There is a rather basic but key economic principle which states that free markets are crucial to efficiently running economies. Free markets facilitate the allocation of capital and resources through unfettered interaction of supply and demand. Free markets encourage competition and are the foundation of market-based pricing. Free markets are also crucial to investment, consumer choice, and innovation. They work in concert to drive and sustain productivity and vital economic growth.
So why is it that free market principles are not being followed in California? Let’s start with the assumption that most California policymakers have taken at least an introductory economics course and should have a fairly good grasp of the free market concept. Yet, given that assumption, their concerns with the high motor fuel prices led them to pass the California Gas Price Gouging and Transparency Law (SB X1-2), which became effective in June 2023.
As written, the law authorizes the California Energy Commission (CEC) to create a margin cap penalty that is designed to control the level of refinery profits, and consequently the level of retail fuel prices. However, this legislation defies free market principles and implementing the margin cap would have just the opposite effect. Expect even higher retail prices due to reduced incentives for refinery investment and the impact of operating uncertainty resulting in less supply and more expensive fuels.
California is clearly seen as a leader in advancing policies and legislation designed to help achieve climate goals and net-zero carbon objectives. These are laudable objectives which have been implemented to help the state achieve its environmental and public health goals, and as a result Californians do pay higher prices for fuels relative to the rest of the country.
At this writing, the average retail price of regular grade gasoline in California is about $1.50 a gallon higher than the national average. Those retail fuel prices reflect the interaction of higher state fuel excise taxes which will reach almost 60 cents per gallon on July 1, versus a national average of about 28 cents. In addition to excise taxes, California imposes a sales tax on gasoline and diesel fuels, which varies depending on the regional price of fuel, but averages about 10 cents per gallon.
Additionally, logistical challenges related to the refining and supply of fuel formulations that are unique to California, a Cap-and-Trade program requiring fuel suppliers to purchase allowances for carbon emissions, a low carbon fuel standard mandating annual reductions in the carbon intensity of gasoline and diesel fuels, and more expensive and required summer fuel blends, all further contribute to the higher retail prices.
Returning to our economics primer, any price cap proposed by the CEC, while designed to stabilize markets and protect consumers by aiming to make fuels more affordable, can lead to unintended and very adverse consequences. One of the most significant dangers is the real possibility that the CEC action inadvertently creates fuel supply shortages by capping refinery margin and thus holding prices below the free market equilibrium levels where fuel demand outstrips supplies.
Understanding that more than two-thirds of California refineries have closed in recent years due to restrictive regulations, suggests the remaining nine refineries have no room for any interference with fuel production. Further compounding the concerns is the fact that there are no plans to build new refineries, add refining capacity or import infrastructure, or bring scalable fuel alternatives to California in the near future. In fact, there might well be fewer refineries and refining capacity due to less investment, if the CEC rulemaking progresses.
The ability of the remaining California refiners to continue to operate in a free market, to evaluate and balance fuel supply and demand without the added and absolutely unnecessary uncertainty that a CEC margin cap would entail, is crucial. The relatively isolated nature of the west coast fuel market and the regional demand for California sourced fuels further compounds the potential for supply shortfalls. It is well to remember that both Nevada and Arizona will also continue to depend on fuel supplies from the California refiners.
Now is the time to seriously evaluate the pros and cons of the SB X1-2 legislation. Punishing the remaining California refiners as they work to provide the fuels that are critical to lives and livelihoods and economic vitality, requires a recognition of the unintended and severe consequences which are likely to unfold. In short, effective energy policy must aim to balance affordability and reliability of fuel supply with demand. Ensuring application of free market principles will fuel successful outcomes.
Mike Roman is Senior Fellow at the American Council for Capital Formation and is the President of CertainPoint Strategies L.L.C.
