This morning while getting ready for work, I heard Marc Lee from the Canadian Centre for Policy Alternatives on the radio with Stephen Quinn talking about the price of gas in the BC Lower Mainland. I understand he also spoke on Jon McComb’s program as well. The basis of this discussion was a new Policy note prepared by the CCPA titled: Turn off the taps? Alberta already has Vancouver over a barrel. This analysis purportedly explains why BC gas prices are too high (hint he blames price gouging) and proposes a solution (hint he proposes more regulation). Coincidentally, this weekend I wrote a post about this very topic so here it is:
I have listened to Mark Lee and read his analyses and remain amazed that someone with his Economics background can continually make arguments that seem so flawed to me. As I have listened, I have wondered to myself how what is he missing? and I think I have the answer: it has to be an incomplete Root Cause Analysis. In this blog post I will attempt to explain where I believe he is getting it wrong.
To start let me explain about Root Cause Analysis. Root Cause Analysis is a tool used in incident investigation to drill down to the root cause of an incident. One of the tools of Root Cause Analysis is the “multiple why” approach. In the “multiple why” approach you have to keep asking “why?” until you determine the root cause of the accident.
As an example consider a trip and fall incident. A worker tripped and fell. Asking “why?” you discover that the worker stepped on uneven ground when a safe path existed nearby. Asking “why?” you discover that the route was faster than the alternative. So the answer is laziness? Maybe, but maybe not, let’s keep drilling down. Ask another “why?” Why did the worker chose the faster route when a safer route existed? Because the worker felt pressured to get work done faster. Wait that is a totally different answer from the worker being lazy. Time for another “why?” Why did the worker feel the need to choose speed over safety? Maybe it is a corporate policy that emphasize output over safety?
As this simple example shows if you stop a multiple why analysis too early the investigator can come to the wrong conclusion. It wasn’t a lazy worker that caused the problem but a corporate policy that valued output over safety that was the root cause. Any solution to address this incident will only succeed if it addresses the root cause “valuing production over safety” in the final conclusion. A true root cause analysis can also come to a variety of independent root causes that all need to be fixed to avoid a repetition of the incident.
Going back to the Marc’s conclusion: that price gouging is to blame for our gasoline price woes. We can see that Marc stopped asking “why?” several questions too early and because he stops his analysis too early his solutions appear equally flawed. So let’s dig deeper.
The obvious question is “why are the refineries gouging (assuming they are)?” Well the clear answer is: because they can? So comes the question “why can they?” and that question brings us to the crux of the problem…the one any reasonable Economist should consider in their analysis but never seems to be considered by Marc in his analyses: supply and demand.
The simple truth of the matter is that the west coast is under-supplied in refined fuels. As I have written previously BC uses about 190,000 barrels per day (bpd) of refined fuels but we only get about 160,000 bpd from domestic supplies. The remainder we have to buy, at a premium, from the US.
According to the US Energy Information Administration (US EIA), the US sent British Columbia about 45,000 bpd of refined fuel in January (last month of available stats) with most of that being jet fuel (~15,000 bpd), diesel and fuel oil (~16,000 bpd) and gasoline (~9,000 bpd).
Now that 9,000 bpd of gasoline is the problem. To understand this problem I recommend you read a short but excellent blog by well-respected Economist Marv Schaffer. In it he explains the:
Puget Sound only supplies a small proportion of the gasoline and other refined petroleum product requirements in the province, but it is what economists call the ‘marginal source of supply’ – the source BC has to turn to when Alberta supply plus the limited local production is not sufficient to meet provincial requirements. Because Puget Sound refiners are the marginal source of supply, they effectively set the market price. Shippers from Alberta can charge the delivered Puget Sound price, even if it is well above their own cost, because they are still competitive with the only available alternative. And Puget Sound is the only available alternative because of limited pipeline capacity for additional deliveries from Alberta.
So once again it is not price gouging that is the cause of our high gasoline prices but the market features of supply and demand. We have too much demand and too little supply. This problem can only be addressed by either reducing our demand or increasing our supply. I have argued repeatedly that the way to address this problem is to build the Trans Mountain Expansion Project and reduce the bottle-neck in our refined fuel supply chain.
Marc has different ideas. Let’s take a moment to take a look at how Marc Lee argues we should deal with the supply shortage. This from his policy note:
There is no supply shortage of gasoline in Metro Vancouver. No vehicles have been turned away from a station because they ran out of gas. The demand for gasoline in Vancouver is very stable and predictable, and storage tanks exist to manage inventories of fuel.
It shouldn’t be too difficult for these companies to supply fuel at comparable prices to other parts of Canada, as they have historically. And if they won’t, the BC government should step in to regulate the market.
It is hard to believe how bad this “solution” really is but I will try.
Remember that the CCPA is a think tank that deals “issues of social, economic and environmental justice. with poverty“, so let’s consider this from a poverty perspective.
Imagine a different think tank like the Fraser Institute argued that: “the problem with the working poor is that they simply don’t save enough money in the bank. If the working poor only had bank accounts where they stored large supplies of extra money for a rainy day then they could deal with their daily needs and have extra money to deal with emergencies“.
Do you think the CCPA would agree with this analysis? Yet this is an exact analogy for the CCPAs argument about gasoline. Marc is arguing that in a market with a chronic shortage of gasoline the solution is for the wholesalers to maintain an excess supply of gasoline in storage facilities.
Can you see how ridiculous this argument really is? If there was enough excess gasoline in the market for the wholesalers to have tanks of the stuff lying around then we wouldn’t be in this problem in the first place. If the working poor had enough extra money at the end of the month that they could fill a bank account with scads of cash, then they wouldn’t be the working poor.
Going back to our Root Cause Analysis we can see that Marc’s analysis stopped a couple “whys” early and as such his “solutions” are equally useless.
In order to fill these tanks with spare gasoline the wholesalers would have to buy expensive gasoline off the world market. But we already know that doing so will cost them more than it costs to buy from the Puget Sound (or they would be doing it already) so that solution makes no sense. It will have no effect on the marginal source of supply and gasoline prices will remain sky-high.
As for the suggestion we regulate the price of gasoline. That only works in jurisdictions where there is an excess of supply. If the government regulated the price of gasoline on the West Coast it would have to do so at a price equivalent to the marginal source of supply. Were they to choose a lower price the suppliers would simply sell to other markets (in this case to Oregon and California). This would leave us with an approximately 9,000 – 10,000 bpd shortage of gasoline in our market. I don’t need to tell you what happens when you use more than you bring in every day? You end up with a shortfall and eventually run out altogether.
Thus the regulation of gasoline would only lock in the price at a price equivalent to the marginal source of supply or it would have to be accompanied with strict rationing to keep our demand equivalent to the supply that is coming in. This is Economics 101.
Arguing that the poor should simply save more money doesn’t work in a poverty discussion and a parallel argument doesn’t work in discussing gasoline prices in the lower mainland. The supply/demand equation has two sides. If you want to decrease price you either increase supply or decrease demand. Any approach that ignores this bedrock principle of Economics is guaranteed to fail. Unless we can address the marginal source of supply we will have over-priced gasoline in BC. This is not rocket science, it is Economics 101.