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Note, Structural Shared Monopoly Under FTC 5: The Implications of the Exxon Complaint, 26 Case Western Reserve Law Review 615 (1976).

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M. A. Adelman et al., Oil, Divestiture and National Security (National Strategy Information Center 1977).

Thomas D. Duchesneau, Competition in the U.S. Energy Industry (Ballinger Publishing Co. 1975).

Walter S. Measday, "The Petroleum Industry" in Walter Adams (ed.), The Structure of American Industry (5th ed. 1977).

Eugene V. Rostow, A National Policy for the Oil Industry (Yale Univ. Press 1948)

Pipelines and Antitrust

Michael E. Canes
Donald A. Norman

CRITIQUE #005
NOVEMBER 1978

The contents of this paper are for the purposes of study and discus-
sion and do not necessarily represent the views of the American
Petroleum Institute or any of its members.

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PIPELINES AND ANTITRUST

I.

INTRODUCTION

In theory and often in practice, United States antitrust

policies are based upon economic models of competition and monopoly.

For example, such models have been utilized by the federal antitrust agencies to determine whether firms in a given market are behaving in socially desirable fashion and to formulate policy prescriptions

if they are not.

For many years, the oil pipeline market has been subject to antitrust scrutiny.1) Because oil pipelines are subject to large economies of scale, the market is said to be characterized by

"natural monopoly," that is, a situation where over the entire range of oil transportation demand a single pipeline facility is the most economical market alternative. Since these conditions are inherent in the technology of pipelines 2) and since there are substantial transportation costs savings associated with larger diameter pipelines, public policy has allowed firms to take advantage of

1/

For a history of such scrutiny, see Arthur M. Johnson, Petroleum Pipelines and Public Policy, 1906-1959, Harvard University Press, 1967.

2/

Essentially, the cross-sectional area of a pipeline, which is related to its output, increases faster than its diameter, which is related to its cost.

3/

See, for example, Leslie Cookenboo, Jr., Crude Oil Pipelines
(Cambridge, Mass.: Harvard U. Press, 1955), or John G. McLean
and Robert W. Haigh, The Growth of Integrated Oil Companies,
(Norwood, Mass.: Plimpton Press, 1954), pp. 185-186. Also,
Spahr has provided indices which related pipeline cost and
throughput capacity to diameter. These are shown below.

Diameter (inches) Pipe Cost Index Capacity Index
4
1.0

1
8
1.9

6
12

2.4

15 16

3.5

28 20

4.3

48 Testimony of Charles E. Spahr, Chairman, Std. Oil of Ohio, before the House Judiciary Subcommittee on Monopolies and

the scale economies but has imposed both rate and common carrier

regulation to avoid monopoly pricing and to provide equal access to

all prospective shippers.

Thus, although firms have achieved large

scale economies with pipelines, these regulatory constraints are meant to have forced pipeline firms to act about as they would have were the pipeline market characterized by a competitive structure.1/

Recently, however, the U.S. Department of Justice has advanced

a different analysis concerning the oil pipeline market.

Noting

that the great majority of u.s. pipelines are owned by vertically integrated oil companies, the Department has reasoned that even if

pipeline rate regulation is perfect, integrated companies can earn monopoly profits in other, adjacent stages of the oil industry by sizing pipelines so as to achieve the monopoly throughput rate. These profits are said to arise because pipeline "undersizing" 27

forces some oil to travel by a more expensive transportation mode,

and because the marginal cost of this other transportation mode

must be reflected in the price of oil at an adjacent industry stage. The reasoning is summarized in recent testimony released by

the U.S. Justice Department.

"As we see it, the ability to avoid regulation is rooted
in the ability of the shipper-owner to limit pipeline
throughput below the level an independent would size or
operate the line. If the vertically integrated pipeline
owner is a significant seller in the downstream market
and the pipeline has market power downstream, the pipe-
line's throughput may be such as to ensure that at
least some not insubstantial amount of supply arrives
The extent to which regulation as opposed to competition
has constrained the behavior of individual pipelines is
open to question, however. Competitive constraints on
pipeline behavior are discussed below (see pp. 9-13).
Henceforth, the term "undersizing" will be taken here to me an
sizing a pipeline at the monopoly output rate.

17

2/

4-579 O - 79 - 39

by the more expensive transport modes. Where this
occurs, the downstream market price would likely reflect
the cost of delivery by the next least expensive
transport mode, allowing the pipeline's shippers to
pick up the difference in transportation costs. •1/

In the recent past, the Department of Justice has applied this reasoning not only to oil pipelines, but also to natural gas pipelines, deepwater ports, and to railroad transportation of coal.2/

Further, it has used the reasoning to advance strong policy pre

scriptions concerning all of these markets.3/ In addition, the

Department's reasoning and some of its policy prescriptions recently

have been adopted by the staffs of both the Federal Trade Commission
and the Senate Antitrust and Monopoly Subcommittee. 4/
17 Proposed testimony of John H. Shenefield, Assistant Attorney

General, Antitrust Division, before the Senate Judiciary
Antitrust and Monopoly Subcommittee, June 28, 1978.

2/

3/

See "Report of the Attorney General Pursuant to Section 19
of the Alaska Natural Gas Transportation Act, July 1977"
(hereafter, the "Alaska Gas Report"); Report of the Attorney
General on the Applications of Loop and Seadock for Deepwater
Port Licenses," November 5, 1976 (hereafter, the "Deepwater
Port Report"); and "Competition in the Coal Industry," May
1978 (hereafter, the "Coal Industry Report").
As discussed below, the Department has endorsed oil pipeline
divestiture; proposed that no gas producers be allowed to
own shares of the Alaskan gas pipeline; proposed 'competi-
tive rules" for deepwater port-owning oil companies; and
proposed that no railroad be allowed to secure new federal
coal leases. The Department also used the reasoning to
evaluate whether the Standard Oil Company of Ohio should be
allowed to construct and operate an oil pipeline from the
West to the Southwest and decided that it should. See
"Report of the Antitrust Division on the Competitive Impli-
cations of the Ownership and Operation by Standard Oil
Company of Ohio of a Long Beach, California-Midland, Texas
Crude Oil Pipeline," June 1978 (hereafter, the "Standard Oil
of Ohio Report").
See proposed testimony of Alfred F. Dougherty, Jr., Director
of Competition of the Federal Trade Commission, before the
Senate Judiciary Antitrust and Monopoly Subcommittee, July 10,
1978; and "Oil Company Ownership of Pipelines," Staff Report
of the Senate Judiciary Antitrust and Monopoly Subcommittee,

4/

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