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.
	

		Endnotes	Chapter 11 Table of Contents