Is There a Good Case for Requiring Gasoline Sellers to Carry Minimum Reserves?

I don’t think so.

Governor Newsom has called a special session of the legislature to consider his plan centered around a minimum inventory requirement on gasoline sellers. The idea is that when a spike occurs in California due to low supply, some state official or organization would allow – or require – release of the inventory, which would increase supply and push down prices.

This is from Severin Borenstein, “Can More Reserves Solve California’s Gasoline Price Problem?” Energy Institute Blog, September 23, 2024.

I think that pretty much any economist who thinks about price spikes for storable commodities such as gasoline will immediately think about futures markets. Why don’t futures markets take care of the problem? And even in the absence of futures markets, if gasoline producers can anticipate a price spike, why don’t they cut back on sales now to make more money when the price spikes?

Borenstein is an economist who thinks a lot about gasoline prices. But read through his post and you won’t see a thing about futures markets. Maybe there’s a reason and maybe the reason they don’t work in this case is obvious to him. But it’s not obvious to me.

He continues:

If implemented carefully and operated without political intervention, an inventory requirement could help consumers.  California’s special blend of gasoline and limited sources of supply makes it vulnerable to supply disruptions, particularly in the fall when refineries often do maintenance that reduces their output. Those events upend the budgets of low-income working families. And because of the increasingly-concentrated ownership of refineries that produce our blend, it is not at all clear that a producer has a strong market incentive to raise supply, which would drive the price back down.

So Borenstein admits that a regulation to take the place of apparently non-existent futures markets needs to be “implemented carefully and operated without political intervention.” In other words, it won’t work. Why? Because the people who would implement the regulation and operate it don’t have an incentive to do so carefully.

Later, Borenstein writes:

Others weighing in against the inventory requirement – including the governors of Nevada and Arizona – have claimed that holding these inventories would reduce supply and therefore drive up prices. This argument, however, ignores the whole point of inventories, which is to acquire them when the system has sufficient production capacity, and have them available when the system might be short.  Sellers would meet the minimum inventory requirement by building up stocks prior to periods when the system could be strained, whether due to high demand or reduced supply.  The price increase caused by the inventory-build at less constrained times would almost surely be minimal, while the price decrease when there are shortages could be substantial.

That’s good reasoning, but why aren’t companies doing that already. What special information does Governor Newsom have about the gasoline industry that the gasoline producers don’t have?

To his credit, Borenstein points out some problems with the proposed regulation:

My own concerns with this proposal is [sic] that the real world implementation is likely to be much more complicated than the legislators or its proponents seem to acknowledge. Someone needs to set and enforce the rules for the inventory requirements: what counts as inventory (blending components? imports soon to arrive?), what’s the sales basis for calculating the required quantity (total gasoline sales? CARB gasoline sales? refinery capacity?), what’s the required ratio of inventory to sales?

Even more importantly, someone needs to decide when to waive the requirement to address a price spike, how to make sure that inventory gets released, and when to require sellers to rebuild their inventories.

This leads to my other concern, that the inventory would be managed in an unpredictable and political way. If the governor or some other political appointee makes the call on when to release inventories, it could easily end up being used for political advantage, including suppressing gas prices even when there is no evidence of a supply shortage (as has happened with the national Strategic Petroleum Reserve).  That’s why any inventory requirement should come with either a predictable rule for when it will be released – for example, when California spot prices exceed Gulf Coast prices by more than a certain amount – or by an independent Board that would make the decision.

These are all good, well thought out concerns. Hopefully, they’ll be enough to talk other proponents, or those on the fence, to oppose this regulation.