Center for Study of Responsive Law
Prepared Statement for hearing on:
Solutions to Competitive Problems in the Oil Industry
Committee on the Judiciary
House of Representatives
Congress of the United States
March 29, 2000
My testimony today will address our concerns about concentration in the petroleum industry, as well as more general concerns about the failure of the FTC and the US Department of Justice to adequately consider the extensive nature of "collaborations among competitors," in evaluating mergers.
At the Center for the Study of Responsive Law, I have worked on several recent oil mergers, beginning with the BP/Amoco merger, and most recently with the Exxon/Mobil and BP/Amoco Arco merger. We opposed all three mergers, on the grounds that they would lessen competition, and harm consumers.
Before my current job, I had extensive experience in analyzing various aspects of the oil and gas industry, and worked on issues as diverse as taxation, oil and gas leasing policy, oil pipeline regulation, and the conservation of oil fields. This work was on behalf of several state governments as well as non- governmental organizations.
My testimony will make the following points:
1. Increases in concentration in the Petroleum Sector.
Since 1998 in particular, there has been a wave of mergers in the global petroleum industry. In a March 10, 1999 hearing before the Committee on Commerce, Subcommittee on Energy and Power, that was examining the Exxon/Mobil merger, William J. Baer, the Director of the FTC's Bureau of Competition, testified:
As many have noted, this merger does not occur in a vacuum, but appears to be part of an ongoing trend of consolidation and concentration in this industry. In recent months, we have seen the merger of BP and Amoco - which was the largest industrial merger in history until Exxon/Mobil was announced -- and the combination of the refining and marketing businesses of Shell, Texaco and Star Enterprises to create the largest refining and marketing company in the United States. In addition, Tosco acquired Unocal's California refineries and marketing business; Ultramar Diamond Shamrock acquired Total's North American refining and marketing operations; and Marathon and Ashland combined their refining and marketing businesses. We also have seen the worldwide combination of the additives businesses of Shell and Exxon. Other combinations, such as the pending combination of the refining and marketing businesses of Ultramar Diamond Shamrock and Phillips (which we are currently examining), likely will follow. These consolidations and joint ventures are not limited to the United States: BP and Mobil have combined their refining and marketing operations in Europe, and Total and Petrofina have recently announced their own merger plans.There were many others. For example, Nippon Mitsubishi Oil Corp, was created out of the merger between Nippon Oil Co and Mitsubishi Oil Co in April 1999. In 1999 BP Amoco sought to acquire ARCO, which was the first merger actually blocked by the FTC, but which may be approved after a sale of ARCO's Alaska assets to Phillips. The fact that the FTC has caused a handful of mergers and joint ventures to be modified is somewhat helpful, but not a particularly aggressive approach to what has occurred.
When the BP/Amoco merger was announced on August 11, 1998, Robert Weissman and I issued a statement that predicted a wave of new oil and gas mergers, and called upon antitrust authorities to provide a public forum on the issue of concentration in the petroleum and mining sectors.
We fear the BP-Amoco merger, announced today, will hurt consumers by raising prices, spur a round of anticompetitive mergers in the oil industry and dangerous concentration of economic and political power. We are asking U.S. antitrust authorities to create a forum for public comment on the issue of concentration in the petroleum and mining industries, and to solicit views on issues such as mergers and joint ventures. Today's announcement regarding British Petroleum and AMOCO suggests we may be faced with a series of mergers, as is now occurring in the telecommunications industry. In the telephone industry, the early mergers were approved without much thought as to how each new merger created an environment where the next merger was more likely. We think it is appropriate to consider in a pro-active way the larger picture, and how public policy objectives of efficiency and consumer welfare are best served -- either by competition among the many or collusion among the few. Insufficient scrutiny of this merger will soon lead to other mergers and a policy crisis in the petroleum sector, given the lack of policy guidance or a well-developed theory regarding concentration that will adequately protect consumers. Consumers currently benefit from low prices for petroleum, a consequence, in part, of the degree of competition in the industry. We believe giant mergers like these will hurt competition, and hurt consumers.
2. The current Department of Justice and Federal Trade Commission horizontal merger guidelines focus on market share metrics that understate concentration, by failing to address the degree and importance of joint ventures and other collaborations.
The current DOJ/FTC guidelines on horizontal mergers place a lot of attention on the Herfindahl-Hirschman Index ("HHI") of market concentration. This is calculated using the sum of the squares of market shares, based upon sales in a relevant market. I think this is a useful metric, but it is clearly an inadequate measure of concentration in an industry where firms are often collaborators in various joint ventures, partnerships and other deals.
The appeal of the HHI is that the index seems to capture the non-linear relationship between market shares and market power that would be predicted by some game theoretic models of imperfect competition and strategic behavior. However, in models of strategic behavior, one should assign a larger role to the extensive webs of collaborative agreements between firms.
3. The Petroleum Industry involves extensive joint ventures and other collaborations, for virtually all aspects of the industry.
The oil industry involves capital intensive projects that often have large economies of scale. Many of these investments are quite durable, and the combination of durable, high fixed, sunk costs is also associated with significant entry barriers.
These are particularly important in the areas of exploration, production, oil and gas pipeline markets and refining, but also to some degree in distribution.
Exploration involves the costly collection of seismic data and analysis of well data. Firms may share costs for seismic exploration, or even share the expense of some exploratory wells. For a variety of reasons, firms sometimes bid together for new oil and gas leases.
Production of an oil field is often done through unitization of the field. For example, there were a large number of owners of the Prudhoe Bay oil field in Alaska, but only BP and ARCO were operators. The other leaseholders shared the expenses and the production as members of the Prudhoe Bay Unit. Sometimes the only way a leaseholder can develop her interest in a field is through participation in a unit.
Oil pipelines benefit from huge economies of scale and are very durable. In the Prudhoe Bay field, the major owners of the oil field were the initial owners of the TAPS pipeline. Firms that were not part of the TAPS ownership suffered from the high TAPS tariffs when they shipped oil to downstream markets.
Every major oil company is involved in countless joint ventures, partnership agreements, units, and other deals.
4. Joint ventures and other collaborations substantially reduce the degree of independence among firms in an industry.
It is costly to be excluded from such agreements, and the risk of exclusion is a credible form of discipline with the industry. In some US states, the state government has the theoretical power to force firms to include a leaseholder in a unitized oil field, but it is difficult to prevent firms from discriminating against a minority interest in a field, or from offering unreasonable terms.
For oil companies of significant size and ambition, there are many advantages to being included in various collaborations, and many costs to being excluded. As markets are concentrated, the relative bargaining power of the larger firms increases, and the relationship becomes more collaborative, and less competitive.
5. As the industry becomes more concentrated, it becomes much easier to monitor cheating within cartels, and to discipline firms that engage in aggressive competition.
The problem for any cartel is cheating. In general, the less concentrated the industry, the easier it is to cheat, and the harder to discipline cheaters. The more concentration (in all aspects of the petroleum industry), the easier to monitor industry actions, and to coordinate efforts. OPEC may benefit somewhat from a more competitive private sector, such as for bidding on leases and development projects. But OPEC also benefits from increased concentration, which makes it much easier to monitor the private actions, and even to solicit cooperation from the leading private actors.
We have raised these issues with the FTC on different occasions, as have others. For example, in an August 13, 1998 letter regarding the BP/Amoco merger, Representative Dennis Kucinich wrote Mr. Robert Pitofsky to ask:
Should the traditional Herfindahl-Hirschman Index ("HHI") of market concentration used in the current horizontal merger guidelines be modified to reflect the degree to which companies that "compete" with each other are participants in joint ventures and partnerships where they cooperate?
. . . To what degree does the nature of the energy industry require extensive use of joint ventures or partnerships for the efficient production and transportation of energy, and what risks are presented by these arrangements?
. . . If BP and Amoco merge, will this create an environment where the new entity's combined market shares of pipelines, production units or other facilities create risks for other companies, and might competitors consider mergers to compensate or react to this increased concentration?
6. The need to provide better metrics for horizontal mergers is a broader issue, and has relevance for other industries such as pharmaceuticals and biotechnology, telecommunications, entertainment and software, to mention only a few areas.
There are many industries where joint ventures, partnerships, strategic alliances, cross licensing of intellectual property and other collaborations lessen competition. One area of particular interest is the pharmaceutical and biotechnology sector, where firms will increasingly need access to broad biotechnology patents and other intellectual property rights to develop new products. We are aware of a case where a firm indicated it did not want to develop a new technology that would undermine Amgen's EPO market, for fear that it would not be able to license other patents from Amgen. Another area is telecommunications. AT&T and Time-Warner are involved in countless joint ventures, partnerships and other collaborations. AOL licenses software and desktop links from Microsoft and also competes against Microsoft. Telecommunications firms that are supposed to be competitors in US markets sometimes are partners in overseas markets.
7. The FTC guidelines on collaboration among competitors are inadequate.
The FTC held hearings on proposed guidelines on "collaborations among competitors" in 1997. The thrust of the inquiry was to provide guidance in areas where antitrust authorities would generally approve or discourage collaboration among competitors. Among the questions the FTC asked were:
a. Whether the price- or output-related decisions of competitor collaborations may harm competition
b. Whether restrictions on competition between or among the members of a competitor collaboration, or between the collaboration and another entity, may harm competition
c. Whether the competitor collaboration increases the likelihood of collusion outside the joint venture as a result of sharing confidential, competitively sensitive information or other mechanisms
d. Whether the competitor collaboration may raise rivals' costs
e. Whether a denial of membership in or access to a competitor collaboration may harm competition
f. Whether a competitor collaboration that lacks market power in any relevant market may still harm competition in a relevant market
When the draft guidelines were published in 1999, the FTC's upbeat press release said "competitive forces of globalization and technology are driving firms toward complex collaborations to achieve goals such as expanding into foreign markets, funding expensive innovation efforts, and lowering production and other costs. The increasing varieties and use of collaborations by rivals have yielded requests for improved clarity regarding their treatment under the antitrust laws."
The FTC/DOJ draft guidelines provided a green light for a number of activities, including explicit safe harbors for agreements "when the market shares of the collaboration and its participants collectively account for no more than twenty percent of each relevant market in which competition may be affected," and for certain R&D collaborations, as well as for a number of other types of agreements that the FTC judged pro-competitive or justified on a variety of efficiency grounds. The guidelines were nuanced, and also identified potential problems and warnings, including, for example, for explicit price fixing agreements.
On the whole, however, the guidelines did not provide a framework exploring the degree to which such agreements undermine the FTC/DOJ's standard analysis of market power, and in particular, the guidelines do not comment in a meaningful way how the existence of a web of collaborative agreements in one set of markets undermines the very notion that firms will act like competitors in a different set of markets. In discussions with the FTC staff, we raised this issue, and we also asked the FTC to turn the discussion around. If the companies could engage in a number of collaborative agreements to achieve efficiencies, as they have for years in terms of joint venture pipelines, unitized oil field development, and shared collections of seismic data, why should the government approve the giant mergers? In what sense was it necessary to create firms through mergers that were so huge, when they could achieve efficiencies in production, exploration and transportation through joint ventures?
Finally, we asked the FTC to do something more proactive and useful for the public in merger reviews. We asked that the Hart Scott Rodino Act and procedures be changed so that firms engaged in mergers would be required to provide a list of joint ventures, partnerships, licensees for patents, and other collaborative agreements, and to the extent possible, this information should be published on the Internet, during the merger review. This would permit the public to better evaluate the true competitive impact of continued mergers in pharmaceutical, telecommunications, oil industry fields and other industries where collaborative agreements are so common.
Equilon is a joint venture between Shell and Texaco headquartered in Houston, Texas. Equilon was formed in January 1998. Shell owns 56% of Equilon and Texaco owns 44% of Equilon.. Equilon is comprised of major components of Shell's and Texaco's midwestern and western U.S. refining and marketing business and their nationwide transportation and lubicrants operations. Equilon refines and markets gasoline and other petroleum products in all or parts of 32 states under the Shell and Texaco brand names.
Equilon is the seventh largest refining company in the U.S. Equilon has an estimated 6.8% share of the national gasoline market and an estimated 13.1% share of the gasoline market in its geographic area. Equilon is estimated to be the fifth largest retail gasoline marketer in the U.S. supplying approximately 9,700 service stations.
Royal Dutch Shell, Texaco, and Saudi Refining
Motiva Enterprises LLC
Motiva is a joint venture between Shell, Texaco, and Saudi Refining, Inc., a corporate affiliate of Saudi Aramco. Motiva was formed in July 1998. Shell owns 35% of Motiva, and Texaco and Saudi Refining each own 32.5% of Motiva. Motiva is comprised of major components these companies' refining and marketing businesses in the Gulf Coast and the eastern United States. Motiva refines and markets gasoline and other petroleum products in all or parts of 26 states and the District of Columbia under the Shell and Texaco brand names.
Motiva is the sixth largest refining company in the U.S. Motiva has an estimated 8% of the national gasoline market and an estimated 16.7% share of the gasoline market in its geographic area.
Equilon and Motiva have a combined capacity of approximately 1.6 million barrels pert day.
Chevron and Texaco
Caltex is jointly owned by Chevron (50%) and Texaco (50%). Caltex refines crude oil and markets gasoline and other petroleum products in approximately 55 countries in Asia, Africa, the Middle East, New Zealand and Australia. In 1999 Caltex sold 1.8 million barrels per day of crude oil and petroleum products.
BP Amoco and Royal Dutch Shell
Altura Energy, Ltd.
Altura is a limited partnership between BP Amoco and Shell combining the respective companies' producing assets in the Permian Basin of West Texas/Southeast New Mexico. Altura was formed in March 1997. BP Amoco owns 64% and Shell owns 36% of Altura.
Exxon-Mobil and Royal Dutch Shell
Aera Energy LLC
Aera is jointly owned by Exxon-Mobil (48.2%) and Shell (51.8%). Aera was formed in June 1997. Aera combined Exxon- Mobil's (Mobil before the merger) and Shell's exploration and production operations in California.
BP Amoco and Texaco
Nerfco is a refinery in Rotterdam, Netherlands jointly owned by BP Amoco (69%) and Texaco (31%). Nerefoc has a production capacity of 380,000 barrels per day.