William J. Polley

I was thinking about your problem with different
refining requirements for oil as I was going through the grocery store the other day. According to the map you cited there are 18 different gas areas. Ok, make it regular, high test and supreme and diesel and it generates almost 80 different types of gas.

But as I walked through the grocery store I counted about 300 different types of soft drinks. There were over 25 varieties of Coke alone by the time I counted up caffeinated, decaffeinated, diet, classic, etc with each in several different size bottles and cans. But as I went into the next isle I found over 50 different varieties of bottled water. But I guess that is why I saw some 250 different bottles of shampoo and 200 varieties of toothpaste -- and they did not even have my brand.

But if free market capitalism provides this type of variety on a daily basis for product after product without any difficulty at all I'm still trying to see what the problem is with having to provide 80 types of gas -- based on the assumption that the brand makes no difference and that your car can not tell if you bought Exxon or something else.

Do you have any evidence at all that these requirements have actually caused shortages or other problems?

When I look at your map what I see is that the densely populated urban areas are the ones with
special requirements except apparently for Calif. & Minn where it is a state wide requirement. I can see that smog and other pollution issues are more of a problem in urban areas compared to the wide open country so you have to pay a penny more per mile so that in Denver you will be able to see the mountains and not be like LA was once where often you could not see the ground from the upper floors of the downtown buildings.That is fine with me and mainstream economic has no problem with this concept.

So what is your problem except for government interference?

Spencer,

Nearly every post that I make on this subject leads you to ask some variation of "What's your problem?"

But generally, I'm not singling out a particular problem so much as I'm asking the question, "Why is it that we see what we see?" In this case, why is it that it seems like gasoline prices are subject to so much volatility and why do there seem to be persistent regional disparities?

Nowhere do I say that environmental regulation is bad. Nowhere do I say that we are being gouged.

Gasoline is not a soft drink. Geographic restrictions on the types of gasoline sold amounts to a type of market segmentation. The market for boutique fuels is not as deep as it would be if there were just one formula. I don't see how anyone can dispute that.

The question is not whether the gasoline industry can produce many varieties. Clearly they can and do. Again, that in itself is not the point. Coke produces many variations of their product as well. But one thing that Coke does is produce varieties that appeal to consumers. Perhaps by creating a black cherry vanilla flavor they will attract customers who might otherwise choose something else.

That is most certainly NOT what gasoline manufacturers do.

Instead the boutique fuel requirements are set by government regulation based on geography.

The Morriss paper that I cite gives a perfect example of what I mean when I suggest that this could have some unintended effects on incentives. He writes:

"Where additional capital investment is needed to produce the boutique fuels, the regulations limit the number of current plants able to produce a particular fuel, create incentives to exit boutique markets, and create barriers to entry into boutique markets. Econometric investigations into these requirements, comparing prices and price volatility between matched pairs of boutique and non-boutique cities, found that not only is there evidence that boutique fuel requirements raise the cost of gasoline, but that the price impact varies with the geographic isolation and degree of competition in the relevant market."

He footnotes the following paper as the source:

Jennifer Brown, et al., Reformulating Competition? Gasoline Content Regulation and Wholesale Gasoline Prices, CUDARE Working Papers, No. 1010, at 4-5 (2006).

I may try to track that paper down.

But my main point behind these posts is to counter the folks who want to blame and punish the oil companies for being evil price gougers. They're not. But neither are they perfectly competitive, and certainly the regulatory factors cited here matter in creating the price differences and the volatility that we see. It may very well be that the oil companies are simply setting their production and pricing optimally given the existing regulatory environment. That doesn't mean that this particular regulatory environment is the best of all possible worlds.

You say that mainstream economics doesn't have a problem with paying a little extra to reduce the pollution. Of course not, and again, I'm not against environmental regulations per se. I do, however, question whether this environment is the way to accomplish the goal.

In the end I am asking whether a reduction of the number of boutique fuels in different metro areas would result in deeper markets with less volatility while still accomplishing the desired environmental impact. That's not a question that can be answered in a blog post perhaps, but it is one that can, and I think should, be asked.

Good response. I feel better after this answer to my points and will let the subject go.

Sorry for being difficult, as I have not problem with your final point that maybe fewer boutique fuels would be more efficient. I have no problem with that, but on the other hand I know nothing about the chemistry involved.

It reminded me of when I was taking price theory at the time the government required firms to remove lead from gasoline. My instructor just could not understand why taking lead out of gas would make gas more expensive. She just would not accept that lead was a catalyst for other chemical reactions that made gas more powerful and that achieving this same result with other chemicals was more expensive.

You may be right. But there may also be very good
reasons that the gasoline blend should be different in Denver at 5,000 feet as compared to Houston at 25 feet above sea level.

Oh you're not being that difficult. Your comments are always sincere and honest, and thus always welcome.

I admit that I also know little to nothing about the chemistry involved with making the different boutique fuels. I would strongly suspect that for any given refinery producing any given formula that there is some cost to switching to another formula (even if the formulas have comparable marginal cost). In that event, there would be a strong incentive to specialize and avoid switching from one formula to another. I'd certainly be interested in hearing from anyone who can tell us more.

And I am also open to the possibility that the blends should be different in Denver than in Houston, but I have never heard anyone explain why that should be the case.

Your comparison to the leaded/unleaded gasoline change is, I think, quite instructive. It was pretty much a no-brainer that unleaded gasoline would be better for the environment, so that regulation was imposed uniformly. Converting the refineries was costly, and as you point out it was more costly to produce, but it would not have had this market fragmentation effect.

So I think the burden is on someone to show why each of these urban areas needs a different blend from a scientific/environmental point of view and why one of those blends would not work for other areas as well.

Yes, but at the time my instructor wanted to blame the evil oil companies.

I suspect I think the political process is a lot more sophisticated and rational then many academic economist think. Typically, business lobbyist and others interact behind the scenes in a fairly intelligently process that assures that most laws are not completely off-base. The behind the scene horse trading is probably more like an auction or a market then economists generally believe.

this probably reflects my background as a business economist that was involved in the process rather then an academic economist.

I certainly don't speak for all academic economists. But I would definitely agree with you that the process is rational. If the system rewards rent seeking behavior, then rational actors will seek those rents. Whether the resulting laws are "off-base" is a matter of your perspective. When firms use the lobbying process to advance their rational self-interest, the resulting outcome is not necessarily the optimal outcome for society. The fact that the behind the scenes horse trading looks like a market says little about the effects that those efforts have on the world outside the smoke-filled room.

From my perspective the behind the scenes horse trading is generally between public interest groups claiming a market imperfection and business interest trying to make sure the restrictions on their freedom are fair -- ie, they do not give one firm an extra advantage -- and not destructive to profits.

When I went to grad school rent seeking was something hardly ever discussed. It is something
new to the economic scene. But from my background within major multinational corporations and in the investment community I can not help but feel that current economic thinking widely exaggerates how much successful rent seeking there actually is.

Wall street research is targeted at discovering any firm that has successfully done some rent seeking and capital moves in very quickly to eliminate it. If rent seeing were really all that successful, profits growth would be a lot stronger then it has been over the last 50 years.

One last comment. When I was in grad school it was the left that was always talking about how govt and business acted together, i.e. rent seeking.

Now it is the right that is always seeing rent seeking everywhere.

Go figure.

"Wall street research is targeted at discovering any firm that has successfully done some rent seeking and capital moves in very quickly to eliminate it. If rent seeing were really all that successful, profits growth would be a lot stronger then it has been over the last 50 years."

No. That does not follow. In fact, if all the firms are optimally rent seeking, profits will be likely not be markedly different from what they would have been otherwise.

Think of rent seeking as being an generalization of profit maximization into the political realm. By that I mean that the resources expended (e.g. paying a lobbyist) on gaining, say, favorable treatment in a bill before Congress are part of the cost of doing business. As long as it is effective, they should keep doing it. But if the marginal cost of lobbying exceeds the marginal benefits, then they should scale back.

Of course every other firm in the industry does the same thing. (As they say, if you're not at the table, you're on the menu.) The combined efforts of all the firms lobbying ensures that the marginal benefits to any one firm are kept in check. Profits remain at a "normal" level, perhaps a little bit higher than industries with less rent seeking--just enough to compensate them for the added cost they incur.

As for your other comment, all I can say about that is that for me personally, my view of rent seeking behavior is quite independent of whatever political opinion I may hold.

A certain amount of rent seeking is to be expected. It would be unrealistic to totally eliminate it in our system of government. And we (i.e. academics, pundits, businesspeople, politicians, and anyone else with an opinion) can quibble over what amount is appropriate to allow. But too much and the wrong kind can have social costs that outweigh the private benefits.

That takes the present case from being one of blaming the oil companies to one of understanding why they do what they do. If the public interest would be served by a less fragmented market then there is a way to solve that problem that solution does not involve windfall profits taxes, vague anti-gouging statutes, or any of that sort of thing. That is my point.

Yes, but obviously there is no significant rent seeking in the refining industry since it has been one of the least profitable industries in the economy.

From inside a corporation I view paying for a lobby as largely a defensive measure that I am forced into against my will.

In reverse order...

"From inside a corporation I view paying for a lobby as largely a defensive measure that I am forced into against my will."

Like I said, if you're not at the table, you're on the menu. It resembles the bad outcome in the prisoner's dilemma.

"Yes, but obviously there is no significant rent seeking in the refining industry since it has been one of the least profitable industries in the economy."

You make an excellent and relevant point which leads me to ask these questions. Who benefits from the segmentation of the market? Is it the refineries or the major oil companies (who own some of the refineries--you could probably tell me what fraction of them they own)?

As an outside observer, it would seem to me that the refineries operate on tighter margins and in a somewhat more competitive wholesale environment. The major oil companies who sell the product at retail in the segmented market operate in a more oligopolistic setting. Which group probably does more rent seeking? My guess is the major oil companies--who happen to own some of the refineries in a classic story of vertical integration. Does this sound about right?

And if the market segmentation I have asserted leads to higher and more volatile retail prices, doesn't that benefit the major oil companies and not necessarily the broader set of refiners?

And isn't it true that the oil company profits are just slightly higher than the average in the economy--perhaps just enough to partly be accounted for by the sort of thing I've asserted?

And again, even if I'm right on the logic here, I'm not faulting the oil companies. In fact, it seems to me that they are behaving exactly as they should to maximize profits. Furthermore, I don't know the whole history of how the regulations evolved into what we have today and who lobbied for what. Maybe it was all based on environmental science and that the politician's decisions were made with full knowledge of the effects of the regulations on the market.

But I kind of doubt it.