Gas market’s structure hits drivers hard

For nearly two decades, Santosh Arya has pumped some of the San Diego area’s cheapest gas at his three Homeland Petroleum stations.

But his streak ended early this month, when wholesale prices started rising sharply, then shot up 40 cents a gallon overnight. To break even, Arya calculated he would have to sell a gallon of regular at $5.10 -- almost a buck higher than at nearby Shell and 76 stations. Instead, he shut down and waited for prices to drop.

“I’ve never seen anything like it,” said Arya, who said he lost $2,000 a day while hanging “out of gas” signs on his pumps.

He has since reopened his stations in Vista, San Diego and Mira Mesa, but has struggled to keep his prices under $4.50 a gallon.


“You can’t believe how customers talk to me,” said Arya, who was born in India but has lived in the U.S. for almost 40 years. “They say, ‘You foreigner, you’re gouging.’ ”

While Arya was losing money, the state’s oil refiners were raking it in. For the week that ended Oct. 8, when the average price for a gallon of gasoline in California hit a record high of $4.67, the portion of the retail price going to refiners, or margin, jumped to $1.22 a gallon. That was up 75% from the previous week. And it was nearly triple the average margin of 42 cents a gallon this year, according to California Energy Commission data.

The price run sparked howls of protest from angry motorists and calls for investigations by California Democratic U.S. Sens. Dianne Feinstein and Barbara Boxer. But the reason refiners made a killing while retailers such as Arya lost their shirts isn’t conspiracy, it’s economics. Oil companies operate what amounts to a legal oligopoly in California -- an arrangement that probably will contribute to more wild gas spikes in the future.

That’s because the Golden State’s gasoline market is essentially closed. The state’s strict clean-air rules mandate a specially formulated blend used nowhere else in the country. Producers in places such as Louisiana or Texas could make it, but there are no pipelines to get it to the West Coast quickly and cheaply. As a result, virtually all 14.6 billion gallons of gasoline sold in California last year were made by nine companies that own the state’s refineries. Three of them -- Chevron, Tesoro and BP -- control 54% of the state’s refining capacity.

“We live on a gasoline island,” said Gordon Schremp, a fuels analyst at the California Energy Commission. “The control refiners have is an artifact of the closed marketplace we’ve created.”

Shielded from outside competition, these refiners benefit from keeping supplies tight. Even as gasoline consumption has declined in California in recent years because of high unemployment and increased vehicle fuel efficiency, refiners have been able to keep prices about 35 cents a gallon higher than the rest of the country. At the same time, the number of refineries operating in California has declined to just 14 today from 27 in the early 1980s.

The lack of competition is also reflected at the retail level. About 85% of California’s gas stations sell branded gas such as Chevron, Arco, Valero or Mobil. Pump prices at these outlets are directly or indirectly controlled by refiners.

In other states, such as Texas, independent, non-branded stations make up as much as 50% of the market, creating more competition. But California’s independent stations are the first to suffer when there’s a hiccup in the state’s fragile supply chain.


In the case of an outage, refiners scramble to supply their own stations first. Independents such as Arya, meanwhile, have to rely on the volatile spot market to fill their underground tanks. California Energy Commission data show that independent retailers and distributors lost, on average, 10 cents for every gallon sold in the days leading up to the price spike this month.

“Gas stations are the ones left holding the bag,” said Liza Tucker of Consumer Watchdog.

The state’s fuel problems are magnified, critics say, because refiners have consolidated over the years, giving fewer players more market power.

Most recently, BP in August agreed to sell its 265,000 barrel-a-day Carson refinery, along with the Arco brand, to Tesoro for $2.5 billion. If the transaction is approved by regulators, just two companies -- Tesoro and Chevron -- will control more than half the state’s gasoline refining capacity.


Tesoro spokesman Brian Kennedy said the merger would help it meet environmental requirements and prevent outages. But some industry experts say the deal could lead to even higher gas prices.

“As the market becomes more concentrated, the incentive to restrict output increases,” said Severin Borenstein, an economist at UC Berkeley’s Haas School of Business who has researched the market power of California refineries. “If one refinery goes down, everyone else makes a bucket of money.”

It might all sound like a conspiracy, but the Federal Trade Commission and California’s attorney general have investigated this market several times, never finding evidence of collusion or price fixing.

California refineries can turn crude oil into a number of products, including jet fuel and asphalt, to supply customers inside and outside the state. If a refiner can make more money selling diesel to Mexico, it has every incentive to do so, especially if it helps keep supplies tight and prices high at home.


Optimizing profits by choosing what products to sell where and when is at the core of running a successful refinery.

“It’s called arbitrage,” said Schremp of the energy commission. “You sell where it makes the most sense to.”

Refiners contend that the price of gas reflects the higher cost of doing business in California. It costs as much as 15 cents a gallon more to refine the state’s clean fuel blend, and green regulations chip away at the bottom line. Fuel taxes, too, are higher than in many other regions.

“It’s a very difficult, challenging market,” said Tupper Hull, spokesman for the Western States Petroleum Assn., whose members include most of the region’s oil companies and refiners.


In August, the group released a report predicting that state rules to limit greenhouse gas emissions and push alterative fuels could force as many as eight of California’s refineries to close in coming years.

As the number of refineries shrinks, the chances that an outage could create disruptive shortages and painful price hikes increases.

“The fragility of the refining system makes California really vulnerable to spikes,” said Carl Larry, president of consulting firm Oil Outlooks & Opinions. “What happened this month looks like the result of a hurricane. But there are no hurricanes in California.”

October’s spike was triggered by two unplanned outages in the state. In August, Chevron’s 110-year-old Richmond refinery caught fire, putting the nearly 250,000-barrel plant partially offline for months. Then on Oct. 1, Exxon Mobil’s refinery in Torrance lost power and went out of service for the better part of a week.


The market was already stretched perilously thin. Refiners always try to keep supplies tight, but they’re particularly conservative before the semiannual switch between summer and winter gas, so as not to get stuck with inventory they can’t sell. Chevron had also closed a pipeline for repairs, and ConocoPhillips announced planned maintenance on two in-state refineries.

“This was building up,” said Denton Cinquegrana, executive editor of the Oil Price Information Service. “You could almost see it coming.”

Exxon Mobil’s shutdown sent traders into a panic as distributors scrambled to secure fuel. In just two days, wholesale prices leaped nearly a dollar in some places. Tesoro and Valero stopped selling to independent distributors in order to meet contractual obligations to stations such as SuperValu and Shell. That forced retailers including Costco to shut down their pumps and drove up street prices 12% in a week.

On Oct. 7, Gov. Jerry Brown took the highly unusual step of allowing refiners to begin selling winter formulation gas ahead of the Nov. 1 switch to boost supply.


Gas prices have since fallen. On Sunday, a gallon of regular averaged $4.44 in California, according to AAA. But the finger-pointing continues.

Oil refiners and distributors blamed speculative commodities traders, and Sens. Boxer and Feinstein called for investigations into the spot gasoline market. Environmentalists have accused refiners of exploiting the spike to sway public opinion against important anti-pollution controls.

Nazhi Simaan, owner of SS Fuel in Paramount, doesn’t know what to think.

Two days into the run-up, his station’s underground tanks ran dry and he had to refill at fast-rising prices. Just to break even he charged $5.39 for regular. Customers balked. He went from selling as many as 2,000 gallons of fuel a day to barely 100.


“We couldn’t even pay the employees,” Simaan said. “Why did this happen?”


Times staff reporter Ronald D. White contributed to this report.