I don’t think so.
Governor Newsom has called a special session of the legislature to consider his plan centered around a minimum inventory requirement on gasoline sellers. The idea is that when a spike occurs in California due to low supply, some state official or organization would allow – or require – release of the inventory, which would increase supply and push down prices.
This is from Severin Borenstein, “Can More Reserves Solve California’s Gasoline Price Problem?” Energy Institute Blog, September 23, 2024.
I think that pretty much any economist who thinks about price spikes for storable commodities such as gasoline will immediately think about futures markets. Why don’t futures markets take care of the problem? And even in the absence of futures markets, if gasoline producers can anticipate a price spike, why don’t they cut back on sales now to make more money when the price spikes?
Borenstein is an economist who thinks a lot about gasoline prices. But read through his post and you won’t see a thing about futures markets. Maybe there’s a reason and maybe the reason they don’t work in this case is obvious to him. But it’s not obvious to me.
He continues:
If implemented carefully and operated without political intervention, an inventory requirement could help consumers. California’s special blend of gasoline and limited sources of supply makes it vulnerable to supply disruptions, particularly in the fall when refineries often do maintenance that reduces their output. Those events upend the budgets of low-income working families. And because of the increasingly-concentrated ownership of refineries that produce our blend, it is not at all clear that a producer has a strong market incentive to raise supply, which would drive the price back down.
So Borenstein admits that a regulation to take the place of apparently non-existent futures markets needs to be “implemented carefully and operated without political intervention.” In other words, it won’t work. Why? Because the people who would implement the regulation and operate it don’t have an incentive to do so carefully.
Later, Borenstein writes:
Others weighing in against the inventory requirement – including the governors of Nevada and Arizona – have claimed that holding these inventories would reduce supply and therefore drive up prices. This argument, however, ignores the whole point of inventories, which is to acquire them when the system has sufficient production capacity, and have them available when the system might be short. Sellers would meet the minimum inventory requirement by building up stocks prior to periods when the system could be strained, whether due to high demand or reduced supply. The price increase caused by the inventory-build at less constrained times would almost surely be minimal, while the price decrease when there are shortages could be substantial.
That’s good reasoning, but why aren’t companies doing that already. What special information does Governor Newsom have about the gasoline industry that the gasoline producers don’t have?
To his credit, Borenstein points out some problems with the proposed regulation:
My own concerns with this proposal is [sic] that the real world implementation is likely to be much more complicated than the legislators or its proponents seem to acknowledge. Someone needs to set and enforce the rules for the inventory requirements: what counts as inventory (blending components? imports soon to arrive?), what’s the sales basis for calculating the required quantity (total gasoline sales? CARB gasoline sales? refinery capacity?), what’s the required ratio of inventory to sales?
Even more importantly, someone needs to decide when to waive the requirement to address a price spike, how to make sure that inventory gets released, and when to require sellers to rebuild their inventories.
This leads to my other concern, that the inventory would be managed in an unpredictable and political way. If the governor or some other political appointee makes the call on when to release inventories, it could easily end up being used for political advantage, including suppressing gas prices even when there is no evidence of a supply shortage (as has happened with the national Strategic Petroleum Reserve). That’s why any inventory requirement should come with either a predictable rule for when it will be released – for example, when California spot prices exceed Gulf Coast prices by more than a certain amount – or by an independent Board that would make the decision.
These are all good, well thought out concerns. Hopefully, they’ll be enough to talk other proponents, or those on the fence, to oppose this regulation.
READER COMMENTS
Rob Rawlings
Sep 27 2024 at 10:18pm
This isn’t directly related to the post, but I happened to be in Monterey this week for my wedding anniversary. My wife has always wanted to visit the aquarium, and as we were driving around, we passed by the Naval Postgraduate School. It immediately reminded me that this was where you used to teach, and I often see you share insights about your time there and your experiences in Monterey.
I’ve been reading your posts on EconLog for over a decade now, and I just wanted to take a moment to thank you for the educational value and entertainment your contributions provide!
David Henderson
Sep 27 2024 at 11:49pm
You’re welcome, Rob.
Too bad I didn’t know. I could have taken you to coffee.
steve
Sep 27 2024 at 11:20pm
My concern with the futures market idea is that international crises can occur suddenly enough that they can react in a meaningful way. If the state wants a reserve they should do it themselves.
Steve
Jon Murphy
Sep 28 2024 at 7:31am
That’s also true of government, however.
David Seltzer
Sep 28 2024 at 8:26am
Steve: Futures contracts are a hedge against crises. Both producers and buyers of commodities and assets guarantee prices by hedging. BP gas stations want to sell gas. Assuming they plan to have enough fuel arriving monthly, they will purchase RBOB Gasoline futures contracts. They know in advance the price they will pay for fuel. Once the contract expires they will take delivery. Delivery risks are quite low in the gasoline markets in spite of government regulation. There is no need for regulations requiring minimum inventories. Markets are much more efficient at determining inventories than gov functionaries simply because all the information needed to make decisions is impounded in the price of the commodity/asset and hence the market. Forcing minimum requirements imposes unnecessary opportunity costs on owners.
Thomas L Hutcheson
Sep 28 2024 at 8:07am
Isn’t it obvious that the State of California would be a more successful speculator than private speculators?
David Henderson
Sep 28 2024 at 9:52am
Good one, Thomas.
Adrian Tschoegl
Sep 28 2024 at 11:32am
Carrying inventories is expensive due to the opportunity cost of the capital tied up in the inventory. Furthermore, if I have to put n new tanks or increase the size of my tanks to hold the excess inventory, the fixed cost increases too. If I know that with probability one, the governor of the state will condemn me as a price gouger if I raise my prices during the shortage period, I know now that I cannot recoup the costs of the reserve during that period. If I have to carry the excess inventory now and can’t recoup the extra costs in the future, I will have to raise now my normal times prices.
Ron Browning
Sep 29 2024 at 6:29am
Possibly the governor could propose a requirement that each consumer of gasoline carry a minimum reserve of cash, which could be released when there is a seasonal spike in gasoline prices.
Don Boudreaux
Sep 29 2024 at 11:21am
Great post, David. And I want to second the comment of Adrian Tschoegl – a comment that prompts me to note that the single best step that Sacramento could take to reduce the size of price spikes is to credibly commit not to penalize or even to criticize merchants who “price gouge.” The expected value today of the profits available tomorrow from price hikes that will be uncontested by government is the best information available to determine just how much money to invest today in inventory-storage facilities and in the inventories themselves.
Put another way, it’s grotesque economic ignorance for grandstanders such as Gavin Newsom, on the one hand, to demand that gasoline suppliers carry more inventory as insurance against supply disruptions, while, on the other hand, at the same time standing ready to criticize so-called “price gougers.”