IV. CONDUCT: COOPERATIVE RATHER THAN COMPETITIVE Conduct in the large, complex, multifaceted petroleum industry is difficult to evaluate. Basically, we must frame hypotheses about the structure and performance of the industry under the assumption of reasonably competitive conduct. Since a competitive model of structure and performance differs significantly from actual structure and performance in the industry, we shall attempt to isolate those aspects of conduct which have contributed to this disparity. Some types of conduct which may not be anticompetitive in competitive industries, or when practiced by small firms, become anticompetitive in concentrated industries or when practiced by firms that possess market power. We find anticompetitive conduct on all levels in which the large integrated firms interrelate. In fact, their behavior should properly be characterized as cooperative, rather than competitive, with respect to: Influencing legislation Establishing the purchase price of crude oil Refining crude oil Marketing gasoline There is no way to determine the degree of influence exercised by industry lobbies in affecting petroleum legislation. However, we do know that major firms have been strong advocates of the Oil Import Control program, and also state prorationing legislation. The Import Control program, according to industry sources, has been largely responsible for the present shortage of refinery capacity. In addition, it has effectively created barriers to entry in the industry. The program has been exploited by the major integrated firms to protect the industry's oligopoly position with respect to refined products. Prorationing has been exploited by the majors to raise crude prices above their competitive level and results in a major misallocation of the economy's resources. Morris Adelman, one of the world's leading authorities on the industry, claims that "the great bulk of oil wells are superfluousa political curiosity, not an economic asset." They are strictly a result of prorationing legislation and import controls, which artificially raise the price of domestic crude, and encourage the development of otherwise uneconomic wells.2 1 Among the choicest of domestic oil fields are those contained in offshore government owned land. The oil leases for these fields are sold through "competitive" bidding. It has been common practice, however, for oil firms to submit joint bids on these leases. The result is a 1 M. A. Adelman, The World Petroleum Market, John Hopkins Press, Baltimore, 1971, p. 46. M. A. Adelman, "Efficiency of Resource Use in Crude Petroleum," Southern Economic Journal, Vol. 31, pp. 101-120. small number of bidders for each lease. Joint bidding, and joint ventures in general, may promote competition in certain kinds of situations, but such conduct by large petroleum firms, given the concentration already existing in the industry, is decidedly anticompetitive. Walter Mead has shown that, with respect to Alaskan Oil and gas leases, firms who were partners in joint bidding for one tract tended not to compete with their former partners in bidding for other tracts.* The lack of competition among major oil firms is particularly apparent in the prices paid for crude oil. In a competitive market, prices are set by the interaction of supply and demand. However, in crude transactions the price is established entirely by the buyers. A price is "posted" in a particular field for a particular gravity of crude by the buyer. Within a few days this price is followed and similarly "posted" by other buyers in similar fields. The seller of crude does not dispute or offer alternative prices to the buyer." Since the posted price is the prevailing price for crude in a particular area, it is in the interest of the integrated firms to post a price higher than marginal costs consistent with each firm's self sufficiency ratio (the ratio of crude production to refining capacity), and the elasticity of demand for gasoline. This is so for two reasons. Remembering, that for the integrated firm, the posted price is the price it both pays itself and uses for tax purposes, the existence of the depletion allowance for crude production means that profits based on high prices at the crude level are "worth" more to the integrated firm than profits at other levels. Second, the integrated firms can "squeeze" those firms which do not have their own crude. An integrated firm, when using its own crude, in effect, pays not the posted price to itself, but rather the real cost of producing the crude. When the non-integrated refiner purchases crude, however, the posted price is, in fact, the "real" price-he is always put at a cost disadvantage if the posted price deviates from marginal cost.8 Lack of competition among the major firms is also evidenced by the absence of bidding for crude produced by independents. Once a major integrated firm erects gathering lines leading from the crude field, it purchases most of the crude from that field and becomes the field's price leader. Furthermore, our survey of independents has shown that Walter J. Mead, "The Competitive Significance of Joint Ventures," Antitrust Bulletin, Vol. XII, Fall 1967, pp. 823-825. Ibid., pp. 841-846. See, for instance, "S. Texas Crude Given Higher Postings," Oil and Gas Journal, June 4, 1973, p. 22. Adelman suggests that "there is very little room for independent bargaining over crude oil prices with independent refiners desirous, and capable, of carefully examining the range of offers, choosing the best, and trying to play one seller against another. In a market where price is so far above cost, the absence of independent bargaining centers at the various levels of production slows down the attraction of price toward cost. Perhaps even more important, the companies, who to some extent coordinate their production plans, meet again as rivals in refining and marketing." Adelman specifically refers to the world market for oil, but his remarks clearly apply to the domestic market. See Adelman, op. cit., p. 145. See M. G. DeChazeau and A. E. Kahn, Integration and Competition in the Petroleum Industry (New Haven: Yale University Press, 1959, pp. 221-2). 8 There is evidence to suggest that the posted price deviates substantially from long-run marginal cost, even when incremental development cost is included in marginal costs. Adelman estimates that total development and operating costs for U.S. crude was $1.22 per barrel while the average price per barrel was $2.89 in 1960-63. In addition, many of our survey crude companies appeared to be earning supernormal profits. See Adelman, op. cit., n. 76 for data on marginal costs, and U.S. Dept. of Interior. Bureau of Mines, Mineral Industry Surveys, Crude Petroleum, Petroleum Products, and Natural Gas Liquids 1960-63, Table 3 data on the total value per barrel of crude. IV. CONDUCT: COOPERATIVE RATHER THAN COMPETITIVE Conduct in the large, complex, multifaceted petroleum industry is difficult to evaluate. Basically, we must frame hypotheses about the structure and performance of the industry under the assumption of reasonably competitive conduct. Since a competitive model of structure and performance differs significantly from actual structure and performance in the industry, we shall attempt to isolate those aspects of conduct which have contributed to this disparity. Some types of conduct which may not be anticompetitive in competitive industries, or when practiced by small firms, become anticompetitive in concentrated industries or when practiced by firms that possess market power. We find anticompetitive conduct on all levels in which the large integrated firms interrelate. In fact, their behavior should properly be characterized as cooperative, rather than competitive, with respect to: Influencing legislation Bidding for crude leases Establishing the purchase price of crude oil Refining crude oil Marketing gasoline There is no way to determine the degree of influence exercised by industry lobbies in affecting petroleum legislation. However, we do know that major firms have been strong advocates of the Oil Import Control program, and also state prorationing legislation. The Import Control program, according to industry sources, has been largely responsible for the present shortage of refinery capacity. In addition, it has effectively created barriers to entry in the industry. The program has been exploited by the major integrated firms to protect the industry's oligopoly position with respect to refined products. Prorationing has been exploited by the majors to raise crude prices above their competitive level and results in a major misallocation of the economy's resources. Morris Adelman, one of the world's leading authorities on the industry, claims that "the great bulk of oil wells are superfluousa political curiosity, not an economic asset."1 They are strictly a result of prorationing legislation and import controls, which artificially raise the price of domestic crude, and encourage the development of otherwise uneconomic wells.2 Among the choicest of domestic oil fields are those contained in offshore government owned land. The oil leases for these fields are sold through "competitive" bidding. It has been common practice, however, for oil firms to submit joint bids on these leases. The result is a 1 M. A. Adelman, The World Petroleum Market, John Hopkins Press, Baltimore, 1971, p. 46. M. A. Adelman, "Efficiency of Resource Use in Crude Petroleum," Southern Economic Journal, Vol. 31, pp. 101-120. small number of bidders for each lease. Joint bidding, and joint ventures in general, may promote competition in certain kinds of situations, but such conduct by large petroleum firms, given the concentration already existing in the industry, is decidedly anticompetitive. Walter Mead has shown that, with respect to Alaskan Oil and gas leases, firms who were partners in joint bidding for one tract tended not to compete with their former partners in bidding for other tracts.* The lack of competition among major oil firms is particularly apparent in the prices paid for crude oil. In a competitive market, prices are set by the interaction of supply and demand. However, in crude transactions the price is established entirely by the buyers. A price is "posted" in a particular field for a particular gravity of crude by the buyer. Within a few days this price is followed and similarly "posted" by other buyers in similar fields. The seller of crude does not dispute or offer alternative prices to the buyer." Since the posted price is the prevailing price for crude in a particular area, it is in the interest of the integrated firms to post a price higher than marginal costs consistent with each firm's self sufficiency ratio (the ratio of crude production to refining capacity), and the elasticity of demand for gasoline.' This is so for two reasons. Remembering, that for the integrated firm, the posted price is the price it both pays itself and uses for tax purposes, the existence of the depletion allowance for crude production means that profits based on high prices at the crude level are "worth" more to the integrated firm than profits at other levels. Second, the integrated firms can "squeeze" those firms which do not have their own crude. An integrated firm, when using its own crude, in effect, pays not the posted price to itself, but rather the real cost of producing the crude. When the non-integrated refiner purchases crude, however, the posted price is, in fact, the "real" price-he is always put at a cost disadvantage if the posted price deviates from marginal cost. 8 Lack of competition among the major firms is also evidenced by the absence of bidding for crude produced by independents. Once a major integrated firm erects gathering lines leading from the crude field, it purchases most of the crude from that field and becomes the field's price leader. Furthermore, our survey of independents has shown that 3 Walter J. Mead, "The Competitive Significance of Joint Ventures," Antitrust Bulletin, Vol. XII, Fall 1967, pp. 823-825. Ibid., pp. 841-846. See, for instance, "S. Texas Crude Given Higher Postings," Oil and Gas Journal, June 4, 1973, p. 22. Adelman suggests that "there is very little room for independent bargaining over crude oil prices with independent refiners desirous, and capable, of carefully examining the range of offers, choosing the best, and trying to play one seller against another. In a market where price is so far above cost, the absence of independent bargaining centers at the various levels of production slows down the attraction of price toward cost. Perhaps even more important, the companies, who to some extent coordinate their production plans, meet again as rivals in refining and marketing." Adelman specifically refers to the world market for oil, but his remarks clearly apply to the domestic market. See Adelman, op. cit., p. 145. See M. G. DeChazeau and A. E. Kahn, Integration and Competition in the Petroleum Industry (New Haven: Yale University Press, 1959, pp. 221-2). There is evidence to suggest that the posted price deviates substantially from long-run marginal cost, even when incremental development cost is included in marginal costs. Adelman estimates that total development and operating costs for U.S. crude was $1.22 per barrel while the average price per barrel was $2.89 in 1960-63. In addition, many of our survey crude companies appeared to be earning supernormal profits. See Adelman, op. cit., n. 76 for data on marginal costs, and U.S. Dept. of Interior. Bureau of Mines, Mineral Industry Surveys, Crude Petroleum, Petroleum Products, and Natural Gas Liquids 1960-63, Table 3 data on the total value per barrel of crude. TABLE II-7.-Company gasoline market shares 1970 NOTE.-Market shares obtained from National Petroleum News, "Factbook Issue," midMay 1971, p. 127. TABLE II-8. A comparison of company ranking in crude production, crude refining capacity, and gasoline sales 1 1 Based on the rankings of tables 4 and 7. Rank in production is for 1969. Rank for capacity and gasoline sales is for 1970. 2 Not ranked within the top 20 firms. |