer protection.

The other report, the fruit of four hearings conducted by the House Judiciary Committee at the direction of former House Speaker John Harris, R-Valdez, recently was released by Rep. Jay Ramras, R-Fairbanks.

His study considered possible legislative action to address high retail prices. Ramras’ report found that high prices can be attributed to market conditions, including lack of competition. His underlying theory is that Alaskans sometimes pay higher gas prices so that refineries can balance losses on aviation fuel, which supports air cargo operations and the military, representing about 10 percent of state employment and of gross domestic product.

“The underlying conclusion is that Alaskans are getting screwed, period,” Ramras said.

The Senate Energy Committee took testimony Thursday on SB 54.

Cook said the bill could be “so oppressive” to the refining industry, Flint Hills could cease fuel production and distribution in Alaska.

“A lower price is of no use to the consumer if there is no fuel available to buy,” Cook said.

Flint HIlls’ North Pole refinery produces less than a fifth of the state’s gasoline supply. Tesoro supplies about 85 percent of in-state gas through its Nikiski refinery. Knudsen testified that Tesoro imports about 25 percent of the oil refined into gas in Alaska.

He spoke in opposition to SB 54. Like Cook, Knudsen said price control will damage his company’s ability to do business and could hurt one of the few value-added industries in Alaska.

Several people testified in favor of the bill as consumer protection.

“We need to regulate the companies; they need to have their books open,” said Pete Roberts of Homer. “You’re here to protect the citizens of Alaska. The big companies do very well here.”

Rep. Bryce Edgmon, D-Dillingham and co-chair of the House Energy Committee, said the reports were enlightening and frustrating.

“I walk away with more questions than answers,” he said. “There is a lot of frustration in my district. ... We’re paying incredibly high prices.”

He said the fundamental conclusion of both reports is the same: Market forces will prevail.

Ramras agreed and said he anticipates a highly partisan debate on the price gouging legislation.

“Are you in favor of more government control or the free market?” he said. “I’m going to pick the free market every damn time.”

Sniffen acknowledged he simply didn’t know if price gouging legislation would have prevented high prices.

“That’s a difficult crystal ball question,” he said. “It would just depend on how the legislation was drafted. It is really important for us to predict what that would do. ... You don’t want to drive the refiners out.”

2008 Alaska Gas Pricing Investigation

Executive Summary

Gasoline, like all other commodities, is not regulated by the state. Instead, prices are determined by the forces of supply and demand. Competition in the marketplace is ultimately responsible for determining the price of all consumer goods and services, with few exceptions.3 We do not live in a "cost plus" society. Sellers are not required to price their goods and services based on what it costs to acquire them "plus" a reasonable profit. Instead, sellers can and do price their goods according to the market conditions. If demand is strong and/or supply is limited, prices may exceed cost by 200% or more. Because gasoline is not regulated, the state does not have the authority to tell sellers how to set their prices. Thus, simply having a "high price" is not illegal by itself. Alaska does not impose price controls or "caps" on any product, and there is no "price gouging" law in Alaska. The price of many consumer goods in Alaska is higher than the price you would pay in Seattle or another large metropolitan area. Gasoline is no different.

Prices can be illegal, however, if they are the result of price fixing or other collusive behavior. The laws directed at ensuring that competition remains fair and unrestricted are state and federal antitrust law. Antitrust laws make it illegal to engage in any concerted action that unreasonably restrains trade.4 It is also illegal to monopolize, attempt to monopolize, or conspire with another to monopolize any part of trade or commerce.5 The purpose of the antitrust laws is to ensure that competition remains fair and unrestricted, which in turn results in lower prices and better service. Thus, if the sellers of gasoline were colluding with each other to "fix" the price of gasoline, they would be violating the law.

Our investigation did not reveal any evidence that this kind of illegal collusion or price fixing has occurred among the refiners, distributors, or retailers of gasoline in Alaska. Instead, there are economic realities of the Alaska gasoline market that likely explain the price of gasoline in Alaska and the relationship between Alaska gasoline prices and prices in the Lower-48.

First, the market for gasoline in Alaska is structurally different than most other gasoline markets in the U.S. Gasoline demand in Alaska is small, and we do not enjoy the same degree of competition as most markets in the Lower-48. There are few participants in Alaska’s gasoline markets at the refining and wholesale distribution level. When few competitors account for the majority of sales, the market is known as an oligopoly. In addition, Alaska is geographically isolated from alternative supply sources outside the state. As a result, potential competition from the Pacific Northwest -- which might otherwise be expected to keep prices in parity with Lower-48 prices -- is limited, particularly during short-term price disruptions such as occurred in 2008. Based on this market structure alone, it is unrealistic to expect that gasoline prices in Alaska should be the same as prices in other parts of the country. The level of competition and available sources of supply in the Lower-48 create supply and demand conditions that are not present here.

Second, the changes in crude oil prices during 2008 were dramatic and unpredictable, making it the most volatile year in crude oil pricing history. After rising $60 per barrel during the first part of the year, crude oil prices dropped by more than $100 per barrel in less than six months. These events created market conditions that have never occurred before. The rapid rise and following decline in oil prices, coupled with Alaska’s unique oligopolistic market structure appears to account for the unusually high spread between gasoline prices in Alaska and the Lower-48 experienced during the second half of 2008.

This unusually large spread is not, however, inconsistent with historical pricing patterns in Alaska. Alaska’s gasoline markets have historically responded more slowly to changes in crude oil prices than larger, more competitively structured markets in the Lower-48. In oligopoly markets there can be a wide range of pricing outcomes depending on the behavior of the individual market participants. Prices can range from a very competitive level to monopolistic. The specific outcome can vary across time and depends on the behavior and goals of the market participants, as well as the potential for competition from non-incumbent sellers to access the market when prices rise above competitive levels. Prices in these types of markets can and do deviate from long-term historical patterns, particularly when input costs change quickly.

Gasoline prices have fallen dramatically in Alaska since the start of this investigation. At the time of writing this report in late January 2009, Anchorage gasoline was selling at about $2.35 per gallon on average, a drop of more than $2.00 per gallon since July 2008. In Seattle, gasoline prices have risen over the last month and now average about $2.10 per gallon. On a tax-adjusted basis this difference is approximately $0.65 per gallon. While still larger than historical norms, the spread between Anchorage and Seattle has started to narrow over the past several months, consistent with historical patterns.

In Southeast and Western Alaska, where fuel is supplied by barge, some of the same economic principles apply. There are few competitors, and alternative sources of supply are scarce. In addition, barge markets are characterized by relatively few large deliveries of fuel throughout the year. Unlike markets where supply is replenished every few days, fuel may not be delivered by barge for several weeks or months. Until new deliveries of fuel are made, the price of fuel is not likely to change. If a supply of higher-priced fuel is delivered in summer, lower priced fuel may be months away. When you add the dynamics of the barge market to other factors that affect supply and demand in Southeast and Western Alaska (for example, low volumes and higher transportation costs), prices tend to be higher.

The Attorney General’s investigation spanned five months. Thousands of pages of confidential documents were reviewed, and key personnel were interviewed. The Attorney General also retained the services of Barry Pulliam, Senior Economist with the Los Angeles-based economic consulting firm Econ One Research, Inc., to assist in this investigation. Mr. Pulliam assisted the Attorney General’s office in its prior investigation of gasoline prices, concluded in 2002. Mr. Pulliam has extensive experience in the analysis of competitive issues involving gasoline markets, and assisted the Attorneys General in California and Hawaii in several investigations involving gasoline prices. Econ One assisted in the preparation of this report.

The key findings of our investigation are set forth below.

Read the full Attorney General's report here:
http://www.law.alaska.gov/pdf/press/2008GasolinePricingReport.pdf