Price gouging is difficult to define, but many people believe that they know it when they see it at the gasoline pump. Volatility in gasoline prices (e.g. up ten cents one day and down three cents two days later) coupled with an overall upward trend in crude oil prices can put consumers and government agencies on the alert for signs of price gouging. To avoid interference in the proper functioning of the market however, care must be exercised in sorting out opportunistic price gouging from normal (i.e. legal) price volatility.

Prices in any commodity may fluctuate dramatically for reasons unrelated to anti-competitive activity. A sudden surge in demand, or an unexpected problem in the supply chain, can cause prices to spike quickly. A change in the price of a necessary input can have a dramatic effect on the price of the final good. Such price changes are disruptive to both consumers and businesses, but they are not, by themselves, evidence of illegal pricing or price gouging.

The factors that drive gasoline prices are indeed complex, involving international crude oil inventories, national wholesale product price discounting, and domestic retail competition, to name a few. Of the factors driving prices, the single most important one appears to be the price of crude oil. The Federal Trade Commission’s (FTC) conferences and staff reports identifying factors affecting gasoline prices concludes that changes in crude oil prices account for approximately 85 percent of the variability of gasoline prices. When crude oil prices rise, as they have recently, gasoline prices rise. Crude oil prices are determined by supply and demand conditions worldwide, most notably by production levels set by OPEC countries. Additionally, other factors that affect the supply of and demand for crude oil, such as the fast growing demand for petroleum in China, influence the price of gasoline in the United States.

In the context of regional gasoline markets, price changes can also occur because of a unique combination of localized supply and demand conditions. The amount of gasoline that can be supplied to a particular region can be inflexible because of various limitations of refining, transportation and storage capabilities or product requirements unique to that region. When a sudden supply shortage jolts the market, perhaps due to a refinery fire or pipeline rupture, the normal consequence of even a relatively small shortage of supply is a sharp increase in price.

Regional inventories of both crude oil and refined petroleum products can have an effect on retail gasoline prices. At the FTC’s conferences, the Energy Information Administration (EIA) reported that high crude prices affect gasoline prices by indirectly reducing gasoline inventories. The National Petroleum Council in a study of the petroleum inventory system noted that “since holding inventory is a cost, there is an underlying continuous pressure to eliminate that which is not needed to meet customer demand or cannot return a profit to the holder.” Consequently, average inventories for refined petroleum products have declined over time contributing to price spikes as additional supply is less available to quickly meet demand.

In a similar vein, the FTC conferences noted that refineries and the pipelines used to transport gasoline to the pump are typically highly utilized. For example, national annual refinery capacity utilization between 1998 and 2002 averaged 92.7 percent. Refinery utilization rates are often higher during peak demand periods, such as during summer months when the demand for gasoline is strong. Pipeline capacity also is stretched in some regions of the country for at least parts of the year. Although it is efficient to run these capital intensive facilities at high rates of capacity utilization, supply disruptions from unexpected refinery outages or pipeline failures may not be easily or immediately compensated for by other supply sources due to capacity limitations, resulting in substantial market price effects in some cases. Moreover, the proliferation of different environmentally mandated gasoline blends has reduced the ability of firms to ship gasoline from one region to another in response to supply disruptions.

Given the many factors that can contribute to gasoline price volatility how then can we differentiate between legal and anti-competitive activities? Anti-competitive non-merger actions are frequently divided into 2 categories: collusive activity and anti-competitive unilateral action by a firm with market power. Horizontal agreement on gasoline price or output, that is, agreement across or among integrated oil companies would be considered collusive activity and is illegal under federal antitrust law. Ongoing Federal Trade Commission monitoring has not identified any instances of collusion to manipulate gasoline prices either recently or going back to incidents growing out of the September 11, 2001 attack.

Anti-competitive unilateral action by a firm with market power has been alleged especially with respect to the issue of “zone pricing.” Zone pricing is a practice under which refiners sell to their affiliated retailers at wholesale prices that differ across geographic areas. Sometimes this practice is viewed as price gouging because it implies the ability to charge higher wholesale prices in geographic zones where their retailers do not have nearby retail competitors, implying a degree of market power. The FTC in its investigation of this issue acknowledged the existence of zone pricing in some limited areas. However it concluded that if zone pricing reflects price discrimination but does not otherwise make the exercise of market power more durable or effective, the impact of zone pricing on the consumer is ambiguous. When sellers practice price discrimination, prices are lower to some consumers and higher to others than would be the case if sellers charged uniform prices.

Vertical integration in the oil industry, that is, ownership of retail gasoline stations by the petroleum industry itself is another facet of anti-competitive allegations. Specifically, the concern is that price manipulation is possible where retail stations are bound to one supplier by contract. In response a few states have passed divorcement laws making it illegal for refiners to own and operate retail gasoline outlets. Maryland was the first to pass such legislation in 1974 with a handful of states following suit. A 2000 California Task Force report from Attorney General Bill Lockyer asserts that “the key to enhancing competition at the retail level is to eliminate vertical integration by petroleum companies.” This, however runs counter to basic economic theory and evidence from field studies according to Cary Deck and Bart Wilson authors of a study entitled “Economics at the Pump.” Essentially, they claim that divorcement imposes double markups and hence higher prices. That is, the refiner’s price to the stations includes a markup above the refiner’s cost and then the station places another markup on top of that. With vertical integration, the retail station only charges one markup to the final consumer. While double markups and hence higher prices may be true where divorcement is required, this argument does not directly address the issue of whether petroleum companies are using retail outlets to command market share and thus set prices higher in the short run than they would be otherwise. Moreover, it is a fair question to ask whether vertical integration has lead to greater price volatility and the possibility of short term price manipulation where branded retail outlets are dominant.

Given these complexities, what constitutes price gouging? Is it simply that more than a reasonable price is being charged for a product in someone’s view? Is it a price higher than consumers are used to? Frequently price gouging is spoken of in terms of profiteering, that is, pricing products or services unreasonably high during an emergency or disaster. States are beginning to address these issues by implementing new laws specifically aimed at price gouging during unusual circumstances. For example, in 2002 Indiana promulgated a new statute that is triggered when the Governor declares a “State of Disaster Emergency” or a “State Energy Emergency.” It allows the Attorney General to investigate and pursue allegations of price gouging. The gasoline price gouging statute requires the Indiana Attorney General to consider pricing which grossly exceeds the average price at which gasoline was available for a retail market during the seven days preceding a declaration of emergency. The gasoline price gouging statute also requires that the increase in price is not attributable to reasonable market forces.