When California Gov. Gavin Newsom signed into law last spring a measure aimed at penalizing oil companies for price gouging, he touted it as proof the state could “beat Big Oil.”
But at that same event — surrounded by supporters and state lawmakers — Newsom acknowledged the work wasn’t done yet. “Nothing is going to happen in the short term,” he said at the bill-signing ceremony.
Nine months later, those words have proven prescient.
State officials right now are knee-deep in an effort to build a system that can monitor oil refiners for excessive profit-making and potentially impose penalties for price gouging. Meanwhile, California continues to contend with the most expensive gas prices in the nation, which hit a yearly high of $6.08 per gallon in late September.
The Newsom administration hasn’t set a deadline for full implementation of the law. A vote that would allow the price gouging penalties isn’t expected until late next year.
In the interim, state officials must wrestle with questions both practical and philosophical — starting with the most basic: What exactly is price gouging? And how does a state set a limit on profit-making that’s fair and legally defensible?
“You’re not going to prosecute anybody simply for making a lot of money,” said Severin Borenstein, faculty director of the Energy Institute at University of California, Berkeley, Haas School of Business. “Making a lot of money is not illegal.”
But, he added, “what you might be able to do — if you can figure out why they’re able to make so much money — is change the market and change the way we regulate it … so that they can’t make that much money and prices wouldn’t be so high.”
The method California ultimately chooses will help determine whether the new price gouging bill actually works — and if the first-in-the-nation legislation has a chance of being repeated in other state legislatures.
What’s in the law
There are several components to California’s price gouging law, starting with its pursuit of new data from the oil industry.
The measure forces oil refiners to send daily reports on wholesale market transactions to the Energy Commission. The idea is to expose “price manipulation in real time” if it exists, according to the governor’s office.
In addition, refiners are required to let the agency know when refineries go offline. The intent is to avoid price spikes that often come when a California refinery is unavailable.
Finally, refiners are supposed to submit monthly reports on their profit margins.
These information-gathering efforts will work in tandem with another component of the law. The price gouging measure created a new gas price investigative unit — housed in the Energy Commission — that is tasked with scouring oil company actions and financial documents for potential market manipulation.
It’s an issue several previous California attorneys general have tackled over the years, with none ever producing evidence of a crime. It’s unclear, analysts said, whether the new law would yield different results.
“It’s a really high bar to show that kind of collusion and market manipulation,” said Ethan Elkind, director of the climate program, Center for Law, Energy & the Environment at UC Berkeley School of Law. “Even with these additional sort of fact finding tools that the law gives the Energy Commission and this independent oversight entity, it’s not clear that that information is going to help.”
Finally, the new law empowers the California Energy Commission to set a limit on an oil company’s “gross gasoline refining margin,” or how much they made on the sale of a wholesale barrel of gasoline, after subtracting their crude oil costs.
To do so, California Energy Commission staff must plow through the voluminous financial information that the law requires the oil companies to turn over. Staff then can propose that the commission pass a regulation or lay down an order that imposes a maximum amount oil companies can keep. Commissioners would need to approve it by a vote.
If the commissioners set that maximum gross refining margin for the industry — and a refiner exceeds that amount — the violation would automatically trigger a penalty. The legislation did not specify any range of fines, and the Energy Commission has not discussed any.
None of this will be easy, said Borenstein with the UC Berkeley business school.
“It’s really hard to figure out what are true costs and whether they are passing along actual costs or whether they are actually manipulating the market,” he said.
The Energy Commission will need to determine each company’s cost for oil and what it produces from it, Borenstein said — noting that the companies also make jet fuel, diesel and more.
There’s another caveat, too.
Before the California Energy Commission can set a maximum refiner profit level, it must first determine whether the likely benefits to consumers would outweigh potential costs. That includes deciding whether a maximum oil company margin would lead to higher pump prices or supply shortfalls.
Gas prices in California right now are at $4.61 per gallon, near the $4.88 cost when Newsom signed the bill in March, according to AAA. Golden State pump prices typically are lower in winter months because state environmental rules allow a less expensive formulation during that period.
Employing a ‘prosecutor’s mindset’ to the oil market
Tai Milder — a former prosecutor in the U.S. Department of Justice’s antitrust division — was tapped to lead the new gas price investigative unit. He said he would use that experience to monitor the fossil fuel industry for evidence of market manipulation or other crimes.
“A prosecutor follows the facts wherever they lead,” he said during a recent briefing with reporters. “A prosecutor is independent. A prosecutor promotes transparency and seeks accountability. That’s the prosecutor’s mindset that we will bring that will guide the new division.”
The new division ultimately will have a staff of about 10 people. It can act independently and does not need prior approval from the California Energy Commission before forwarding any suspected misdeeds to the California attorney general.
The California Attorney General’s Office referred questions on implementation of the new oil law to the California Energy Commission.
James Sweeney, a Stanford University professor of management science and engineering, said the investigators face a major challenge. Indicators of market manipulation can look very similar to allowable business practices responding to market forces, he said.
“If you look at the marketplace at times oil prices went up, it happened to be times where their inventories were low,” he said. “That’s exactly when you’d expect companies to hold back supplies and in order to protect their inventory. But that also pushes up prices.”
It’s a quandary, Sweeney added, because “how do you tell what’s in their minds and what calculations they were doing in order to make a decision as to how much to put out on the market?”
The oil industry meanwhile has warned that limiting how much money refineries can make could drive them out of the state, which could lead to less competition and higher gas prices.
California already is somewhat of an island in terms of fuel. State regulations require cleaner-burning gasoline and diesel. That means it can’t easily be shipped in when there’s a refinery outage or other problem, which often leads to gasoline price spikes.
Industry representatives also blamed a tight market for gas on what they called a backlog of drilling permit requests that California officials haven’t processed.
“So there is a direct impact to cost and price at the pump from not producing crude oil here in California,” Catherine Reheis-Boyd, president and CEO at the oil industry trade group Western States Petroleum Association, said at a recent CEC workshop on implementing the new law.
There are abundant supplies here, she said, but “we just can’t get permits from the state of California to produce it.”
Hawaii imposed then repealed price cap
Because the price gouging law is the first of its kind in the United States, there’s no exact example to follow.
One previous case of state action aimed at lowering gasoline prices came in Hawaii, where it lasted from September 2005 to May 2006.
The Aloha State law tied wholesale gasoline prices to how much gasoline sold for in the wholesale market in the U.S. Gulf Coast, New York Harbor and Los Angeles. The Hawaii Public Utilities Commission each week announced the maximum price for wholesale gasoline. Pump prices ultimately were set at the retail level.
Consumers quickly became dissatisfied with the law, however, when events in the rest of the United States drove up Hawaiian pump prices. In the weeks following Hurricane Katrina’s destruction of New Orleans in 2005, pump prices jumped even though Hawaii doesn’t get any fuel from the Gulf Coast region, experts said.
Oil refiners raised their prices then because the law allowed the linking of wholesale prices to the higher level in the U.S. Gulf Coast — and they wanted to build in a buffer for when they wouldn’t see as much profit, said Dave Hackett, board chair at Stillwater Associates. He’s a consultant who has sold his services to both oil companies and governments.
And because the Hawaii Public Utilities Commission announced maximum prices each week, it gave consumers a heads-up on when prices were going to go up. They then lined up to get gas — a behavior that sometimes triggered fuel shortages.
The price cap law was repealed in May 2006.
“Consumers weren’t feeling that it was really working,” said Jack Suyderhoud, professor emeritus at the University of Hawaii, Manoa, Shidler College of Business. “Price caps are always difficult to enforce and to implement, even with the best of intentions.”
Other industries face similar rules
California’s push to stop price gouging at the pump might be new, but the state has tried a similar approach with other industries.
Multiple California laws and regulations have set limits on how much profit a particular industry can make, said Dave Jones, director of the Climate Risk Initiative at UC Berkeley law school’s Center for Law, Energy and the Environment. He was state insurance commissioner from 2011 to 2018.
State ballot measure Proposition 103, which passed in 1988 in an effort to rein in insurance prices, allowed the state to regulate insurance companies in a new manner. It permits insurers to recover costs plus profit, he said.
“It allows for a profit, which generally comes in at about 6 or 7 percent,” he said. “It’s not set forth expressly, but the thrust of the regulations that were adopted enable the insurers to earn a return of about 6 or 7 percent.”
Similarly, he said, California Public Utilities Commission regulations essentially limit the profit of utilities.
Jones also warned that court challenges could drag out implementation of the price gouging law significantly. With Prop 103, he said, lawsuits lasted about five years. The U.S. Supreme Court ultimately declined to intervene, leaving in place a state Supreme Court decision.
How much profit is OK?
Efforts by the California Energy Commission to determine the average gross refining margin could become complex, said Hackett, the Stillwater Associates oil issue consultant.
“Each refiner has their own cost of crude [oil], and that’s going to be different from their competitors,” he said.
Deciding what wholesale price means also presents a challenge, Hackett added.
“Is it the price at the loading rack where gasoline gets put onto a truck” before it’s distributed to gas stations? he said. “Or is it the price of gas that’s delivered to a station? So there are any number of issues around the definitions.”
Setting the allowable industry margin too low might mean oil companies “would likely go out of business,” at least in the state, Hackett said. On the other hand, if the margin is set too high “then the whole thing would be … sort of irrelevant.”
It’s important, he said, “what benchmark are you gonna use to decide what the correct penalty margin should be.”
Jamie Court, president at Consumer Watchdog, said fast action is needed because recent oil refiner margins have been at notably high levels.
In early September, when California gasoline prices jumped to $5.70 per gallon, oil refiners made an average $1.49 per gallon in gross refining margins, new CEC data shows. That’s well more than double their 66-cent margins in January.
No margin as high as $1.49 has been reported publicly before, Court said.
“This data proves California oil refiners profited wildly from California gasoline price spikes in September and is precisely why California needs to implement a strong price gouging penalty as soon as possible,” he said in a statement.
This story also appears in Energywire.
