We all turn a little bit crazy when prices rise in a crisis

Dr Eric Crampton
Sunday Star Times
13 November, 2022

At about three in the morning, three days after the 2011 Christchurch earthquake, our family got into the car.

Power and water had been out at our South New Brighton home since Tuesday’s earthquake. We had found a bolthole on the west side of town with power and water. But we could not risk being caught in traffic.

Our car was running on fumes after hours of post-quake traffic congestion. Every filling station on our side of town was, as best we could tell, non-functional. And every news bulletin brought stories of petrol stations on the other side of town with hours-long queues or no fuel at all.

The fuel shortage in Christchurch was ridiculous. It did not need to happen. In theory, it shouldn’t have happened. But it did.

On Wednesday, Energy and Resources Minister Megan Woods announced new rules requiring fuel companies to maintain on-shore supplies sufficient to cover about a month-long disruption to supplies from overseas. She also announced the government would purchase diesel stock to cover emergency services in such an event.

The regulation requiring on-shore supplies will be expensive and fuel sellers will have to pass this cost on to consumers. We will all be paying more because of it.

But it is not a bad idea, even though it would not be needed in a better world.

The problem is not that fuel companies are too greedy to maintain sufficient supplies against emergencies all on their own. The real problem is that fuel consumers – all of us – turn just a little bit crazy when we see prices rise in a crisis.

To see why, think back on the Christchurch earthquake.

After the earthquake, everyone knew more fuel would be coming. Lyttelton Port was out of action but tanker ships were being diverted south. It would take longer to offload, and trucks had to be sourced to haul the fuel back up State Highway 1. Fuel was coming but hadn’t yet arrived.

Earthquakes bring uncertainty and full fuel tanks provide options. People with a half tank wanted a full tank. People with a second car wanted both tanks full. And some wanted jerry cans as well.

The immediate resulting shortage was less about the earthquake and more about everyone wanting to fill up simultaneously.

There are three basic ways of dealing with the shortage. Prices could increase and those least willing to pay would miss out for a few days. Prices could hold steady and those least able to queue for hours would miss out. Or some rationing system, impossible to establish well in haste, could allocate smaller amounts of fuel to those deemed worthy of it.

Unlike America, where some states prohibit ‘price gouging’ after a disaster, no law here prevents petrol companies from increasing prices. But fuel companies feared, almost certainly correctly, that customers would punish them more for raising prices for one week than for running out of fuel. There was certainly backlash against the small number of dairies that increased prices rather than running out of stock.  

So the fuel companies did not increase prices, and they ran out.

Letting prices ration scarce supplies would not just save everyone the cost of queuing. Companies would also have stronger incentive to invest in capacity. If a company expected to be able to sell fuel at multiples of normal prices in an emergency, it would make sense to invest in tanks to hold that supply ready.

High prices in the crisis would cover the cost of building capacity ahead of time. There would be no need for mandates, though the government might still want to purchase emergency supplies for emergency services.

But no one will invest enough in that capacity if they expect punishment for increasing prices when the crisis happens. Consumer backlash, government edicts, or punitive taxes on gains that populist governments portray as ‘windfalls’ are all very real risks.

So we are stuck in a very second-best world. In a better world, those of us most willing to pay for fuel in times of crisis would be the ones who cover the cost of that capacity. And we could get by with less emergency capacity because high prices would reduce demand during the crisis.  

Instead, regulation is buying us a form of insurance. We all will pay a premium for fuel during normal times and less than we otherwise might if fuel supplies are disrupted.

Whether the government has chosen the right amount of insurance against these kinds of scenarios is anyone’s guess. Overinsuring is a real risk. But forcing us all to pay for at least some insurance through higher fuel prices is not mad.

The real madness was the pumps running dry in Christchurch when no one dared to increase fuel prices. Clear thinking about prices in a crisis is too scarce.

Perhaps we need an emergency reserve of it somewhere.

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