RESTRICTING OUTPUT TO RAISE PRICES? Father Andrew Greeley preaches a sermon on "Pride goeth before the fall." Too much stuff there for a careful analysis this evening, but let's concentrate on one line.

The cost of gasoline climbs almost every day because the obscenely profitable oil companies have not plowed any money into building new refineries for the last 15 years.

A New Republic article from 2004 suggests both competitive and collusive explanations for this phenomenon. First, economic losses are a signal to investors to withdraw capacity. That was the case in the mid-to-late 1990s.

In a 1996 internal Texaco document released by Senator Ron Wyden's office, the company bemoaned "surplus refining capacity, and the surplus gasoline production capacity" in which "supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results." In 1995, a similar document from Chevron argued that "if the U.S. petroleum industry doesn't reduce its refining capacity, it will never see any substantial increase in refining margins."

The obvious solution was to slow the growth of capacity, primarily by cutting the number of refineries. And that's just what happened. Since 1995, 23 refineries have closed ...

On the other hand, economic profits are a signal to investors to provide capacity. The article suggests an oligopolistic rather than competitive instinct at work.

In a normal market, increased demand and profit would immediately spur producers to increase supply. And yet in the last four years oil companies have neither significantly expanded capacity at existing facilities nor begun serious efforts to open new refineries. How do they get away with it? Quite simply, because gasoline is no longer a normal market. Thanks to a wave of industry mergers over the last decade, there are now significantly fewer independent refineries; they are, instead, controlled by a shrinking number of oil-industry giants--there have been 33 mergers in all since 2001 alone, totaling $19.5 billion. According to a recent General Accounting Office study, these mergers have drastically changed the structure of the nation's regional gas markets, such that every single market is now considered "heavily concentrated." According to a report by the Senate Permanent Subcommittee on Investigations, markets in 28 states are "tight oligopolies," in which four companies control 60 percent or more of gasoline supply. The upshot of this concentration, combined with the difficulty of opening new refineries, has been that oil companies can reduce capacity without much fear that a competitor will try to undercut them. And while gas prices will likely go down as demand declines following its early-summer peak, low refinery capacity virtually guarantees that gas prices will stay high for a long time. That's good news for the oil industry--but bad news for the rest of us.

There are two caveats to this argument, however. First, immediate entry is a prediction of a competitive or contestable market model with no irreversibilities. A refinery involves a great deal of asset-specificity that renders a bad investment only useful as scrap. Second, refineries produce a lot of pollution as a byproduct and obtaining a permit to build one is not without costs. (Knowledge Problem has some more recent observations.)

SECOND SECTION: Deinonychus antirrhopus notes that environmental regulations abet the oligopolists' desire to keep the club closed.

The basic idea in all of this is that the oil companies like the environmental laws (although they may claim otherwise) in the sense that it can prevent entry into the market. The hostile environment in CA to new refineries helps the oil companies drive up prices.

But creating new refining companies to break open the club is a bit more of a challenge.