OPENING STATEMENT OF SENATOR EDWARD M. KENNEDY

The Antitrust Subcommittee for over two decades has devoted a great deal of effort to examining vertical integration in the petroleum industry. Today we are taking up a special aspect of that integration: the ownership of pipelines by integrated oil companies.

Pipelines, unlike other aspects of the petroleum business, are natural monopolies. Since the passage of the Hepburn Act in 1906, interstate pipelines have been subject to federal regulation. Under the law they must operate as common carriers and their tariffs must be just and reasonable. Virtually every State imposes some type of regulation on intrastate pipelines. Therefore, while the pipeline issue is part of the general vertical integration question, it is also part of a different and narrower question involving the ownership of a regulated monopoly by some of its own customers.

This is, of course, not a new issue. On the basis of both economic theory and long experience, public policy in this country has repeatedly resolved it by prohibiting such ownership of regulated carriers. In fact, the Hepburn Act as it was originally passed by both Houses of Congress made no exemption for pipelines when it prohibited shipper-ownership of transportation common carriers. Only after a second conference were pipelines exempted from that general prohibition. Senator Lodge of Massachusetts strongly protested this exemption, saying:

I can see no possible reason why the men controlling these great trunklines of pipe should not make a carrying business and be content to carry oil for all producers at a reasonable rate. We make the railroads do it, and I do not see the slightest reason for this change.

In the over 70 years since Senator Lodge made those remarks there have been numerous studies, investigations, and reports on the question of pipeline ownership. The overwhelming weight of authority is on the side of the Senator. After reviewing the evidence and studies on this subject, the Antitrust Subcommittee staff, in a report issued last week, concluded:

There thus remains only one practical and effective solution to the grave competitive problems inherent in oil company ownership of petroleum pipelines: to prohibit oil companies from owning petroleum pipelines and to require divorcement of existing pipelines from oil company ownership.

Historically, the discussion of competitive problems has focused on two basic issues: The first involves restrictions on access by outside shippers. The integrated company which owns a pipeline has a basic conflict of interest. On one hand it has a legal obligation to treat all shippers equally. On the other hand it has the incentive, as well as countless opportunities, to give preference to its own shipments over

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those of its rivals. This need not involve anything as gross as outright denial of access. Rather it is more frequently a question of subtle discriminations in service that generally make it more convenient to sell petroleum to the pipeline owner rather than retain title as a shipper. As the chief economist of one large oil company wrote:

In practice, privately owned carriers have not been readily accessible to non-owners through the use of limiting qualifications such as tender size, batching, tankage, grade restrictions, long term forecasts, etc.

The second basic issue involves the setting of tariffs. It has never been seriously contended that the ICC did a good job regulating pipeline tariffs. It waited 6 years after the passage of the Hepburn Act before it even asked the pipelines to file tariffs. This pace of activity did not change much over the years.

Recently the Justice Department in its Deepwater Ports report and its filings before the Federal Energy Regulatory Commission in the Trans-Alaskan Pipeline rate case raised a very serious question; whether effective rate regulation is ever possible when a pipeline is owned by an integrated company, because the integrated oil company has an overwhelming incentive to make its pipelines too small, and charge too much for their use.

The Department argues that regulation of a shipper-owned pipeline must involve the regulation of capacity-which is not now permitted in the law. If shipper ownership were precluded, however, such massive regulation would be unnecessary. If, as Senator Lodge put it, "the men controlling these great trunklines of pipe should... make a carrying business and be content to carry oil for all producers at a reasonable rate," then there would be no reason to regulate capacity. A firm dependent wholly upon pipeline revenue would have no incentive to restrict capacity in order to increase the downstream value of its oil. On the contrary, it would have every incentive to expand both its pipeline business and its asset base.

The most frequent objection to divestiture is that the incentive and the capital of the major oil companies are needed to build new pipelines. This argument ignores the obvious fact that pipelines are very profitable. The year 1976 was a record year for pipeline profitability, overall, but some companies turned in downright unbelievable performances. Mobil reported a 26 percent rate of return on its investment in the Mobile Pipe Line Co. Exxon made nearly 37 percent, Shell 81 on its pipelines. Colonial earned a whopping 121 percent for its owners. Overall the cash flow of the pipeline industry came to almost one-half of their operating revenues-a truly amazing financial performance, and one which would easily attract independent investors.

In sum, we have three choices. First, we can continue with oil company owned pipeline and with the current ineffective scheme of regulation. This has the obvious disadvantage of permitting the integrated companies unreasonable leverage over their rivals and consumers. Its only advantage is it requires us to do nothing.

Second, we can drastically increase federal regulation. This at least will ensure some protection for nonowner shippers and the consuming public. But the cost will be a staggering amount of regulation, the effectiveness of which in the long run is highly questionable, if history is any guide.

Third, we can find some means of severing the integrated company from pipeline ownership. This will not only resolve the basic problems of equitable access and effective rate regulation; it would substantially reduce the amount of necessary regulation.

In the end the choices are among private monopoly, massive government regulation, or free enterprise. To permit the continued exercise of private monopoly power under inadequate and ineffective regulation in this vital energy area would be irresponsible. On the other hand imposing the massive regulation necessary to control this power runs counter to all we have learned about regulation over the past decade. Nothing in that experience suggests that such an effort would be successful.

This leaves us with trying to minimize the need for regulation by removing those incentives and opportunities that make such regulation necessary. In our present dilemma, divestiture is by far the least radical solution. It will permit the maximum responsible reliance on the unfettered activity of private business.

PREPARED STATEMENT OF JOHN H. SHENEFIELD

I welcome the opportunity to present the views of the Department of Justice on the subject of divestiture in the oil pipeline industry. My testimony today is consistent with prior statements by Department officials on the competitive problems of vertically-owned and integrated pipelines. One of those statements, the Attorney General's 1976 Deepwater Port report, established the analytical framework that has been followed by the Department since that time. As the Committee may be aware, in the past 2 years, the Antitrust Division's longheld competitive concerns about the petroleum pipeline industry have turned to action on many fronts. Because of the competitive significance of oil pipelines, we have dedicated substantial resources to this area. These efforts have run the gamut from open dialogue with industry representatives to full participation in administrative hearings. In between has come continuous documentary, economic and legal study of the industry, and the communication to others of what we-in what amounts to almost a task force approach-have learned. Those views have principally taken the form of advice to Federal leasing, permitting or licensing authorities, and statements to congressional committees, such as this one, properly concerned with the potential anticompetitive impact of petroleum pipelines.

Our efforts have provided us with a unique vantage point from which to observe the relationship of this regulated industry to those Federal agencies that regulate or otherwise have attempted to license or control it. By this process we have been able to test the validity of the economic analysis we developed to explain and predict the market behavior of petroleum pipelines owned and operated by vertically integrated oil companies. My purpose today is to explain in detail how and why these conclusions point strongly toward pipeline divestiture. To put this discussion in the proper framework, I would like to begin with a general overview of the industry.

I. INDUSTRY OVERVIEW

The pipeline industry is, in many respects, invisible. Buried underground, the lines are out of public view and pipeline transportation is hardly a consumer item. This invisibility belies how important petroleum pipelines are in two major sectors of our economy: transportation and energy. I put transportation first because of the little known but surprising fact that oil pipelines regularly account for up to onefourth of all ton-miles of freight shipped in all forms of inter-city freight transportation. But as important as pipelines are as transportation networks, they take on an added significance by virtue of the identity of the sole commodity they carry-petroleum, from un

1 Statement of Ulysse J. Legrange, ICC Proceeding, Ex Parte No. 308, May 23, 1977 (now FERC Dkt. No. RM 78-2).

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processed to refined. In fact, pipelines have a significant role at two stages of the petroleum industry: as crude lines, they provide the key link between crude production and refining, and as product lines they connect refining centers with product markets. More oil-crude or product is moved more miles in the United States by pipeline than by any other transport mode.2

A. Industry growth

Historically, crude lines developed before product lines. By the early 1930's, for example, the railroads' share of interstate crude shipments had dwindled to 3 percent, but they still carried 75 percent of product shipments. Today, crude lines' share of total crude movements is still larger than product lines' share of all product movements, owing largely to the need for extensive use of trucks on surface streets to carry product to local markets.

Major advances in the development of modern, large diameter oil pipelines occurred during World War II with the construction of the Federally-sponsored Big Inch and Little Big Inch Pipelines. These pipelines, at 24 and 20-inch diameters and capacities of 300,000 and 235,000 barrels/day of crude and product, respectfully, demonstrated to the private sector the feasibility of large diameter pipelines. Despite the success of these lines, post-war movement in the industry to large diameter pipelines was relatively slow, especially for product pipelines. The 1950's and 1960's, however, market the advent of the large diameter joint venture crude and product lines, such as Capline and Colonial. Now, in the post-Arab embargo era, with perhaps the exception of TAPS and its progeny, growth trends have been largely confined to adding capacity to existing lines rather than building large new pipelines over different routes. However, the rate at which significant geographical shifts in demand for pipeline transportation-crude or product-have occurred has traditionally been very low.

Another significant pipeline industry characteristic is the level of ownership dominance that vertically integrated petroleum companies have obtained. For example, 1975 date 10 reveal that there were 104 common carrier pipelines subject to Interstate Commerce Commission (ICC) jurisdiction. The ICC categorized ten of these lines as independents, 59 lines as affiliated with a major oil company, that is, one of the top 20 in sales, and 35 as affiliated with non-major, oil related companies. This listing included 42 pipelines which were joint venture stock companies, of which 5 were owned by non-major, oil-related companies and the remaining 37 by major oil companies. In addition, the ICC listed separately 27 undivided interest pipeline systems operated as common carriers. In some respects, these figures tend to understate the extent to which petroleum companies (majors and non-majors) dominate the pipeline industry. In 1975, the pipelines affiliated with oil

2 Senate Comm. on Energy and Natural Resources, National Energy Transportation Report, Vol. I, Publ. No. 95-15, 95th Cong., 1st Sess. 182-84 (1976) (NET).

3 Id. at 169.

Id. at 143, 184.

5 Id. at 173-74.

Id.; A. Johnson, Petroleum Pipelines and Public Policy, 1906-1959, at 325 (1967).

7 NET at 181.

Id. at 190-93; Johnson at 382-83.

NET at 206.

10 Statement of David L. Jones, Ex Parte No. 308, at 8-9 (April 28, 1977) (hereinafter cited as Jones).