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PREPARED STATEMENT OF ALVIN L. ALM

I am pleased to appear before you today to discuss the problems associated with integrated oil company ownership of common carrier oil pipelines. Oil pipelines are the vital transportation link of the oil industry and problems in their organization or structure, competitive or otherwise, have a ripple effect throughout the industry and an indirect effect on the price the consumer pays for energy. Your recently issued staff report amalgamating the historical and competitive perspective adds substantially to the body of literature on an analysis of this subject. I compliment you and your staff for assembling in one place the foundation upon which we all can build a solution to this problem.

CONCERN FOR AND RECOGNITION OF THE PIPELINE PROBLEM

As you are well aware, pipelines are characterized by increasing economies of scale. Let me illustrate this concept with an example. The cost of building a 36-inch line would be about 31/2 times the cost of a 12-inch line, yet it could carry 17 times the volume. In other words, 17 pipelines, each 12 inches in diameter, would be required to carry the same volume as one 36 inch pipeline.

The economies of scale create an economic climate where often only a single pipeline can efficiently serve a particular region; this fact is at the heart of the competitive problem. Without regulation, pipeline companies would have little constraint on the prices they could charge because of the monopoly position created by these economies of scale. That is, it is generally not economic to construct a second pipeline from the area of production to markets because of the greater costs of smaller pipelines.

Rate regulation, if it works properly, will control the pipeline's ability to directly use this national monopoly position to increase prices to the consumer. But, even with effective rate regulation, an integrated oil company pipeline owner will have economic incentives to control the capacity of its pipeline by restricting access and other means, thereby forcing its competitors to use more expensive transportation modes. Although regulation is designed to squeeze out excessive profits from pipelines, no certain way has yet been found to assure access to pipelines by nonowners. Hence, depending on the market, it may be possible for the integrated oil company pipeline owner either to reap unnecessarily high prices through its ability to increase transportation costs to its competitors, or to unfairly undercut them in the marketplace.

DOE CONCERN AND ACTION The Department of Energy is concerned that the existing pipeline structure may operate to the detriment of competition. Pursuant to its congressional mandate, the Department has created the Office of Competition to deal with a broad range of energy issues. One issue that is high on its agenda is that of integrated oil company ownership of pipelines. The office will undertake a thorough review of the extent of actual and potential anticompetitive problems and will explore a range of possible corrective measures.

In the course of this analysis, the office will review legislative, litigative, and regulatory proposals. Each of these has its drawbacks. For example, there are many unanswered questions with respect to legislative divestiture: Do we really know which pipelines are most troublesome? Can legislation be crafted to differentiate among those pipelines which ought to be divested and those which ought to remain part of the integrated system? We believe there are many questions to be answered in this area.

Litigation also has its difficulties. It is apparent from history that divestiture cases would require years before they could be brought to a conclusion. The FTC's Exxon case is an obvious example.

Finally, there are the regulatory approaches. These remedies require a great deal more study before any can be advanced as an appropriate course of action. The scope, authority and goals for any rulemaking or adjudication, as well as their proposed time frame, can present obstacles. One regulatory approach is the one taken by the Secretary of Transportation with respect to the license issued to the deepwater port known as LOOP. With LOOP just in the development and construction phase, this approach has not been tested as to its efficacy. There are many who are skeptical as to whether this is a workable regulatory approach.

More recently, the President approved the Alaskan Natural Gas Transportation System with restrictions on pipeline ownership by Alaskan natural gas producers. Such ownership restrictions, balanced against an ability to provide backup guarantees for long term debt, were designed to provide sufficient protection against undue influence by the integrated oil companies that produce the Alaskan natural gas. We are committed to examining all of these questions.

The Department has an interest in the continued development of low-cost transportation systems. It is in the Nation's interest to see that pipelines will be built in the future. Since pipelines are the least costly overland transport mode, all their efficiencies and benefits would be lost if they could not be built. Thus, it is important to address whether proposed solutions would actually lead to higher prices by precluding construction of pipelines.

The Department is aware of the major financing vehicle presently used to finance new large joint venture systems, the so-called “90:10% method. Under this method, the pipeline is financed through_90 percent debt and 10 percent equity contributions from the owners. The debt is guaranteed by the owners by a throughput and deficiency agreement that, in essence, says that the owners will ship sufficient oil through the pipeline to cover all operating and debt service costs. If there is a deficiency, the owners will advance funds to cover any such deficiency. It is possible that this form of financial guarantee could be used to finance independent pipelines. Before it can be determined whether this form of guarantee is feasible, however, we need to know whether integrated oil companies would be willing to give such guarantees to independents and on what terms; whether we would be substituting direct ownership for indirect control with similar consequences, and whether other forms of financing are available. I do not believe these questions can be answered satisfactorily at this time.

CONCLUSION

In summary then, the Department is aware that the ownership of pipelines by integrated oil companies raises substantial competítive issues that will be looked at in an earnest and objective way by the Department. But also, we are concerned about the effects of taking remedial action that might inhibit future pipeline construction. It appears to us that important questions remain unanswered-how will pipelines be built in the future if the existing rules regarding their ownership or control are changed, and what is the best approach to deal with these issues. The Department is committed to answering each of these questions in the near future. We then will be in a better position to make recommendations concerning the most appropriate course of action.

PREPARED STATEMENT OF ALFRED F. DOUGHERTY, JR. As Director of the Bureau of Competition, I appreciate this opportunity to address the subcommittee on the competitive consequences of oil company ownership of petroleum pipelines. My remarks will outline my perception of the problems raised by the major oil companies' dominance over pipelines, the adverse impact of this ownership on independent refiners and marketers and on the consuming public, and alternative approaches to resolution of these competitive problems. These remarks are, of course, my own and do not necessarily reflect the views of the FTC nor any individual commissioner.

Petroleum is usually found in places distant from marketing centers. It is difficult and expensive to store. Refineries generally require a constant flow of crude oil to operate efficiently. These characteristics combine to make an efficient transportation system critical to the economic well-being of the petroleum industry. The crude producer or refiner who does not have access to an efficient transportation system is virtually barred from the market, while those firms that control the least-cost method of transportation into a given market area control the market.

Pipelines dominate modern petroleum transportation, carrying 87 percent of domestic crude oil and 50 percent of the Nation's petroleum products. Indeed, in many areas of the country pipelines may provide the only efficient means of oil transport.

The predominance of pipelines is not surprising. Pipelines are efficient, permitting continuous movement of large quantities of crude oil and petroleum products. Oil which is transported by pipeline is not delayed by bad weather, and pipelines, once constructed, are inexpensive to operate. Pipelines are ordinarily the least-cost mode of petroleum transportation.

Pipeline technology affords great cost savings in petroleum transportation. Development of larger diameter pipelines has yielded exponential increases in line capacity with linear increases in costs. Once in place, the capacity of a large diameter pipeline can be increased substantially, as needed, by addition of pumping stations. The continued need to proration available space on a number of the most significant pipelines, however, suggests that expansion and development of these lines has failed to keep pace with the needs of the petroleum industry.

Most oil pipelines are owned and controlled by large integrated oil companies. These pipelines have been constructed to serve the transportation needs of their owners. The conventional method of pipeline financing insures continued domination of pipelines by major oil companies. To secure financing, major oil companies guarantee to ship a specified quantity of crude oil or petroleum products through the pipeline for a period of years. Such throughput commitments are universally employed by major oil companies to finance the construction of their own pipeline subsidiaries. Similar commitments have not been extended to pipelines which they do not own. This attitude will have to change, however, if establishment and control of their own pipelines is no longer a viable alternative for major oil companies.

Ownership and operation of pipelines by major integrated oil companies have created serious problems which prevent the American people from fully benefiting from the available technology. The anticompetitive problems inherent in major oil company dominance of pipelines can be analyzed from two perspectives: first, the underlying incentives that integrated pipeline owners have to limit capacity and access, and second the mechanics used by pipeline owners to carry out their incentives.

Perhaps the best way to describe the problems created by oilcompany owned pipelines is reference to observations in internal planning documents of large oil companies, disclosed in the Attorney General's Deepwater Port report. These documents demonstrate that these oil companies, pipeline owners themselves, perceive that many of the access problems experienced by non-owners stem from discriminatory denial of access and from inadequate capacity. An official of Ashland Oil Company, an integrated oil company and itself a pipeline owner, stated, for example, that

there are many subtle ways that non-owners can, in effect, be locked out by limiting grade, tankage use, batch size, schedul

ing, etc. He went on to name two large joint venture-pipelines, Colonial and Explorer, as examples of lines that "clearly inhibit non-owners.” 2

Another Ashland internal document stated that the published tariff rate is usually not significant since "outside business is accepted only if it is incrementally very profitable or compensatory adjustments are made such as in posted crude price or a loading charge.

Ashland's appraisal of the disadvantages faced by non-owner shippers is not unique. When a Gulf Oil Company official learned that a pipeline that it was interested in shipping on would be an undivided interest line (i.e., a line for which each of several owners publishes its own tariff), the official urged that Gulf become an owner of that line since “as a shipper ... [it] could not be assured of obtaining the required capacity.” 4

Another oil company, concerned about space availability in Capline, a large midwest crude carrier, wanted to buy into Capline. However, the problem was finding a seller. The firm thought it possible that “one or more companies such as Union would be willing to exchange support

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1 This commitment binds a shipper only if pipeline revenues fall short of those needed to permit the pipeline to meet its financial obligations. Whereupon the shipper may be called upon to provide a deficiency payment to the pipeline in proportion to its share of total throughput commitments. These payments are credited to the shipper as advance payment for future transportation services.

U.S. Department of Justice, Report of the Attorney General on the Application of LOOP, Inc. and Seadock, Inc. for Deepwater Port Licenses (November 5, 1976) at 80-81.

81d. at 83. * Id. at 79.

4-579 O.

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