Ungouging
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I'll try to make this as clear as possible: The thousands of links generated by search engines are irrelevant to me. I don't care whether there are anti-gouging laws or not because politicians and regulators have their own agenda. I care about two things in this discussion:
1) Can anyone define "price gouging" in such a (scientific) way that we can distinguish it from normal, everyday "price raising"?
The laws cited use arbitrary values of 10%, 25%, and 30 days without explaining why 10.1% is gouging and 9.9% is not, or why the average 30 days ago is applicable in an industry renowned for its seasonal nature rather than 365 days, or why only booked costs are considered at the exclusion of demand, opportunity, and future costs.
2) Can anyone defend the use of the pejorative phrase, "price gouging", showing that the distinct phenomenon described in (1) is always and everywhere harmful and therefore deserving of a morally charged name?
After reading through the posts you cited on Calculated Risk, I think you share a belief with Bill O'Reilly: that there is a True Price which can be calculated according to the simple formula
True Price = (cost of inputs) + (fair markup)
This would explain your attention to the prices of the mixed fluid in the tank and whether you need to look at the books to determine whether price gouging has occurred. This simple formula is intuitively appealing, but was abandoned by economic science with the "marginal revolution" of the late 19th century when they discovered that explaining prices requires the incorporation of the consumer utility (demand). Alfred Marshall [summarized it] eloquently:
"We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens."
So I might rewrite the formula above (at the risk of being chastised by Prof. Hamilton for simplifying that which ought not be simplified in this way) with a function f() to account for demand, and expand Marshall's explanation to include risk (of running out, of losing market share, of losing money) and other things not accounted for (X):
Price = (cost of inputs) + (fair markup) + f(Quantity Demanded, risk, X)
The problem with this is that the quantity demanded is itself a function of price, and we end up with a transcendental equation that must be solved by iteration because - as my e-mag professor taught me - "by iteration" sounds better than "guessing" in peer-reviewed journals. However, guessing is exactly what gas station operators must do until the public starts publishing their marginal utility functions.
How might this occur in practice?
One morning, the station operator gets a call from his supplier, telling him that they lost power to the refinery and won't be able to make his delivery this week. That's a problem, because at the rate he is selling, the tank will be empty by the Tuesday and most of his business comes on Friday and Saturday. So he calls a jobber who has been trying to win his business and asks if he can deliver. "No," comes the answer, "but if you had called an hour earlier I might have. Storm affected everybody. Maybe I can scare some up and call you back." Mild panic begins to set in because he uses gas as a loss leader to keep a steady stream of people coming through the door to buy 5 cents worth of soda for $1.49, so he calls a less-hospitable refiner and asks him. "Sure," he says, "but it's going to cost you and we can't deliver until Thursday." So our manager agrees to half a tank to buy himself some time, and then gets a call from the jobber who informs him that they convinced a refiner in California to ramp up production and send some this direction by the weekend. In other words, they are bidding on a scarce commodity that has just gotten scarcer.
But he still won't get a tanker in till Thursday, and he calculates that he'll run out on Tuesday. When he runs out, he still has a payroll, rent, utility bills, and loans to pay back, and people aren't going to come by just for the soda, so he needs to make sure he keeps some in the tank. He has a couple of options: shorten his hours, shut a few pumps down, or raise prices. You can see three other stations from his property, so shortening the hours and shutting pumps down to create an artificial shortage is only going to lose market share and do nothing to address his fixed costs, so he thinks about raising prices.
This is a risky game, but because of the shortage, his options are limited. If he doesn't raise prices, he is going to run out, and he is going to run out faster if his competitors raise their prices while he stands pat, so both of those scenarios say raise. If he raises prices, and they don't, he won't sell anything: bad. If he raises prices, and they follow, he'll be okay. Three of the four combinations say "raise", the other says "stand pat." Fortunately for him, at least one other competitor if not all of them is facing the same calculus, so once one raises, everyone will follow. Odds are they raise.
(A similar problem follows for whether he shifts the relative prices of the high-test and low-test: consumers will shift to the lowest cost fuel (relative) and run it out faster.)
But now that he has decided *to* raise prices, it still isn't clear by *how much*. He needs to cut demand 20%, a competitor needs to cut demand 40%, another needs to cut 10%. On the whole, we know that the regional capacity was down about 15-30%, but that's only clear in hindsight, and that's only an average (it probably varied from one firm to another between 0% and 100%). At the time, the prediction was 30%, so on average everyone in the region needed their demand to go down that much. We have been repeatedly reminded by the Peak Oil pessimists that gasoline demand is inelastic, but we know it's not *perfectly* inelastic, so we know that prices need to rise by more than the demand fall we desire (percentage-wise). How much? One might use a rule of thumb of 2x the desired demand drop (60%), another might try starting at 20%, take stock of the effect on demand and the actions of his competitors, and then change again. That is what solving by iteration means, and Figure 4 on this page shows how complex this is as the jobbers, refiners, futures markets, and spot markets are all seeking a balance at the same time as our protagonist. There is no "correct" or "true" price; supply and demand can move independently of one-another and are coordinated by means of changing the prices at the raw, refined, and retail levels.
BTW, we know that the average needed to have been 30% by the reports available at the time. Gasoline demand is inelastic, so we know before we've started that we will exceed the 25% test used in some jurisdictions, and we've just flat blown through the 10% used in others. Using the 60% mark, and having a retail price of about $2.40 prior to the storm, we find that prices should have gone to about $3.84. That's a remarkably close estimate, and we should applaud the guy who checks and adjusts 6 times rather than the guy who went straight to $4 because he was taking the most interactive path and his *average* price was lower as a result. If everyone used this rather than the direct approach, the chances of overshooting the equilibrium level will be lower. Yet these guys are made out to be the villains.
This storytelling exercise is interesting only in illustrating the heuristics they may be using, but science by story-telling is fraught with danger and I invite courteous criticism. Still, at this point, the only thing I have found that distinguishes this type of price rise from a "normal" price rise is (A) the cut in useful capacity (which shows up as a decrease in *used* capacity in the EIA figures), (B) the bidding that ensues for the remaining capacity and for stored supplies, and (C) redirecting the output of other refineries into this market. That's exactly what you can see from the EIA data, the increases in the spot and futures markets, the increase in imports, and the subsequent rise in prices in CA due to gasoline being shipped east (arbitrage). It isn't surprising that there is a delay in the import data; it takes time to ship it in. And it isn't surprising that costs would go up when you get gas from different refiners than normal: if they were the low-cost refiners, wouldn't they already be the source? If not, then it probably costs more to bring oil from them into a new market. I don't see "gouging" there, I see "raising prices to balance supply and demand", same as they do every day. But let's go further.
Let's say that one of our protagonist's competitors is a vertically integrated major. They may have a lower cost both before and during the crisis; before because of economies of scale, and during because they can internally redirect unaffected refinery capacity to make up for lost capacity. Before the crisis, they are content to let the independents be the price leaders because the majors make money from gas, not sodas. During, they are still willing to sit back and let the independents drive the prices and take their extra profit. Is that gouging? After all, they aren't facing the availability problems as the independents, and they are the low cost suppliers. Perhaps. Is that bad? I don't think so. After all, they are the low cost suppliers. They make more money because they are more efficient. If they didn't exist, the independents would be happy to raise their prices and make their money off gas instead of soda, but then the independents would probably integrate and we'd be right where we are. They aren't acting as price leaders, they're acting as price followers. If they keep their prices low out of the goodness of their hearts, and thereby drive the independents out, they risk prosecution for "predatory pricing". If they try to match them exactly, they risk prosecution for collusion.
But let's look at the system operating under threat of prosecution for gouging alone. The independents are loathe to raise prices because they don't have the legal or accounting infrastructure to defend themselves. So I'll make five testable predictions for communities with two characteristics: (a) a credible threat of prosecution *and* (b) frequent crises (Florida comes to mind as meeting both, as does Houston during the intra-storm period):
1) More cases are brought against majors, but a larger percentage of cases are won against or ceded by independents
2) There are more attempts to use non-price demand adjustments, especially by independents (because of the threat of prosecution and the cost of having to defend against the charge, even if not true)
3) Vertically integrated companies are more dominant (because they have corporate counsels, they can adjust their accounting over a longer period to absorb higher crisis costs, and they have access to more supply through a crisis)
4) Regular prices are higher prior to crises and the price rises are lower through the crisis (because there are fewer independents using the fuel as a loss leader and/or trying to win market share, and the majors have more options for bringing fuel in during the crisis period)
5) Vertically integrated companies are major donors to AGs and politicians who make threats against "price gougers"
We actually saw evidence of this in Houston, where the AG made threats between Katrina and Rita. In one story in the WSJ (25 Sep 05) , there was a description of a station that had shut down pumps (they forced him to re-open them), and others of people waiting in line for tanker trucks to show up.
"I've had people making U-turns and getting behind me," he said, beginning to unload his cargo at the Exxon station near Beltway 8. The station was selling gas at $2.65 a gallon, its pre-Rita price. Drivers were clogging the pumps as a line of 25 cars snaked into the station. As one driver plowed over an orange safety cone, Mr. Gonzalez yelled to the driver who merely shrugged before pulling away. "It's unbelievable; they think this is the end of the world," Mr. Gonzalez said.
Furthermore, when the oil prices collapsed in the late 90s, then-Energy Secretary Richardson floated an idea to provide relief to domestic oil producers. Now-Governor Richardson just sent out an energy-relief check to his constituents. When Jeffords defected and Jeff Bingaman (D-NM) took over as Energy Committee chair, they floated the idea of a "counter-cyclical tax credit" which would operate between $11 and $14/bbl. At the time, he was third on the OpenSecrets.org list of Senators receiving money from Oil & Gas companies with $136k. In 2002, Pete Domenici was #5 with $164k on the Oil & Gas donation list at Opensecrets.org. Current Texas Senator and former anti-gouging Attorney General (the a-g AG?) John Cornyn was #1 with over $500k. John Kerry was #1 in the Senate in 2004 with $305k. W gathered in about $2,627k. I predict passage and signage of an anti-gouging law, followed by consolidation within the industry and generally higher prices.
-----------------------------Since then, we find that New Jersey has achieved awards against Sunoco and Hess, with suits pending "against 10 of 18 independents." A suit against Shell is also pending, and BP settled before a suit was filed. If everyone is raising prices, how the hell can anyone be raising above the average? Specifically, "investigators found more than 100 violations at 400 gas stations, including stations illegally raising prices more than once every 24 hours, charging more than the posted prices and failing to maintain proper records, the state said in suing Sunoco, Amerada Hess, Motiva Shell and several independent gas station operators."
1) Collecting this data is notoriously difficult. In my next post, I'm going to talk about a research idea I have (for any grad student that wants to tackle it, not me), and found out that one researcher had his wife collect the pricing data. Another researcher used Gastips.com. So how did the State of New Jersey find time to collect data on 400 stations? Is this really the best use of their time?
2) Should it be illegal to raise prices more than once every 24 hours? Better keep these guys clear of the New York Stock Exchange.
3) Charging more than the posted price seems to me to be fraud - why let them off with a plea and a fine? I smell "legal technicality" that wouldn't hold up under appeal.
4) "Failing to maintain proper records" - any guess as to what this is? My guess is that the state defines gouging as "changing the price when they have not received new deliveries," and so when people don't keep detailed records of each delivery, they get nailed for that, too. Or, they required the gas stations to keep their own pricing records so that they provide the rope with which to hang themselves. Ever read the 5th Amendment? It says, "No person ... shall be compelled in any criminal case to be a witness against himself."
Oh well, all's fair in love and populist pandering.
Labels: energy
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