California Energy Crisis — Take Two?

September 5, 2003 • Commentary

The political freak show that is the California gubernatorial recall election got freakier on Aug. 28 when one of the supposedly mainstream candidates — Democratic Lt. Governor Cruz Bustamante — called for the state to treat the gasoline industry like a public utility. “Californians are being gouged, and under current law we are powerless to do anything about it.”

Well, that’s all to the good. The last time the state tried to restructure an industry along political lines, the lights went out and the power companies — along with the state — went bankrupt. Turning over the gasoline industry to the same bunch of political clowns tempts a repeat of history.

So what spawned this latest fit of madness? Candidate Bustamante claims that “six oil companies control 90 percent of the California market. In the last two weeks they caused the largest jump in gasoline prices ever recorded.” All by themselves? No help from Mr. Supply or Mrs. Demand? Prices just went up because oil company execs were bored?

Apparently so in the world‐​according‐​to‐​Cruz: “The oil companies explain their behavior the same way Enron did. They say it was someone else’s fault. … But what they never say is that their profit margin in California is the highest in the nation.”

Well, that much is true, but it doesn’t necessarily mean that chicanery’s afoot. The Energy Information Administration (the analytic arm of the U.S. Department of Energy) reports the following: “A confluence of events has constrained gasoline supply at the same time demand has reached record levels, leading to the inevitable–higher gasoline prices. A pipeline rupture in Arizona on July 30 led to a complete shutdown of the pipeline on Aug. 8, leaving many gasoline stations in Phoenix not just with much higher prices, but with no gasoline at all. The power blackout on Aug. 14 resulted in the temporary shutdown of three refineries in the Midwest region. Key refineries in California have also experienced some problems and an unconfirmed report of a refinery outage along the East Coast added to the supply concerns. While the U.S. gasoline market may have been able to handle any one of these supply problems separately, it was the combination of all of these problems that exacerbated the price increase.”

If you’re running for governor, however, you clearly have no time to keep up with such things. Bashing the “gougers” is a far better use of your time.

But what constitutes price gouging? To Bustamante & Co., “gouging” is selling something at the highest level that the market will bear regardless of production costs. By that definition, Bustamante is right — we’re being gouged.

But pricing goods and services at the highest level that the market will bear is what everyone in a capitalist economy does every day. Moreover, it happens regardless of whether prices are rising or falling. Oil companies were trying just as hard to charge what the market would bear in December 2001 (when gasoline was $1.13 a gallon nationwide) as they are now. Given present scarcities, however, the market can bear a higher price today than yesterday.

Curiously, many of the same people shaking their fist at “Big Oil” right now are, as we speak, putting their houses on the market and enthusiastically gouging the living daylights out of anyone looking for a new home. Surprisingly, however, no one ever rages against real estate price gouging. In fact, the opposite is the case. Business reporters gush about returns and politicians pledge to do whatever it takes to keep the real estate bubble afloat.

So is price gouging okay if you’re the gouger but not the gougee? It would appear so. But in reality, price gouging — like spinach — may be unappealing at first bite but it’s good for everyone in the long run. Gougers are sending an important signal to market actors that something is scarce and that profits are available to those who produce or sell that something. Gouging thus sets off an economic chain reaction that ultimately remedies the very shortages that led to the gouging in the first place. Without such price signals, our economy would look like Cuba’s.

Price gouging also efficiently rations scarce goods. If service station owners were overtaken by fits of brotherly love and decided tonight to sell gasoline at $1.20 gallon, it would simply disappear across the state in a matter of days. Service stations can mark up gasoline quite a bit today for one simple reason: There’s not much of it to go around at the moment.

Of course, California has a lot of experience at imposing price controls on energy that happens to be a bit scarce at the moment. It will be interesting to see whether the state learned anything the last time it succumbed to such policies.

About the Authors