BILL ANALYSIS 1
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SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE
DEBRA BOWEN, CHAIRWOMAN
SB 304 - Morrow Hearing Date:
May 6, 2003 S
As Amended: April 7, 2003 Non-FISCAL
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DESCRIPTION
Current law finds the distribution and sale of motor fuels affect
the general economy of the state, the public interest, and the
public welfare, and competition and freedom from unreasonable
discriminatory practices are essential to the fair and efficient
functioning of a free market economy.
Current law makes it unlawful for any refiner to discriminate
between purchasers where the effect is to decrease competition,
and provides for treble damages in cases where a refiner is
convicted of engaging in such discriminatory practices.
Current law establishes procedures for the transfer of any
gasoline dealer franchise and limits the ability of the franchisor
to deny a franchise transfer.
This bill makes numerous findings and declarations, including:
The marketing of motor fuel in California has become highly
concentrated;
This concentration and the use of certain marketing practices
has resulted in artificially high wholesale and retail gasoline
prices;
California refiners have inflated profits through higher
gasoline prices by utilizing practices that encourage reduced
production, low inventories, and the formation of import
barriers, all under the guise of meeting California's clean
burning fuel mandate;
This conduct is harmful to consumers and the economy of
California and should be prohibited.
This bill limits the price at which refiners can sell motor fuels
to any franchisee service station dealer. That price is the
lowest wholesale price, calculated in a specified manner, which
the refiner charges to stations which it operates ("owned and
operated" or "O&O" stations) that are served by the same truck
loading terminal.
This bill bars refiners from setting, attempting to set,
controlling, or economically influencing, either directly or
indirectly, the retail price or profit margins of motor fuel sold
at any retail service station other than O&O stations.
This bill bars refiners from taking ownership of or controlling
any service station owned by an independent dealer after January
1, 2005. However, refiners may temporarily operate such stations
for up to 90 days under specified circumstances.
This bill provides if any provision is held invalid, the remaining
of the provisions shall remain valid.
BACKGROUND
Despite being home to a number of oil refineries, Californians
can't seem to shake high gasoline prices. In 1996, California
gasoline prices spiked from $1.15/gal to $1.47. In 1999, gasoline
prices spiked again, rising as much as $0.50/gal higher than the
rest of the nation. Earlier this year, gas prices spiked yet
again, this time from $1.57/gal to $2.15/gal. Each of these price
spikes prompted public outcries, legislative responses, and, in
1999, an investigation by the Attorney General.
The current concerns over gasoline prices prompted the Governor to
order an investigation by the California Energy Commission (CEC).
That investigation noted gasoline prices climbed 36% from the
beginning of the year through March 17, which if sustained will
cost consumers more than $20 million per day. The cause of the
price increases was attributed to large increases in the price of
oil due to uncertainty about the U.S.-Iraq war, an oil strike in
Venezuela, and a cold winter in the eastern U.S. Refiners also
switched from a winter gas formula to a summer formula, which is
typically more expensive to produce and, during the switchover,
temporarily tightens supplies. Additional gasoline demand in
Phoenix reduced California supplies further, as did the move to
phase-out the use of MTBE.
Current Market Structure
California has 16 refiners, 6 of which control 86% of the refining
capacity in the state. The largest refiners are vertically
integrated, owning crude oil supplies, refining operations, and
retail distributors. About 15% of all California gas stations are
owned and operated by dealers who are independent from refiners,
15% are owned and operated (O&O) by the refiner, and 70% are
franchisees of the refiners. All franchisees are contractually
obligated to obtain their gasoline from the refiner at prices
established by the refiner, making the franchisee dependent on his
competitor to provide him with his product.
Attorney General Report
In 1999, the Attorney General opened an investigation into the
activities of the refiners to determine whether they were
operating in a non-competitive manner in violation of California
and/or federal law. This investigation in ongoing, but has yet to
result in any prosecutions.
The Attorney General also convened a Task Force on gasoline
pricing. A summary of the Task Force discussion was published in
May 2000 in a report entitled "Report on Gasoline Pricing in
California." A preliminary report provided to the Attorney
General noted three contributing factors to California's
relatively high gas prices:
A relative lack of competition in California's gasoline refining
and marketing industry;
Supply constraints related to California's unique cleaner
burning gasoline requirement;
Somewhat higher state taxes.
In a recent update, the Attorney General suggested considering the
following proposals:
Creating a strategic fuel reserve;
Increasing fuel economy standards and encouraging non-gasoline
based technology;
Enabling gas dealers to shop for the best wholesale prices;
Examining ways to import more fuel into the state.
Prior Legislation
The lack of any finding of anti-competitive behavior doesn't mean
the state's gasoline market is truly competitive because legal
behavior may still lead to unfair prices. For that reason, there
have been many efforts to change existing law. Two bills were
successfully enacted during the last gasoline price spike were:
AB 2076 (Shelly), Chapter 936, Statutes of 2000, required the
CEC to examine the feasibility of operating a strategic gasoline
reserve to buffer the state from any temporary gasoline supply
disruptions. The bill also required the CEC to develop
recommendations for reducing California's petroleum
independence. The CEC expects to issue these reports in the
next few months.
AB 2098 (Migden), Chapter 963, Statutes of 2000, required the
CEC to examine the feasibility of building a pipeline from the
Gulf Coast to California. The CEC expects to issue this report
in the next few months.
California vs. The Other 49 States
Since the mid-1990's, California's gasoline has been generally
more expensive than gas found in other states and that difference
has been more pronounced during price spikes. There are two major
causes. The first is that in 1996, California switched to a
unique type of gasoline that burns cleaner than gas sold in most
other states. Few non-California refiners produce this type of
gasoline, making it difficult for additional supplies to be
imported into California. When prices in California rise, the
non-California refiners that choose not to produce "California
gas" aren't able to ship gasoline in to keep prices down.
The second major cause is the increasing consolidation among
refiners. In 1980, there were 35 refiners operating in
California. By 1990, only 25 refiners were operating and by 1998,
that number had dwindled to 16. Accompanying the consolidation of
refiners was an increase in vertical integration, so now 85% of
all retail service stations are owned, operated, or controlled by
refiners.
A relatively constant factor that keeps California gasoline more
expensive is gasoline taxes, which are on average five cents
higher than the other states. However, higher taxes contribute a
relatively small amount to California's price discrepancy with
other states - in fact, California's gasoline taxes are actually
lower than those in Nevada.
Oil Company Profitability
If the allegations of anti-competitive behavior and price gouging
are true, then the profitability of the oil companies should be
high. It isn't particularly useful to examine the return on
equity (ROE) for the oil companies, since their California
refining and marketing operations are a relatively small part of
their overall business. In any event, the ROE's for the major oil
companies are unremarkable, comparable to that of the major
utilities, notwithstanding ExxonMobil's recent record first
quarter profit of $7 billion.
The only publicly available measure of profitability for the
California operations of the major oil companies is refinery cost
and profit data kept by the CEC. By determining the average
wholesale price and subtracting from it the price of crude oil,
the CEC determines how much is left to pay for the cost of
refining and to provide the refiner with a profit, known as the
refinery margin. This is a rough calculation based on aggregated
data that doesn't incorporate all actual wholesale transactions.
2002 2001 2000 1999 1998
Refinery Margin/gal $0.40 $0.58 $0.42 $0.40
$0.32
In March 2003, the refinery margin averaged $0.63/gal and in the
first two weeks of April it was $0.68/gal. This is an unusually
high margin that many wouldn't expect to find in a truly
competitive market.
COMMENTS
1.We'll Pay What They're Paying . This bill is premised under the
belief that oil companies can keep gas prices artificially high
because they control retail markets through their O&O stations
and through their control over the wholesale price of gas to
their franchisees. This level of control allows the oil
companies to pinpoint their response to whatever competition
exists by lowering prices only in specific locations.
This bill forces the oil companies to lower wholesale prices on
a regional basis rather than only in specific locations. These
regions are defined as the area served by a truck loading
terminal and could be as large as northern California between
Sacramento, Chico, and Lake Tahoe, or as small as the San
Francisco peninsula.
Under the bill, the "allowable wholesale price" means an oil
company franchisee can't be charged more than an imputed
wholesale price for gas retailed by any O&O station in that
region. That imputed price is calculated as the retail price
less the cost of retailing, which includes labor, overhead for
the property, and other costs incurred with the retail activity.
(This is referred to as the "market retail price" in the bill,
a somewhat confusing term that the author and committee may wish
to consider altering for the sake of clarity.) As an example,
if an O&O Shell station in Chico is charging $2.00/gal and the
cost of retailing the gas is $0.30/gal, then the imputed
wholesale price is $1.70/gal. Every franchised Shell dealer in
the region, which includes Chico, would be entitled under this
bill to buy their gasoline at no more than $1.70/gal.
Under this system, an oil company that lowers its retail price
at one specific location would be required to provide gasoline
to its franchisees in the same region at a wholesale price based
on that retail price. This is, in effect, establishing a
maximum wholesale price for each region.
2.Does This Create An Incentive For An Oil Company To Replace Its
Franchisees? This type of pricing mechanism could create an
incentive for an oil company to replace its franchisees, thereby
freeing it to compete in selective locations.
This bill attempts to foreclose that possibility by preventing a
refiner from acquiring any of its existing franchised stations.
However, it doesn't require a refiner to sell any of its O&O
stations, nor does it prevent a refiner from opening any new O&O
stations. The author and committee may wish to consider whether
it's appropriate to preclude an oil company from buying a
station from one of its franchisees. While the intent of this
provision is clearly to prevent an oil company from "forcing" a
franchisee to sell his or her station, there presumably many
reasons why a franchisee may want to voluntarily sell his or her
station. Should the latter occur, this bill precludes the oil
company from purchasing such a station.
The bill also contains a broad provision which bars any refiner
from setting, attempting to set, control, or economically
influence, either directly or indirectly, the retail price or
profit margin of any motor fuel sold anywhere except O&O
stations.
3.Will Region Pricing Create An Incentive To Keep All Prices High?
This bill forces oil companies that lower wholesale prices for
one specific location to lower them for all locations in a given
region (defined as the area served by a truck loading terminal).
Establishing a maximum regional price is arguably "fairer" to
franchisees, since it will mean all sellers of a refiner's
branded gasoline will pay close to the same wholesale price for
that gas. No longer will a franchisee have to compete against
an O&O station that gets gas at a lower price.
However, this provision may simply create an incentive for the
refiner not to lower any prices, since lowering them in one spot
effectively lowers them in all locations across the region.
A maximum regional price also won't help with the regional price
differences that have caused so much concern. It's possible the
bill will exacerbate those differences as refiners make up for
lost margins in the more competitive regions (e.g. Los Angeles)
by increasing prices in the less competitive regions (e.g. San
Francisco).
4.Enforcement . Enforcing this bill won't be easy. In addition to
keeping daily track of the retail price for all the
company-owned stations in a region, someone will need to
determine the cost of retailing for each station so the imputed
wholesale price can be determined.
The provision barring a refiner from setting, attempting to set,
control, or economically influence, either directly or
indirectly, the retail price or profit margin of any motor fuel
sold anywhere except O&O stations is very broad and imprecise,
making it difficult to comply with and enforce. For example,
refiners by definition "indirectly economically influence" every
franchisee's profit margin since the refiner sets the price
their franchisees pay for gas. Because current law already bars
price discrimination, the author and committee may wish to
consider whether this provision is necessary, and, if so, how it
can be narrowed.
5.Regulations vs. The Free Market . The refining and marketing of
gasoline isn't economically regulated, so wholesalers and
retailers are free to negotiate deals and set prices as they see
fit. By the same token, people who drive (and need gasoline)
are free to choose from a wide variety of vehicles that vary
greatly in terms of their fuel efficiency (thereby giving people
the chance to stretch their gasoline dollars). They can also
choose not to drive at all.
This gasoline free market has regularly resulted in prices which
drivers view as unfair, sometimes because California prices are
far higher than other states, sometimes because some regions
within California pay higher prices than other regions, and
sometimes because the prices just don't comport with what people
think they ought to be paying for gasoline.
The fundamental question is whether the market for gasoline can
ever produce outcomes that satisfy everyone. Drivers want low
and stable prices and in an ideal, fully competitive market with
many buyers and many sellers, that could happen much like it
does in markets for food and consumer electronics. The current
gasoline world doesn't look like that - there are many buyers,
few sellers, and little prospect for additional sellers. Couple
those realities with a demand for gas that's barely effected by
its price and you get a world where price spikes are inevitable.
The imbalance between California gasoline supply and the demand
for it is likely to continue to grow. Supply is constrained by
virtue of California's unique cleaner burning gasoline, while on
the demand side, Californians have exhibited an ever-growing
thirst for gasoline. While the average fuel economy of gasoline
vehicles in California rose from 12.4 mpg in 1972 to 19.5 mpg in
1992, that improvement has virtually ceased: In 2002 the average
was 20.8 mpg. Coincident with this stagnant improvement in fuel
economy, the volume of gasoline sold in California has risen
steadily since 1992, from 13.1 billion gallons to more than 15
billion gallons in 2002.
6.Other Answers . The ongoing spate of gasoline price spikes has
generated several ideas for reducing prices:
? Reducing the demand for gasoline can dramatically help
with prices, as was seen during the recent electricity
crisis. Improving vehicle fuel efficiency, either by
increasing the efficiency of each vehicle or encouraging the
use of more fuel-efficient vehicles, could be accomplished
through incentives or mandates.
? Linking California's gasoline market to the rest of the
country could make it harder to manipulate California prices.
One proposal would allow non-California gas to be imported
and subject it to a pollution surcharge fee to mitigate the
increased pollution caused by use of the dirtier
non-California gas. If wholesale prices in California were
higher than those in other states, there would be an
economic incentive to import the non-California gas (assuming
the price difference still existed with the inclusion of the
mitigation fee). The success of this proposal rests on the
ability of California gas dealers to access non-California
gas, which they may be barred from pursuant to their
franchise agreements.
? The Foundation for Taxpayer and Consumer Rights (FTCR), a
non-profit education and advocacy foundation, suggests
limiting refiners to being able to sell a single grade of
gasoline. It argues this would make it harder for refiners
to limit inventories, which FTCR believes is the cause for
high gasoline prices. How this would affect vehicles that,
according to manufacturers, require a higher grade of gas is
unclear.
? The President Pro Tempore of the Senate has announced the
creation of a Select Committee on Gasoline Zone Pricing. The
members of the committee have not yet been announced.
1.Technically Speaking . The author and committee may wish to
consider adopting the following technical amendments:
v Page 4, Line 18 - the term "convert" should be replaced
with "acquire."
v Page 4, Line 30 - the term "truck loading terminal" is
imprecise and should be refined.
v Page 4, Line 33 - the term "process" should be replaced
with "price."
1.Related Legislation . AB 146 (Kehoe) allows franchisees to shop
for their gasoline at any wholesale outlet operated by the
franchisor via a mechanism, known as "branded open supply". AB
146 is similar to SB 123 (Peace), which was approved by the full
Senate in 1999 before dying in the Assembly Utilities & Commerce
Committee. AB 146 is pending in the Assembly Business &
Professions Committee.
POSITIONS
Sponsor:
Author
Support:
Automotive Repair Coalition
Automotive Trade Organizations of California, Inc.
California Service Station and Automotive Repair Association
California Small Business Association
Oyster Petroleum, Inc.
South Bay Shell & Car Wash
The Foundation For Taxpayer and Consumer Rights
Utility Consumers' Action Network
Oppose:
A. Juner Chevrons
Bigge Crane and Rigging Company
California Chamber of Commerce
California Independent Oil Marketers Association
California Manufacturers & Technology Association
Chevron dealer in San Mateo County
ENTRIX, Inc.
Redman Equipment and Manufacturing
Western States Petroleum Association
Randy Chinn
SB 304 Analysis
Hearing Date: May 6, 2003