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included in the return on capital, LOOP's rate of return becomes about 11.5% anȧ SEADOCK's 14.7%. These figures are not as unreasonable as the equity returns, but are still far above the 8.5% median of the 5-year averages of 850 companies listed in Forbes /, or more particularly of such profitable regulated companies as AT&T (6.5%), Pacific Gas & Electric (5.9%), American Electric Power Co. (5.9%), Southern Railway (5.4%), The Chessie System (3.1%), and Burlington Northern (2.2%).

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The ports are designed to make just enough profit to return to the shareholders 100% of the allowable dividend. This is normal for pipelines Why return dividends to the major tariff-payers when the same result can be achieved less indirectly, by lowering prices to the point where expenses are met and tax savings realized? The answer is twofold: (1) Port profits are obviously reduced in the more direct approach in that transportation cost advantages could no longer be pocketed as profits by the owners; but (2) transportation demand would be higher at the lower tarift. If that increased demand were met, the price of final products would fall and downstream profits would be reduced. If by some degree of access denial the demand is not met, all the profits would be downstream, available not only to owners but also to those nonowners to whom access is granted. By adopting the roundabout approach, the owners keep a high percentage of their total monopoly profits in the port itself, shielding those profits from nonowners permitted to ship. in the unregulated extreme, all profits ovld be taken at the port; there would be none downstream. The tariff would be at a monopoly level where there is no need to deny access since there are no downstream profits there would be no unsatisfied demand to ship via the part in order to capture downstream profits. In short, to the extent that nonowners with efficient downstream refinery, distribution or marketing operations for petroleum products exist, the financing structure of the ports may prove to be a serious threat to nonowners' ability to capitalize on those efficiencies with lower market prices. For this reason, the competitive rules which we propose for incorporation in the requested licenses are designed to minimize that danger although their effect on tariffs may be long range and tenuous. Consonant with this, we have recommended that the Secretary condition the licenses to require that tariffs first be submitted to him for review, and that the Secretary prescribe an appropriate rate of return (and hence, a lower tariff) which will pass on the transportation savings to all potential users.

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*/ January 1, 1975

Another aspect of tariff calculation is the treatment of income from reserves set aside for deferred taxes and 7% tax reductions due to the Investment Tax Credit (ITC). Financing plans for both ports reveal that neither of these items, if used, is expected to affect the 7% allowable dividend. (SEA916, 972) In fact, the ITC may

DOCK

LOOP

accrue to the owners' benefit and lower transportation costs. It has been estimated that the ITC can lower the tariff by 1 cent per barrel., The ITC could be construed as non-carrier (i.e., non-transportation) income to be passed on to shareholders as outside the Consent Decree's 7% limitation. Apparently Mobil already is doing this. SEADOCK's latest approach is not to use the ITC to lower tariffs, but apparently to pass it on to the owners. This would appear to be contrary to the basic purpose of the Consent Decree, which was to set a ceiling on the amount by which a pipeline owner has an economic advantage over a nonowner simply by virtue of ownership. Tariffs based upon taxes at an expected rate should reflect the actual tax rate that will be paid, and this should take account of any expected credits such as the ITC. As for tax reserve income, the oil companies' argument that this is non-transportation income also misses the point. The source of the income is immaterial; the net economic advantage of owner over nonowner is the critical factor, and this should not ignore any owner payments from the pipeline venture, whatever the source. Whether or not these views are consistent with post-Consent Decree or ICC practices ;is not decided here. What matters is that this approach is the one which ought to be implemented in licensing LO? and SEADOCK in order to minimize the ownership advantage.

One other aspect of financing deserves special mention. For reasons explained more fully below, we conclude that shareholder readjustment of ownership should be frequent rather than a one-time thing. From all that appears in the LOOP and SEADOCK documents that we have reviewed, the oil industry is not opposed to frequent readjustments. One LOOP owner has pressed for adoption of this policy. (962) The prevailing thinking has been caution borne of antitrust concerns; however, we think the procompetitive approach is to adjust ownership to throughput at every practical interval. Of course, this sort of requirement cannot be imposed without regard for its impact on the financing of the projects. One approach is LOOP's, which will proceed with its one readjustment, at least internally, if it does not achieve external (i.e., lender) acceptance. SEADOCK's solution is essentially the same, with perhaps a more positive statement that lender acceptance of the readjustment will be sought.

The development of SEADOCK's approach is informative on the issue of leader acceptance. Initially, the first few

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versions of the SEADOCX draft throughput agreement were bifurcated affairs with two separate agreements--a lender agreement and an inter-company agreement. (See CMW Draft II, 9-30-74,

. The lender agreement provided for one readjustment within defined limits of change. The inter-company agreement had the effect of removing from the lender (throughput) agreement both the traditional internal settlement mechanism for adjusting basic liability for cash deficiencies among companies, and the required amendment at the time of (and to reflect) ownership readjustment. The drafter explained his approach as one which simply removed from the lender agreement things which did not concern him. (738) Over some opposition, he maintained his view that this was the better approach observed that it should be more, not less, acceptable to lenders than the usual combined approach, and added:

Indeed, if lenders had never seen a conventional
pipeline throughput agreement, I think they would
not--and, even so, they well may not--ask about
those provisions; but of course there need be no
hesitancy to disclose them, in the separate Agree-
ment, either to lenders or to the Federal licensing
agency. I do not conceive that the T/D Agreement's
omission of those provisions has any bearing on
whether or not it is a guaranty; and I would again
emphasize the separate Agreement's considerable
virtue of accommodating changes of ownership of
Seadock's shares, realistically and, in particular,
without disturbance of the T/D Agreement.

These considerations point to the conclusion that there is no real lender problem with frequent readjustments. If the idea is novel, so was Seadock's attempted bifurcation, and both have sound explanations behind them. Further, the shareholder agreement's two-tier approach, with or without incorporation into a separate inter-company document, points the way toward implementation of a frequent readjustment rule without lender acceptance. Even so, lender disapproval, at least on the basis set forth in the financing letters from First Boston and Morgan Stanley, seems very unlikely. To illustrate, Morgan Stanley said SEADOCK is likely to get an Aa/AA rating, as it had at least 80% ownership by companies with that rating or better. In fact, the figure is 83.82% at present, the remainder attributable to Crown, Cities. Service, and Dow. This means that those three companies would have to increase throughput by about 25% while the others remained constant in order for there to be any question of the rating's soundness under Morgan Stanley's test. Even if that did occur, over 60% of SEADOCK would still be owned by Aaa/AM rated companies. The net result is that there is no reason to believe ownership

readjustinents would have much, of the debt.

if any, effect on the rating

The same conclusions can be drawn for another of our procompetitive principles, that of ownership access. If a small nonowner-shipper desires ownership, and it will not impair the rating of the debt securities to incorporate its ownership interest into the Financing Agreement, there is no reason the shipper should not be afforded ownership on this basis. In all other cases, where the rating might be impaired, the new Owner can become a participant with an appropriately secured inter-shareholder obligation which leaves the earlier shareholder-lender obligations unaffected.

H. Corporate Organization

A few miscellaneous issues relating to the structure of the two joint ventures remain to be discussed.

1. Control Over Expenditures

As finally drafted, the shareholders' agreements show that the major participating shareholders have retained tight control over the decision to authorize significant corporate expenditures. In SCADOCK's case, an early draft of the Shareholders Agreement put the control over such expenditures in the hands of a majority of the Board of Directors. It was not an entirely comforting arrangement to which sought and failed to get the shareholders to agree to a unanimity requirebut was successful in getting approval tică

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to cerchip interests, with a 70% approval requirement.
desire to link control to ownership levels is plain from a
letter
it wrote in protest to the majority rule:

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Authorization of corporate expenditures by only an
affirmative vote of a majority of the Board of Direc-
tors of Secóock comprised of one Director nominated
by each shareholder owning 2% of more of Seadock
voting stock (Shareholders Agreement, article 3) is
wholly inconsistent with future stock ownership
and financial responsibility based on system
throughput. Under the presently proposed corporate
documentation, a majority of the Directors nominated
by shareholders owning substantially less than 503
of the outstanding voting stock of Seadock could
authorize substantial corporate expenditures not
approved by Directors nominated by shareholders
Owning substantially more than 50% of the voting
stock and having substantially more than 50% of
the financial responsibility for such expenditures.

This probability is particularly troublesome since short-term debt (maturing in less than twelve months) can be incurred by Seadock when authorized by the affirmative vote of only a majority of the Directors and without the approval of shareholders owning not less than 70% of the voting stock as is required for long-term debt (article 5.2). In order to avoid possible future shareholder disputes relating to Seadock expenditures, we propose that appropriate provisions be included in the Shareholders Agreement or other corporate instruments requiring that annual operating and capital budgets, and any capital expenditure not budgeted, be approved by both a majority of the Directors and the owners of not less than 70% of the voting stock of Seadock. LOOP's restrictions are, if anything, even tighter (75%).

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Both of these restrictions will have to be eliminated under our proposed competitive rules, at least insofar as they could operate as a roadblock to port expansion when the rules and external conditions dictate that expansion must take place. Otherwise, it is not unreasonable to allow the larger shareholders a proportionately larger voice in how the company operates, and no other antitrust concerns seem apparent solely from those provisions.

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Both companies have avoided, for the present, a curulative voting arrangement. In LOOP, Ashland noted that the adoption of a "one-shareholder-one-director" approach was

of benefit to the smaller participants and is
basically motivated to soften competitive effect
allegations. This is despite quite reasonable argu-
ments that those with the material investment should
have the control. Nevertheless this was the over-
whelming straw vote of the group. (838)

We agree with this view. Considering the tight control over expenditures as noted above, this seems a much preferable approach to ensuring that the port is operated in a manner that will not unfairly discriminate against lower-volume users, owner and nonowner alike. If there is ever any problem with regard to possibly conflicting state corporation law, it would seem as a matter of federal pre-emption that a federal requirement prohibiting cumulative voting by the shareholders would prevail.

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