Preventing Price-Gouging of Gasoline after Natural Disasters

by rmalhotra November 10 2008, 15:59

I. Introduction

In 2007, in response to the public’s anger about the high cost of gasoline after the hurricane disasters, the House of Representatives drafted and passed the Federal Price Gouging Prevention Act (“FPGPA”), which reads in part:

“It shall be unlawful for any person to sell…during a period of an energy emergency, gasoline…at a price that 
(A) is unconscionably excessive; and 
(B) indicates the seller is taking unfair advantage of the circumstances related to an energy emergency to increase prices unreasonably.” [1]

To date, the Senate has not voted on the bill.  While the victims of recent hurricanes were understandably angered with rising gasoline prices in the days following the disasters, the FPGPA would ultimately do these consumers more harm than good in terms of economic recovery because the language of the bill sets an unclear standard for law enforcement, merchants and consumers, and anti price-gouging legislation has been shown to cost consumers more money long-term.  Rather, modification of federal and state legislation already in place would most effectively prevent the unfair manipulation of gasoline prices.

II. Legal Standard

Paragraph (1) of the FPGPA defines punishable behavior as that which is unconscionable and that which takes unfair advantage.[2]  Such terms require subjective interpretation that increases the difficulty of both compliance and enforcement.[3]  U.C.C. §2-302 does not even contain a definition or a standard to determine whether the terms of a contract are in fact unconscionable.[4]

In attempting to provide a workable standard, paragraph (3) of the FPGPA looks to whether the amount charged: (i) grossly exceeds the average price at which the gasoline was offered for sale during the 30 days prior to such proclamation; (ii) grossly exceeds the price at which gasoline was readily obtainable in the same area from other competing sellers during the same period; (iii)reasonably reflected additional costs, not within the control of that person, or reflected additional risks taken by that person to sell gasoline under the circumstances; and (iv) was substantiallyattributable to local, regional, national, or international market conditions. (emphasis added) [5]

Though this paragraph is intended to provide guidance, it only provides additional terms that are equally open to subjective interpretation; the terms grosslyreasonably, and substantially do not significantly clarify the standard for paragraph (1).   The argument for the use of such terms is that their subjective quality gives the court discretion in deciding whether an action or contract qualifies as unconscionable or one that takes unfair advantage.[6]  Greater specificity might rob the law of its flexibility, its ability to evolve with changing times and changing community standards.[7]

The disadvantage of using such vague terminology in the FPGPA is that the language sets an unclear standard that harms merchants and consumers alike.[8]   Without a clear guideline as to what constitutes an actionable price, consumers in a post-disaster state jump to report prices they believe are unfair, and otherwise innocent merchants are forced to defend themselves in court for prices they thought were reasonable, clogging bureaucracy with false claims.[9]  The FPGPA’s language creates a significant risk of litigation costs, the burden of which ultimately falls back on the consumer.[10]

Such discretionary language is not required for price-gouging legislation.  A number of states that have passed anti price-gouging legislation have recognized the disadvantage of the ambiguous standard and have opted for more specific standards in the form of percentage-caps or no-increase laws.  California and Arkansas, for example, bar hikes in the wake of a declaration of an emergency that exceed a certain percentage-point increase over the pre-emergency price level.[11]   Georgia, Louisiana, Mississippi, and Connecticut bar any price increase beyond that required by the higher costs of post-disaster economic activity.[12]   While these standards may not initially appeal to merchants in that they restrict prices, the standards are actually beneficial because of their clarity. 

III. Existing Federal Legislation

Generally speaking, anti-trust laws cover three broad areas: collusion among competitors, anti-competitive mergers, and exclusionary practices.[13] 

Prevention of collusion falls under the Sherman Anti-Trust Act, which Congress intended to protect the right of producers to compete on their merits, and, in turn, the right of consumers to enjoy the lower prices that must result from that competition.[14]  Thus, horizontal price-fixing of gasoline, such as agreements by competitors to set a floor on prices or to raise prices, would be a violation of that Act.[15]

The Sherman Act also reflected Congress’s opinion that when businesses combine in such a way as to reduce competition, consumers suffer, and legislative bodies have both a right and a duty to intercede on behalf of those vulnerable consumers.[16]  This conclusion is restated in the Clayton Act, which prohibits mergers that may substantially lesson competition or tend to create a monopoly.[17]   

Finally, the antitrust laws also protect consumers from “abuse by single-firm conduct such as the illegal maintenance or acquisition of monopoly power.  Generally, unilateral conduct violates the antitrust laws only if a firm has sufficient market power that its actions could not be counteracted by its competitors or by new entry.”[18]

Significantly, anti-trust laws do not necessarily guarantee low prices, only the conditions that lead to them.[19]  This distinction is intentional; the United States Supreme Court has recognized that while it may set the circumstances for achieving a fair price, the workings of a liberal market are better able to determine the fair price itself.[20]  While anti-trust laws prohibit fixing maximum prices, the entire goal of the FPGPA is to accomplish just that.  In doing so, the FPGPA fails to recognize the Supreme Court’s view that “[a]ny combination which tampers with price structures is engaged in unlawful activity.  Even though the members of this price-fixing group were in no position to control the market, to the extent that they raised, lowered, or stabilized prices they would be directly interfering with the free play of market forces.”[21]

IV. The Effect of the FPGPA on the Market

Free-Market Theory
Most hurricane victims who felt they were subjected to price-gouging assumed that the supply of gasoline to their disaster area remained constant, and that merchants took advantage of consumers who had no other options.  This assumption is incorrect; a disaster actually cuts off the supply of gasoline to merchants in the disaster area.  Consumers then outbid one another for the limited amount of gasoline available, and the price peaks at an amount no consumer is willing to outbid.  Those who cannot afford the price find alternatives (walking, biking, and carpooling) that eventually reduce the demand for gasoline.  As the area recovers, supplies of gasoline return to normal levels, causing merchant competitors to then reduce their prices to attract consumers.  Thus, gasoline price fluctuations after a disaster are not breakdowns in the market system, but rational, predictable responses to changing circumstances.[22]  Statistically, the responses to Hurricane Katrina and Rita tracked the supply-and-demand model almost perfectly.[23]

Consequences of Price Controls
In 1971 President Nixon attempted executive branch implementation of price controls for crude oil and refined petroleum, and the results were overwhelmingly negative.[24]  One of the short term consequences of price controls is that they make gasoline lines longer.[25]  Under supply and demand theory, prices rise to an amount that only a certain number of consumers can afford, thus ensuring that the limited supply of gasoline in the disaster area will last until regular supply routes can be reestablished.  With price controls, however, many more consumers can still afford to purchase gasoline, virtually ensuring that the supply in the disaster area will run out.  The fear of losing supply triggers consumers to fill up more frequently, causing long lines at stations.  Gas station operators, unwilling to pay extra for bringing in gasoline from elsewhere because they cannot pass the costs on to consumers, then close their stations, making lines even longer at the stations left open.[26]   

Another short-term consequence of price controls is market waste.  A study of the gasoline lines that developed when California ordered Chevron to sell gasoline at a discount estimated that the added costs in time associated with price controls were 116 percent of the monetary savings provided by price controls.[27]  In other words, price controls did not allow time to be used most efficiently; because time wasted can never be recovered, price controls result in what is known as market waste. Any savings to consumers from lower prices are dissipated by the cost of time lost.[28] 

A third consequence of price controls is an inefficient use of the limited supply of gasoline available.  When gasoline is purchased by consumers who have time to wait in lines (consumers with “lower time value”), more highly valued uses of gasoline go unfilled.[29]  Instead of gasoline going to those most willing to pay for it (e.g. delivery trucks), it goes to those with the most time on their hands (e.g. the household teenager).  Because price controls give suppliers no financial incentive to stockpile extra gasoline or increase the supply to a disaster area, reestablishing supply takes an even longer time.[30]  Areas with less need, but free price range, receive the gasoline instead.   

Market prices avoid these consequences and guarantee that resources will flow from those areas untouched by the catastrophe.  After the hurricanes, demand in the affected areas for gasoline grew significantly due to evacuations and relocation efforts.[31]  Consumption actually increased in the Gulf Region despite about a thirty-nine cent increase per gallon of gasoline; cost in surrounding, unaffected areas, however, rose about sixty-one cents per gallon, causing a reduction in demand by about fourteen percent.[32]  Market prices allowed the gasoline to move from the area of lower demand to the area of higher demand.  Had price increases been illegal in Louisiana and Mississippi, gasoline prices would have remained low and gasoline would have instead gone to higher paying areas such as the Northeast.[33]

This suggests a slippery slope: as the perception emerges that price controls are not leading to efficient and equitable allocation of gasoline, the temptation is to create even more stringent regulations.[34]   This downward spiral into more and more legislation accounted for much of the waste associated with oil prices in the 1970s.[35]

Vulnerable Populations
The argument against letting the market control the distribution of gasoline after a disaster is that only a small population of wealthy consumers will have access, while the vulnerable population will be left to fend for itself.

The reality is that lower-income families and consumers in rural areas do not benefit from price controls.  “[E]vidence shows that choosing between a significantly cheaper gasoline with wait time and a more expensive/no-wait station is not highly sensitive to income.  Rather, price caps in effect give individuals with higher income the advantage of using their resources to obtain the scarce good.  Those with high values of time have an incentive to hire others with lower values of time to wait in line on their behalf.”[36]  Price caps hurt rural areas even more by lowering the financial incentive for distributors to take on the additional costs needed to get the gasoline there.[37]   

In addition, disconnects between market prices and controlled prices of goods often lead to black market operations.[38]  “[S]ellers recognize that there are consumers who are willing to pay a higher price to ensure access to their desired goods.  The higher prices on the black market will cause the seller to divert goods away from the legitimate market...”[39]  As more goods become siphoned off to the black market, those who benefit become the ones with the resources necessary to take part in the illegal transactions.[40]  The population sought to be protected by price controls suffers as it usually has less resources, and the market performs less efficiently than it would with an equal balance of information.[41]

V. State Involvement and Alternatives

Twenty-nine states and the District of Columbia already have laws that prohibit the excessive pricing of gasoline during periods of abnormal supply disruption, normally triggered by a declaration of emergency by the President or the governor.[42]  These statutes are just as troublesome as the FPGPA because they aim to control prices in a manner that works against supply and demand theory.  Short of being repealed (which no state legislator would attempt to do without risking voter approval) these statutes should be modified so that they cause minimal interference with market recovery.

First, any price-gouging statute should define the offense clearly.[43]  An ambiguous standard would only confuse consumers and businesses and would make enforcement difficult and arbitrary.[44]      

Second, anti-gouging laws should be limited to the areas of the actual disaster, or areas where survivors are likely to flee.[45]  Proposals that apply on a state-wide level, even when the disaster only physically impacts a limited area, risk market recovery in the entire state as opposed to a narrowly-tailored region.  Similarly, applying anti-gouging laws in areas far from disaster-zones do not make economic sense because they prevent gasoline supplies from being most efficiently used.[46]   

Third, anti-gouging laws should only apply in circumstances where there is actual and widespread physical destruction, particularly to banks and electronic payment systems.[47]  Breakdowns in such financial systems may prevent market forces from operating as supply and demand predicts; consumers may place immense value on gasoline but may not be able to complete transactions due to limited financial access.[48]  Gasoline, then, will not sell to those who value it the most but to those who happen to have liquid assets.[49]  Thus, anti-gouging laws may serve as a price holder while consumers regain access to their finances.      

Fourth, anti-gouging laws should come with strict time limits.  While merchants and consumers alike are vulnerable immediately after a disaster, holding prices too low for too long in the face of temporary supply problems risks distorting the price signal that ultimately will relieve the problem.[50]  If supply responses and the market clearing price are not considered, wholesalers and retailers will run out of gasoline and consumers will be worse off.[51]   

Finally, anti-gouging laws should provide for consideration of local, national, and international market conditions that may be a factor in the tight supply situation.[52]  International conditions that increase the price of crude oil naturally will have a downstream effect on retail gasoline prices.[53]  Local businesses should not be penalized for factors beyond their control.[54] 

Initiating state change, however, is an uphill battle given that many of these statutes were enacted to appease emotional voters.  To provide incentive for states to modify their anti-gouging laws, the federal government should reward states that chose to adopt disaster relief laws more in sync with the laws of supply and demand theory.[55]  The federal government could, for example, take an active role in directing relief supplies to areas where the prices for those goods were highest, presumably those areas where the demand for those goods are the greatest.[56]  This plan would provide the following benefits over the FPGPA, detailed below.

First, this would encourage states to abandon artificially low price caps on gasoline.[57]  Current statutory price limits on gasoline dictate an amount far lower than what supply and demand would dictate under post-disaster circumstances.  By distributing disaster aid to regions with higher prices (based on a greater need), states would have an incentive to let the price reflect the true demand.

Second, the possibility of governmental competition will prevent suppliers who truly do possess monopoly power from pricing above the competitive level.[58]  The fear of drawing in competition in the form of emergency relief will induce suppliers to charge a lower price that might otherwise be charged.[59]   

Finally, the price of goods might provide a better indicator of need for aid providers.[60]  Such providers often face difficulty in determining which areas to distribute relief to, and how much relief to provide.  The market price of emergency supplies might be the most efficient way to allocate scarce goods to those who need them most.[61]   

VI. Conclusion

In limiting free market prices, FPGPA and its state counterparts will ultimately do more harm than good to the consumers and the economy.  Instead of protecting and serving vulnerable, low-income populations after a natural disaster, the FPGPA will cost them more in time and money.  Because the federal government already has legislation in place to prevent the unfair manipulation of gasoline prices, and because alternative solutions are more effective in allowing gasoline markets to recover efficiently, the FPGPA should not be passed by the Senate. 

[1]  Federal Price Gouging Prevention Act, H.R. 1252, 110th Cong. (2007)
[2]  Id.
[3]  FED. TRADE COMM’N, INVESTIGATION OF GASOLINE PRICE MANIPULATION AND POST-KATRINA GASOLINE PRICE INCREASES (2006), at 191.
[4]  U.C.C. §2-302 (2003)
[5]  H.R. 1252, 110th Cong. (2007)
[6]  Gerald T. McLaughlin, Unconscionability and Impracticability, 14 Loy. L.A. INT'L & COMP. L.J. 439, 444 (1992).
[7]  Reasonable Doubt, 108 HARV. L. REV. 1955, 1965 (June, 1995).
[8]  EXEC. OFFICE OF THE PRES., COUNCIL OF ECON. ADVISORS, A WHITE PAPER ON THE ECONOMIC CONSEQUENCES OF GASOLINE PRICE-GOUGING LEGISLATION (June 20, 2007).
[9]  Steve Bousquet, Price Gouging Cases Bring Few Lawsuits, ST. PETERSBURG TIMES, Aug. 16, 2006.
[10]  W. David Montgomery et al., Potential Effects of Price Gouging Legislation on the Cost and Severity of Gasoline Supply Interruptions, 3 J. COMPETITION L. & ECON. 357, 363 (Sep. 2007).
[11]  Geoffrey C. Rapp, Gouging Terrorist Attacks, Hurricanes, and the Legal and Economic Aspects of Post-Disaster Price Regulation, 94 KY. L.J. 535, 543 (2005-2006).
[12]  Id. at 548
[13]  FED. TRADE COMM’N, supra note 3, at 186.
[14]  Michael Brewer, Planning Disaster, 72 BROOK. L. REV. 1101, 1108 (Spring 2007).
[15]  Rapp, supra note 11, at 539.
[16]  Brewer, supra note 14.
[17]  15 U.S.C. §18
[18]  FED. TRADE COMM’N, supra note 3, at 188.
[19]  Brewer, supra note 14, at 1110.
[20]  Id.
[21]  United States v. Socony-Vacuum Oil Co., 310 U.S. 150, 221 (1940).
[22]  Brewer, supra note 14, at 1121.
[23]  FED. TRADE COMM’N, supra note 3, at 62.
[24]  CRS REPORT FOR CONGRESS, PRICE INCREASES IN THE AFTERMATH OF HURRICANE KATRINA (Sep. 2, 2005).
[25]  Montgomery, supra note 10, at 376.
[26]  Id.
[27]  Id. at 377.
[28]  Id. at 375.
[29]  Id.at 376.
[30]  Id. at 378.
[31]  Id.
[32]  Id.
[33]  Id.
[34]  Id. at 380.
[35]  Id. at 390.
[36]  Id. at 380.
[37]  Id.
[38]  Brewer, supra note 14, at 1132.
[39]  Id.
[40]  Id.
[41]  Id.
[42]  FED. TRADE COMM’N, supra note 3, at 189.
[43]  Id. at 196.
[44]  Id.
[45]  Rapp, supra note 11, at 555.
[46]  Id. at 556.
[47]  Id.
[48]  Id. at 554.
[49]  Id. at 555.
[50]  FED. TRADE COMM’N, supra note 3, at 197
[51]  Id.
[52]  Id.
[53]  Id.
[54]  Id.
[55]  Brewer, supra note 14, at 1135.
[56]  Id.
[57]  Id.
[58]  Id.
[59]  Id.
[60]  Id. at 1136.
[61]  Id.

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