Chevron's annual refinery fire stops price declines.

By Charles Langley, UCAN Gas Project,  As of this writing the average price of gasoline is about $2.92 a gallon in San Diego. And prior to this morning, we had predicted some steep declines in the price of fuel over the weekend of six to twelve cents a gallon on average.

Then it happened: Chevron had its annual refinery fire.

Did we say annual refinery fire?

Yes, as a matter of fact we did.

Chevron owns two refineries in California that control roughly 25% of the supply of gasoline for the State of California. The Richmond refinery produces roughly 12% of the state's supply.When one of these refineries is taken offline, a whole series of dominoes start falling that result in higher gas prices for consumers and businesses.

Domino #1:  Chevron stops supplying Arco with fuel. 

For years we have said that competitors should not trade fuel supplies with each other - it is anti-competitive, but in the oil industry, regulators have turned a blind eye to the fact that Arco and Chevron swap fuel supplies with each other like wives at a Hollywood Hot-tub party.

Domino #2:   Arco raises the wholesale price to its dealers.

In the oil business, people love to hate Arco because they are cost-cutters. Nobody likes a cost-cutter - they are bad for profits. But the reality is a lot more complicated. Arco works in a team fashion with Chevron to control the price of gasoline in california. The reality is, BP/Arco only appears to be a cost-cutter; in reality, they maintain the price floor for gasoline.

Domino 3 and 4: Arco and Chevron start buying surplus fuel, forcing Independently owned stations to operate at a loss.

The only real competitors left in California are "Indies" - unbranded independent dealers.  These dealers, which are unaffiliated with any major brands are the single most competitive segment of the gasoline market. They are almost always small, locally owned stations that buy their fuel from jobbers who buy surplus gasoline on the spot market.

Because the Indies buy surplus fuel, their street price tends to be about a dime cheaper cheaper, on average,  than the "rack" prices that the major brands charge their own dealers. But when the surplus disappears the cost of fuel skyrockets. This process is known as a rack inversion. At this point Arco will often sell its fuel at a loss to its dealers who are located near Indy stations.

This process disciplines the Indy and serves as a warning to the Independent Dealer that undercutting Arco's street price by more than two cents is a bad idea.

Domino #5: Other brands join the buying frenzy to drive up the price.

Once Arco raises the price floor, it serves as a signal to Shell and the state's other major refiners to start raising prices.

Domino #6: The most competitive dealers go broke.

As mentioned before, the stations that get hurt the most in this game are Unbranded Independent Dealers.  Even worse is that in general, the oil industry wants fewer retail locations (more locations mean more competition). So what they are doing is revoking franchises to independnet dealers and forcing them to go independent ... and ultimately, bankrupt.

So what's the solution?

First, we need regulators who are willing to regulate. Second, we need to do what Teddy Roosevelt did in 1910:  break up the "oiligarchy" in California, where six companies control almost all of the oil produced in the State, and disrupt vertical integration.  And third, lawmakers should consider changing the laws that allow refineries to "zone price" their product.  Zone pricing (also known as price redlining), allows refiners to subsidize for their gasoline in areas where competition from Indies is tougher.