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Brooklyn Law Review




Virtually everyone holds an opinion on what is wrong with gasoline markets. Some critics argue that gasoline costs too much, fattening greedy oil barons at the expense of consumers. Some link reducing oil producers' profits to stopping terrorism. Others contend that gasoline costs too little, subsidizing suburban sprawl and gas-guzzling SUVs at the expense of the environment. Web sites track gasoline prices and grocery stores sell low-cost fuel to lure shoppers. Policy makers debate whether gas taxes should be cut to lower the cost of living; need to be increased to make drivers pay the full cost of their behavior; or whether gas taxes should be a user fee for highway use. The Federal Trade Commission (FTC), congressional committees, and a host of state governments have repeatedly investigated gasoline prices, searching for someone to blame when prices rise.

These debates treat gasoline as a fungible commodity, widely traded in a national or international market. And for most Americans, gasoline gives every appearance of being just such a commodity--you can fill up in Boston or Dallas, Los Angeles or Cleveland, from pumps that look much the same from city to city, and your car will run without noticeable differences in performance regardless of where you bought gas. But Gulf Coast refinery closures in the wake of Hurricanes Rita and Katrina highlighted the fragility of gasoline markets, and significant differences in gasoline prices throughout the United States over the last few years have raised questions about whether a national market really exists. If the gasoline market is not a national one, there are serious implications for both consumer welfare and public policy. Broad, national markets are able to absorb the impact of regulations at lower costs to the consumer than are narrow, fragmented markets. Moreover, fragmented markets offer the potential for implicit collusion among producers, collusion that can be facilitated by regulatory measures.

A recent regional price spike in Phoenix, Arizona illustrated the fragmented nature of U.S. gasoline markets. On July 30, 2003, the pipeline supplying gasoline to Phoenix ruptured, cutting gasoline supplies to Phoenix by 30%. Phoenix gas stations sought alternate supplies from West Coast refineries, offering to pay higher prices to bid the gasoline away from California retailers. These West Coast refineries had limited gasoline supplies, however, after earlier unplanned refinery closures had left them with lower than normal inventories. Because the Environmental Protection Agency (EPA) requires Phoenix to use a special blend of gasoline to control air pollution, gasoline from nearby Tucson could not be sold in Phoenix until the EPA waived the boutique fuel requirement on August 20. Once the waiver was granted,gas from Tucson was trucked to Phoenix, raising prices in Tucson but lowering them in Phoenix.

U.S. gasoline markets are fragmented and that fragmentation stems from over a century of often inconsistent, overlapping regulations of gasoline and petroleum markets. This article charts the sources and extent of that fragmentation and its likely effects on the domestic gasoline market. We highlight the dangers of following the current regulatory trend toward additional fragmentation and recommend that policy makers and industry analysts acknowledge the market's fragile condition and take remedial steps to avert future crises. Part I outlines the characteristics of competitive markets and examines the structure of the gasoline market as shaped by the traits of gasoline, refining, distribution, and crude oil. Part II turns to the regulatory measures that affect the market for gasoline, tracing the impact of economic and environmental regulation. We then identify the incentives created by the structure of U.S. environmental regulation that lead to the creation of regulatory market externalities and we suggest measures to reduce those incentives and so avoid market fragmentation. Part III concludes with recommendations for avoiding this problem in the future.

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