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Refiners Maintain a Firm but Legal Grip on Supplies

Clean-gas mandates thinned the competition a decade ago. Companies that stayed 'take advantage of the crazy rules' and enjoy huge profits.

June 18, 2005|Elizabeth Douglass and Gary Cohn | Times Staff Writers

The motor homes showed up before dawn. Soon, hundreds of cars, trucks and sport utility vehicles joined the line, drawn by radio promotions for a new service station willing to sell gasoline for 90.3 cents a gallon for four hours.

In her boyfriend's Dodge Ram truck, Pam Silva spent 90 minutes waiting for her turn to fill up. Rising gas prices had put a big crimp in the household budget, and Silva figured the savings -- about $47 to fill the 35-gallon tank -- would be worth enduring the 1,000-vehicle line that formed early last year at the Encinitas Arco. "People like me, I have to care," she said. "I could use the money on some other bill."

Spurred by the escalating cost of oil over the last 18 months, gasoline prices everywhere have spent long stretches in record territory. But as this summer's car-trip season kicks into high gear, Silva and other California motorists continue to pump the most expensive fuel in the continental United States.

Some consumer advocates and politicians believe that the state's higher prices stem from unlawful manipulation by California's small band of gasoline producers. Government investigations have questioned some industry practices but have found no proof of illegal activities.

For The Record
Los Angeles Times Friday June 24, 2005 Home Edition Main News Part A Page 2 National Desk 2 inches; 73 words Type of Material: Correction
Gasoline price series -- A map with an article in Saturday's Section A about oil refiners' practices showing gasoline costs gave the correct price of gasoline in South Carolina, $2.01, but pointed in error to North Carolina. Also, an article in Sunday's Business section about how refiners set wholesale gasoline prices misspelled the last name of the director of retail pricing at the Oil Price Information Service. He is Fred Rozell, not Rozelle.

A more likely explanation: California refiners are simply cashing in on a system that allows a handful of players to keep prices high by carefully controlling supplies. The result is a kind of miracle market in which profits abound, outsiders can't compete and a dwindling cadre of gas station operators has little choice but go along.

Indeed, the recent history of California's fuel industry is a textbook case of how a once-competitive business can become skewed to the advantage of a few, all with the federal government's blessing.

"They don't have to collude, they don't have to form a cartel, they don't have to be monopolists," said Stanford University economist Roger Noll. "All they have to do is take advantage of the crazy rules."

Little more than a decade ago, California was awash in relatively cheap fuel.

But in 1996, the California Air Resources Board began requiring a special gas that was the least polluting in the world. Although the change did wonders for California's dirty air, it also was a first crucial step toward permanently eliminating the state's gasoline cushion.

One-third of the state's refineries closed, largely because they couldn't afford to comply with the new fuel rules. In addition, most outside suppliers were shut out of California because they couldn't make the unique blend.

Today, the state's gasoline comes almost exclusively from refiners in California, a group that has grown smaller and more powerful through mergers.

What's more, the gap between gasoline prices in California and the rest of the nation, once about 5 to 10 cents a gallon, has swelled in recent years. At times, the price difference has been as wide as 40 or 50 cents a gallon. That price chasm extracted an extra $3 billion from Californians in 2004 and an additional $1.5 billion so far this year, compared with the U.S. average.

California's fuel prices aren't their fault, the oil companies contend, but instead reflect the forces of supply and demand -- with supplies constrained by environmental rules and demand booming because of population and economic growth. They note that other factors contribute to the state's costly fuel, including California's combined state and local taxes on gasoline, which rank third in the nation, currently adding about 37 cents to the 18.4-cent federal tax.

Yet along the way, refiners acknowledge, their California businesses have become the most profitable in the nation.

Most of the large oil companies operating in the state -- Chevron Corp., Arco parent BP, Shell Oil Co., ConocoPhillips and Exxon Mobil Corp. -- declined to make executives available to explain these market changes. Only Valero Energy Corp. and Tesoro Corp. agreed to discuss their operations; they and the oil industry's trade groups emphasize that refining earnings wax and wane in cycles and historically have lagged behind those of other industries.

"The industry needs to generate a decent income stream because it's forced to fund very large capital investments from time to time," said Rich Marcogliese, senior vice president for refining for Valero, which operates two fuel refineries and supplies nearly 700 service stations of various brands in California. Because the state's refineries strain to meet demand, the occasional problem "does generate periods of high margins, but they're not sustainable."

Still, the Golden State has been a bright spot for refiners even during less-profitable cycles.

"It turns out that they've been making decent money at it," said Severin Borenstein, director of the University of California Energy Institute in Berkeley. "Sometimes the margins aren't that great, but a lot of the time, they're really quite spectacular."

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