Celebrating Chevron’s Profits

Recently there was a bad fire at the Chevron refinery in Richmond, CA, as you probably know.  The refinery will be offline for an unknown period, probably months.  Upon reading this, and knowing that the CA government prohibits “imports” of gasoline from other states, I knew the retail price would jump.  I made a mental note to fill up my Thunderbird next morning.  Too late – regular had jumped from $3.85 to $4.01.  This morning it was $4.06, and $4.13 by afternoon.

My reaction?  I’m delighted that the market is doing its job of balancing supply, which has suddenly dropped, with demand.  But predictably, ignorant fools have jumped on this situation, as in this letter in this morning’s San Francisco Chronicle:

Please ask Chevron to explain why the cost of gasoline will go up because of an accident at their plant.

Don’t they have insurance to cover the loss of their equipment? Is Chevron going to recoup the lost income (deducted from the billions of dollars in profit that they make every year) from us?

If the accident was determined to be due to Chevron’s negligence, are they going to compensate all of their neighbors “inconvenienced” by this?

But most of all, please ask all the other oil companies why their costs are going up because of a fire at a Chevron refinery.

If the other companies are not suffering a financial loss from this devastating environmental disaster in the Bay Area, why are prices expected to rise at Exxon-Mobil, Royal Shell Dutch, BP (Arco, lest anyone forget) and any other company I might be too angry to remember at this moment?

I might have to hold my breath until you find out the answers to these questions or until the air clears, whichever comes first. I’ll let you guess which one that will be.

Chevron probably doesn’t carry insurance because they are big enough to be self-insured, and the risks may be too large and uncertain for an insurance company to estimate.  But insurance is irrelevant to retail pricing.  The basic problem is the all too common myth on which this letter is based: that cost determines price.  The myth is that suppliers add up their costs and then tack on as much profit as they think they can get away with.  As anyone who has studied economics should know, supply and demand jointly determine price in a competitive market such as gasoline.  Set your price too high and you lose customers and your profit declines.  Set it too low and your margin declines, and you may sell out your supplies.  The sweet spot varies constantly with shifting supply and, to a lesser extent, shifting demand.

Of course, profits benefit Chevron’s shareholders.  But they are vastly more valuable to Chevron’s customers because they are the driving force (putting aside government interference) that tells Chevron what kind of products we want, where they are offered, how they are delivered, etc.

Of course, government interference is substantial and shouldn’t be set aside.  Politicians worried about rising gas prices could help out by lifting the prohibition on imports.

Hurray for profits!

An Ominous Expansion of Eminent Domain

A new assault on private property is in the works and it hasn’t gotten much attention – yet.  Needless to say, it goes by an Orwellian name, in this case the “Homeownership Protection Act.”  As summarized recently by Kathleen Pender in the San Francisco Chronicle, the scheme has been hatched by two cities in San Bernardino County and has not taken effect yet but is under serious consideration.  A new agency called a “Joint Powers Agreement” would be formed to do the dirty work.

The idea is to use the power of eminent domain to seize mortgages – not houses but mortgages owed to lenders by homeowners who have defaulted or are under water.  Using Ms. Pender’s example, suppose there is a $300,000 mortgage on a house worth $200,000.  The agency decides the mortgage balance should be $190,000 which would leave the homeowner with $10,000 in equity.  It seizes the mortgage and compensates the mortgage holder in an amount such as $170,000.  A new mortgage in the amount of $190,000 is then issued by a private firm which would reimburse the agency some lesser amount, say $180,000.  Thus the private firm pockets $10,000 up front and the agency another $10,000. One such firm, Mortgage Resolution Partners, has already been formed in San Francisco for this purpose.

There are some technical questions.  How is the house value determined?  By appraisers, presumably, but we saw in the housing bubble how useless their numbers were.  And what if the mortgage had been securitized, i.e., put into a mortgage-backed security?  The Federal Reserve holds a lot of these securities.  What if a local government entity tried to seize a mortgage that was ultimately owned by the Fed?  Wouldn’t that be fun?

Technical questions aside, the whole idea portends a massive new assault on private property by ravenous politicians and bureaucrats and their private co-conspirators.

Eminent domain has generally been understood as a way of solving holdout problems when a “public” project is proposed.  Such projects typically require acquisition of property from a number of owners and can’t be built at all unless and until all owners are willing to sell.  A single holdout can ruin the project.  Thus eminent domain has almost always been used to seize real property (land and buildings) as opposed to personal property such as mortgages.  (Private solutions to holdout problems have been proposed.)

The only ultimate limitation on the use of eminent domain is a clause in the Fifth Amendment to the U.S. Constitution which says “nor shall private property be taken for public use without just compensation.”  That clause is of course wide open to varying interpretations of “public use” and “just compensation.”

A landmark Supreme Court 5-4 decision in 2005 held that the City of New London could seize a modest house owned by Suzette Kelo and hand it over to a private developer.  The house and surrounding buildings were seized and destroyed but the project went bust and the land is still vacant.  This was a significant extension of the notion of “public use.”  Justice Stevens in his decision to uphold the City noted that “a public purpose will often benefit individual private parties.”

Indeed.  Can there ever be a public project that does not benefit some private party?  Any public project necessarily diverts resources to some private party such as a contractor or neighbors whose property values are enhanced.  Turning the proposition around, almost any private project throws off some public benefits.  Kelo opened the door to conspiracies of private developers and public officials to launch almost any sort of assault on anyone’s private property.

The “just compensation” clause is also gravely problematic.  Suzette Kelo loved her little pink house.  Its market value wasn’t nearly enough to compensate for the emotional loss she suffered when she was kicked out.  Values, as distinct from prices, are subjective and are revealed by voluntary transactions.

In addition to the obvious grave immorality of this latest assault on private property, consider the incentive problems that it raises.  Future savers will be reluctant to invest their savings in mortgages or financial products containing mortgages knowing they could be expropriated.  Homeowners will find loans harder to get, thanks to the “Homeowner Protection Act.”  (Echoes of Ludwig von Mises: government interventions invariably make things worse for their ostensible beneficiaries.) There will be a marginal shift away from saving toward consumption.  Economic growth will be marginally slowed, for which politicians will blame the free market and plump for yet more expansions of government power.

Should the San Bernardino project go forward, it will be very likely to end up at the Supreme Court.  The Kelo and Obamacare decisions do not bode well for the result.