California's phase II environmental regulations: Effects in the retail market

This paper seeks to determine whether California’s Phase II Reformulated Gasoline Regulations increased profits at the retail level of production for dominant producers in the state. A simple linear model is used to develop theoretical expectations as to the effect that increased gasoline rack prices would likely have on California’s retail gasoline market, given the high degree of vertical integration employed by the largest firms in the industry. Then panel data is used to explore the disparity that exists between California and several control groups in terms of finished gasoline retail prices and the retail market share of fully integrated retailers. Finally, empirical results are compared with that found in Brown (2009) in order to provide an adjustment, if necessary, to the profitability of Phase II on California’s large, vertically integrated refiners.    

Results indicate that California’s large, vertically integrated retailers did experience an increase in the retail price of gasoline which surpassed the increase in costs from the Phase II regulations.  This result implies that the implementation of Phase II was not only profitable in terms of wholesale gasoline sales, but also in terms of gasoline retail sales.  Additionally, large, vertically integrated retailers were able to gain a price advantage over their competitors that led to a noticeable shift in market share among all gasoline retailers in the state.  Of special note, however, is that this price advantage stemmed from an increase in the gasoline retail price which is smaller in magnitude than the increase in the gasoline rack price found by Brown (2009).  Because of this, the total profitability of Phase II for California’s large, vertically integrated refiners, while still positive, is lower than might be thought from analyzing wholesale prices alone.