If prices can't allocate, we may need greater prudential reserves

My column at the Sunday Star Times this week harkens back to the petrol shortages in Christchurch after the earthquake. Stations on the west side of town, where there was still power, had substantial queues and were running out of fuel. But prices didn't go up.

If prices could go up in a crisis, that would provide incentive to invest in capacity against such crisis. But if you fear consumer backlash, legislation, or expropriation, it won't happen.

Last week, Minister Woods announced new rules requiring fuel companies to maintain onshore reserves against scenarios where international fuel shipments are disrupted. It'll increase the cost of fuel during normal times to maintain some capacity during a crisis. It wouldn't be needed if prices could allocate in that event. But it seems rather unlikely they'd be allowed to. 

The column concludes:

Letting prices ration scarce supplies would not just save everyone the cost of queueing. 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. Over insuring 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.