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. 2 M. A. Adelman, "Efficiency of Resource Use in Crude Petroleum," Southern Economic Journal, Vol. 31, pp. 101-120. 3 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. 7 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., p. 76 for data on marginal costs, and U.S. Dent. 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. there appears to be no competition for the right to erect gathering lines; although a crude field may be geographically convenient to several refiners, only one refiner asks to install gathering lines. Only in the smaller fields is there some semblance of competition-there, major firms appear to compete with smaller trucking firms in order to secure the crude. From the gathering lines, crude proceeds to large pipelines. These pipelines are generally owned jointly by a number of major integrated petroleum companies. Although the pipelines are, by law, common carriers and are regulated by the Interstate Commerce Commission, the major firms who own them nevertheless engage in many discriminatory and exclusionary practices with respect to smaller firms who wish to use the pipelines. In addition, cooperative ownership of pipelines provides one more plane on which major integrated firms avoid the rigors of competition. It is normally the case that in the neighborhood of their refineries, petroleum firms produce less than enough crude oil to meet throughput requirements, but more than enough gasoline to meet the demands of their branded marketers. Therefore, they engage in two kinds of practices designed to keep refineries running at near capacity, while at the same time avoiding excess costs for transporting crude oil and refined products: (1) Exchange agreements.-Company A with refinery in area X will supply crude oil to company B with refinery in area Y. Meanwhile, company B will supply his crude oil in area X to company A. Similarly, A will supply gasoline to B's marketers in area X, while B supplies gasoline to A's marketers in area Y. (2) Processing agreements.-A will refine B's crude oil in area X under contract. In other words, B owns both the crude oil and the final product. He simply pays A for refining it. Not all exchange and processing agreements are anticompetitive. However, the eight largest firms prefer to keep exchange agreements in the family. This reliance on barter, rather than direct market sales. limits the availability of crude oil to independent refiners and gasoline to independent marketers. As a result, in 1971, less than two percent of the eight largest firms' output was sold to independent marketers. We shall see that these exclusionary practices, in addition to increasing refinery margins, have enabled the major integrated firms to exploit the present shortage of domestic crude oil and refinery capacity, thus threatening the continued viability of the independent marketing sector. Even prior to the current shortage, anticompetitive conduct, as practiced by the largest firms, effectively limited the independent share of the market. For example, in 1971, independents controlled 34 percent of the market in District 3. However, in Maine, where there are no nearby independent refiners, independent marketers accounted for only 4.75 percent of sales.10 Independent marketers have been exceptionally innovative in their marketing styles. Therefore, in restricting their access to gasoline the majors have created major misallocations of resources. This is par For a detailed discussion of these practices, see section on Barriers to Entry. 10 1972, National Petroleum News Factbook. ticularly true in view of the majors' failure to innovate and meaningfully compete among themselves at the retail level. In fact, it appears that the majors have tacitly agreed not to compete with respect to retail prices. They appear willing to compete in secondary respects (appearance of stations, location of stations, giveaways, etc.) but the result is a remarkable homogeneity in the final product and prices offered to consumers. In the many levels in which they interrelate, the majors demonstrate a clear preference for avoiding competition through mutual cooperation and the use of exclusionary practices. Together they dictate a common price for raw material and seek to stabilize price for refined product. Their common conduct with respect to pipelines and their tendency to bypass the market mechanism through the use of exchange and processing arrangements, has been clearly exclusionary. These exclusionary practices are directed at a common target the independent sector of the industry. In sum, the majors continually engage in common courses of action for their common benefit. V. INDUSTRY PERFORMANCE A thorough analysis of industry performance for specific levels of operation is not possible at this time as the industry is dominated by integrated international companies who do not report profits in any consistent form for less than the company operations as a whole. However, some indications of industry performance may be derived from the data presently available. As shown in Table 1, the weighted average rate of return on stockholder's equity for these firms for the period 1951-1971 was above the average rate of return for all manufacturers for all years but five. It declined from a high of 15.3 percent in 1951 to 9.6 percent in 1958, and rose to 12.4 percent in 1967. In the period 1969-1971, it remained relatively stable, with a 1971 average rate of 11.1 percent. For this 21 year period, the median difference between the weighted average rate of return for these companies and for all manufacturing was a positive 1.1 percentage points. That is, for approximately onehalf of this period, the weighted average rate of return for these companies was more than 1.1 percentage points above that of all manufacturing. (32) |