Data suggests that price spikes in May and October may have been the result of market manipulation and not supply shortages.
Back in 2000-2001, California—and San Diego in particular—fell victim to the price fixing schemes of a virtually unregulated electricity market. Back then the state became the center of the nation’s attention when the state’s electricity markets went absolutely kablooey (that’s a technical term). Electricity providers SDG&E, PG&E, and Southern California Edison were forced to sell off their production facilities as a part of then governor Pete Wilson’s grand deregulation experiment, in which San Diego was the guinea pig. The new owners of the generating plants smelled opportunity, and they took full advantage of it.
The companies that now owned the power generation plants took their plants off line during peak usage times due to “maintenance issues,” driving up wholesale prices, which in turn drove up the prices for consumers. They created an artificial shortage, forcing retailers like PG&E and SCE to pay exorbitant prices—higher than the retail prices they were getting in some cases–putting them billions in debt and bankrupting one. Electricity prices for ratepayers more than tripled, forcing small businesses to shut their doors. The California economy staggered, and the state had to endure repeated rolling blackouts in order to avoid running out of electricity altogether.
Maintenance issues weren’t the only way the power generators manipulated the market. Due to the shortage of electricity in California, the state had to begin importing power from other states, such as Arizona. The generators and the people who controlled them—ENRON for one—saw a massive opportunity there, too. They sold and transferred what electricity they did generate to their out-of-state-affiliates, who then sold it back to the electric companies in California at a severely inflated rate. They had no choice but to pay it because they needed the electricity; the state needed the electricity.
It wasn’t discovered until later that companies such as ENRON and Dynegy had deliberately manipulated the markets to jack up profits. And it was all perfectly legal(ish), if not incredibly unscrupulous.
This is what happens when the markets are left to their own devices without any adult supervision. With no rules and regulations in place, the “free markets” are free to manipulate and gouge to their little hearts’ content. The idea behind deregulation was that increased competition would drive prices down, but exactly the opposite happened. And it was us, the consumers, that suffered for it.
Apparently those lessons have been forgotten, if they were ever learned at all.
A November 14th story from McClatchy news services details how it may have happened again, only this time with the oil and gas industry. McClatchy was given a sneak peek at a report compiled by McCullough Research that concluded that refineries in California that were supposedly down for maintenance or suffered severe mechanical malfunctions were, in fact, operational at the time they were supposed to be down. Further, the gasoline shortages that had supposedly hit California never existed—the supplies of refined gasoline in the state actually increased during the “crisis.”
Back in May, refineries in the Bay Area reported that they were going to shut down their operations to perform seasonal maintenance in preparation for the summer driving season. During the summer months, state law requires refineries to produce a different formulation of gasoline that helps reduce emissions and thus air pollution. Seems pretty routine. As a result, California experienced a modest spike in the price of gasoline in anticipation of possible shortages.
Except that McCullough’s study showed that the refineries did not, in fact shut down. They examined measurements of emissions during the times when the refineries were supposedly inoperative and compared them to when the refineries operated normally. They found no difference in the emissions. Had they been shut down, the study states, emissions from the plants would have been near zero.
Then this past October, California saw a ridiculous rise in gas prices. In San Diego, prices jumped from an average of $4.09 in late September to nearly $4.70 per gallon. The explanation was a fire at Chevron’s Richmond, CA, facility on August 6, which supposedly strained supplies, causing a jump in both wholesale and retail prices. Contributing to the May price spike was (allegedly) a February 18 fire at BP’s Cherry Point, WA, refinery, supposedly causing a slight supply shortage of its own.
Common sense and Economics 101 tells us that when supply is down but demand remains high, prices will by necessity go up to balance out market forces. That’s the good ‘ol invisible hand working its magic.
But according to McCullough, no such shortages occurred, neither in May nor in October. In fact, they found that gasoline inventories actually increased during the time of both price spikes. Even more specious was the fact that the refinery fires that supposedly caused the supply shortages took place months before. From the McCullough report:
The May spike was blamed on the February 18 fire at the Cherry Point refinery and the October spike was blamed on the August 6 fire at the Richmond refinery. The lengthy delay between cause and effect makes these explanations suspect. It is not the refinery outage itself that increases price, but rather the impact of the outage on supply. Moreover, if a decline in production levels causes price increases – a hypothesis at odds with the statistical data – prices should have risen soon after the outages and not two or three months later. While the EIA does not provide inventory data in sufficient detail to understand West Coast inventory levels, CEC data shows that during the May price spike, inventory levels actually increased.
The report concluded that it is very possible—if not probable—that the sudden and jarring jump in the price of gasoline in California is the result of collusion between the oil companies.
The existing data gives few insights into the exercise of market power in the California gasoline market, although it does allow us to rule out one option – the decision of a pivotal supplier to sacrifice market share in order to capture windfall profits when a perceived shortage occurs. In isolated markets, a pivotal supplier is one who can create a shortage by not offering its production to consumers.
There is no one dominant supplier in the state, meaning that there is no one company with enough market power to manipulate the price of gasoline by themselves. But McCullough found evidence of collusion among the oil refiners in the state:
If the exercise of market power is collusive at the sales level either through withholding or cooperative pricing agreements, this need not affect the individual refinery production decisions. Our review of NOx emissions levels over the past five years indicates that there is some evidence of production coordination among the California refineries.
The West Coast—and California in particular—is isolated from the rest of the country when it comes to oil supplies. There is no pipeline that transports crude oil or crude oil products from the Midwest or anywhere else to the West Coast. California is particularly dependent on refineries located within the state, making it ripe for market manipulation.
“This is an environment where market power, defined as the ability of a few producers to set prices outside of market forces, is likely to exist,” the report states. “However, the lack of correlation between fundamentals and prices does not necessarily prove market power. It certainly does not prove collusion among the principal suppliers, since specific data by refineries is difficult to procure. However, the data does suggest the need for an investigation on a refinery by-refinery level.”
It’s shocking that this report has received almost no attention in the broader media, and that the McClatchy story went almost completely unnoticed until MSNBC’s Rachel Maddow featured it on her program. But it only further demonstrates the vulnerability of consumers—the very consumers who make our economy work in the first place—to bad actors in the marketplace who are solely concerned with profits.
To the conservative way of thinking, the free market is capable of policing itself and allows everyone to prosper if we would only get government out of the way so that the “job creators” can do their thing and make everyone rich.
What we have here is clear evidence to the contrary; that corporations cannot be trusted to be left to their own devices. We’ve seen what happens when the electricity markets were deregulated and the markets left entirely to their own devices, and we have strong evidence here that the pursuit of the almighty dollar has led to collusion in order to drive up gas prices an average of $.66 per gallon above what it should have been in October, leading to a windfall profit of $25 million per day for the oil companies.
The problem is that the basic theory of the free market depends on perfect (or near perfect) competition. And free market principles clearly state that monopolies and oligopolies are detrimental, since it discourages efficiencies and encourages corruption. What we have here is strong evidence that the oil refiners colluded (very illegally, I might add) to goose their profits, solely out of greed because they saw an opportunity to take advantage of weaknesses in the marketplace. That kind of manipulation is highly detrimental to our economy, particularly given how dependent we are on gasoline to make it move.
The Senate Committee on Energy and Natural Resources are looking into the McCullough report (we hope…..at least that’s what Washington Senator Maria Cantwell told Rachel Maddow). Cantwell, the Chair of the Energy Subcommittee, said that the committee is encouraging the Department of Justice to look into it, much like they did with ENRON.
Let’s hope they take up the case and get to the bottom of this mess. After all, it’s only our entire economic existence that’s at stake.
Follow Andy on Twitter at @AndyCohenSD.