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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.

Does the man doth protest too much? The impact of attacks on coal by oil and gas

BHP-Billiton-Middelburg-1Did you read about Andrew Mackenzie, CEO of BHP Billiton, and his plea to his colleagues in the oil and gas industry? He asked them to stop publicly asserting that natural gas and oil produce fewer carbon emissions than coal. Interpreting, liberally: You guys (a euphemism for men and women) are hurting BHP and its mining and resource development businesses, as well as the entire sector.

Mackenzie said it nicely. He suggested that they lay off the criticism. Because we live in a peaceful, collaborative, problem-solving era (you’re supposed to laugh at this point), his solution, sort of Isaiah-like, was, “Come, let us now reason together.” On behalf of BHP, a conglomerate and the biggest mining company (dollar capitalization) in the world — a company that also has big stakes in oil and gas — Mackenzie asked that fossil fuel companies break bread together and find mutually beneficial solutions to the carbon problem — assumedly consistent with their respective bottom lines. Put another more interpretive way, why should his colleagues in the industry undercut each other by demeaning each other’s products? Paraphrasing a common phrase today, Mackenzie seems to believe that we are all BHP; we are all Exxon; and we are all Texaco. We all have carbon issues and face government emission regulations.

Mackenzie called for the industry to develop carbon capture and storage solutions. His proposals can be construed as relatively company-friendly in that they start off seemingly focused on protecting the diverse resource production menu of each company, particularly, but not only, coal. They also may help each company avoid (at least initially) caps, taxes and fixed emission or production targets.

We shouldn’t be cynical. Carbon capture and storage have been, and continue to be, supported by some respected environmentalists and scientists. Both are endorsed in their many papers, speeches and media.

By his proposal, Mackenzie suggests that the resource-development industry is stronger when the companies that are in it work together. Accordingly, they should not be at each other’s throats and denigrate products of their competitors. We should have peace rather than war! The calls from oil and gas companies to switch from coal to gas, as a strategy to reduce GHG emissions, Mackenzie indicates, is a “very western, rich country solution.” People in many developing countries have easier access to coal than gas. To get out of poverty, they will need to “burn coal cleanly.” He said: “I think there is a marketing ploy, which is ‘give up coal and burn more gas.’ ” Very insightful! Wow! When did he discover this?

The transition to natural gas from coal among utilities has led to a visible reduction of GHG emissions. Natural-gas-based ethanol promises the same kind of reduction in transportation. Don’t knock competition or abort it unless his desired industry collaboration can result in something better and cheaper!

Whether Mackenzie’s thoughts generate from the public interest or the bottom line, from expiation of guilt or inner wisdom, it doesn’t really matter. The industry, as a whole, has been laggard in coming up with and carrying out proposals concerning GHG or criteria pollutants. Maybe we need an Australian-based firm to energize it to ultimately play or pay! But maybe not!

Mackenzie said: “I still accept the drift from coal to gas is a good thing, but these things happen gradually. We need the power of the whole oil and gas industry and the whole mining industry, together aligned on this agenda to move the needle.” What needle, and where is it being moved? Doing good while making money? Perhaps. But his language doesn’t quite go that far. Sounds more like making money by doing as much good as we have to do. From a business standpoint, both are consistent with the view of those that the business of business is business.

It’s hard to know, from a policy perspective, exactly what to do with Mackenzie’s industry-wide collaboration idea or his proposals. It’s not a case of like them or leave them. But caveat emptor!

Sequestration, the fancy name for what he opines as a solution to GHG emissions, is expensive, uses lots of energy, takes a lot of time to initiate, and is unsafe in some areas, depending on geology. Contrary to his words, it may not be relevant to poor nations or poor areas. Yet, on the other hand, it’s worthy of consideration by both the public and private sector because its strategic use can reduce emissions. We need to weigh relative benefits and costs of emissions-reduction strategies. Further, and most important, if public funds are sought, the opportunity costing analyses must be transparent and convincing before moving toward scale-up possibilities.

Elimination of competition within the industry could end up muting the value of alternative fuels and alternate power sources. It could be very costly to the public. Most experts indicate there is no such thing as “clean” coal. There is cleaner coal, but it’s still dirty, and oil remains a major GHG emitter and criteria pollutant. Reliance on both coal and oil, when we have access to cleaner alcohol-based transitional fuels for power, industrial plants and transportation is problematic, at best, and bad policy concerning GHG and other pollutants, at worst.

Lots of questions: Is Mackenzie an enlightened business leader or a leader mainly interested in preserving the value of his coal reserves? Is sequestration in its various forms a viable option that would allow the use of coal, and other portfolio resources, without major GHG impacts? Are there better alternatives? Since market segmentation is external and will likely result in increased sensitivity by CEOs to criticism concerning the public harm caused by multiple energy related products, will collaboration among them generate controlled energy markets and ultimately minimize efforts to reduce GHG emissions and provide a cleaner, healthier environment? Remember that the industry, particularly the companies in it that produce lots of oil, has been and remains against open fuel markets and increasing the number of flex-fuel vehicles. There are no easy answers.

Mark Twain, a great oil and gas man, once said, “It takes your enemy and your friend, working together, to hurt you to the heart: the one to slander you and the other to get the news to you.” Finally, borrowing and amending Shakespeare, maybe Mackenzie doth protest too much!

Photo Credit: africagreenmedia.co.za