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Adam Smith is dead! Will moving his body help secure absent competition in fuel markets?

Former Gov. Richard Lamm of Colorado and I once led a group of CEOs on a trip to London. It was focused on what Colorado could learn from the British healthcare system. During the trip we visited St. Elizabeth Hospital. There in the lobby was a stuffed, mummified body of Sir Jeremy Bentham, so I took a picture with him. He was not very talkative.

But the resulting photograph brings back memories, perhaps apropos to the oil industry. Seeing Bentham looking so well and remembering how much he meant to my life — both the pain and joy — I propose we bring back Adam Smith, and place him in the lobbies of the big oil companies. Why? Easy: they seem to have forgotten about the value of free markets, competition and capitalism. A little dose of recall and guilt every morning when they go to work and when they leave their offices every evening wouldn’t hurt. Over time, maybe there would be substance behind their luncheon or dinner speeches concerning free markets and capitalism. Maybe they would remember Smith’s warning that, “People of the same trade [in this case, the oil industry] seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Right on, Adam! You are not my favorite economist or ethicist, but your quotation appears to fit the behavior of the oil industry. Sen. Dianne Feinstein, during California’s increase in gas prices a couple of years ago, suggested that oil companies and investors might have tried to set prices and blur their actions by casting blame on the refinery fires for gas price spikes. Her view was that market variations alone did not explain the high prices consumers were paying at the pump. Her comments implied some sort of collusion or manipulation.

E85 and E10 PricesThe general behavior of the big five oil companies concerning competition from E85 lends credence to Feinstein’s suspicions. Listen, my reader, and you shall hear some examples of big oil’s apparent, sometimes seemingly coordinated, efforts to restrict the growth of E85 sales here (sorry, Longfellow), even though E85, at the time, posed no real immediate competitive threat to overall gasoline sales. Of the just over 150,000 retail fuel or gas stations in the nation, only 2.5 percent offer E85 and less than one half of one percent of the major brands provide E85 under their branded canopy. How nice of them! Read a franchise agreement from Exxon or Texaco, and see if you can find a provision for an E85 pump…maybe there are words suggesting a location in the back of the station, near the men’s or ladies’ room or in front of the station, clearly off center and not under the canopy.

Look hard at the language and the decisions of nationally branded retail stations. Franchisees are generally limited as to price, fuels, location of pumps and marketing strategies. Maybe these restrictions are legal and from a monetary and profit point of view, understandable. But from a consumer perspective, they limit choice and often frustrate competition.

Some have charged oil companies with price fixing or collaboration in setting prices (a nicer way to say fixing). “No, not in America,” you say? Adam Smith would turn over in his grave! According to a report by AJW company in 2014, “Since RIN prices began to rise in 2013, the nationwide average discount for E85 vs. E10 at independent stations has been 14 percent or greater for all but one month. During the same period, the nationwide average discount for E85 at major branded stations reached 14percent only once. This discount is only a price comparison and does not factor in relative energy content of the fuels. As long as there is limited availability and unattractive pricing at major branded stations, low E85 demand likely will persist among consumers using those stations.”

Generally, I am not a fan of special-interest group research or funded research. I prefer to rely on, at least, relatively independent think tanks, universities and scholars. Yet, recently gifts of money for research blurs the line between the interest of funders and the integrity of the word independent. Caveat emptor!

A 2014 case study by the Renewable Fuels Association (RFA), an advocacy group funded, in part, by self-interested donors, tracked the per gallon fuel costs of all nine retail stations selling E85 in St. Louis during the summer of 2014. Each station had the brand names of one of the five largest oil companies.

The data indicated that there is some support for the notion that gasoline producers/suppliers and their franchised retailers in at least St. Louis purposely employed pricing strategies to discourage E85 consumption. They, apparently, wanted to negatively influence the consumer perceptions about the fuel.

Oil companies appeared to control key price behavior at the nine stations and, to some extent, worked together to set prices, either formally or informally. RFA argues that it’s hard to believe that the price similarities at stations in St. Louis happened by chance. For example, the average E10 retail prices were $3.45 dollars per gallon while the average E85 retail price was $3.47 dollars per gallon. Wholesale prices of E85 were an average of $2.58 per gallon, while E10 averaged $2.93 per gallon. “Based on prices for locally available ethanol, hydrocarbon blend stock, RFS RIN credits and a typical markup, E85 could have been offered at retail for $2.44-2.55 dollars per gallon.” There probably are many reasons why average E85 prices were more expensive than E10 and almost one dollar larger than their wholesale price….like someone from outer space tampered with the pumps or consumer demand for E85 overwhelmed supply and the stations responding to market pressures raised the E85 price to mute interest from buyers. Neither, of course, was true!

Oil companies and their retailers appeared to set the price of ethanol to steer E85 and fuel-agnostic buyers to gasoline. They also wanted to keep the loyalty of gasoline buyers. The similarity of prices could have occurred by chance. Sometimes, I wear a blue shirt in the morning and so does my colleague. We never discussed what we would wear. But our color schemes are coordinated. What the study doesn’t answer is why other St. Louis stations, independent from national brands, did not see an opportunity to come in below the prices of majors and sell E85. Personally, I would have liked the analysis better if other cities were included as cases for comparison and if the time period went beyond the summer. But it was an interesting provocative report and you can’t have everything.

Anecdotes and studies based on the relatively recent California methanol fuel experience and Colorado’s effort to build E85 sales seem to support the RFA study. They suggest that the fear of competition from alternative fuels among oil companies and or retailors led to, at best, begrudging support for both methanol and ethanol. They often located pumps (if they agreed to have them at all) in unfavorable positions in their or their franchisee’s retail stations. Marketing strategies were marginal at best, and non-existent at worst. Stories from some astute observers suggest that relatively high methanol and E85 prices were put in place to detour customers to gasoline. Among other factors leading to problems with each state’s initiatives, there was a lack of sustained interest by major oil companies in building and sustaining sales of both alternative fuels with competitive pricing.

Maybe things will change. The present downturn in oil and gasoline prices has led some oil company leaders to think more charitably about alternative fuels —natural gas, ethanol, methanol, biofuels — particularly in light of the development of more flex-fuel cars coming from Detroit, and from consumers who convert their older cars to be flex-fuel vehicles. They have begun to view alternative fuels more favorably as part of their future business and strategic plans. If they go further, they will have to face questions, which include: whether they integrate gasoline and alternative fuels under one organization and canopy or separate both, perhaps, as different brands. Real competition, probably, will require Congress to consider some variations on a theme of open fuels legislation. Success in building competition at the pump would make Adam Smith happy, were he alive, and be good for the environment, the economy and consumers.

Matching ethics and policy: Free markets, subsidies and fuel

There is probably a reason that ethicists rarely sit at the public policy table with respect to transportation fuel. Let’s think about it for a few minutes in the context of a diverse group of econo-ethicists. Let’s match the ethics of presently monopolistic gasoline markets, the huge oil subsidies granted to oil companies and, yes (for environmental folks), the gift of HOV lanes and tax subsidies for those with the “right” cars, with:

  • John Rawls’ ethical guideline that we should respond to the least among us as we would want to be responded to ourselves,
  • Jeremy Bentham’s ground rule that we should seek the greatest good for the greatest number),
  • Karl Hayek’s admonition that the least government is, generally, the best government,
  • Michael Douglas’ statement in “Wall Street” that “greed is good.”

Currently, oil company policy and behavior with respect to gas stations they own, franchise or influence is very restrictive. Even when they allow alternative fuels to be sold in gas stations, companies play the role of Cinderella’s ugly stepmother. Alternative fuel pumps, often, are placed apart from the gas pumps, sometimes out of sight. If they were human, the alternative fuel pumps, legitimately, would have a discrimination case, need psychiatrists and would probably cry a lot because of loneliness. Lacking choices, consumers must pay an extra tariff for gasoline. Prices for gas reflecting little or no competition are arbitrarily high.

Congress supports the oil monopoly at the pump. It has failed to allow methanol as a transportation fuel and has not passed open fuels legislation.

Certainly, an ethical judgment of the current fuel market and those who establish its limited boundaries should be easy to make. You would get an “A” from both Rawls and Bentham as well as from Hayek if you said, “It is rough on the poor who pay upwards of 15-17% of their income for gasoline and it forces extra costs for all of us at the pump.” Finally, it illustrates Hayek’s warning that too much government restrictions limit freedom. Gosh, who ever thought I would agree with Hayek, even in a limited way? Perhaps, however, Mike Douglas wins this one. Greed has been good for the oil companies.

Douglas also wins big on tax subsidies to oil companies. Yet, despite diverse ethical principles, everyone scores well on the granting of tax subsidies to the oil industry. Both liberal and conservative groups, as well as the Congressional Research Service (CRS) agree that many of the tax subsidies are not needed to secure production and distribution. Why, then, does the industry benefit from such beneficence? History granted them favored status; politics and money give them influence at budget-making time.

I was in favor of (and probably deep down still tilt toward) HOV lanes. But, I do have some real doubts about tax subsidies, particularly subsidies not tied to income.

I am worried about the ethics of both. Most of the benefits of HOV lanes and tax subsidies to secure buyers of cars that use them go to relatively affluent income folks. Both are paid for by general taxpayers, including income-deprived tax payers.

Further, most low and moderate-income households face severe budget constraints if they try to buy new so called clean vehicles that are now allowed in the HOV lanes and secure tax benefits. No preference is granted to other alternative fuels like ethanol, and the federal government does not readily allow the relatively inexpensive conversion of existing cars to alternative fuels — methanol, ethanol. States generally do not permit the small number of converted cars in HOV lanes. Lastly, in terms of debits, HOV lanes do increase congestion, when they are not utilized to the fullest, increasing driving costs for every one of us who are not so lucky to own the “right” vehicles.

So HOV lanes and tax subsidies for favored cars do raise ethical questions. They don’t treat the least among us fairly, they are not good yet for the greatest number of us, and they reflect government behavior that reflects a bit of shooting from the hip before tough analysis concerning efficiency, and effectiveness. Let me see, Rawls, Bentham and Hayek would at least be sensitive to the involved ethical issues.

Alright, are you happy, indifferent or sad that ethicists are not at the policy table? Let me know.