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The House of Representatives recently passed legislation (the Federal Energy Price Protection Act of 2006) that purports to protect American consumers from price gouging by unscrupulous gasoline retailers. This blatantly populist legislation has three problems: (1) There is almost no evidence that price gouging by gas station owners is a serious or prevalent problem; (2) the legislation, if it passes, is likely to make the perceived problem worse; and (3) neither Congress nor anyone else seems to be able to define what constitutes price gouging in the first place. Devoting scarce law enforcement resources to attack a nonexistent problem surely is a waste of public funds. More problematic for national energy policy, however, is that Congress, instead of taking action that could assist the American consumer, has chosen, once again, to play politics with energy issues and to avoid tough decisions. THE MYTH Of GAS GOUGING It’s never very clear what politicians mean by “price gouging.” As a practical matter, it seems to be prices and profits higher than what the politicians think are appropriate, with a suggestion that gas prices aren’t really the result of market forces of supply and demand. Yet gas stations owned by large integrated oil companies such as Shell, Exxon, and BP simply do not engage in price gouging, however one wants to define it. The cost to the reputation of these companies and their brand image, as well as the likelihood of reprisals from Congress in terms of “windfall profit taxes” or other penalties, simply makes such conduct non-profit-maximizing. What about price gouging by the independent, single-station owner? Logic and basic economic theory would suggest that, with the large number of gas stations in most urban areas and with gasoline being a largely nondifferentiated commodity product, price gouging by a rogue dealer would be quickly and effectively defeated by market forces. This is particularly true in an industry that relies heavily on repeat purchases by consumers. Who is going to be loyal to a station owner who charges the highest prices in town or who is perceived to be an opportunistic price gouger?
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That leaves us with the independent station owner, located on a busy highway, whose business is primarily from nonrepeat customers. Is this the guy who is charging exorbitant rates for gasoline and for whom we need a federal legislative fix? Well, there certainly is no empirical evidence that it is happening with any frequency, and the price increases observed tend to be largely explainable by higher wholesale prices, which are completely beyond the control of the independent station owner. Congress recently charged the Federal Trade Commission with investigating, among other things, whether retail gasoline dealers suddenly became price gougers in the wake of Hurricane Katrina. For the purpose of the analysis, the FTC was told to assume that price gouging involved any price increase by a dealer that could not be explained by higher wholesale costs or national or international market trends. The FTC’s comprehensive and well-researched study sheds light not just on price gouging post-Katrina but also on the likelihood for price gouging by independent gasoline retailers in other circumstances. The FTC’s report concludes that gasoline retailers generally faced higher wholesale costs for their gasoline in the wake of the hurricane but, nevertheless, tended to use the same factors in setting prices that they would have used in normal conditions. Most interesting, however, was the commission’s finding, after looking at thousands of alleged consumer complaints, that a total of only six single-station retailers in the entire United States might potentially qualify as price gougers under the congressional definition. Thus, the empirical evidence suggests that, perhaps, six stations nationwide may have engaged in some form of price gouging after the storm of the century. Do we really need federal legislation to address this level of activity? DON’T WE EVER LEARN? Anti-price-gouging legislation is a form of price control, and, in the United States, we have too often experienced the dire consequences of implementing such market-altering strategies. For example, in 2000 and 2001, then-Gov. Gray Davis of California (D) refused to lift retail price controls on electricity. The result: rolling blackouts and a true energy crisis for the state’s consumers. Similarly, in the early 1970s, the Nixon administration tried price and wage controls to fight inflation, without success. For gasoline, the Nixon price controls helped produce massive shortages, gas lines, and even product rationing. Almost all economists would agree that any form of price regulation has the potential to disrupt market forces, misallocate scarce resources, and limit output. Moreover, if prices are held artificially low for too long, a substantial risk exists that markets may be unable to correct. Conversely, free markets often correct quickly. For example, the FTC study observed that higher gasoline prices in the United States after Hurricane Katrina resulted in the shipment of substantial additional supplies of gasoline to our nation from foreign locations. This partially corrected the demand/supply imbalance and kept prices from rising higher. Moreover, higher prices may dampen demand, which also may help the markets return to equilibrium after a temporary supply crisis. UNDEFINED TERMS The FTC has told Congress that “price gouging” is not a defined legal or economic term, and the agency would appear to question the value of the definition supplied by Congress. More important, the FTC observed that a gas station owner, absent collusion with other gas station owners, who raises prices temporarily in response to supply problems caused by natural disasters or by sudden, unanticipated increases in demand should not be deemed to have acted unlawfully. In interviewing various retailers during its investigation, the FTC found that many retailers, in the wake of Hurricane Katrina, had to choose between running out of product altogether or increasing prices to allocate supply. Some station owners raised prices to allocate their dwindling inventory, others maintained prices and ran out of product, and still others paid higher wholesale prices to keep their customers supplied, even if they lost money. Each response appears to have been rational economic behavior and, in some cases, even praiseworthy. The FTC, despite apparent congressional pressure, would seem to have little appetite for pursuing allegations of gas gouging by owners of service stations. The Federal Energy Price Protection Act, nevertheless, would require the FTC to come up with a definition for unlawful price gouging. And enforcement would be required, with follow-up civil actions by the FTC and state attorneys general and with the potential for criminal prosecution by the Department of Justice. Regardless of what Congress and the FTC eventually decide to do, the states continue to charge ahead. Twenty-nine states and the District of Columbia have laws that prohibit the excessive pricing of motor fuels under certain conditions. Nine states (Alabama, Connecticut, Florida, Georgia, Illinois, Missouri, New York, Tennessee, and Virginia) have initiated law enforcement actions against gas station owners for alleged gouging of one type or another. Settlements have been obtained with a total of slightly more than 100 stations — about 0.06 percent of all stations in the United States. Despite this flurry of activity by zealous local prosecutors, the FTC staff has not been able to identify a single judicial decision involving allegations of price gouging from hurricane-related gasoline price increases. Those station owners who were so unfortunate to be charged tend to settle cheaply, rather than incur litigation costs that would likely dwarf any fine they might pay. The states, similarly, are more than willing to settle because they know that substantial uncertainty about what constitutes an “unconscionable,” “excessive,” or “exorbitant” price — the common language used in the various state statutes — puts their prosecutions at risk in any full-scale litigation. WHAT CAN CONGRESS DO? Most gasoline retailers earn between 3 and 13 cents per gallon of product sold. Obviously, with prices above $3 per gallon, it is not the gasoline retailer margins or price-gouging activity after Katrina that is causing the American consumer angst at the pump. Moreover, remember that state laws everywhere require the posting of prices in large, easy-to-read numerals, which both informs the consumer and facilitates shopping for the best price. Markets tend to work best when buyers and sellers have more information. If Congress or the states believe that consumers would be better off knowing whether retailers are “ripping them off,” they could mandate that prices be posted in red numerals if the retailer profit margin is above a certain level and blue numerals otherwise. Alternatively, they could require that if prices have been increased by a certain percentage above some previous period, a similar warning must be supplied to consumers. These are not perfect solutions, but the need for any “solution” is questionable where it has not been established that a problem exists in the first place. Nevertheless, any response that avoids price controls or expensive law enforcement actions would be a step in the right direction. In the end, the price of gasoline at retail is largely determined by its price at wholesale. And Congress and the administration have many tools to reduce the price of gasoline at the wholesale level. Most tools involve increasing supply — e.g., eliminating drilling restrictions in Alaska and offshore Florida, promoting the development of new refineries in the United States, and not imposing expensive ethanol additive requirements at the beginning of the driving season. Others involve reducing demand — e.g., increasing the miles-per-gallon requirement for auto manufacturers so as to decrease the amount of gasoline that consumers purchase. One might even argue that higher gasoline prices are a good thing for the American consumer. They make American markets more attractive to foreign gasoline producers, thus ensuring supply, and they encourage the development of new technologies, such as hybrid-engine cars that require less fuel. The bottom line is that we have a serious energy crisis in America. We need serious solutions to address these problems and less scapegoating — particularly at the expense of largely powerless, independent service station owners.

Sean F.X. Boland is a partner in the D.C. office of Howrey and co-chair of the firm’s antitrust practice group. He has an active practice in the energy area, but does not represent any gas retailers or others with an interest in the subject of this commentary.

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