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Vol. 14, No. 8 Week of February 22, 2009
Providing coverage of Alaska and northern Canada's oil and gas industry

Pricing not illegal

Two reports say high gas prices last year didn’t break the law; a pair of proposed bills would tie Alaska gas prices to Washington state rates

Eric Lidji

Petroleum News

A pair of reports say market forces, and not illegal activity, caused high gasoline prices in Alaska last year, but considerable public outrage about pump prices above the national average and a pair of bills working through the Legislature guarantee the issue isn’t over.

High gasoline prices last year caused national frustration, but the mood was heightened in Alaska as prices at the pump stayed high, even as they started to fall across the country.

In the early months of 2008, Anchorage paid less than Seattle for a gallon of gas, but by fall, the average prices in Anchorage were more than a dollar above those in Seattle.

The growing difference between Alaska and the Lower 48 prompted two investigations, one by the Attorney General’s office and another by the House Judiciary Committee.

The two reports describe similar market conditions leading to higher prices in Alaska: unprecedented volatility in world oil prices, an “oligopoly” where just a few refiners in Alaska supply a predictable market, barriers preventing new companies from entering the mix and a jet fuel operation that often takes precedence over the retail gasoline business.

But neither investigation found evidence of collusion or price fixing.

“Both enlightening and frustrating” is how Rep. Bryce Edgmon, a Democrat from Dillingham, described the findings. Many lawmakers agree with his adjectives, especially the latter, and wonder how the reports will impact Alaska’s economy, law and people.

Prices traced to refineries

Alaskans often complain that gasoline is expensive even though all the ingredients, from crude oil, to pipelines and the refineries, are nearby, and the state tax burden is so low.

But while complaints began early in 2008, as prices continued to rise, the investigations only began once prices in Alaska seemed to be acting differently than prices nationally.

A year ago, Anchorage paid less for a gallon of gas than Seattle. As oil prices peaked in summer, Anchorage paid about 33 cents more than the Pacific Northwest. By November, with oil down $100, Anchorage was paying $1.06 more per gallon of gas than Seattle.

Gov. Sarah Palin ordered the Attorney General to investigate for illegal activity in gasoline pricing, while then-Speaker of the House John Harris, a Republican from Valdez, asked the House Judiciary Committee to explain this “decoupling” of prices.

Both reports traced the prices back to Alaska refineries, as opposed to gas stations.

Although there are six refineries in Alaska, only two produce gasoline. The Tesoro refinery in Nikiski produces about 80 percent of it, and the rest comes from the Flint Hills refinery in North Pole, which mainly supplies communities in the Interior.

Gasoline sold in Western Alaska and Southeast Alaska typically arrives on barges or planes, creating a unique market in those isolated towns unrelated to Alaska refineries.

Alaska drivers consumed some 268 million gallons of gasoline in 2007, the least of any state in the country and only around one-tenth the amount used in Washington state.

Alaska refineries are geared toward jet fuel, which accounts for about 60 percent of the petroleum products produced in the state. Gasoline makes up just 15 percent, compared with 45 percent on the West Coast, a key difference cited by the House Judiciary report.

Jet fuel is king in Alaska

Alaska can have the relative stability of Seattle, but only at a price, according to Rep. Jay Ramras, a Republican from Fairbanks and the prime author of the House Judiciary report.

The House Judiciary report said measures to control the price of gasoline in Alaska could lead to one of the refineries shutting down, which could ripple through the Alaska economy, threatening local Air Force bases, the railroad and the two largest airports.

Despite holding several public meetings last fall, the House Judiciary Committee did not get a “definitive answer” to explain the behavior of gas prices in Alaska last year, but did arrive at a theory that has since drawn some criticism, frustration and a bit of surprise.

The jet aviation fuel produced in Alaska supports a refueling industry at Ted Stevens Anchorage International Airport, among the largest air cargo operations in the world.

Because jet fuel competes on a global market, Ramras suspects that during periods of high oil prices, the price of jet fuel in Alaska is dropped and the lost profits are made up by increasing the price of other products, like gasoline, diesel fuel and home heating oil, Ramras told fellow members of the House Special Committee on Energy on Feb. 12.

“The refineries are laying off the costs when they are losing money in jet aviation fuel … onto consumers,” Ramras said.

After releasing the report, Ramras received criticism for saying his conclusions came from “intuition.” During the committee hearing, Ramras said the report, compiled mostly through public information, is just a “theory,” one he invited others to try and disprove.

An efficient market in Alaska

The House Judiciary report presented several other explanations for increased prices.

The refineries in Alaska are simple, meaning they can only produce a limited range of products. The Flint Hill refinery takes oil from the trans-Alaska oil pipeline, refines what it can, and returns any excess to the pipeline, paying a fee for lower quality product.

Tesoro sells a third of what it makes, all heavier products, outside the state at a loss.

“A simple refinery, like the Tesoro refinery and the Flint Hills refinery, can adjust their output according to the marketplace. A complex refinery cannot,” Ramras said.

As high gas prices changed driving habits in the Lower 48, refiners could not adjust their output accordingly, causing a glut of gasoline and lowering the price, Ramras said.

In Alaska, refiners can adjust their output to meet a change in demand, but rarely have to: The local market is fairly predictable and there is rarely, if ever, too much supply.

As the difference between Alaska and the Lower 48 grows, though, refineries along the West Coast should be able to barge fuel products north to compete for customers.

This doesn’t happen because Alaska is a small market without much storage.

Both reports said major gasoline retailers, like the chain grocery stores, buy their supply from refineries on long-term contracts, which eliminates a ready market for outside gas.

A 10.5 million gallon tanker of gasoline could supply the Railbelt for 20 days, according to the Attorney General, and an outside refiner lucky enough to capture 10 percent of the market would have enough gas for six months, a long time to be locked into one price.

With more storage at the Port of Anchorage, a possibility under proposed expansion plans, an outside refiner could stash cheap gas in Alaska and hold it until prices spiked.

Illegality hard to find

Those conclusions closely track the findings of the Attorney General’s investigation.

Unlike the House Judiciary report, the Attorney General was able to use both subpoenas and Civil Investigative Demands to collect thousands of pages of documents.

The Attorney General did a similar investigation under Gov. Tony Knowles from 1999 to 2002. The case went to the Alaska Supreme Court, as the state tried to get confidential information from companies, but the investigation also found no signs of illegal activity.

From the start, it seemed unlikely this investigation would be any different.

High prices alone aren’t illegal. Because Alaska doesn’t have a price gouging law, refineries and retailers can charge whatever the market will bear for fuel products.

Current state law prohibits collusion, where competitors meet to set prices; attempts to monopolize a market, such as splitting it between competitors; and predatory pricing.

“To find something ‘unscrupulous’ or ‘unconscionable’ is very difficult to do. That’s very extreme kind of behavior that’s not really explainable by almost anything else,” said Ed Sniffen, an assistant attorney general who wrote the state report. “We didn’t find that here because you could explain some of these prices just with these market conditions.”

Sniffen said small markets often have parallel pricing without collusion, especially considering the fact that gas stations know exactly what competitors are charging.

“You work in a small environment with few competitors long enough, you can predict the reactions of your competitors,” Sniffen told the House Energy Committee on Feb. 12.

The Attorney General report also decided recent gas prices didn’t violate the Unfair Trade Practice and Consumer Protection Act, which sets out 55 illegal activities.

The report said that while recent gasoline prices might seem “unfair,” “excessive” or “unconscionable,” terms used by the state Supreme Court to gauge inappropriateness, the prices can be explained by world commodity prices and the market structure in Alaska.

New bills in the works

But that doesn’t mean the law can’t be changed.

“We, as a Legislature, have the right to add to the 55 acts that are already considered ‘unfair,’ and then the Supreme Court would be required to accept our definition of ‘unfair.’” Sen. Bill Wielechowski, a Democrat from Anchorage, said Feb. 12.

Senate Bill 54, which Wielechowski sponsored, would do just that, amending the Unfair Trade Practice Act to add a 56th illegal activity related to the sale of refined products.

SB 54 would tie fuel prices in Alaska to those in Washington state. Under the proposed law, the prices Alaska refiners charge for gasoline, diesel fuel and heating oil could not be more than 10 percent above the average price of similar products in Washington.

“We’ve always stepped in to intervene to help out consumers when issues like this arise,” Wielechowski told fellow members of the Senate Special Committee on Energy.

Wielechowski said reduced competition in Alaska means the local market is not free, and therefore Tesoro and Flint Hills were “able to set prices at any level that they desire.”

“Unfortunately,” Wielechowski added, “it’s the people of Alaska who are paying for the exorbitant prices that were being charged by these refiners.”

Wielechowski said the bill, while capping prices, also gives refiners “the benefit of the doubt” by tracking prices to Washington, which is typically above the national average.

Referring to the House Judiciary Committee report, and its conclusion that Alaskans should subsidize the jet fuel industry at times, Wielechowski said, “Alaskans are sick and tired of subsidizing large businesses at their expense. Alaskans are tired of paying these huge costs so that large corporations can pay multimillion-dollar bonuses to their executives. This is one way that we can stand up for the consumers of Alaska.”

Rep. Pete Petersen, a Democrat from Anchorage and member of House Energy, sponsored House Bill 68, a companion to Wielechowski’s bill. HB 68 has been referred to the House Labor and Commerce Committee, but has not been scheduled for a hearing.

Following the Attorney General’s report, Petersen released a statement saying, “The truth is, the free market only functions properly when there’s healthy competition. That’s why we have anti-trust laws, and that’s why Alaskans need to be protected at the pump.”

Initial public support

SB 54 has traction with the public, getting much support at a recent public hearing.

One man contrasted gasoline with natural gas, saying if prices for natural gas in Alaska are tied to Henry Hub, an index desired by some producers, then gasoline prices should also be tied to some market in the Lower 48. “You can’t have it both ways,” he said.

Another said refiners and wholesalers should be subject to a “profit cap” instead of a price cap. A third said the bias toward air cargo comes at the expense of other industries.

Merrick Peirce, a board member for the Alaska Gasline Port Authority, said the bill would remedy “very obvious price gouging,” but a longer-term solution would be a gas pipeline allowing local consumers to fuel their vehicles with Compressed Natural Gas.

Two people calling from Kotzebue, a coastal community in the Northwest Arctic, said the bill should include wholesalers to protect rural areas not served by Alaska refineries.

Strong industry opposition

Representatives from Tesoro and Flint Hills testified against SB 54.

Both made the point that as independent refineries, Tesoro and Flint Hills must buy the oil they use to make their product, and therefore make more money when oil is cheap.

“We make commodities. Jet fuel, gasoline, propane, asphalt: they’re all commodities. They’re run on commodity markets, and prices are determined through the fundamentals of the commodity market,” said Kip Knudson, external affairs manager for Tesoro.

Therefore, he said, independent refineries like Tesoro, which don’t produce oil, only make a profit when the cost of the “inputs” are less than the price the companies charge.

“When gas prices were exceptionally high, we were actually losing money. It’s a very difficult concept for people to understand in the marketplace. It’s irritating and frustrating,” Knudson said.

Jeff Cook, with Flint Hills, said, “Price control legislation will harm consumers by causing shortages” because the bill could force Flint Hill to stop refining in Alaska.

Cook said environmental regulations, particularly regarding sulfur, have forced the company to import products, and therefore “supplies are tight and margins … are small.”

Flint Hills is currently working with the state to find ways to keep the refinery open.

Many who oppose SB 54 and HB 68 point to efforts by Hawaii, a state with similar market constraints as Alaska, to cap gasoline prices in 2005. The measure is believed to have driven gasoline prices up to the cap, and the law was repealed the following year.

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