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July 3, 2000 Wall Street Journal

The Outlook

SAN FRANCISCO

The pain of $2-a-gallon gasoline in the Midwest has been palpable, and politicians and the
Federal Trade Commission have been quick to respond by calling for an investigation.

But sorting through the various factors to figure out where the price increases come from when
the product passes from refiners to terminals to distributors to gas-station owners and dealers
won't be simple. Just ask the states of California, Hawaii and Alaska, all of which have seen
gasoline prices in recent years soar above national averages and stay there.

In each case, isolation was a factor. For Alaska and Hawaii, it's geographical. California for
years has required a special kind of gasoline to meet environmental regulations. Now, the
Midwest stands apart because its states decided that a new reformulated gasoline required in
some cities since June 1 should use ethanol, a corn derivative, instead of the more common
MTBE used in other regions. That meant gasoline made for sale in Texas can't be shipped to
Chicago.

"There is a cost to isolation, for sure," says Gary Ross, chief executive of the energy-consulting
firm PIRA Energy Group. Economic islands are more vulnerable to supply disruptions, creating
a volatile market, says Mr. Ross.

But how much of the spike in gasoline prices reflects natural economic forces as
opposed to possible collusive practices or price gouging? That's a notoriously difficult
question to answer. Several states have tried -- and have gotten nowhere. It's doubtful
that future investigations will prove more successful.

Last summer, California Attorney General Bill Lockyer launched an investigation when prices
in the state climbed to nearly $2 a gallon. Oil companies blamed a series of refinery fires and
other crises that squeezed supply. After a yearlong look, Mr. Lockyer said he couldn't find any
hard evidence to show that oil companies or others were simply gouging. Instead, he concluded
the state must increase its supply or accept that it will always pay more. An FTC investigation in
the state is continuing.

In Hawaii, residents for years paid as much as 40 cents a gallon more than average to gas up
their cars. Some economists and oil companies shrugged and called the difference "the price of
paradise." Two investigations didn't find any wrongdoing.

But when oil prices collapsed and gasoline prices plunged across the nation in 1997 and 1998,
prices in Hawaii barely budged. Convinced that only anticompetitive activity could explain that,
Hawaii sought out Spencer Hosie, a San Francisco attorney who has made a career out of suing
oil and gas companies, mostly over unpaid taxes and royalties.

On behalf of the state government, Mr. Hosie filed suit against Chevron Corp. and six other
refiners, accusing them of taking advantage of the island market to kill competition and jack up
prices.

Earlier this year two companies, BHP Petroleum Americas Refining Inc. and Tesoro Petroleum
Corp., settled with the state for $15 million. The two denied any anticompetitive actions and said
they settled because it was cheaper than going to trial.

The other companies continue to fight. They say isolation -- not illegality -- can
explain why prices are high. Limited competition, high demand and higher costs in
Hawaii provide ample reasons for charging more. Hawaiians are used to paying
higher prices for almost everything. Why should gasoline be different?

Oil companies say they looked at the market and individually decided that the conditions were
right for higher prices. And what's wrong with making a healthy profit? "The [Hawaiian]
attorney general would like the people to think that being profitable is some kind of criminal
activity. But of course it is not," says Bob Mittelstaedt, lead outside counsel for Chevron.

But the attorney general, Jack Rosenzweig, counters that companies are taking advantage of
those market forces and Hawaii's location in the middle of the Pacific. "We're an island. When
prices get too high here, you just can't load up a tanker truck in California and wheel it in and
undersell the majors," Mr. Rosenzweig says.

When the case goes to trial next year, Mr. Hosie is expected to argue that companies
conspired to set market share through "exchange" agreements to sell gasoline to each
other. Those agreements allowed them to uniformly charge high prices without being
undercut. Mr. Hosie concedes that his theory is based mainly on circumstantial
evidence. "There were no smoke-filled meeting rooms where people sat around
agreeing to charge $1.57 a gallon," he says. "There are much more subtle ways of
doing it."

In the Midwest, refiners say that pipeline disruptions, unusually skinny inventories, new
environmental regulations and other factors sent prices climbing. Consumers, who have seen
prices fall seven to 12 cents a gallon in the past week or two, will likely be skeptical when
second-quarter earnings next month show huge increases in refining profits.

Jack Griffin, assistant attorney general in Alaska, also is leading an investigation into his state's
own steep gas prices. His concern: It may be ultimately impossible to single out collusion from
natural economic forces.

"The market effects of isolation can mimic economically what you would see in a market where
there was anticompetitive, collusive conduct," he says. "It does make it more difficult to prove a
case."