Oil industry faces end of the road in California regardless of Newsom penalty on profits

Source: By WES VENTEICHER, Politico • Posted: Monday, December 19, 2022

Fossil fuel companies face an existential threat in California as the state shifts to a carbon neutral future.

Oil rigs extract petroleum.
Oil rigs still dot the Los Angeles landscape, but the City Council has banned new oil wells. | David McNew/Getty Images

SACRAMENTO, Calif. – Oil companies in California are planning an all-out fight against Gov. Gavin Newsom over his proposal to punish them for what he calls “unconscionable” profits. But that may be the least of the industry’s worries.

Fossil fuel companies face an existential threat in California as the state shifts to a carbon neutral future: Lawmakers have set a deadline to ban the sale of new gasoline-powered vehicles. State and local officials have restricted, or in some cases banned, new oil wells. And some cities are even banning gas stations and non-electric lawnmowers.

These and other measures suggest a grim outlook in the country’s largest car market for an industry more closely tied to the state’s development than the Gold Rush.

The industry isn’t giving up without a fight. Oil companies and their lobbyists are working to head off Newsom’s latest proposal, which would penalize companies if they again raise prices to the record-high levels of the fall, when California gas cleared $6 per gallon.

The state’s prices at the pump climbed to nearly $3 above the national average in October, at $6.42 per gallon, while oil companies nearly doubled their year-over-year profits.

If lawmakers pass some version of Newsom’s proposal, it will be a first-in-the-nation move with big implications for other states and the potential to accelerate or slow clean-energy transitions. California would also join what is effectively a massive experiment in energy price controls unfolding in Europe.

“They’re taking advantage of you because they can,” Newsom said of the oil companies at a Dec. 5 news conference. “Because no one has stood up to them. Why? Because they have unlimited funds, unlimited capacity to manipulate and mislead, lie to people, lie to people. And that’s what I expect they’ll do once again, in this effort.”

His proposal, still lacking in detail, would take a portion of oil refiners’ profits above a to-be-determined threshold and distribute the money to consumers. The state legislature is expected to consider the plan in January.

But industry representatives and analysts say the issue is not as simple as Newsom, who directed regulators to ban sales of new gas-powered vehicles by 2035, makes it out to be.

“He wants to regulate and tell us to maintain our facilities, but he’s also saying: ‘Look, we’re not going to sell gasoline-powered cars by 2035,’ and shortly thereafter he wants us out of business,” said Western States Petroleum Association spokesperson Kevin Slagle. “So, at some point, refiners will have to look at California and decide whether it makes sense to be there or not. And that starts to become a real problem for consumers and others who need fuels.”

California is taking more aggressive steps than any other state to address climate change by reducing the use of fossil fuels. Its air quality regulation agency on Thursday approved a plan to achieve carbon neutrality by 2045 in part by reducing fossil fuel demand by about 90 percent.

Whether the state can meet these goals is an open question. Gas use has been declining in recent years as more people buy electric vehicles, work from home or commute less because of the pandemic. But prices at the pump are often the highest in the nation — and politicians felt the sting of voter anger this past summer and fall.

Trying to regulate fuel prices turned out to be ineffective in the past, notably under Richard Nixon and Jimmy Carter, when price caps led to supply shortages and long lines at stations.

“They’re going to spend all their time trying to figure out how to manage the margin instead of spending the time and resources competing with one another,” said David Hackett, chairman of the board for Irvine-based consulting firm Stillwater Associates.

Conflict between Sacramento lawmakers and the oil and gas industry isn’t new.

State lawmakers have weighed oil against the environment since at least the 1920s, when they started taxing production to fund public parks and shorelines, mollifying beachgoers who objected to the oil derricks that crowded Southern California’s shores, said Paul Sabin, a Yale University professor and author of “Crude Politics, The California Oil Market, 1900-1940.”

Newsom’s proposal targets 11 oil refineries that still operate in the state, the oldest of which dates to 1896.

“People don’t necessarily think about California as a Western state that is a place of resource extraction, but Southern California was really an oil town in a lot of ways,” Sabin said.

Oil pumps still dot Los Angeles, but three days before Newsom announced his proposal on Dec. 5, the Los Angeles City Council banned new oil wells and ordered an end to production in the city within 20 years. The council’s ban followed a state prohibition on new wells within 3,200 feet of schools, parks and homes.

“[Newsom is] really aggressive, but I don’t think too aggressive, because the situation demands action,” Court said.

As on other issues before, California is borrowing from Europe. The Council of the European Union opted in September to impose temporary windfall taxes on nearly all its member states to try to rein in excess profits amid price spikes tied to Russia’s invasion of Ukraine. The United Kingdom is trying it, too.

Details of the EU measures vary greatly, but most are based on a tax on profits of more than 20 percent above the previous four years’ average earnings, Reuters has reported.

The broader fossil fuels-vs.-renewables saga is also playing out on the world stage, with clean energy making gains, according to the International Energy Agency’s annual analysis of renewables released this month. The world will grow its renewable energy capacity in the next five years by 30 percent more than the agency projected last year, according to the report.

China, the European Union, the United States and India are driving the accelerated growth, most of which is coming from wind and solar power. Renewables are expected to become the largest source of global electricity generation by 2025, and solar is expected to surpass coal as the world’s largest power source by 2027, the report said.

In California, the transition to renewable energy depends on budget surpluses, new technologies and other factors. But state lawmakers aren’t likely to escape the powerful political prod of gas prices anytime soon.

To Vince Fong, one of 18 Republicans in the 80-member California State Assembly, Newsom’s urgency and rhetoric suggest he’s more interested in scoring political points than addressing the factors that contribute to prices at the pump.

“He’s not focusing on the fundamental aspects of the supply and demand in the energy market, and the volatility that still exists,” said Fong, whose Bakersfield district is an oil industry hub. “He’s trying to make headlines and he’s demonizing the very people who power California.”

Before the proposal was formally introduced to the Legislature as a penalty, Newsom was calling it a windfall tax.

The Democratic leaders of the state’s Senate and Assembly said then that taking “excessive profits out of the hands of Wall Street” and transferring them to consumers deserved “strong consideration” by the Legislature.

Neither leadership office had refined their public positions by this week.

“The speaker is still reviewing this proposal, and looks forward to discussing the issue with his colleagues,” Katie Talbot, spokeswoman for Assembly Speaker Anthony Rendon, said in an email Tuesday.

Record profits aside, California’s gas market is unique in a number of ways.

There are no crude oil pipelines into California. Refiners in the state have to produce cleaner gasoline from crude oil than other states, meaning other states’ gas can’t be supplied directly to California stations.

The high fuel standards cost more, and California imposes the second-highest excise tax — after Pennsylvania — on wholesale oil. The state also imposes higher taxes at the pump than other states.

For a long time, those factors accounted for the difference between California’s gas prices and the national average, Gordon Schremp, a senior fuels specialist at the California Energy Commission, said at a Nov. 29 hearing.

But in 2015, a processing unit exploded at ExxonMobil Refinery in Torrance, temporarily reducing supplies. Refiners increased prices in response, driving up profit margins, and never returned them to pre-explosion levels, Schremp said.

California’s demand for gas peaked in 2017 and has been declining since, due to electric vehicle uptake and the pandemic’s shift to remote work, Schremp said. Next year, demand is expected to drop to 12 percent below 2019’s levels, he said.

At the same time, California has lost nearly 10 percent of its refining capacity since 2019, compared with a national loss of 4.3 percent.

Limited competition is a factor in California’s prices. Just five companies — Chevron, Marathon, Valero, PBF Energy and Phillips 66 — produce the vast majority of gasoline sold in the state.

California has twice as many licensed drivers per gas station as the rest of the country, according to Hackett, of Stillwater Associates. A disproportionate share of the stations are run by branded retailers such as Shell and 76.

“We just don’t have the competition and discipline from those off-brand stations,” said Severin Borenstein, a UC Berkeley economics professor and former chairman of the Energy Commission’s now-dissolved Petroleum Market Advisory committee.

Borenstein and Hackett each believe competition needs to be addressed as part of California’s solution to persistently high gas prices — spikes or no.

“There’s a problem with insufficient competition that regulatory changes should at least be considered for,” Borenstein said.

Court, of Consumer Watchdog, said that if the profit margin threshold in Newom’s proposal is sufficiently high, companies will still be able to earn plenty of money in California’s enormous market. In his view, oil companies aren’t so different from other businesses that must justify price increases to regulators.

“We’ve done this before with insurance, we’ve done it before with utilities, we’ve even done it with cellphones,” he said.