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Sunday, April 11, 2004



Price caps will not
help Hawaii consumers

The global oil market is
too complex to easily manipulate


Despite the good intentions of those in the pro-gas cap camp, their methods will do serious harm to Hawaii's economy and consumers and make the state a world laughingstock.


art

I already have received several calls from oil and gas industry journals that are watching the Hawaii case with amusement and, if the price cap stands, promise to write about our insanity.

I am now traveling in California, and I cannot find any service stations in Los Angeles or San Francisco with a gasoline price lower than Hawaii's. So why is the state of California not seeking to impose a gas price cap?

Capping gas prices is a faulty concept by definition, seeking to accomplish something in Hawaii that other free-market economies have dismissed for good reason. It seeks to put into effect a system that is practiced no place else in the United States, Europe, Australia, New Zealand, Japan, Korea or even a developing country like India. Gas caps would make Hawaii an odd place, where the sponsors of the bill have chosen to invent a price system that no important economy in the world has adopted. Gas caps have not been rejected by other economies because their legislators were not smart enough, and not because Hawaii's circumstances are completely different from island states like Singapore or Puerto Rico. Gas caps have not been implemented elsewhere because they are based on faulty logic and misunderstanding of the global oil market.

The global oil market is dominated by the members of OPEC. The price of oil globally is affected by OPEC policies in restraining production, by geopolitical fears such as Iraq or Arab-Israeli disputes and many other problem spots in the world. Higher oil prices have reduced the inventory levels held by refiners, which has added to the volatility of crude prices. Even when crude prices remain stable, fuel prices will be volatile. Any international crisis also results in higher prices.

The global oil market is much like a swimming pool. If you take one bucket from one side and empty it into the other side, there is no change in the water level. In Hawaii, we import no oil from the Middle East, Nigeria or Venezuela. Yet the war in Iraq and the labor strikes in Venezuela and Nigeria affected our prices just as if we were importing directly from these countries. We cannot delude ourselves by assuming that we can have an impact on the price of oil by legislating a gasoline price cap. We are in the big swimming pool of the world oil market and there is no escape from that.

In this big swimming pool there are different qualities of water. When people talk about the price of oil, it gives the impression that there is one global price for oil. What people refer to is the price of West Texas Intermediate, the most widely used crude in the United States, directly or as a marker. Except we do not use any WTI in Hawaii and most of our crude imports have no linkage to WTI. To compare and measure the price of WTI and relate it to product prices in Hawaii indicates a serious lack of understanding of the markets affecting the Pacific basin.

Hawaii depends heavily on very sweet crudes from the Pacific rim, which have a very low sulfur content and can meet the specification of fuel oil needed for HECO. The nuclear crisis in Japan, which has resulted in the shutdown of more than 10 large nuclear power plants, also has resulted in Japanese utilities buying this type of crude for direct burning, raising the price of this crude. This crisis, which started in 2002, will probably continue until mid-2005. The sweet crudes in Indonesia are not priced on the basis of WTI; their prices are usually quite high and they do not follow the ups and downs of WTI.

Linking the Hawaii prices to the national average prices, which are WTI-based, makes no sense.

The proposed gas cap adds an economically unacceptable burden to the oil industry. It tries to link Hawaii prices to the national average, as if Hawaii prices for housing, food, clothing and everything else are comparable to the national average. Several factors contribute to the high price of gas in Hawaii: divorcement laws, which do not allow oil companies to build more service stations; Hawaii's dependency on Indonesian oil (which is now very expensive because of the Japanese nuclear crisis) for more than 50 percent of its supplies in order to meet the fuel standards set by HECO; huge shipping costs from having to import everything (shipping alone can add 5-10 percent to the price of crude oil); Hawaii's need for 50 percent jet fuel output from refineries, which usually produce less than 20 percent, resulting in expensive conversion processes; and having Hawaii customers who are not price sensitive. While complaints are heard here often, few actually go out of their way to get better prices. Capping prices to limit industry profits simply does not address these issues.

Hawaii will always be more expensive than the mainland. It's the price of paradise and no government regulation can change that.

A key argument in Hawaii has always been concern about lack of competition. This may be partly true but it is not because the refiners or suppliers do not want to compete for market share. In a small market, competition is not fierce, especially when there is almost no demand growth. While Aloha Petroleum, as an independent marketer with access to import terminals and in competition with some of the larger players in Hawaii, chooses not to import gasoline from outside, the message is clear. When companies such as ExxonMobil decide not to come to the Hawaii market, the message is clear. The message is that this market, for its size, already has too many players in it and that it is not economically worthwhile to go outside and bring oil into Hawaii. The consequences of the price-cap legislation would be to drive business people away, both retailers and refiners.

For those who worry about not having enough competition in Hawaii, gas caps will surely create fewer players and even less competition. They also will make Hawaii an investment-unfriendly place, which does not shy away from enacting bizarre and faulty legislation in the name of consumer protection.

Remember the swimming pool concept and the OPEC domination concept. It is foolhardy to believe that while at a drop of a hat the prices in the international crude market can go up and down by, say, $5 a barrel, the gas cap can protect the consumer from the international market by linking prices to the national average. Establishing gas-cap pricing in Hawaii is as pointless as legislating an oil price cap against OPEC's power to set international oil prices and link them to the national average cost of production in the United States.

If the Legislature wants to help consumers, it should start to deal with the underlying causes of higher prices in Hawaii.


Fereidun Fesharaki is a senior fellow at the East-West Center specializing in oil and gas market analysis. He is a former president of the International Association for Energy Economics, senior fellow of the U.S. Association for Energy Economics, a senior associate of the Center for Strategic and International Studies in Washington, D.C., and a member of the Pacific Council on International Policy.

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