Question (8) of the Resolution requests the views of survey participants on the following: (8) The effects of regulating retail gasoline prices of company-operated retail service stations. State Government AG: The Attorney General stated that "[t]he competitive effect of regulating prices is to eliminate price competition": The theoretical economic effect of regulating prices is to fix marginal revenue for the sale of gasoline at the regulated price. To maximize profits and minimize losses, the seller must adjust its marginal costs so that they equal the regulated marginal revenue. If the size of the operation at that level of cost is anything other than the most efficient size in the long run, the effect will be to upset the efficient allocation of resources among various industries in the State. The consequent tendency would be toward over-investment in some markets and under- investment in others, and hence toward waste. Waste is harmful to consumers.380 DBEDT: The department noted its earlier opposition to the regulation of petroleum prices in Hawaii in its responses to questions (1) and (7), and further stated that no evidence has been found that oil companies in Hawaii are engaged in anticompetitive behavior: More specific to the case of regulating gasoline prices of only company-operated retail service stations, we believe getting the price right would be difficult, if not impossible. A major problem for regulators in this instance would be to match the regulated price with market-driven prices which may fluctuate minute-by- minute in the world market. Further, but perhaps more important is the fact that after years of investigation, no evidence has been found of any anti- competitive behavior on the part of the oil companies in Hawaii. Their is also no evidence that company- owned and franchised stations, or those leased to branded dealers are detrimental to competition in the retail gasoline market.381 Gasoline Dealers HARGD: The Association found that while costs to implement such a program would be substantial, it would nevertheless benefit Hawaii's consumers in certain circumstances: It would not attack the issue relating to the lack of competition at the supply level of distribution or the control over the supply of petroleum products. Although it would require substantial financial resources, it would provide the state with information with respect to petroleum marketing and the profits required to justify prices approved by the agency establishing such prices. It would provide protection to the Hawaii consumer if in-fact the differential in prices between the West Coast and Hawaii were not justified. Under these circumstances, the costs of implementation of such a program would be justified.382 Jobbers HPMA: HPMA asserted that free-market competition was preferable to government regulation of prices, which would hurt consumers: Governmental regulation of prices as opposed to free- market price regulation has never proved to be effective. Any industry that has been saddled with government price regulation has proven to be a disincentive to reinvest and participate in free market profit opportunity. If the intent in retail gasoline is to provide the best service at the best price to the consumer, the only way to achieve this goal is through free-market competition. As long as investors see an opportunity to participate in future profits, industry will reinvest to harvest this potential profit. HPMA believes that the consumer deserves choices, and regulation of retail gasoline prices will hurt the consumer because the major oil companies, jobbers and private investors will not invest in an unknown regulated environment. The marketplace is the best regulator for retail gasoline prices.383 Aloha Petroleum: Aloha Petroleum stated that regulating retail gasoline prices would be both anticompetitive and anti- business, as well as probably unconstitutional: Regulating retail gasoline prices of company-operated retail gasoline stations would restrict competition and would not be beneficial to Hawaii's petroleum market. Any business needs the flexibility to adjust to market conditions. Regulating gasoline prices of company- operated stations would be anti-business. Finally, since this regulation would only apply to company- operated stations, it is probably unconstitutional.384 Oil Companies Shell: Shell noted that it did not have any company- operated retail service stations in Hawaii, but was unaware of any reason why this category of station should be singled out for government regulation of prices. Shell also reiterated its opposition to government regulation of prices as harmful to consumers in its response to question (7), noting that price controls and mandatory allocation of gasoline in the 1970s produced severe product shortages, causing long lines at service stations to buy gasoline.385 Shell further noted that price controls would result in broader negative market repercussions: Moreover, limiting price regulation to company- operated stations would not necessarily limit the adverse economic effects of unnecessary regulation to those stations and their customers. Regulating prices at company-operated stations would not only increase their cost of operation and consequently increase their prices, but would also have wider market effects. The regulated price would likely become a target or marker that would facilitate the establishment of similar prices throughout the retail market. Depending on the level of the regulated prices, they would be likely either to stabilize prices at higher levels than would otherwise prevail, or if the regulated price were set too low to provide suppliers a reasonable return on their investment, suppliers' incentives to provide gasoline and invest in service stations would be diminished and the amount of gasoline and automotive services available to consumers would be reduced. Shell is aware of no evidence that public administrators are better suited than market participants to the task of determining appropriate prices for products sold in competitive markets, or quickly adjusting such prices in response to changing market circumstances so as to avoid adverse economic effects for consumers.386 BHP: BHP argued that regulation would be detrimental to consumers by removing their freedom to choose the competitive prices and service offered by company-operated stations: The landscape of gasoline retailing in Hawaii encompasses competitive product/service offerings of many different types. Be it price, convenience, quality, service or some other buying characteristic, the gasoline consumer has the unrestricted capacity to choose between competitive offerings and select the one deemed to be superior in value in their circumstance. In short, consumers and purchase decisions serve as the ultimate value judgment on how successful a product and business is. Consumers decide what they want and how much they are willing to pay for it and successful retailers must find their niche within this landscape. Regulating retail gasoline prices would serve to take the value judgment out of the consumers hand and place it instead with some third party regulator. Given that no one is in a better position to know what consumers want than the consumers themselves, under a regulated scenario the consumer is worse off. The consumer may be left with the lowest common denominator with competitors having no real incentive to meet consumer requirements. A scenario in which only a segment of retail outlets such as company operated stations were regulated would restrict these stations in their ability to compete effectively in the marketplace to win and maintain customers. Discriminative regulations would allow competitors to make offerings to consumers designed to win business from the regulated company operated station to which that station may not be able to respond to. Putting it bluntly regulated company operated gasoline stations would be sitting ducks subject to the actions of non-regulated competitors. Prices could be regulated too high, in which case customers would cease to patronize the station and it would go out of business, or prices could be regulated too low, in which case costs would not be covered and the station would go out of business. Non-regulated stations would be free to make either scenario a reality as they would have the ability to freely set their price and regulated stations would not be able to adequately respond. In conclusion regulation of company operated stations would serve to disadvantage them relative to their competitors. Consumers would also be losers since there could be less competitors and they would have a diminished ability to make value judgments on competitive offerings through their purchases. They would no longer be free to exercise their right to pay for what they want, and a segment of the market would be restricted from offering to them what they may desire at a price they are willing to pay.387 Chevron: Regulating these prices would result in the closure of Chevron's company-operated stations: [T]here would be no purpose in regulating such prices except to keep them "up." ... Chevron has only three company-operated stations in Hawaii. It sets consumer prices at those stations to match its local competition. If Chevron were required to keep those prices artificially high, the stations would lose volume, would become uneconomic, and would go out of business. Government mandates which keep gasoline prices at company-operated stations artificially high are the equivalent of banning such stations. [S]tudy after study on this subject has demonstrated that banning such stations results in higher prices to consumers.388 Discussion This section discusses question (8) of the Resolution with respect to price controls, focusing on proposals for below-cost sales and minimum-markup legislation, and equal protection of the laws. Price Controls Generally, a state may control prices for the public welfare under the state's "police power", i.e., the power to impose restraints on personal freedom and property rights to protect the public health, safety, and morals, or the promotion of general prosperity and public convenience, subject to federal and state constitutional limitations.389 Although price controls impair the value of private property, they are generally not considered to be takings unless they unreasonably impair the use or value of property, in which case they may be deemed a "regulatory taking" requiring compensation.390 Federal government price controls, which are usually imposed for reasons of equity and perceived market inefficiencies, may take several different forms, including cost-of-service ratemaking, historically-based price regulation, windfall profits taxes, subsidies, competitive bidding for monopoly rights, and nationalization.391 With respect to the gasoline marketing industry, although price controls may be similarly justified for reasons of equity and to remedy perceived market defects, several commentators have noted various problems attributed to price controls under nonemergency conditions.392 For example, Sorensen (1991) maintained that proposed legislation to regulate gasoline prices would either limit the ability of refiners to respond to market conditions by fixing prices on the basis of historical costs, or would mandate some minimum spread between dealer tank wagon and rack prices. With respect to the former, he argued that the gasoline industry is not a natural monopoly and, as such, should not be subject to price control regulations similar to that of a public utility.393 Moreover, Sorensen believed that a system of gasoline price controls would mandate "significant new government spending for administration and enforcement. The history of government price controls for the oil industry in the 1970s provides evidence of the inefficiency of such controls."394 In arguing that federal government-imposed price controls were the proximate cause of the gasoline shortages in the 1970's, Merklein and Murchison (1980) cited an internal memorandum of the United States Department of Energy as setting out the case against gasoline price controls.395 That memorandum noted that an inability to earn an adequate return on new capital investment, together with fixed profit margins, worked as a disincentive to such investment. Although consumer demand for unleaded and high-octane gasoline had increased during the 1970s, refiners had not invested in unleaded gasoline production facilities that were sufficient to meet increased demands, since price controls prevented that product's profitability from rising with changing demand. In addition, the memorandum stated that price controls had "contributed to many inefficiencies in the market, inhibited experimentation with new pricing structures, and created serious distortions in the competitive relationship of firms."396 Fenili (1985) also found that decontrol allowed for greater efficiency in gasoline marketing. In particular, the removal of federal price and allocation controls permitted operational changes consistent with emerging technology and consumer demands, including a shift away from full-service sales to lower-priced self-service sales, but which had been constrained by federal regulations.397 The inefficiencies caused by federal price controls might be similarly experienced by Hawaii's refiners and marketers under a system of state imposed price controls, it may be argued, ultimately leading to higher costs for Hawaii's consumers. For example gasoline price controls may lead to more bureaucracy and, as a result, higher taxes and gasoline prices.398 To the extent that proposed price controls are intended to eliminate price gouging, for example, during a price inversion, these efforts may also be misplaced. In addition, proposals to enforce a mandated differential or functional discount below dealer tankwagon price for jobbers may "undermine a competitive market process where the extent of contractual agreement between the parties determines the degree of price volatility faced by wholesale buyers."399 Yamaguchi and Isaak (1990) also maintained that because petroleum products are jointly produced goods, regulating only gasoline prices would create serious market distortions: The first thing that should be noted is that it is impossible to regulate only gasoline prices without introducing serious distortions into the market. Unlike a single energy commodity such as electricity, petroleum products are jointly produced goods. The profits from refining are the sales revenues of all the products less the cost of crude and operations. Often the cost of one product is falling while the cost of another is rising. The overall profitability of refining can easily be calculated, but the profitability of any one product is impossible to evaluate. It is often hard for outside observers to understand, but there is no such thing as the "production cost" of gasoline. It is therefore impossible to set a fair price for gasoline that will ensure a fair return on investments. Economists have grappled unsuccessfully with this problem for years. In the end, countries that have decided to regulate the price of any oil product have found that they have to regulate the prices of all oil products if serious distortions are to be avoided. Under regulation, it is quite easy for a government-set price to be considerably higher than what would be seen in an unregulated market--especially if only a single price is controlled.400 They further noted that most countries attempting to regulate gasoline prices soon realize that they must not only regulate all prices, but must also control imports, investment, and operating decisions; "[o]ne price regulation decision soon leads to regulation of the entire industry, and usually to controls on trade of a type that it is not clear are enforceable or legal at anything below the national level."401 Below-Cost Sales and Minimum-Markup Laws In the gasoline marketing industry, according to the GAO (1993), states have proposed several types of laws regulating the price of petroleum products in response to concerns of unfair pricing by the petroleum industry, including below-cost sales laws, which generally require that a refiner not sell gasoline for less than the refiner's average cost, and minimum-markup laws, which establish minimum wholesale and retail gasoline margins.402 Below-Cost Sales Laws. In addition to below-cost sales laws focusing specifically on petroleum products, many states have enacted below-cost sales laws with respect to commodities and services generally pursuant to their police power in response to perceived anticompetitive practices, which have withstood constitutional challenge.403 These statutes are not price-fixing laws but are rather aimed at "loss leader" selling, and are intended to protect small independent merchants who cannot afford to sell below cost and are unable to compete with those retailers that engage in these practices.404 Hawaii's below-cost sales law is contained in the State's Unfair Practices Act, codified in chapter 481, part I, Hawaii Revised Statutes, which generally prohibits firms from producing or selling a commodity or service "with the intent to destroy the competition of any regular established dealer" in that commodity or service.405 Hawaii's below-cost sales law prohibits any person from selling, offering for sale, or advertising any product or service "at less than the cost thereof to such vendor", or from giving away any such article "with the intent to destroy competition."406 In addition, Hawaii's Unfair Practices Act provides exceptions to otherwise prohibited below-cost sales, including exceptions for damaged goods, the closing out of stock, and good faith efforts "to meet the lawful prices of a competitor ... selling the same article or product, or service or output of a service trade, in the same locality or trade area...."407 With respect to petroleum products in particular, proponents of below-cost sales laws and other gasoline pricing regulations have maintained that such legislation is necessary for reasons similar to those advanced by proponents of retail divorcement legislation, namely, to preserve competition by protecting competitors--in particular, small and independent businesses- -against predatory pricing by large oil companies.408 Several states have cited these arguments in enacting legislation regulating gasoline pricing. For example, Tennessee's Petroleum Trade Practices Act, which provides in part that "[n]o dealer shall make, or offer or advertise to make, sales at retail at below cost to the retailer, where the effect is to injure or destroy competition or substantially lessen competition..."409 was enacted to preserve independent and small wholesalers and retailers in the motor fuel marketing industry and to prevent the subsidized pricing of petroleum products.410 The Montana Legislature has also found that subsidized, below-cost pricing is a predatory practice, and that below-cost pricing laws are effective in protecting independent retailers and wholesalers of motor fuel.411 Florida has similarly enacted a Motor Fuel Marketing Practices Act, which contains a below-cost sales provision "to replace retail divorcement with a more effective and pro-consumer statutory scheme to address specific unfair and predator practices in motor fuel marketing."412 In part, that statute makes it unlawful for refiners to sell any grade or quality of motor fuel at a retail outlet below refiner cost, or for a nonrefiner to sell such fuel below nonrefiner cost, "where the effect is to injure competition."413 Exceptions are made for "[a]n isolated, inadvertent incident" or if the below-cost sale was made "in good faith to meet an equally low retail price of a competitor selling motor fuel of like grade in the same relevant geographic market which can be used in the same motor vehicle....".414 Florida enacted this statute to encourage competition and prohibit predatory practices.415 Opponents of below-cost sales laws, however, maintain that these laws are responsible for higher gasoline prices416 and that evidence of systematic predatory pricing--one of the prime rationales for enacting such legislation--has not been found. Federal, state, and industry studies indicate that the petroleum industry is not engaged in predatory pricing against dealer- operated stations, either on the U.S. mainland or in Hawaii's retail markets. It is further argued that pricing below cost- -one of the characteristic features of predatory behavior--makes little economic sense because of its unprofitability, and would expose predators to existing antitrust laws if they were able to gain any monopolistic control over the market.417 Minimum-Markup Laws. Proponents of minimum-markup laws similarly contend that these laws help to prevent predatory pricing.418 The United States Department of Energy (1984), however, found that this rationale and other reasons frequently offered in support of minimum-markup laws were flawed. In particular, the DOE found that "[t]here is no reason to believe that predatory pricing of gasoline is taking place. No oil company has the power to establish a monopoly in gasoline marketing."419 Another rationale offered in support of minimum-markup legislation is the prevention of the use of low-priced gasoline as a "loss leader," i.e., a retail item sold at a loss to attract customers. However, according to the DOE, gasoline is not the type of commodity that makes a very good loss leader, since "[i]t is too large an item in the service station's total sales to allow losses on gasoline sales to be more than offset by increased sales of other items."420 Arguments that such legislation could facilitate a manufacturer's cartel or avoid free rider effects are similarly rejected by the DOE.421 The department also maintained that minimum-markup legislation may have the effect of impeding efficient gasoline distribution by protecting high-cost firms from more efficient competitors: Minimum markup laws may serve to protect high-cost firms from the competition of efficient ones. In particular, they may protect existing firms from efficient new competitors by creating a barrier to entry. In gasoline marketing, high-volume retailers have been capturing an increasing share of the market. Minimum markup legislation would tend to stem this movement toward more efficient gasoline distribution by interfering with the market responses of business firms and consumers. New marketers would not be able to sell at low margins initially in order to attract customers to try new distribution and marketing techniques. In addition, they would be reluctant to reduce prices if unexpected changes in costs (perhaps due to unexpected changes in sales volume) might put them in violation of prohibitions against below-cost sales.422 Finally, the DOE stated that minimum-markup laws may hurt consumers by resulting in higher gasoline prices, both by denying consumers the benefits of more efficient distribution and marketing methods and by forcing consumers to purchase more services than they would otherwise consume under free market conditions. Minimum-markup laws are also costly and difficult to enforce.423 Equal Protection It may be argued that legislation regulating the retail gasoline prices of only company-operated retail service stations- -as opposed to all retail service stations--violates the equal protection guarantees of the United States and Hawaii Constitutions.424 Specifically, the major oil companies in Hawaii may contend that there is no rational basis for singling out company-operated stations to achieve the purpose of this legislation. Generally, while the State may make classifications to promote the general welfare, these classifications must not be made arbitrarily.425 The court's initial inquiry is whether the legislation should be subjected to a strict scrutiny or rational basis test.426 The court has traditionally used the rational basis test where suspect classifications or fundamental rights are not at issue.427 Under the rational basis test, the court determines whether a statute "rationally furthers a legitimate state interest" and seeks only to determine "whether any reasonable justification can be found for the legislative enactment."428 Once the court determines that the Legislature passed the law to further a legitimate state interest, "the pertinent inquiry is only whether the Legislature rationally could have believed that the [statute] would promote its objective."429 Because the classification made in question (8) of the Resolution is presumably for regulatory purposes, the burden would be on the litigants, i.e., the incumbent oil companies, to show that it is arbitrary and capricious and bears no reasonable relationship to the object of the statute; "[t]he general law is that regulatory classifications are presumed valid and constitutional, and are to be upheld unless no reasonable state of facts is conceivable to support them."430 Presumably, the State's objective in enacting legislation regulating the retail gasoline prices of company-operated retail service stations would be to increase the viability of independent dealers and increase competition in the State's gasoline retail market. Oil companies, on the other hand, may argue that the means chosen to accomplish this purpose do not bear a reasonable relationship to that purpose, since regulating retail gasoline prices at these stations would ultimately result in a decrease in competition as company-operated stations are driven out of business. The decision of the United States Supreme Court in Exxon Corp. v. Governor of Maryland,431 while not directly on point, is nevertheless instructive in this case. In denying a substantive due process challenge to Maryland's retail divorcement statute, the Court found that Maryland's statute was rationally related to the legitimate purpose of controlling the state retail gasoline market, despite evidence presented by refiners casting doubt on the economic wisdom of that statute: Responding to evidence that producers and refiners were favoring company-operated stations in the allocation of gasoline and that this would eventually decrease the competitiveness of the retail market, the State enacted a law prohibiting producers and refiners from operating their own stations. Appellants argue that this response is irrational and that it will frustrate rather than further the State's desired goal of enhancing competition. But, as the Court of Appeals observed, this argument rests simply on an evaluation of the economic wisdom of the statute ... and cannot override the State's authority "to legislate against what are found to be injurious practices in their internal commercial and business affairs...." ... Regardless of the ultimate economic efficacy of the statute, we have no hesitancy in concluding that it bears a reasonable relation to the State's legitimate purpose in controlling the gasoline retail market, and we therefore reject the appellants' due process claim.432 While the oil companies' equal protection challenge would include the argument that the classification made in this case is arbitrary and does not rationally further any legitimate state interest, the State could maintain, as in Exxon, that regulating the retail gasoline prices of only company-operated retail stations is necessary to remedy injurious practices in the Hawaii's internal commercial and business affairs, and is rationally related to the legitimate purpose of controlling Hawaii's retail gasoline market.
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