California Gas Prices – How Free Markets Work in a Shortage

Californians are pretty unhappy right now.  With gas prices approaching or over $6.00 per gallon in many areas, and some stations closing down since the amount they lose when someone doesn’t pay takes forever to recoup with the small profit margin they get, Golden Staters have a reason to be upset.  California went Democratic in the last several elections, but given that people usually blame the President for gas prices – fairly or unfairly – one has to wonder what the folks in the Oval Office are thinking about the high prices.  Then again, Obama’s energy secretary said he wanted gas prices at $6-$8 per gallon to entice people out of their cars (although he probably did not want them right before the election).  This same sentiment has been expressed by many environmentalists in California.  Perhaps utopia is at hand.

The reason the prices are so much higher in California than in other places (the national average is somewhere around $3.73 per gallon, which is still high by historical standards) is that California has a limited number of places it can get its gas from.  Because of state-specific requirements, there are only a few refineries that make the blends that can be used in California.  Normally gas prices there are 30-50 cents higher than in neighboring states because of these restrictions.  Throw in a couple of refinery fires or maintenance shutdowns, and you get what you see today.

Notice however, how the free economy is working.  Because there is a shortage in supply, prices have risen.  Prices are still low enough that you can buy gas if you really need to.  For example, if you need to get to work and there is no other way, you can buy gas – there is still gas available.  Because gas has gone up in price, however, people are probably not doing much pleasure driving if any, people are surely combining or delaying errands to save gas, and people are surely car pooling, taking mass transit, and doing other things to save gas.  This means that despite the shortage, there is gas available for those who really need it.

People are also probably looking for jobs closer to home, which will reduce demand in the future and help bring prices down.  They may even be looking at scraping the requirements for the unique blends, and scraping the politicians who put the requirements in place.

Compare this with the 1970’s (note the parallel of these times with the 1970’s, not the 1930’s) where prices were fixed but there was rationing of gas.  When people were told that they would only get a certain amount of gas, and that they could only buy on certain days, they would buy all they could, whether they needed it that day or not, because they were not sure if they would be able to get gas again.  There were long gas lines, there were fights at the pumps, and people who really needed gas were not always able to get it.

Today gas is still readily available, and there are no long lines, but you need to pay a lot to get it.  This has caused people to only get the gas they really need, which is how markets are supposed to work.  The only issue is that some station owners are not buying gas because of the small amount they get (maybe 10 cents per gallon) and the high cost for them of refilling their tanks.  They also stand to lose a lot of money if people drive off without paying.  This could be solved if station owners were able to set whatever markup they felt they needed to in order to cover the risk they were taking.  This may happen if the high prices continue long enough for several stations to stop buying gas so there is leverage to negotiate with the gasoline suppliers.

Notice also that the current shortage is also different from the one caused by the partial electricity deregulation in the late 1990’s in California.  There the utilities were forced to sell their generating plants and buy electricity on the open market.  The consumer, however, was still protected from price spikes by regulators who set the price for electricity.  Furthermore, the utilities were forced to supply as much electricity as consumers demanded, regardless of their costs.

While the crisis was blamed on companies like Enron who took advantage of issues with the market, the markets were not able to work as they were supposed to because of the partial regulation.  In a free market, the consumer would have seen huge jumps in electricity prices.  Suddenly running the air conditioner or electric heat would become a rarity.  People would have found cooler places to be, hang the clothes out to dry, turn off the TV, and sat in the dark a lot more.  Instead the consumer saw the same prices and therefore kept on using as much as always.  The utilities were forced to pay whatever prices were charged.  The lack of control from the consumer caused rolling blackouts as demand outstripped supply.  Because the utilities were paying a lot more for electricity than they were able to charge, they went bankrupt.

So the lesson is that free markets are able to deal with shortages very well.  As long as there is sufficient competition to ensure that the prices charged are reasonable based on the supply, while prices may get high they will not be exorbitant given the scarcity of the commodity.  Such price hikes also ensure that those who really need the commodity will be able to get it.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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