Understanding the Gas Cap

High prices at the pump may have you wondering–what kind of gas cap is this?

As the first state to enact a gas cap law, is Hawai’i breaking new ground and setting trends for the rest of the country to follow? Or are Island leaders locked in a political ivory tower, isolated from the basic principles of economics?

Analysts who have studied Hawai’i’s gas cap law say it doesn’t make sense. Retailers call the result since it took effect on Sept. 1 “total chaos.” Legislators continue to bicker with one another. The governor’s hands are tied. And the rest of us are left driving on fumes and frustration, hoping that next week the tab at the gas pump won’t continue to resemble the numbers on the cash register in the grocery store.

illustration: Scott Thigpen

HOW DID WE GET HERE?

• Led by then-Gov. Ben Cayetano in 1998, state Attorney General Earl Anzai filed an antitrust lawsuit against the major oil companies to reclaim up to $2 billion for “colluding on pricing and overcharging consumers.” This followed decades of concern about the issue or, some might say, years of ill will against Chevron. The timing also coincided with Cayetano’s campaign for re-election.

• By 2002, with the lawsuit doomed, all parties settled for a total of $30 million.

• “The Legislature basically reacted to that failure,” says Jack Suyderhoud, a professor of business economics at the University of Hawai’i. The result was Act 77, which included a cap on fuel prices at the wholesale and retail levels, with values tied to markets in Los Angeles, San Francisco and the Pacific Northwest. The state Department of Business, Economic Development and Tourism (DBEDT) says the impetus for Act 77 “came from the Legislature’s findings that there is a need to ensure lower gasoline prices for Hawai’i’s consumers … and to address the uncompetitive market.” Act 77 was passed in 2002, but implementation was delayed until July 1, 2004.

• Meanwhile, the Legislature allocated $250,000 to DBEDT to study the matter. DBEDT conducted a nationwide search and selected California-based Stillwater Associates. The team of energy consultants interviewed stake-holders and analyzed several hundred thousand pages of documents.

• Stillwater’s final report in 2003 recommended against price caps because, “they would have actually raised retail prices, and caused numerous other unintended negative consumer, economic and policy impacts.”

• The study also pointed out that price controls have not worked in other markets. They typically lead to higher prices for consumers and poorer service, in the form of the shortages and long lines witnessed in the 1970s. In Canada, price caps failed to produce any measurable consumer advantages.

• Hawai’i’s legislators forged ahead anyway. In 2004, Act 242 amended Act 77, limiting the cap to wholesale prices and allowing gasoline retail prices to remain untouched by the government. They further postponed the effective date until Sept. 1, 2005.

• The Public Utilities Commission determines the wholesale price cap. The formula is based on a weekly average of spot gasoline prices in Los Angeles, the Gulf Coast and New York Harbor, linking Hawai’i to the Mainland’s more volatile markets.

• Spot prices are averaged from Wednesday to Tuesday. The new week’s prices are announced on Wednesday for implementation the following Monday.

WHAT’S HAPPENING NOW?

A recent San Francisco Chronicle article noted that, while gas prices are supposed to rise and fall in sync with those on the Mainland, Hawai’i is the only state that has seen prices move steadily upward. Furthermore, adjustments in the cap formula for transportation costs translate to higher prices in remote areas on the Neighbor Islands–often where people can least afford them.

“It means total chaos,” says former Kahala Shell owner Bill Green, who now serves as a consultant to the station. Instead of improving customer service and employee training, gas stations spend their time answering questions from the media, analyzing prices and trying to figure out how to manage the coming week.

“I believe that it is not working,” says Rep. Lynn Finnegan. “No matter what you do, Hawai’i is a unique market.” There are several reasons for this. Hawai’i’s refineries must use oil low in sulfur, called “light sweet.” Because the two refineries in the state were built in the 1960s and have no place to store excess sulfur (unlike more modern refineries), they incur added costs. Light sweet crude oil commands a premium–up to $3 more per barrel. Demand is high and it requires less processing.

Aloha Petroleum, which recently purchased Mahalo gas stations, bringing its total number of gas stations to 80, has the ability to store 21 million gallons of gasoline, diesel and ethanol, allowing it to import fuel from other sources. However, the company anticipates that it will continue to purchase most of its fuel from the local Chevron and Tesoro’s refineries.

For once, the airlines are way ahead. Their ability to import jet fuel from different sources aids the tourism industry by blocking soaring air travel costs and increasing the competition for the local refineries. But it might also lower the profit margin in this area, creating the need to increase the margin elsewhere.

If prices are lowered too much across the board, the oil companies–or local gas station dealers–can’t make a profit and won’t survive. “It doesn’t make sense to me,” says Finnegan. “We’re regulating business. What message does that send? Hawai’i’s business climate is difficult enough as it is.”

But Cayetano and gas cap supporters such as Sen. Ron Menor believe the law has enhanced competition and will stimulate lower prices in a market that previously remained high no matter what the circumstances.

Cayetano’s recent editorial in The Honolulu Advertiser claimed that gas prices would see no limits if not for the enactment of the gas cap. “I don’t think he understands Free Enterprise 101,” says Sen. Fred Hemmings. “The best way to compete against oil is to make it obsolete.”

For now, legislators appear to be inclined to give it a chance–at least until public outcry demands change. Finnegan’s advice? “Just admit to the mistake and move on.”

WHY SO MUCH VARIATION?

The price of crude oil determines the price of gasoline, which fluctuates constantly. World events, such as recent hurricanes, war, labor unrest or other factors can affect supply and demand and cause sharp increases or decreases, making historical costs irrelevant.

So why does it seem that prices rise more dramatically than they fall in relation to crude-oil prices? It often comes down to retailers, who must gauge consumer psychology and buying patterns (retailers know that consumers buy from the most convenient stations) to survive less profitable times. Retailers price gasoline according to what the market will bear. Of course, once a retailer has reduced prices, others may follow. Or not.

It’s no secret to anyone who has purchased a gallon of milk for $1.99 in Seattle that Hawai’i is a distinctive market. Food costs more. Rents are higher. Taxes and electricity costs are among the highest in the nation. So it follows: Costlier real estate for distributors and dealers means they must increase prices to survive. Hawai’i will never possess the economies of scale that most cities on the Mainland enjoy.

WHAT’S LINGLE DOING?

It’s no secret that Gov. Linda Lingle does not support the gas cap. “She basically doesn’t believe that artificially controlling something like this–essentially a world commodity–is the right approach to lower gas prices for consumers,” says the governor’s chief of media relations, Russell Pang. “Everybody wants lower gas prices. But she doesn’t believe this is the right law to do it.”

She opposed Act 77 in 2002, but she did not veto the amended version in 2004, to prevent the enactment of the original version. It’s likely the veto would have been futile anyway. During the last session she introduced a bill to repeal the gas cap law, and it “didn’t go very far,” says Pang.

Now the governor has two options. She can use emergency powers to suspend the law in part or in whole–but only if it’s causing a major negative impact to the economy. Stillwater’s president, David Hackett, agrees, noting that for the governor to take action, the situation must be so severe that, for example, emergency vehicles run out of gas and can’t answer 911 calls. “The only way this is going to change is through the legislature,” he says. “You all have got another eight or nine months with this.” At best.

Her second choice is to provide some relief at the general excise tax level. When gas prices rose, the state enjoyed a windfall from the 4.16 percent GE tax, on top of the 16 cents per gallon fuel tax. The latter, however, is something the governor does not want to touch, because it is used to repair roads and leverage matching funds at the federal level.

Hemmings shares the governor’s concern that savings from tax cuts might not be passed along to consumers at the gas pumps.

This is why Lingle wants to require gas companies and gas wholesale distributors to report their costs and increase the transparency of the process. Opening the books would show whether or not the oil companies are making a profit–something nobody seems to know definitively–and possibly attract competitors.

ARE THE OIL COMPANIES EVIL?

Prior to the enactment of the gas cap, prices remained steady. But some people alleged this was a sign of collusion among the oil companies.

Is big bad oil a reality? The final conclusion after years of analysis: It’s hard to tell. But most research–largely from Stillwater’s exhaustive investigation–says no. The results of their study indicate that “Hawai’i’s gasoline market is not perfect, but it is not ‘broken.'” Stillwater cautions that “import parity prices can be achieved by government intervention, but is not without risks to industry and the consumer.”

The team recommended repealing gasoline price caps. The state didn’t listen. Divorcement, a complex law meant to protect gasoline dealers and separate retail from refining and production, was deemed ineffective at best. Yet it’s still around.

The two refineries on O’ahu import crude oil and supply almost all of the gasoline for the state, according to Albert Chee, Chevron’s spokesperson. Chevron stations must buy and sell fuel from Chevron’s refinery. The same goes for Tesoro’s refinery and stations. But all independent stations can import and store their own fuel.

“As an on-island producer, we definitely make our sales pitches to these owners,” says Chee. “If they can’t secure a price they want, they will just import it. The two refineries really don’t have a stranglehold on this market. We have a great deal of motivation to sell our products here locally.” If there’s an excess of crude oil, the refinery must ship it out on a barge, adding operating costs to the process.

Indeed, claims that the oil companies have enjoyed excessive profits have “been refuted over and over,” says Chee.

HOW BAD CAN IT GET?

Energy consultants Stillwater & Associates report retail price limits during the 1970s left one lasting memory in many consumers’ minds: interminable lines at the pumps and gas siphoning. Market distortions–predicted in Stillwater’s report–seem to have taken effect. Because consumers know ahead of time the price of gas for the following week, they alter their purchasing behavior, filling up gas cans when prices are lower (possibly creating a public safety concern), running on fumes and driving all over for the lowest price.

However, the gasoline distribution system was designed to meet a more constant demand. If sales surge, long lines could develop or gas stations could run out of their supplies. The cost of keeping up with unpredictable needs will get passed along to consumers over time.

“If retailers are smart,” notes UH’s Suyderhoud, “they’ll say, ‘Well, hell, I’m going to raise the price now,'” to make up for the weeks when prices drop. Retailers are trying to predict consumer behavior and figure out how to stay in business; consumers are trying to guess what the retailers will do; and everyone is eyeing the Public Utilities Commission for the latest update on wholesale prices.

At press time, the gas cap had raised Hawai’i’s gas prices an average of 28 cents per gallon above what gas would have cost without the cap.

“It’s not like this is something brand new,” says Lowell Kalapa, president of the Tax Foundation of Hawai’i. “We had price controls before (in the Nixon years). One, it created shortages. The manufacturers stop producing, you lay off people, goods become scarce and what happened was by the end of the 1970s, early 1980s, people had money but there weren’t any goods, so that drove inflation up.”

At this point, residents can do their best to understand the global scale of the issue, monitor gas prices at various stations, budget their own consumption and communicate with legislators, who should listen to their constituents. “A lot of people see this as a grand experiment,” says Hackett. “Yet not one economist will say this kind of price control works. Therefore, it’s not an experiment. It’s wrong. It certainly is damaging to Hawai’i’s economy. And it’s bad for consumers.”