California’s Gas Crisis Is a Policy Failure at Every Level

Wall Street traders coined a grim acronym for the energy shock caused by the Iran War—NACHO, short for “Not A Chance Hormuz Opens.” No U.S. state has more reason to dread that outcome than California, where drivers pay more than $6 per gallon and refiners depend on Persian Gulf crude. This war did not create those conditions. Decades of policy decisions did, leaving the state’s fuel supply with almost no margin for geopolitical shock.

California’s refineries were originally built in the late 19th and early 20th centuries to process the heavy, highly sulfurous crude oil underlying the San Joaquin Valley. That geological circumstance set the template for what followed. California’s refining equipment, configured for thick, high-sulfur feedstock, does not easily accommodate lighter grades, such as most crude oil extracted domestically in the continental United States. When Alaskan North Slope production, also heavy and sulfurous, declined in the 1990s, refiners required a replacement with nearly identical properties. Persian Gulf crude, particularly from Iraq and Saudi Arabia, fit the existing equipment with little modification. What began as a coincidence of geology became, over several decades, a deliberate commercial dependency.

That dependency is now California’s central vulnerability—and a warning for the nation. Iraq and Saudi Arabia together supply approximately 25 to 30 percent of California’s foreign crude imports, and the West Coast accounts for 47 percent of all U.S. imports from Middle East Gulf sources. The state operates as an energy island, isolated from the rest of the country’s fuel distribution network. California has no major crude pipeline connections to the Gulf Coast, and its mandatory California Air Resources Board fuel specifications mean that gasoline produced in other states cannot readily serve as a substitute.

The Jones Act restricts domestic maritime shipping to U.S.-flagged vessels, further limiting California’s ability to source finished gasoline from Gulf Coast refiners. A temporary waiver issued in March provides modest relief, but analysts estimate its price impact at less than two cents per gallon. Refiners in South Korea and India have historically supplied finished gasoline to fill the gap, but those refiners are now curtailing exports as they scramble to replace lost Middle Eastern crude. California’s primary and backup supplies are disrupted simultaneously.

No new refinery has been built anywhere in the United States since 1976, and California’s refining capacity has declined sharply from roughly 40 facilities in the early 1980s to fewer than a dozen today, with only eight currently producing transportation fuel. Federal and state environmental regulations have made building new facilities from scratch economically prohibitive and have directed investment toward compliance upgrades rather than capacity expansion. The result is a small number of aging facilities carrying substantial regulatory cost burdens, with no new facilities likely. These conditions—few sellers, high barriers to entry, and a captive market with no ready substitutes—are precisely the conditions under which economic theory predicts the exercise of market power and prices in excess of competitive levels.

The University of California, Berkeley’s Severin Borenstein identified a persistent “mystery gasoline surcharge”—an unexplained price premium ranging from 20 to 70 cents per gallon since 2015 that taxes, crude costs, and regulatory compliance cannot account for. Supply disruptions do not merely coincide with elevated margins but provide cover for refiners to widen them persistently—a dynamic Borenstein documented following the 2015 Torrance refinery fire, after which prices spiked and never returned to their pre-fire level.

California passed a refinery profit margin cap under a 2023 statute, AB X2-1, but regulators delayed implementation for five years, leaving the mechanism dormant at precisely the moment for which it was designed. The conflict in Iran shows no sign of resolution: As recently as June 1, the U.S. and Iran exchanged fire in the Strait, and Iran asserted sovereignty over the waterway, proposing tolls of approximately $1 per barrel as a condition of any long-term reopening. The direct price impact of such a toll is modest, roughly two cents per gallon, but legitimizing Iranian control of the world’s most critical energy chokepoint carries geopolitical risks that markets are pricing far more seriously. Analysts at the Stanford Institute for Economic Policy Research estimate that a prolonged closure could drive California pump prices toward $7 per gallon statewide, with the most adverse projections approaching $10 at some stations.

Global policy responses provided limited relief. The International Energy Agency coordinated an emergency release of 400 million barrels of oil—the largest in its history—amounting to roughly 20 days of normal Hormuz transit volume. As part of that effort, the U.S. withdrew 172 million barrels from its Strategic Petroleum Reserve. Research consistently finds that releases from the reserve provide temporary market liquidity rather than meaningful medium-run supply. A National Bureau of Economic Research working paper estimates that a 10 million barrel release reduces spot prices by only 2 to 3 percent temporarily. Saudi Arabia has redirected exports through its East–West pipeline at its full capacity of 7 million barrels per day, but that falls far short of the roughly 20 million barrels per day that transited the Strait of Hormuz before the war. The market is adjusting at the margins, but it has not found a substitute for the strait.

Meaningful relief requires structural change at both levels of government. In Sacramento, the most immediate levers are in AB X2-1 itself: activating the dormant profit margin cap and the California Energy Commission’s inventory management authority, and a temporary relaxation of California Air Resources Board fuel specifications to widen the supply base, though the latter requires subordinating air quality goals to price relief. Expanded public transit and sustained electric vehicle incentives could reduce demand over time, though California already ranks among the national leaders in electric vehicle adoption, and fleet turnover remains slow. At the federal level, crude oil from the Permian Basin in the southwestern United States could reach West Coast refiners with targeted pipeline permitting reform, and extending the Jones Act waiver would preserve what supply flexibility it provides. Corporate Average Fuel Economy standards are the primary remaining lever for the federal government on the demand side, but higher new vehicle prices lead consumers to retain older, less efficient vehicles longer—the Gruenspecht effect—eroding anticipated fuel savings. Sustained commitment to all of these, rather than the reversals that have characterized recent years, is essential.

California’s gasoline price problem predates the current conflict—the war has simply made the underlying policy failures impossible to ignore. The question for Washington and Sacramento alike is whether this crisis will produce meaningful reform or policymakers will wait for the next geopolitical shock to relearn the same lesson.

R.J. Briggs is a senior economist at the Alliance for Policy Research.