Mobile Edition
Print
Get the Mag
Weekly Updates1. INTRODUCTION
In 1992, the California Air Resources Board (CARB) implemented Phase II of its reformulated gasoline regulations. These regulations were aimed at reducing emissions from gasoline fueled vehicles and were expected to substantially increase costs for both large and small refiners in the state. Because of this cost increase, the Western States Petroleum Association (WSPA) opposed Phase II. Additionally, the California Air Resources Board voiced concern over the ability of small refiners to remain in the market under what appeared to be a disproportionate burden resulting from compliance to Phase II. (1) ARCO Products Company, on the other hand, provided strong support for Phase II, as well as the original, more stringent set of regulations proposed. (2) This support for the Phase II CARB gasoline regulations has previously been thought of as a strategic action by ARCO to raise rivals' costs. (3)
This paper aims to empirically analyze the market changes resulting from Phase II by examining the impact that these regulations had on the wholesale price of finished gasoline in California, as compared with several Petroleum Administration for Defense Districts (PADD's) throughout the country, as well as trends in industry concentration and market share.
While a few recent studies have focused on the impact of environmental regulations on wholesale fuel markets, (4) this study focuses specifically on the impact of gasoline content regulation on California's wholesale gasoline market. This focus is important for two reasons.
First, California has historically been much more stringent regarding environmental regulations than other states in the United States and, indeed, the Phase II CARB reformulated gasoline regulations exceeded federal reformulated gasoline regulations amounting to what the WSPA referred to as "the most costly regulation ever considered for the refinery industry." (5)
Second, the possible use of the Phase II reformulated gasoline regulations as a raising rivals' costs measure by ARCO raises some questions as to whether these regulations produced significant changes in California's refining market, as would be consistent with a raising rivals' costs strategy. (6) This is important because, while other studies have examined the price difference between conventional and reformulated wholesale gasoline prices, this study is able to consider the general heightening of wholesale gasoline prices in California that may have occurred, regardless of formulation, as certain segments of the refining market were disproportionately burdened by Phase II. (7)
The analysis finds that large refiner compliance to Phase II increased the rack price of finished gasoline in California, as compared with other regions, in a manner consistent with the literature. This may suggest that increased production costs associated with Phase II placed upward pressure on relative wholesale gasoline prices. However, as small refiners were required to comply with these regulations, this paper finds that the wholesale premium paid for finished gasoline in California increased, again, in a statistically significant manner. This combined increase exceeds the estimated increase in the average variable cost associated with Phase II (8) which may suggest increased profitability to surviving firms. (9) Additionally, because the impact of Phase II on wholesale gasoline prices in California exceeds that which has been found in earlier studies, this result suggests that the combination of adjustments in market structure and increased costs of production related to Phase II were more costly to consumers than previously thought. Finally, along with trends in industry concentration, this result suggests that Phase II may have disproportionately disadvantaged California's small refiners in a manner consistent with raising rivals' costs.
2. BACKGROUND
2.1 Literature Review
Pashigian (1984) first offered insight regarding the impact that environmental regulations can have on industry by empirically measuring the significant benefits environmental regulations have bestowed upon a select group of industry members in the past. The author not only provides an empirical examination of the effect that environmental regulations have on plant size and market structure but, in doing so, provides a deeper understanding of the effectiveness of environmental regulations, as compared with Occupational Safety and Health Administration (OSHA) regulations, in causing a shift in market shares to larger firms within an industry, thus providing incentive for larger firms to support these regulations.
Pashigian's analysis reveals that the environmental regulations enacted between 1972 and 1977 resulted in a market structure change which included a shift toward fewer plants in the industry. In addition, those plants able to weather the cost increases associated with such regulations tended to be large (or had the capacity to increase in size for survival's sake) and tended to experience an increase in capital intensity in an already relatively capital intensive environment. (10)
Several recent studies consider the impact that environmental regulations can have on prices in the petroleum industry. Taylor and Fischer (2003), for example, explore the make-up of the differential in finished gasoline retail prices between California and the Gulf Coast. The authors identify several factors contributing to the price differential including California's reformulated gasoline regulations.
Muehlegger (2006) examines the impact that gasoline content regulation has had on gasoline prices throughout various regions of the United States. Among other results, the author finds that California's gasoline content regulations increased the wholesale price of gasoline by 4.8 cpg as a result of both increased production costs and product heterogeneity across regions.
Brown, et al. (2008) use a city-level analysis to estimate the impact of gasoline content regulation on the wholesale price of gasoline. Through a differences-in-differences approach, the authors find that the implementation of gasoline content regulation increased the wholesale price of gasoline. The authors also find that a reduction in the number of suppliers positively impacts the wholesale price of gasoline.
The purpose of this paper is to build on these previous studies by analyzing not only the production cost driven price increases resulting from the implementation of gasoline content regulations, but also the price impacts that occur when a portion of the industry carries a relatively larger burden of compliance than their competitors.
2.2 Technical Review
The purpose of the Phase II reformulated gasoline regulations, which were a follow up to the 1991 "Phase I Reformulated Gasoline" regulations, was to "establish a comprehensive set of gasoline specifications designed to achieve maximum reductions in emissions of volatile organic compounds ("VOCs"), oxides of nitrogen ("NOx"), carbon monoxide, sulfur dioxide and toxic air pollutants from gasoline-fueled vehicles." (11)
As a result of several disadvantages the Phase II CARB Gasoline Regulations were expected to impose upon the smaller refiners within California's petroleum industry, modifications were made to the original regulation to provide relief to small refiners such that they would eventually be able to come into compliance with the new regulations. Without such relief, the California Air Resources Board believed that, "... the Phase 2 RFG regulations may cause some small refiners to go out of business" and that "Elimination of the small refiner segment of the California refining industry would result in job losses and could have significant anti-competitive effects because small refiners contribute to competition in the petroleum industry." (12) The relief afforded the small refiners came in the form of an extension of the compliance deadline, from March 1996 to March 1998, which would apply to roughly half of the required specifications.
In terms of the costs ultimately imposed upon California's refining industry as a result of Phase II, Lidderdale and Bohn (1999) estimate that, during the period of January 1997 to December 1998, the wholesale price of CARB gasoline in Los Angeles was 4.2 cpg higher than that of conventional gasoline in the same city. (13) Much like Muehlegger (2006), Taylor and Fischer (2003) consider this price difference to be driven by increased production costs and use it as an estimate of the increased average variable cost associated with producing CARB reformulated gasoline. In addition to an increase in the average variable cost of production, Phase II compliance also required many capital improvements which resulted in over three billion dollars of capital expenditures for refiners throughout the state. (14)
3. MARKET OUTCOMES
3.1 Price
In a simple analysis of gasoline rack prices in California, it may not be obvious whether the peaks and valleys in the data represent a significant, sustained increase in price as the result of any one regulation. This is because, due to the driving force that many national shocks have on local markets, it is not possible to isolate the effect that any one local shock may have without controlling for movements in gasoline rack prices in other parts of the country. Because of this, it is the price differential (or the relative rack price of gasoline in California as compared with that in other parts of the country), that holds the key to determining the true effect that the Phase II CARB gasoline regulations have had on the gasoline market. (15) This price differential reveals the average premium paid for wholesale finished gasoline in California stemming from local shocks in the refining industry.
FEED