Gas prices and the limitations of “free markets”

This thing about gas prices in northwestern Vermont just keeps getting more and more interesting.

Earlier this week, Senator Bernie Sanders called for a federal investigation into why gas prices are higher in the northwest, while they’ve dropped in other parts of the state. (Including very nearby parts.) He offered a hint to the feds: the fact that gas station ownership is heavily concentrated in the Northwest. Nearly 60% of the gas stations in Chittenden County are owned by four companies.

(One of them,. R.L. Vallee, is owned by Skip Vallee, a very generous donor to Republican campaigns. For his fundraising work in 2004, he was named Ambassador to Slovakia by President Bush. Earlier, he’d made one spectacularly unsuccessful foray into politics, spending a massive $134,000 on a losing bid for State Senate.

If anyone out there has information about the political affiliations of the other three, I’d be happy to hear it. The other three outfits are Champlain Oil owned by the Cairns family; Simon’s, owned by Joe and Charles Handy; and S.B. Collins, owned by Bruce Jolley.)

In today’s Freeploid (available here if you haven’t used up your monthly allotment of ten freebie articles), there’s a really good story about the issue. And the Big Four had some fascinating (in a stupid and/or condescending way) things to say about gas prices. I’ll present a selection here, and follow with some information on why free markets don’t work in sectors like this.

First new bit: Bernie reports that Burlington-area gas prices are out of whack with a Federal Trade Commission computer model. According to said model, the price of a gallon of gas should have been somewhere between $3.25 and $3.58 — not the actual $3.68 average.

The Big Four gas station operators were quick to take umbrage at Bernie’s call.  

“It’s normal competition,” said Bruce Jolley of S.B. Collins Inc. of St. Albans. “You watch what everybody else is doing.”

Interesting way of putting it, Bruce. That could mean you’re making sure your prices are the lowest around, or it could mean you’re not lowering your prices unless you have to. Jolley continues…

Asked why Burlington-area prices earlier this week were 35 cents a gallon higher than in Middlebury, Jolley said Middlebury had “different competitive pressures.”

Yeah, Middlebury is more isolated and has a lot fewer drivers. You’d think those factors would raise prices, not lower them. After all, it’s harder to get the gas there, and you’re selling in substantially smaller quantities. Whatever happened to economies of scale? But wait, Jolley has one more insight to offer:

Asked why Burlington’s prices were the among the highest in New England, he said, “I don’t have an answer for that.”

Well, thanks a lot. You’ve been in the gas station business since the mid-1970s, and you don’t know how gas prices come about?

Skip Vallee offered the biggest howler of all. After the jump…

Vallee said Sanders should support the Keystone pipeline project and the plan to refine tar sands oil from Canada for use as gasoline and other petroleum products if he is truly interested in saving his constituents money at the gas pump.

“That would save Vermonters 30 cents a gallon,” Vallee said.

Sure thing, Skippy. The Keystone pipeline would funnel tar sands oil from Canada to refineries and ports on the Gulf of Mexico for export overseas. It would have no direct effect on Vermont gas prices, and would not lower US prices at all unless the Canadian oil is so abundant that it floods the global market, lowering oil prices for everyone. And that’s

As it happens, I recently read a very good explanation for the gas price phenomenon. It comes from a study of electricity markets done by Sarosh Talukdar of Carnegie Mellon University, as reported in David Cay Johnston’s excellent book “Free Lunch.”

Talukdar created an ideal market for electricity. It had a decent number of producers and utilities, competing on an equal footing. You’d expect that competitive pressures would force electricity prices to fall to the lowest level that would allow producers a reasonable profit.  

But they didn’t. Prices rose. Talukdar ran the model four times, adjusting the parameters, and each time the result was the same.

If this had happened in real life, you’d be crying “collusion” and “price fixing.” But these weren’t real companies, it was just a computer simulation. The conclusion, as reported by Johnston:

What the experiments showed was that sellers could jack up prices in this market because the buyers are forced to buy. If the price of a share of stock or a piece of land is too high, buyers can walk away. Not so electricity.  …So long as no one broke ranks and undercut the market, the sellers overall get higher prices and fatter profits…

…This unstated coordination gave the producers of electricity what economists call market power, which means the ability to set prices higher than a competitive market would allow.

…”Collusion is a crime,” Talukdar noted, “but learning is not. My studies show it is easy to learn from the signals given by others how to get the benefits of colluding without breaking the law.”

The markets for electricity and gas are very similar in one crucial way: captive customers. If you’re driving around Burlington and your gauge is on “E”, you’re not driving to Middlebury for a fill up. Hell, if your tank is 1/4 full, you’re not driving to Middlebury just to save 25 cents a gallon. The Burlington area is. practically speaking, a captive market.

Remember, this works even if there is no active collusion — just a handful of experienced operators who, as Talukdar puts it, know how to read the signals.  

Conservatives these days are fond of putting their faith in free markets. But that’s not enough. Winding up the free market and letting it go simply doesn’t work for a variety of products and services, including the most essential ones. Talukdar concludes that “the design of markets matters a great deal and the design must be verified to see if it really works as a free market.”

That notorious communist Adam Smith had some things to say about this, too. He was the foremost apostle of free markets — but he included some very strong caveats. He warned that a free market wouldn’t work unless buyers and sellers were equally knowledgeable about the transaction, equally free to engage in commerce or not, and had free choice of equivalent options. The second qualifier doesn’t apply to Chittenden County gas prices: sellers are free to sell, but buyers are stuck with the choices available in their geographic area. In that circumstance, as Talukdar proved, prices are likely to be higher than they should.  

14 thoughts on “Gas prices and the limitations of “free markets”

  1. and thanks to Bernie for calling the question

    isn’t it interesting how we have become accustomed to these high prices; talk about a giant sucking sound, at least 80% of the cost of a gallon leaves the state

    as we listen to the endless complaints about the “burden” of Vermont taxes, we rarely (if ever) hear about the enormous drain on households & businesses from transportation & heating fuels; it is the equivalent of a tax

    how can it possibly be in the public interest to export so much money for basic needs?  

  2. Was it not rumored someplace that GasolineValley as Freyne called him, basically colluded with some other Colchester folks to basically bury the Colchester COSTCO’s plan to introduce lower cost fuel to the area???   Rumored further that SKIP actually was so bold as to tell the COSTCO folks that he would not deliver to them-he being BOTH the wholesaler and the retailer (two bites at the profit apple) but Costco has their own source in Jersey so they told him to pound sand.   Then he and others apparently threw a wrench into the zoning process which has delayed the project but not apparently completely stalled it.  More time for Skip to take a few more pennies out of our pockets and buy pretty flowers for the Maplefields crappers.  

    Skip is also the guy who called our friend Jim Jeffords a Benedict Arnold on national TV….when he bolted from the party due to the education issue.  

  3. Middlebury’s pricing advantage may be just one more example of how wealthier people (in this case, communities) enjoy advantages over poorer people when it comes to the so-called “free marketplace.”

    The poor are more likely to put up with price exploitation than are the rich because they simply haven’t the luxury of time and focus to expend on smaller battles when they are just trying to pull in a living wage.  This has been played out innumerable times in poor urban neighborhoods in New York and Chicago, where retailers charge exorbitant prices for a single cucumber or tomato, while their suburban counterpart charges virtually the same amount for half-a-dozen.

    The “free market” becomes the “captive market” when you are too poor to drive far enough to choose a bargain over a swindle.

    No doubt Jolley has figured out long ago that you don’t put one over on the nobs of Middlebury.

  4. The cost of price shopping for gas is too high, because you have to drive your car to do it!  At IRS reimbursement rates of $.55 per mile, to get a 5 cent per gallon savings, you would use it all up driving just one mile (assuming an 11 gallon fill up to make the math easier).  Going 70 miles round trip to Middlebury would cost nearly $40, $21 for the gas alone.  Gas would have to be $1.60 per gallon for that to make sense.

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