[Joint House and Senate Hearing, 110 Congress]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-202
 
    IS MARKET CONCENTRATION IN THE U.S. PETROLEUM INDUSTRY HARMING 
                               CONSUMERS?

=======================================================================


                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 23, 2007

                               __________

          Printed for the use of the Joint Economic Committee



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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE                               HOUSE OF REPRESENTATIVES
Charles E. Schumer, New York,        Carolyn B. Maloney, New York, Vice 
    Chairman                             Chair
Edward M. Kennedy, Massachusetts     Maurice D. Hinchey, New York
Jeff Bingaman, New Mexico            Baron P. Hill, Indiana
Amy Klobuchar, Minnesota             Loretta Sanchez, California
Robert P. Casey, Jr., Pennsylvania   Elijah E. Cummings, Maryland
Jim Webb, Virginia                   Lloyd Doggett, Texas
Sam Brownback, Kansas                Jim Saxton, New Jersey, Ranking 
John E. Sununu, New Hampshire            Minority
Jim DeMint, South Carolina           Kevin Brady, Texas
Robert F. Bennett, Utah              Phil English, Pennsylvania
                                     Ron Paul, Texas


                            C O N T E N T S

                              ----------                              

                      Opening Statement of Members

Hon. Charles E. Schumer, Chairman, a U.S. Senator from New York..     1
Hon. Jim Saxton, a U.S. Representative from New Jersey...........     5
Hon. Carolyn B. Maloney, Vice Chair, a U.S. Representative from 
  New York.......................................................     6

                               Witnesses

Statement of Thomas McCool, Director, Center for Economics, 
  Applied Research and Method Groups, U.S. Government 
  Accountability Office..........................................     8
Statement of Dr. Michael A. Salinger, Director, Bureau of 
  Economics, Federal Trade Commission............................    10
Statement of Dr. Diana L. Moss, Vice President and Senior 
  Research Fellow, American Antitrust Institute..................    24
Statement of Dennis DeCota, Executive Director, California 
  Service Station and Automotive Repair Association..............    26
Statement of Samantha Slater, Director, Congressional and 
  Regulatory Affairs, Renewable Fuels Association................    28
Statement of Red Cavaney, President and CEO, American Petroleum 
  Institute......................................................    30
Statement of Dr. James L. Smith, Cary M. Maguire Chair in Oil & 
  Gas Management, Edwin L. Cox School of Business, Southern 
  Methodist University...........................................    32

                       Submissions for the Record

Prepared statement of Senator Charles E. Schumer, Chairman.......    41
    Chart entitled ``Gas Prices Continue to Rise, Setting New 
      Records''..................................................    44
    Chart entitled ```Unexpected' Refinery Outages and Pipeline 
      Problems Fueling Price Surge in Gasoline''.................    45
Prepared statement of Representative Jim Saxton, Ranking 
  Republican Member..............................................    46
Prepared statement of Representative Carolyn B. Maloney, Vice 
  Chair..........................................................    47
Prepared statement of Senator Sam Brownback, Senior Republican 
  Senator........................................................    47
Prepared statement of Thomas McCool, Director, Applied Research 
  and Method Groups, GAO.........................................    48
Prepared statement of Dr. Michael A. Salinger, Director, Bureau 
  of Economics, Federal Trade Commission.........................    54
Prepared statement of Dr. Diana L. Moss, Vice President and 
  Senior Research Fellow, AAI....................................    64
Prepared statement of Dennis DeCota, Executive Director, CSSARA..    69
Prepared statement of Samantha Slater, Director, Congressional 
  and Regulatory Affairs, Renewable Fuels Association............   110
Prepared statement of Red Cavaney, President and CEO, API........   113
Prepared statement of Dr. James L. Smith, Cary M. Maguire Chair 
  in Oil & Gas Management, Department of Finance, Southern 
  Methodist University...........................................   129


                  IS MARKET CONCENTRATION IN THE U.S.
                 PETROLEUM INDUSTRY HARMING CONSUMERS?

                              ----------                              


                        WEDNESDAY, MAY 23, 2007

             Congress of the United States,
                          Joint Economic Committee,
                                                     Washington, DC
    The Committee met at 10:10 a.m., in room 216 of the Hart 
Senate Office Building, the Honorable Charles E. Schumer, 
Chairman of the Committee, presiding.
    Senators present: Bingaman, Brownback, Casey, Klobuchar, 
and Webb.
    Representatives present: Cummings, Hinchey, Maloney, and 
Saxton.
    Staff present: Christina Baumgardner, Katie Beirne, Ted 
Boll, Chris Frenze, Nan Gibson, Colleen Healy, Brian 
Higginbotham, Michael Laskawy, Matthew Salomon, Jeff 
Schlagenhauf, Annabelle Tamerjan, and Robert Weingart.

OPENING STATEMENT OF HON. CHARLES E. SCHUMER, CHAIRMAN, A U.S. 
                     SENATOR FROM NEW YORK

    Chairman Schumer. The hearing will come to order, and I 
want to thank everyone for being here. It's a critical hearing 
on the state of competition in the market for U.S. petroleum. 
We have a lot of business to cover today, so I am going to ask 
that Ranking Member Saxton and Vice Chairman Maloney offer 
their opening statements; and contrary to the usual practice 
we've had here, I'm going to ask our fellow Members to submit 
their opening statements for the record so we can get right to 
it.
    Now, after a wage of mergers in the industry over the past 
two decades, we have an elite group of five very large, 
integrated oil companies dominating our domestic petroleum 
market, and there has been very little analysis of the impact 
of those mergers, since many of them have occurred recently.
    The looming question hanging over us that we will strive to 
answer today is whether lack of competition in this market is 
harming consumers, and should we begin a serious exploration of 
whether or not to undo some of these mergers that occurred in 
the last two decades?
    To answer this question, we need to explore three areas: 
price manipulation, refining capacity, and barriers to entry 
for renewable energy alternatives:
    On prices: Are oil companies exploiting their market 
control prices? If this market is, as some say it is, an 
oligopoly, then oil companies don't have to meet behind closed 
doors to set the price of oil; one company can take the lead, 
and the rest can all follow and sort of wink at each other. 
Economists call this ``price leadership'' and the more 
concentrated the oligopoly, the more market power they have to 
set prices above competitive levels.
    It's common sense that if there were 15 large companies, 
the chances of two or three saying ``I'm going to break the 
mold, increase market share, even if I don't increase price'' 
would be more likely.
    Refining capacity. Are oil companies strategically under-
investing in refinery capacity and maintenance in order to 
constrict supply, drive up prices and maximize profits? Again, 
the more competition, the less likely that everyone would 
follow the same pattern of behavior.
    Barriers for renewables. And are oil companies using their 
market power to block the availability of alternative energy 
choices, such as E-85, at the pump?
    The goal of this hearing is to examine in depth whether the 
oil industry's market structure is to blame for the sky-high 
gas prices, lack of adequate refining capacity, and lack of 
alternative fuels at the pump that are harming consumers today.
    And frankly, I can't imagine a more appropriate time to 
have this hearing--the national average gasoline price reached 
$3.22 a gallon last week--that's the highest level on record. 
As you can see in the chart right here--well, I hope people can 
see it. Can the audience see it, too? Nope.
    I don't know how we do this so that everybody can see it.
    Well, in any case--thank you.
    [Chart entitled ``Gas Prices Continue to Rise, Setting New 
Records'' appears in the Submissions for the Record on page 
44.]
    That's the highest level on record.
    We are here today because the American people suspect that 
the high prices they are paying at the pump go straight to oil 
companies' profits. They're concerned that these profits are 
not going towards renewable energy alternatives or curbing the 
cost of gasoline at the pump.
    We are here today because, in the words of Teddy Roosevelt, 
``We demand that big business give people a square deal.'' A 
square deal means passing along efficiencies achieved through 
mergers to consumers, investing in new production and refinery 
capacity, and ensuring reliability of supply so that gas prices 
don't shoot up by over $1 a gallon in a matter of months. 
Today, American families are getting a raw deal, while oil 
companies make out like the robber barons of Roosevelt's time.
    And finally, we are here today because competition in the 
petroleum industry is critically important to the health of the 
economy of this Nation--an economy that has been dragging its 
feet in recent months. And the Federal Government has an 
important role to play in ensuring that this market is 
competitive.
    Scanning the landscape of the U.S. petroleum market, it 
isn't clear that we have anything that can remotely be called 
competition.
    Since the late 1990s--mergers between the giant oil 
companies like Exxon and Mobil in 1999, Chevron and Texaco in 
2001 and Conoco and Phillips in 2002--have left us with only 
five major domestic oil companies controlling the majority of 
our domestic refining capacity.
    In 1993, the largest five oil refiners controlled one-third 
of the market, while the largest 10 had 56 percent. Look at the 
difference. And that's just in 12 years (1993-2005).
    By 2005, the largest five controlled 55 percent of the 
market, and the largest 10 dominate the market with over 80 
percent of market share. There's been huge consolidation since 
the mid-1990s in the refining industry. And again, I don't 
think anyone has seriously examined the effects of that; and 
the consumer may be well receiving, unfortunately, the effects.
    Despite ever-increasing petroleum prices, our major oil 
companies don't feel they need to compete to create new 
domestic gasoline supply. All things being equal, high gas 
prices should be an incentive for increased refining capacity. 
But we haven't had a new refinery built in 30 years, forcing 
refineries to operate longer and harder, and at capacity levels 
that are overtaxing the system.
    The oil companies tell us that instead of building new 
refineries, they are focused on upgrading existing refineries 
to keep up with increasing demand. Yet it isn't clear how much 
they are really investing in their existing refining plants 
when ``unexpected'' refinery accidents and unplanned 
maintenance closings have become a regular occurrence, choking 
off supply and causing steep price surges at the pump in recent 
months.
    The rust and neglect has crept into the pipelines as well. 
Just yesterday, BP announced it would shut down 100,000 barrels 
a day in capacity ``for a few days'' because of a pipeline 
leak. And that's just the latest in a series of missteps for BP 
in their production and distribution systems.
    Look at this chart. This chart looks at unexpected refinery 
outages and pipeline problems fueling the price surge in 
gasoline in just the last 4 months, 3\1/2\ months.
    [Chart entitled ```Unexpected' Refinery Outages and 
Pipeline Problems Fueling Price Surge in Gasoline'' appears in 
the Submissions for the Record on page 45.]
    Meanwhile, even as oil prices are dropping, gas prices are 
going through the roof! That's the anomaly now. The actual 
price of crude goes down a little, but gasoline prices go up. 
Right now, crude oil prices are lower than they were last year 
at the onset of the summer driving season. But gas prices this 
morning, at $3.22 a gallon, are 34 cents higher than they were 
a year ago. The Department of Energy is predicting that crude 
oil prices will average about $66 a barrel this summer, versus 
$70 a barrel last summer. But the agency is predicting gasoline 
will average about $2.95 a gallon this summer, up from $2.84.
    As a result, with capacity as tight as it is, and the 
spread between oil and gas prices widening, refining profit 
margins are at historical highs. ConocoPhillips, the largest 
U.S. oil refiner, posted its biggest quarterly profit since its 
merger in 2002. Exxon-Mobile, the second largest just reported 
its highest first quarter earnings in 13 years; and Valero, 
which is No. 3, tripled its profits during the first quarter of 
this year.
    I don't understand how an industry that makes tens of 
billions per year can still have rusty refining plants that 
constantly break down. I don't know of any other business where 
the ratio of profits to infrastructure breakdowns is as high. 
And I don't know any other industry where an equipment 
breakdown in one company benefits every other oil company by 
raising prices.
    On the surface, it seems that Big Oil is pumping cash 
rather than petrol, strengthening profits rather than rusty 
pipes, and they're using their dominant market position to buy 
back their own stock rather than meet the growing demand for 
fuel in this country.
    One example. Exxon-Mobile, the world's most profitable 
company, dolled out $29 billion, that's 60 percent of its cash 
flow, on stock buybacks last year alone. This was more than any 
other company in the S&P 500. This was $9 billion more than 
Exxon invested back in its own business. More money for stock 
buybacks than to either maintain production or increase 
production.
    Meanwhile, as news reports show, Exxon's overall production 
``barely budged'' since its 1999 merger.
    Exxon-Mobile is not alone. Overall, the oil industry spent 
$52 billion on buybacks last year, nearly double the amount in 
2005. And like Exxon-Mobile, production levels at the Big 5 
have been flat. The question looms:
    If there was more competition in this market, wouldn't 
these companies be investing in new production rather than 
sending their oligopolistic profits back to their shareholders? 
Wouldn't they have the incentive to take more risks in and 
innovate to get ahead on the renewable energy curve?
    This is a long overdue debate, and my instinct tells me 
that a reconsideration of oil company mergers in the last two 
decades may well be in order.
    When markets have been distorted from lack of competition 
in the past, the Federal Government has taken action. Standard 
Oil, U.S. Steel, and AT&T come to mind.
    It's no coincidence that I again quote Teddy Roosevelt, a 
Republican and a New Yorker, who had a lot to do with restoring 
competition in markets that had been lost, when he once said 
``Rhetoric is a poor substitute for action, and we have trusted 
only to rhetoric. If we are ready to be a great Nation, we must 
not merely talk, we must act big.
    It's time to consider acting big.
    We're looking forward to learning from our witnesses today 
what's going on in the market so we can best figure out how to 
proceed here. I will now turn the podium over to our Ranking 
Minority Member, Jim Saxton.
    [The prepared statement of Chairman Charles E. Schumer 
appears in the Submissions for the Record on page 41.]

 STATEMENT OF HON. JIM SAXTON, A U.S. REPRESENTATIVE FROM NEW 
                             JERSEY

    Representative Saxton. Thank you, Mr. Chairman. You're 
right, this is an extremely important subject for a lot of 
reasons. I would like to thank you for calling this hearing.
    I'd also like to join in welcoming our witnesses, 
testifying before the Committee today. Obviously, we all share 
the concern about the current level of oil and gasoline prices 
that hits the entire American population. A few years ago, no 
one would have imagined pulling up to the gas pump and spending 
$40 or $50 or $60 to fill up.
    There are many possible factors that can influence oil and 
gasoline prices. For example, we can examine the impact of the 
oil industry mergers as certainly an important subject of this 
hearing today.
    The GAO, as a matter of fact, has performed econometric 
modeling on a number of such mergers, most of which occurred, 
during the last half of the 1990s. I would point to Ultramar 
Diamond Shamrock (UDS)-Total, Tosco-Unocal, Marathon-Ashland, 
Shell-Texaco, BP-Amoco, Exxon-Mobil and Marathon-Ashland 
Petroleum (MAP)-UDS, all of which occurred in the second half 
of the 1990s.
    So whatever can be said, as you so articulately pointed 
out, Mr. Chairman, about the impact of such mergers, the large 
mergers modeled by GAO reflect the antitrust policies that have 
been in place for many, many years, going back into the 1990s 
when these large mergers occurred.
    Let me suggest that, as you pointed out correctly also, Mr. 
Chairman, that this is a very important debate, and in my view 
should be widened beyond domestic oil companies. Crude oil and 
its refined products are traded in a global market, and OPEC 
dominates that market at the source with control of 70 to 80 
percent of the known conventional oil reserves. Seventy to 80 
percent, depending on how one counts.
    Any analysis of gasoline prices or other refined product 
prices therefore ought to start with OPEC and the gross 
distortions it has wrought in the petroleum industry. Consider 
this: OPEC's cost of crude oil production is less than $5 a 
barrel in the Persian Gulf, and less than $9 a barrel outside 
the Persian Gulf. The cartel systematically curtails production 
in each of its member states by imposing production quotas. 
Despite its enormous reserves and low cost of oil, the cartel's 
share of world production today is about 40 percent, while 
controlling 70 to 80 percent.
    By colluding to throttle the rates of oil output, the 
cartel members are artificially increasing oil scarcity in the 
world market and causing buyers to bid up the price of oil far 
above the resource's true scarcity and far above the cost of 
production.
    Large increases in oil demand from Asia in the last few 
years have raised the question of whether OPEC has encountered 
short-run output limitations, and the incremental demand is 
pushing the price up higher than OPEC intended. However, there 
is no doubt that OPEC is opportunistically exploiting the Asian 
demand.
    Since last fall, when the price was $50 to $60 per barrel, 
and trending down, the cartel decided to cut its output quotas 
on two separate occasions by a total of 1.7 million barrels per 
day. Now with the price at $60, it has refused to raise 
production again. The cartel officially abandoned its price 
target range of $22 to $28 per barrel at the start of 2005 in 
favor of higher prices, and it has not indicated how much 
higher it wants the price to rise.
    Consider this: From 2002 to 2006, OPEC's estimated annual 
oil revenue increased by 200 percent, more than tripling, from 
$183 billion to $580 billion, while the rate of oil output 
increased by a mere 17 percent.
    OPEC's restrictive output policy discourages oil field 
development by its members. Many oil fields require substantial 
investment to increase production rates or reverse declines. 
While some investment is taking place, the cartel has made no 
commitment to raise output and has not indicated what market 
share or price would satisfy it in the long run. Uncertainty 
and even higher prices may prevail.
    OPEC causes enormous volatility as Persian Gulf countries 
alone sit on 730 billion barrels of oil with the price up 15 
times more than the cost of production. OPEC has severed the 
normal connection between the cost of production and the price 
it receives in the marketplace, and has driven its profit 
margin to staggering heights.
    So Mr. Chairman, I'm pleased that we're here today to 
discuss this wide range of issues, and I look forward to 
hearing from our witnesses.
    [The prepared statement of Representative Jim Saxton 
appears in the Submissions for the Record on page 46.]
    Chairman Schumer. Thank you. And I wanted to acknowledge--
he had left, I was going to ask him if he wanted to say a few 
words; a Member of our Committee, but also Chairman of the 
Energy Committee, Jeff Bingaman was here, and we thank him for 
coming.
    And now we'll hear from Congresswoman Maloney.

  OPENING STATEMENT OF HON. CAROLYN B. MALONEY, VICE CHAIR, A 
               U.S. REPRESENTATIVE FROM NEW YORK

    Representative Maloney. Thank you, Mr. Chairman. This is a 
very timely hearing because the price of gasoline is rising 
just as the summer travel season is upon us.
    Is it coincidence or corruption? Either way, it's a hard 
blow to the American consumer. The average weekly price of 
gasoline hit $3.22 a gallon just this week, the highest price 
on record. That means families are spending about $55 on 
average every time they fill up their car, an astonishing $30 
more per tank since President Bush took office.
    Rising gas prices are forcing American families to cut back 
on other spending, putting our economic growth at risk. The 
current run-up in gas prices underscores the urgent need for a 
better national energy policy. But instead we see stubborn 
inaction and complicity on the part of this Administration.
    The Administration's priority has been to give tax breaks 
to oil and gas companies even as their profits have soared to 
new heights. The Big 5 oil companies that dominate the market 
enjoyed eye-popping profits, of $120 billion last year.
    Instead of using those profits to expand refinery capacity 
or make serious investments in renewable energy, the Big Oil 
companies are buying back their own stock to enhance prices for 
their shareholders.
    Oil companies seem to be working hard to prevent gasoline 
alternatives such as ethanol-based products from being pumped 
at their branded gas stations. The administration has also 
turned a blind eye to oversight of the oil and gas industry in 
general, but especially mergers. The president has approved 
mergers at such a breakneck speed that by 2005 the top 10 
refiners controlled 81 percent of the market, up from 56 
percent since 1993. That is an astonishing gain.
    This concentration of refiners has restricted production 
capacity, causing American consumers to pay more at the pump 
than they would with more market competition. The lack of 
competition is hurting consumers now, and will hurt our economy 
in the future.
    But elsewhere at home and around the globe, leaders are 
recognizing the need to invest in clean and renewable energy 
sources and technologies. Just yesterday it was announced in my 
home district that New York City cabs are going green. The 
mayor plans to replace the City's fleet with hybrid cars by 
2012.
    Democrats in Congress are working on legislation to protect 
consumers, increase our energy independence by investing in 
renewable energy sources, reduce global warming emissions, and 
strengthen the economy.
    Chairman Schumer, I thank you for holding this important 
hearing, and I look forward to the testimony.
    [The prepared statement of Vice Chair Carolyn B. Maloney 
appears in the Submissions for the Record on page 47.]
    Chairman Schumer. Thank you. And I think now we'll get on 
to the--do you have a statement, Senator Brownback?
    Senator Brownback. Thanks, Mr. Chairman. I'll put it in the 
record so we can get to the panels. I do hope they can testify 
to us what it is that the Congress can and should be doing to 
get at this energy price, supply, demand, refinery capacity. I 
would hope the witnesses would be as specific. We all want to 
try to do something to get these prices down, and help us in 
what we can move forward with.
    I thank the Chairman for holding the hearing.
    [The prepared statement of Senator Sam Brownback appears in 
the Submissions for the Record on page 47.]
    Chairman Schumer. OK, let's get on to our panel, and I 
thank our witnesses for being here. We're going to hear from, 
two different points of view on the effects of competition.
    First, Thomas McCool, the Director of the Center for 
Economics in the GAO's Applied Research and Method Groups. He's 
been at the GAO for 20 years, beginning in the Tax Policy and 
Administration Group. In 1994 he joined the Financial 
Institutions and Market Group as associate director, and later 
director.
    Before joining GAO, Dr. McCool taught economics at Vassar 
College and Georgetown University. He has a B.A. in economics 
from St. Joseph's University, a Ph.D. in economics from 
Columbia.
    Dr. Michael Salinger is Director of the Bureau of Economics 
at the Federal Trade Commission. Since July 2005, he's on leave 
from the Boston University School of Management, where he is 
professor of economics and chair of the department of finance 
and economics. He's published articles on a wide variety of 
antitrust topics; most notably tie-in, vertical mergers, and 
the competitive effects of market structure. He has a B.A. in 
economics from Yale University and a Ph.D. in economics from 
M.I.T.
    We're first going to hear from Dr. McCool, and then from 
Dr. Salinger. You may begin, and your entire statements will be 
read into the record.

  STATEMENT OF THOMAS McCOOL, DIRECTOR, CENTER FOR ECONOMICS, 
      APPLIED RESEARCH AND METHOD GROUPS, U.S. GOVERNMENT 
                     ACCOUNTABILITY OFFICE

    Dr. McCool. Mr. Chairman and Members of the Joint Economic 
Committee, we are pleased to participate in today's hearing to 
discuss the factors that influence the price of gasoline.
    Few issues generate more attention and anxiety among 
American consumers than the price of gasoline. Price increases 
are accompanied by high levels of media attention and consumers 
questioning the causes of those higher prices. The most current 
upsurge is clearly no exception.
    For the average person, understanding the complex 
interactions of the oil industry, consumers and the Government 
can be quite daunting. Given the importance of gasoline for our 
economy, it is essential to understand the market for gasoline 
and what factors influence the price that consumers pay.
    In this context, my testimony addresses the following 
questions: What key factors affect the price of gasoline, and 
what effects have mergers had on market concentration and 
wholesale gasoline prices.
    Let me sum up by making the following observations. First 
of all, over the long term, one of the primary determinants of 
the price of gasoline is the price of crude oil. These prices 
have tracked one another pretty closely--again, over the long 
term, with some individual short-term divergences.
    A number of other factors also affect gasoline prices, 
including first of all the increasing demand for gasoline; even 
though again demand has fluctuated over the long period of 35 
years that we looked at. In fact, effectively it's grown pretty 
much consistently about 1.6 percent per year. The demand has 
been increasing.
    At the same time, refinery capacity has not expanded at the 
same pace as the demand for gasoline, and in particular in 
recent years, which coupled with high refinery capacity 
utilization rates, reduces refiners' ability to sufficiently 
respond to supply disruptions.
    A third factor is that gasoline inventories maintained by 
refiners and marketers of gasoline have seen a general downward 
trend in recent years. This is in keeping with similar aspects 
of other industries; just in time inventory processes and 
delivery processes that reduce the cost of inventory holdings 
in a lot of industries; but it is true that the average stock 
of gasoline that's held in inventory has fallen from about 40 
days of consumption in the 1980s to about 23 days in 2006.
    And lastly, regulatory factors such as national air quality 
standards have also had an effect on the price of gasoline, 
because they have induced some states to switch to special 
gasoline blends; they have been linked to higher gasoline 
prices.
    And finally, consolidation in the industry can also play a 
role in determining gasoline prices. For example, mergers raise 
concerns about potential anti-competitive effects because 
mergers can result in greater market power. However, they can 
also lead to greater efficiency, enabling the merged companies 
to lower prices.
    Let me turn to our work on mergers. The 1990s saw a wave of 
merger activity in which mergers occurred in all segments of 
the U.S. petroleum industry. This wave of mergers contributed 
to increases in market concentration in the refining and 
marketing segments of the U.S. petroleum industry. For example, 
the Index of Market Concentration in Refining increased all 
over the country during the 1990s; and changed, for example, 
from moderately to highly concentrated in the East Coast.
    In addition, in 1994, about 27 states had moderate to high 
levels of concentration in the wholesale side of the industry, 
and in 2002, it was up to about 46 states.
    In addition, qualitative evidence suggests that mergers may 
also have affected other factors that can impact competition, 
such as vertical integration and barriers to entry. Some of the 
mergers that we examined in particular, involved fully or 
partially integrated firms, or previous independents who have 
become more integrated as a result.
    Now the econometric modeling that Congressman Saxton 
referred to earlier we performed on eight majors. That chart 
here has eight mergers--the eight we looked at plus some 
subsequent mergers. We performed our analysis on eight mergers 
involving major integrated oil companies in the 1990s, and the 
analyses show that after controlling for other factors 
including crude oil prices, refinery capacity utilization, 
inventories, and supply shocks, that the majority of these 
eight mergers resulted in wholesale gasoline increases, most in 
the range of a penny or two, but one in particular up to 7 
cents a gallon.
    Now additional mergers since 2000 are likely to have 
increased the level of industry concentration. However, because 
we've not performed modeling of these mergers, we cannot 
comment on potential effects on gasoline prices at this time. 
We are in the process of updating our previous study and 
planning to look at more recent mergers.
    Now in conclusion, Mr. Chairman, Members of this Committee, 
I would also like to say that one of the things that we believe 
comes out of our study is to show the importance of doing what 
we call retrospective analyses. That is to say, looking at the 
effect of mergers, the state of competition, after the mergers 
have taken place, in addition to doing them prospectively when 
mergers are being approved. And I think the FTC is tending to 
agree with us, and we're glad about that; we think it's a good 
idea to use the retro prospective analyses, both as an 
oversight tool of what's going on in the industry, and also as 
a way of trying to inform your own prospective analysis going 
forward.
    Mr. Chairman, that completes my prepared statement. I'd be 
happy to respond to any questions.
    [The prepared statement of Thomas McCool appears in the 
Submissions for the Record on page 48.]
    Chairman Schumer. Thank you, Dr. McCool.
    Dr. Salinger.
    Dr. Salinger. Thank you.
    Chairman Schumer. Your entire statement will be read in the 
record as well.

   STATEMENT OF DR. MICHAEL A. SALINGER, DIRECTOR, BUREAU OF 
              ECONOMICS, FEDERAL TRADE COMMISSION

    Dr. Salinger. Mr. Chairman and Members of the Committee, I 
am Michael Salinger, Director of the Bureau of Economics of the 
Federal Trade Commission.
    I'm pleased to appear before you to present the 
Commission's testimony on FTC initiatives to protect 
competitive markets in the production, distribution, and sale 
of gasoline in our vigilant and comprehensive merger program.
    My written statement represents the views of the Federal 
Trade Commission. My oral presentation and responses to 
questions are my own, and do not necessarily represent the 
views of the Commission or any commissioner.
    Recently, gasoline prices have been rising. Over the past 3 
months, retail gasoline prices have increased between 95 cents 
and 115 cents per gallon, depending on location. The national 
average price of gasoline has risen from approximately $2.20 
per gallon in early February to over $3.22 per gallon as of May 
21.
    The lion's share of the recent increase in gasoline prices 
appears to be attributable to three factors: Refinery outages, 
increased demand for gasoline, and decreased gasoline imports.
    Based on substantial Commission investigations and research 
into the petroleum industry over many years, we do not believe 
that consolidation in this industry has been a major factor in 
higher prices.
    Although the FTC does not regulate energy market sectors, 
the agency plays a key role in maintaining competition and 
protecting consumers in energy markets. The Commission has been 
particularly vigilant regarding mergers in the oil industry 
that could harm competition.
    It examines any merger and any course of conduct in the 
industry that has the potential to decrease competition and 
thus harm consumers of gasoline and other petroleum products. A 
review at least 4 months ago concerning horizontal merger 
investigations and enforcement actions from fiscal year 1996 to 
fiscal year 2005 shows that the Commission has brought more 
merger cases at lower levels of concentration in the petroleum 
industry than in any other industry.
    Indeed, unlike in other industries, the Commission has 
brought enforcement actions in petroleum markets with levels of 
concentration characterized, in the Department of Justice and 
Federal Trade Commission merger guidelines, as moderate.
    Although we analyze each petroleum merger according to 
numerous market factors surrounding the transaction, an overall 
analysis of merger policy in the petroleum industry necessarily 
takes a longer and broader view.
    Over the past 25 years, the Commission's merger policy has 
been consistent across administrations. Applying sound 
principles of economics, it has been designed and focused to 
prevent the accumulation and use of market power to the 
detriment of consumers. Since 1981, the Commission has filed 
complaints against 21 petroleum mergers and achieved 
significant divestitures or other relief in 17 of those cases. 
The other four mergers were abandoned after the Commission 
challenged them.
    Over the past two decades, the petroleum industry has 
undergone a structural upheaval, punctuated by a burst of large 
mergers in the late 1990s. The driving forces behind these 
mergers were technological, economic and regulatory factors 
that led toward reliance on a smaller number of larger, more 
sophisticated refineries that can process different kinds of 
crude oil more efficiently.
    The development of crude oil spot and futures markets have 
reduced the risks of acquiring crude oil through market 
transactions, thus contributing to a decline in vertical 
integration between the crude oil production and the refining 
stages among the major oil companies.
    The number of major integrated firms have restructured to 
concentrate on one or more segments of the industry, and a 
number of unintegrated refiners or retailers have entered. 
Domestic crude oil production has fallen, and foreign sources 
have supplied an increasing share of the crude oil refined in 
the United States, thus enhancing the importance of competition 
in the world market for crude oil.
    That competition has intensified over the last decade, with 
a dramatic increase in crude oil demand from newly 
industrializing countries.
    Despite these structural changes, most levels of the 
petroleum industry remain only low or moderately concentrated. 
The industry exhibits many economic indicators of strong and 
effective competition. Nonetheless, the FTC will remain 
vigilant and will challenge any merger or course of conduct 
which threatens this competition.
    I look forward to the Committee's questions.
    [The prepared statement of Dr. Michael Salinger appears in 
the Submissions for the Record on page 54.]
    Chairman Schumer. Thank you, Dr. Salinger. And we're going 
to try to stick strictly to the 5 minutes, because I know both 
sides have votes coming up, and we have another panel after 
this as well.
    So my question is to actually both Dr. Salinger and Dr. 
McCool. We've heard repeatedly that the high price of gasoline 
is tied tightly to the price of crude oil; crude oil goes up, 
gas prices are supposed to go up. While gas prices are about to 
hit record highs no, crude oil are below where they were last 
year at this time.
    And this chart--which is coming right up--shows it pretty 
clearly. I'm not going to repeat the numbers, but the bottom 
line is, while the price of crude is going down the price of 
gasoline is going up.
    My question is: How do you explain this recent acceleration 
in gasoline prices that by far exceeds changes in the price of 
crude oil. Doesn't that divergence suggest the presence of 
severe problems in the refining and distribution end of 
gasoline production, regardless of what's happening in the 
crude oil scene?
    So Dr. McCool, you want to go first? And then Dr. Salinger.
    Dr. McCool. Well, as I said, I think over the long term, 
gasoline prices and crude oil prices tend to track themselves, 
track one another fairly closely. There are, however, 
divergences, and this indicates divergences in both directions. 
You get times when the gap expands to the advantage of the 
refiners, and at times may shrink to the disadvantage of 
refiners.
    Recently, it's been in the former direction, but----
    Chairman Schumer. And why do you think that has happened?
    Dr. McCool. Well, again, I don't really know exactly what's 
happened, all the details of what's happened in the recent 
past; but I think some of these--again, I'll put it in quotes, 
``unexpected disruptions'' of either breakdowns at refineries, 
the fact that inventories started out substantially below what 
they normally would be this time of year, and the fact that 
foreign gasoline supplies haven't been as available as they had 
been in previous years--are obviously confounding factors.
    Whether there's a long term trend toward increased refining 
margins that we would expect to lead to much more increases in 
refined capacity, that's again a hard thing to disentangle 
between short-term blips and sort of long-term trends.
    Chairman Schumer. Dr. Salinger.
    Dr. Salinger. Well, you're quite right, of course. That is 
what has been different about recent months, and also true of 
last summer; that gasoline prices have gone up more than can be 
explained just by crude prices alone. That in my opinion is 
because refining capacity is tighter relative to demand than it 
had been in the past.
    I'll make two points about that. First, you can't look at 
the gasoline spreads at a single point in time; you'd have to 
look first of all over the entire year, and also over many 
years. Because investment in refining capacity is a long 
investment; and the second point I make is you want to ask the 
question----
    Chairman Schumer. What about upgrading and maintaining as 
opposed to building new refineries? We've had a lot of 
breakdowns lately.
    Dr. Salinger. We have. But the other point I would make is 
that the question I want to ask: Is there any evidence that the 
level of refining capacity is below competitive levels? And 
that's a complicated question that we've been asking ourselves 
about, but we have not seen any evidence of that.
    Chairman Schumer. Let me ask you this, and this really goes 
to Dr. Salinger.
    From 2000 to 2005, the oil industry reported about $383 
billion in profits. They invested $1.2 billion in clean, 
renewable energy sources.
    Again, how can we argue this has been better for consumers; 
then if there were more competitors in the marketplace, it 
seems to me that it's just logic that if you had the number of 
competitors say we had in 1980, a few of those companies would 
venture out into alternative energy. They have the ability, the 
muscle, the know-how and the distribution capacity to do it.
    Do you find those numbers confounding?
    Dr. Salinger. I don't find the profit numbers confounding, 
when you look at the scale of the industry and what's happened 
to prices, I would question the competence of the companies if 
they weren't making profits at those prices.
    As for the investments, the question you want to ask is 
whether they are passing up profitable investments. And we've 
not seen evidence of that.
    Chairman Schumer. Do you agree, Dr. McCool?
    Dr. McCool. Well, again, I haven't been able to look at 
this particularly, very closely. I guess my thoughts would be 
that one would expect that they see investments as being 
profitable, or you would think they wouldn't put resources in 
them. But again you also have to ask yourself the question, how 
long do you need to see these margins as higher than 
historically----
    Chairman Schumer. I just am utterly amazed that they're 
using----
    Dr. McCool [continuing]. The norm, to make that decision.
    Chairman Schumer [continuing]. I'm just utterly amazed that 
they're using all this money to buy back their stocks at a time 
when we're facing an energy crisis in the country. It says 
something is wrong. Maybe we'll have different prescriptions, 
but something is really the matter, as prices keep going 
through the roof, energy shortages occur, and a vast majority 
of their money is to buy back their stocks. Something is wrong 
there.
    Congressman Saxton.
    Representative Saxton. Dr. Salinger, in its 2005 report, 
titled: ``Gasoline Price Changes: The Dynamics of Supply, 
Demand, and Competition,'' the FTC states:

        To understand U.S. gasoline prices over the past three decades, 
        including why gasoline prices rose so high and so sharply in 
        2004 and 2005, we must begin with crude oil. The world price of 
        crude oil is the most important factor in the price of 
        gasoline, the report states:
        Over the last 20 years, changes in crude oil prices have 
        explained 85 percent of the changes in the price of gasoline in 
        the U.S.

Unquote.
    Accordingly, I would like you to begin with questions about 
the world price of crude oil. The OPEC cartel, as I pointed out 
in my opening statement, holds an enormous amount of known 
crude oil reserves. Nine hundred and two billion barrels, to be 
exact about the estimates, which represents up to 80 percent of 
the world total percent of crude.
    The cost of producing this oil is extremely low. Again, as 
I pointed out in my opening statement, less than $5 per barrel 
in the Persian Gulf.
    Would you please explain the effect on price of OPEC's 
restrictive output practices over the decades, and how it has 
constricted its oil field development, and that it explicitly 
limits the oil production rates in its member states on an 
ongoing basis.
    Dr. Salinger. I'll do the best I can. It's certainly true 
that when OPEC successfully succeeds in cutting output, that 
that raises prices. And that that's something that if it were 
done by private companies would be viewed as being illegal.
    Representative Saxton. And the restriction on production 
would affect prices at any given time, but the restriction on 
production over time would have a cumulative effect, would it 
not?
    Dr. Salinger. What you'd want to look at is the supply--you 
want to look at prices at any particular point in time, that 
would be based on supply at that point in time; and to the 
extent that their investment decisions have had long run supply 
effects, they would have a long run effect on prices.
    Representative Saxton. As OPEC makes its decision on 
production, which they do from time to time, actions taken 
today on the restriction of production and lack of investment 
on their part to produce, would it have effects down the road 
as well, would they not?
    Dr. Salinger. Congressman, I don't know how long it would 
take OPEC to expand production, if they chose to do so.
    Representative Saxton. In its investigation of post-Katrina 
gasoline prices, the FTC found that OPEC is a functioning 
cartel whose activities, as you just pointed out, would be 
illegal if undertaken by private companies.
    Is that a fair characteristic; characterization of what it 
says.
    Can you briefly explain why that is?
    Dr. Salinger. Sure. Under the antitrust laws, companies are 
not allowed to agree to raise prices. And in order for 
companies successfully to raise prices, they'd have to agree to 
cut output.
    So when the OPEC countries get together and have 
discussions about production, and agree to limit production, 
that is exactly what the Sherman Act makes illegal.
    Dr. McCool. I would just point out, Mr. Chairman, that we 
are questioning whether something like that may be happening 
with oil companies that are listed on the chart here, or 
others; and certainly Dr. Salinger is correct, that if what 
OPEC practices were done by the oil companies that we're 
examining, we would consider it to be illegal, under our 
statutes.
    The FTC has stated especially, quote: ``Especially, when 
demand surges unexpectedly, as in 2004, OPEC decisions on 
whether to increase supply to meet demand can have a 
significant impact on world oil prices.
    Dr. Salinger, can you comment on the effect of OPEC's 
supply manipulation on the price of crude oil and its products 
in the past several years?
    Dr. Salinger. Well, if you look at the last several years, 
crude prices have gone up quite a bit, and that would not have 
happened without OPEC supply restrictions.
    Chairman Schumer. OK, thank you, Congressman Saxton.
    Now Congresswoman Maloney.
    Representative Maloney. Thank you, Mr. Chairman.
    We all get questions from our constituents about the sky 
rocketing cost of gasoline prices. And both of you touched on 
it in your testimony, but I would like you to each respond in 
the simplest terms possible, why are gas prices so high? Just 
simply. I mean, $55, that's now an astonishing $30 more per 
tank since the President took office. Why are they so high?
    Dr. McCool.
    Dr. McCool. Well, again, I think that some of the factors 
we've already touched on; the fact is that the demand-supply 
balance is very tight to begin with, in the best of times, 
especially since refinery capacity has not kept up with 
increases in demand; and that tightness means that any small 
sort of movement in particular on the supply side is what seems 
to be the recent case, where again either inventories are 
unexpectedly low or you have these breakdowns or malfunctions 
in refineries and/or--again, a less availability of imports.
    The smallest kind of shock to the supply because of the 
inelasticity of demand, which is to say the fact that demand 
doesn't respond very quickly to price, generally leads to 
fairly large changes in price.
    Now the hope is that they're short-term and that the supply 
starts to increase, and maybe demand falls back a little bit, 
and that can restore prices to a more reasonable level. But it 
seems to me that's the only way I can conceive of it right now.
    Representative Maloney. Dr. Salinger?
    Dr. Salinger. Well, they are high compared to what they 
used to be. And I know this is a very tough sell, but I don't 
think people realize how fortunate we were to have prices as 
low as they were for as long as they were.
    I started studying oil markets in the seventies, when 
prices went through the roof, and we were taught in economics 
programs then, that they would continue to go up. In real 
terms, in 2002 they were below what they were below the first 
oil shock. But since then we've seen the supply and demand 
balance shift.
    Representative Maloney. Dr. Salinger, is there hard 
evidence that the oil industry mergers have in fact created 
greater efficiencies?
    Dr. Salinger. Yes, there is.
    Representative Maloney. And if there are greater 
efficiencies, what benefits have come to consumers because of 
these efficiencies?
    Dr. Salinger. The decline in prices in real terms that we 
saw over several decades, starting at the end of the second oil 
crisis, were due in part to increased efficiency in the 
industry.
    Representative Maloney. But have gas prices gone down now 
because of efficiencies?
    Dr. Salinger. Well, the question you want to ask is whether 
they're lower than they otherwise would be. And of course it's 
very hard to know, over a long period of time, what would have 
happened otherwise. But I believe they are.
    Representative Maloney. I'd like to ask Dr. McCool, have 
oil industry mergers increased barriers to entry, barriers that 
serve to deter new competitors from entering the market?
    Dr. McCool. Well, some of the majors probably have enhanced 
certain barriers to entry, and in particular to the extent that 
we again have firms that are somewhat more vertically 
integrated, it does become a little bit harder for a new 
entrant to come in; when you have to come in at a number of 
different levels.
    Again, whether those barriers, which were based in some 
ways on sort of the economics of the industry, whether they 
lead to a situation such that there's not still effective 
competition, that's a harder question to answer.
    Representative Maloney. That doesn't help consumers, does 
it?
    Dr. McCool. Well, again, there's this question about 
whether the vertical integration and the potential benefits 
that generates in terms of lower cost does or doesn't offset 
any market power effects.
    Representative Maloney. What are the potential impacts on 
consumers of increased barriers to entry to the refining and 
distribution segment of the oil industry?
    Dr. McCool. Again, it's really sort of a similar question. 
It's a question of whether the cost savings do or do not pass 
through compared with any kind of increases in market power 
that may lead to higher prices. And it's that balance; it's 
hard to determine before the fact.
    Representative Maloney. My time is up. Thank you.
    Chairman Schumer. Congressman Hinchey.
    Representative Hinchey. Thank you very much, Chairman 
Schumer. And thank you, gentlemen, for your very interesting 
testimony.
    Dr. Salinger, if I heard you correctly, you said that two 
of the actions that affect prices are refinery outages and the 
importation of petroleum. And there was another one which I 
didn't get.
    Dr. Salinger. An increase in demand.
    Representative Hinchey. Increase in demand, OK. Well, 
increase in demand is pretty clear, where that comes from; and 
the fluctuation in prices that we've seen in the past, 
particularly in the 1970s, were concentrated in the oil 
producing countries; OPEC caused those jumps in 1973 and 1979.
    But based upon the information that we have now, we find 
that OPEC is less responsible for the increases in refined 
product, and the oil companies seem to be much more responsible 
for them. The mergers that we've seen over the course of the 
last 10 or 15 years are really amazing.
    The fact that now the oil companies dominate close to 90 
percent of the refining industry is also something that is 
quite spectacular.
    So if the core of the imports, of the effective prices or 
the effective demand, and then the other two refinery outages 
and the importation of petroleum, it seems to me that those two 
factors are in direct control by the oil companies themselves. 
They can manage the refinery outages, they can allow them to 
happen or not allow them to happen, and they can determine how 
much oil is imported.
    So if that's true, then isn't it true that the oil 
companies are determining the price of the refined product, the 
price of gasoline on the market right now?
    Dr. Salinger. Well, I don't agree that the largest oil 
companies can prevent the importation of oil----
    Representative Hinchey. If they're the principal marketers 
of oil, why isn't it that they can't determine the price? 
Because they're going to determine how much oil comes in, and 
therefore how much they sell. How much they refine and how much 
they sell.
    Dr. Salinger. Well, the markets remain structurally 
competitive by the standards that we generally use in the 
antitrust enforcement.
    Representative Hinchey. What are those standards? How can 
they remain competitive when you have these oil companies that 
have engaged in so much merger activity, and now control close 
to 90 percent of the refining capacity?
    Another aspect of the way in which the oil companies 
operate around the country is this: You can travel across the 
country and you see that there are certain oil companies that 
sell oil in some parts of a State but not in other parts. You 
obviously have an agreement between the oil companies as to 
where they're going to market, in addition to how much they're 
going to charge.
    Dr. Salinger. Well, I wouldn't agree that because some oil 
companies are selling one place and others are selling another 
place that that means that there's been an agreement. I mean, 
that happens in other markets; there are grocery stores that 
sell in one part of the country and not in others; they haven't 
divided up the country.
    And you asked about outages. The question you want to ask 
is whether, when a company has an outage, it personally 
benefits--the company benefits from those outages. And the 
evidence we've seen is that when companies have outages, they 
do everything they can to try to bring the refinery back.
    Because at current prices, selling gasoline is very 
profitable.
    Representative Hinchey. Well, of course it's profitable, 
because they control the price. And if they can control what's 
on the market and the amount of that product that's on the 
market, then they can control the price much more effectively.
    And by regulating the refineries, since your oil companies 
control at least 90 percent of them across the country, and 
regulating the amount of crude product they bring in, then they 
can impact the price. And I'm quite surprised that the FTC 
hasn't looked at that much more carefully.
    You say that mergers are not affecting prices. That just 
surprises me. How can it be that mergers are not affecting 
prices? It's pretty clear that the mergers are affecting 
prices, if you just look at it roughly. As mergers have 
increased, as the oil companies have become more consolidated, 
the prices have gone up. That gives them that power to jack the 
price up on the basis of those mergers.
    The Sherman Antitrust Act, why are you not enforcing that 
Act in this particular case?
    Dr. Salinger. In my opinion, the Commission is enforcing 
the antitrust laws quite vigorously. We are currently in 
District Court bringing action against a merger between Giant 
and Western.
    If you look at our enforcement statistics with respect to 
the oil industry, the data are clear that we are more 
aggressive in this industry than with any other industry. And I 
would just disagree with your characterization that it's the 
merger of----
    Representative Hinchey. Well, I would disagree with your 
statement that you're more aggressive in this industry; because 
we don't see an example of that.
    One of the interesting things you said in response to a 
question that was asked a little while ago is that OPEC is 
restricting production on the market. If they were a private 
company, that would be illegal based on the Sherman Antitrust 
Act. But if the oil companies are restricting the amount of 
product on the market, that doesn't seem to be, in the view of 
the FTC, to be illegal. Because you're not doing anything about 
it.
    Dr. Salinger. They were agreeing, the companies were 
getting together and agreeing to restrict output. I am quite 
confident----
    Chairman Schumer. You mean to tell me, you don't think the 
oil companies are getting together to agree on output?
    Dr. Salinger. Yes. I mean to tell you that.
    Representative Hinchey. That's amazing.
    Dr. Salinger. I understand you disagree, but that's my 
opinion.
    Chairman Schumer. Time's up, but they don't have to get in 
a room and agree, and they can do price leadership or quantity 
leadership; and when there are very few of them, the can play 
the same game and have the same effect. To me, that's always 
been a fundamental weakness of antitrust law.
    Senator Webb.
    Senator Webb. Thank you, Mr. Chairman, and you can count me 
among the cynics that believe market forces are the determinant 
in what we are examining right now; I would associate myself 
with a lot of Congressman Hinchey's comments.
    I'm going to start by reading out again what you said: The 
five largest oil companies had $120 billion in profits last 
year alone. If this were simply market forces, there wouldn't 
be--going into the profits that are being plowed back into 
stock options.
    I can recall from the campaign last year--let's remember, 
oil was $24 a barrel when we went into Iraq. It went up to $73 
a barrel during the campaign, and then miraculously, the last 
month or so of the campaign, oil jumped to $50 a barrel; prices 
were going down and I was being asked on the campaign trail how 
long was this going to last. My general answer was: ``Well, 
probably until Thanksgiving.'' Now we're back up, to $67 a 
barrel.
    So when you look at the facts that Chairman Schumer and 
others have pointed out and others, gas prices have more than 
doubled in the last 5 years. We haven't seen new refineries 
being constructed since 1976, although the capacity of these 
refiners has grown. Are we finding margins at all time highs? 
The first quarter of 2007, profits increased 36 percent over 
the last year. You know I can't see that there are market 
forces at play.
    And that goes to a question: What is a windfall profit? And 
what should we do about windfalls? Why don't we define a 
windfall? Well, the windfall is when external conditions allow 
you to make money but don't have to work any harder.
    When you look at the fact that the price of a barrel of oil 
tripled since the time we went into Iraq, because of external 
forces, because of oil being bought based on the predictability 
of international conditions and these sorts of things, I would 
say that's a windfall.
    When the price of a barrel of oil goes up, whether it's 
being bought out of that region or anywhere else, I would say 
that's a windfall.
    What American companies do when they have this kind of a 
windfall? Well, you don't always, to get to the other 
gentleman's question--if OPEC is colluding, it doesn't mean 
that all companies have to decide what they're going to charge 
earlier, at this higher price.
    This argument of ``We can't help ourselves,'' doesn't 
particularly work, in my opinion. You can't expect a company to 
do any more than meet a profit line, so then the question 
becomes: What do your responsible Government leaders do? What 
are we supposed to do? Allow this to continue? I think that we 
have a responsibility, as Government leaders, to create 
conditions where we're not having to operate at the mercy of 
international instability. I think that's what we'd have to do.
    If companies will not turn around and invest in either 
alternate energy programs or in greater refining capabilities 
and these sorts of things, if they can't help themselves, maybe 
we have an obligation to try to figure out a way to do that.
    Senator Casey has a bill that addresses some of those 
issues. I would hope that we could get a clear vote in the 
United States Senate on this issue, without having it become 
part of one of these omnibus bills where it's harder to address 
such a significant issue.
    But I would like to ask both of you to characterize this if 
it's not windfall profit. Dr. McCool?
    Dr. McCool. Senator, again I'm not sure--I think it's a 
problem I have, it's just often hard to define what you mean by 
``windfall''.
    Senator Webb. Windfall is when external conditions allow 
you to make money without working hard. I think that's a 
windfall.
    Dr. McCool. The problem is, there's lots of cases we have 
of windfalls, where we don't necessarily try to tax it away. So 
the question is--and also, what the effect of that tax would 
be.
    So I think--and again, this is outside the area of my 
current expertise, that putting in place a windfall profits 
tax, it's hard to sometimes keep that from having an effect on 
costs, and defining it correctly is very difficult.
    Senator Webb. Maybe it's a bad term to use; maybe we could 
figure out a way to call it something else. But when a portion 
of corporate America is making these humongous profits, and is 
not reinvesting it in a way that we can solve a national 
problem, truly a national problem, what do you call that?
    Dr. McCool. Well, what we call that is sort of the capital 
markets at work, I guess. If capital markets don't believe that 
investing in more refining capacity is worth the alternative 
uses of those funds----
    Senator Webb. When it's affecting national security and the 
economic health of our working people, perhaps there is a point 
where the Government has to help--solve a larger problem.
    Dr. McCool [continuing]. Policy.
    Chairman Schumer. Senator Klobuchar.
    Senator Klobuchar. Thank you, Mr. Chairman. I want to 
follow up a little with what Senator Webb is talking about.
    In my State, they see that Exxon's profit last year was 
$39.5 billion, a record profit year; while you have people in 
St. Cloud, Minnesota that are filling up their tanks only half 
full because, they're middle class people and they can't afford 
to buy more. There is a major issue here.
    When I look at all this money that Congress has given to 
the oil companies based on the idea that it's supposed to 
produce more oil, and be better for consumers. I see that it 
just hasn't happened.
    I specifically want to ask, Dr. Salinger, about the March 
of 2001 FTC report about the Midwest Gasoline Price 
Investigation. In that report it was noted that by withholding 
supply, the industry was able to drive prices up and thereby 
maximize its profits. What I want to know is what has the FTC 
been doing to deal with the bottleneck issues in the refining 
sector, and to penalize the companies that have been engaging 
in this market manipulation.
    Dr. Salinger. Senator, I'm not sure that how you 
characterize the conclusions of the Midwest Gas report is 
correct. In terms of what we're doing to address bottleneck 
issues, what the Commission does is it reviews mergers, and it 
takes actions when it's presented with mergers that create a 
risk of harming competition.
    Senator Klobuchar. Do you go back and look at these mergers 
after you've approved them to see if you think they've actually 
been good?
    Dr. Salinger. We do. We have an active program doing merger 
retrospectives; we've had a lot of dealings with Dr. McCool 
over this. We did a major retrospective of the Marathon-Ashland 
joint venture, we did a major retrospective of the Marathon, 
Ashland, Ultramar Diamond Shamrock----
    Senator Klobuchar. Can I just ask one more thing? I know 
one of the remedies that you've called for is to divest itself 
of downstream assets in the merger. One example may be cited 
during the Chevron Texaco merger in 2001. There, the FTC 
proposed that Texaco be required to divest all of its interest 
in two joint ventures. But Texaco's partner in the joint 
ventures was Shell Oil.
    What really happened was that Shell Oil then scooped up 
these assets. The purported divestiture of Chevron Texaco did 
nothing to encourage competition, because then Shell just took 
over these refineries as downstream assets.
    My question is, have you looked at that and its effect on 
consumers?
    Dr. Salinger. I don't know that we have done a specific 
retrospective on that one, but the divestiture that the 
Commission sought in that case was to make the very specific 
markets involved in that merger competitive.
    Senator Klobuchar. Do you think that we've made more 
unbranded, cheaper gasoline available? Or, do you think that 
it's harder to find than it was in the early nineties?
    Dr. Salinger. My understanding is that there has been a 
movement towards branded gasoline. Consumers--many consumers, 
when given a choice between branded gasoline and unbranded 
gasoline, as is the case with other products, choose branded 
gasoline.
    Senator Klobuchar. OK, Dr. Salinger. Others have said gas 
is up at $3.22, I can tell you some of my consumers are willing 
to go to unbranded gasoline, if they had the choice. The other 
issue right now that I'm going to explore with the next panel 
is we've been trying to get E-85 pumps and ethanol pumps 
throughout the country. There's only about 1,020 of them now 
nationwide out of the 170,000 gas stations. Three hundred are 
in my State, and we have cheaper prices for that type of 
product. I think it will get even cheaper as time goes on, if 
there's not a bottleneck and people aren't prevented from 
getting that.
    I'm just concerned about the effect that these mergers have 
had on the availability of not only unbranded gasoline, but 
also other alternatives that aren't owned by the oil companies.
    Dr. McCool, my final question is, do you see any reduction 
in unbranded, cheaper gasoline in your studies with GAO?
    Dr. McCool. Again, we looked at it, in our work in 2004 we 
saw some indications; but again, it's hard to get good numbers 
on branded versus unbranded. But we really saw some indication 
that the unbranded was shrinking relative to branded.
    Chairman Schumer. Congressman Cummings.
    Representative Cummings. Thank you very much, Mr. Chairman.
    I share the other Members of this panel's concerns about 
the cost of gasoline and the problems it is causing for my 
constituents, just to get to work and back.
    Dr. Salinger, you said at the end of your testimony that, 
we see evidence of effective competition. And the big, 
unresolved question is, if that is true, then why is the price 
of gas so high? You say we have effective competition, but what 
is the problem?
    Dr. Salinger. Well, the price of gasoline is higher than it 
was. And the difference between the price of gasoline and the 
price of crude is higher than it was, but we do have to ask the 
question: Is there any evidence that the supply of gasoline is 
being held below competitive levels? And we have not seen such 
evidence.
    Representative Cummings. Going back to some questions asked 
earlier, how would you recommend that the FTC merger review 
process be made more rigorous? Or do you think it should be 
made more rigorous.
    Dr. Salinger. Well, we are constantly reevaluating what we 
do. And we do merger retrospectives, as Senator Klobuchar asked 
about, and which I just testified to.
    So it's important that we keep doing that. But I do believe 
that our review of mergers is quite rigorous.
    Representative Cummings. I guess the thing that concerns 
me, are you all, either one of you, saying to the American 
people that we, the Members of the Congress, and of the Senate, 
have no ability--is there anything that we can do to make a 
difference?
    Because see that is the bottom line. All these questions 
that they are asking are nice, but when I go back to Baltimore 
tonight, and I'm standing at the gas pump, and there is a guy 
filling up his tank, and now it costs him $30 more than it did 
a few months ago, he wants to know what are you doing and what 
can you do?
    And that is what I want to know: Are there things that we 
can do to make a difference? And if we can not, if you think 
that we can not, tell us. Both of you.
    Dr. McCool. I'm not sure that I can come up with a policy 
prescription for solving this particular problem in the short 
term; I do think it's important to conduct these kind of 
hearings and to do oversight, and to keep the light on the 
topic; and also to see whether, for example, these refinery 
margins do lead to what they should lead to, which is increased 
capacity, substantially increased capacity. If they don't, then 
that might be a symptom that something else needs to be done.
    Representative Cummings. Increasing capacity, is that you 
are saying?
    Dr. McCool. Eventually. Refining capacity.
    Representative Cummings. How long do you think we--what 
indicators must we have before we----
    Dr. McCool. Again, as Dr. Salinger stated earlier, these 
are very long-term investments; they take time to get up and 
running; but I think it's something that needs to be monitored. 
And I think Congress has--I'm sure FTC will do it as well, but 
I think Congress probably should be in the game as well.
    Representative Cummings. Dr. Salinger?
    Dr. Salinger. Congressman, the only way we're going to 
bring down prices is to increase supply or curb demand. So for 
any policy that you are considering, I would ask the question: 
Is this policy going to increase supply or is it going to 
reduce demand? Because a lot of the things that are being 
proposed are going to have exactly the wrong effect.
    In terms of what can you do, I would go back to the late 
seventies where we had another crisis with energy prices, and 
then we had two decades of declining prices in real terms. And 
I would ask the question, how did we get that long stretch of 
real price declines?
    I would argue that the main thing we did was we let the 
market work. I know that's a very tough sell, but that's my 
answer.
    Representative Cummings. When you reviewed the proposed 
merger of Exxon and Shell, the Federal Trade Commission, 
knowing that the big oil companies often set prices based on 
their competitor's prices rather than their annual cost is part 
of the so-called zone pricing schemes at the retail level, what 
is the Federal Trade Commission's current thinking on the 
impact of zone pricing.
    Dr. Salinger?
    Dr. Salinger. Well it's a complicated question. But our 
thinking is that it would be a mistake to interfere with zone 
pricing.
    Representative Cummings. Why is that?
    Dr. Salinger. Well, because the incentive to invest in 
additional retailing assets to take advantage of areas where 
you can get a somewhat higher price might require that you 
allow companies to do zone pricing.
    Representative Cummings. I see my time is up.
    Thank you, Mr. Chairman.
    Chairman Schumer. Senator Casey.
    Senator Casey. Thank you, Mr. Chairman. Thank you for 
calling this hearing. I might be even less than five, because I 
have to preside, which is one of our important duties. I want 
to thank both of you for your testimony. I just have a few, and 
some of this will be by way of review.
    The first thing, in terms of something I think the Congress 
can do, in talking about taking affirmative steps to deal with 
this crisis--there's no other way to describe it--in the minds 
and the lives of Americans, this is a gas crisis.
    One thing to do would be to pass the legislation that I 
sponsored, and Senator Webb is a cosponsor; and other Members 
of the Senate I think are taking a look at this, which is to do 
two things. One is, and there are disagreements about both 
aspects of this; but the first thing is, I think that there 
should be an excise tax on the amount of dollars beyond the 
price of oil going above $50 a barrel; it's been above that for 
a long time now, $15 or more dollars above that. Fifty percent 
of that should be used, to be targeted to a fund for low-income 
Americans, especially those trying to pay for mass transit 
costs, paying the bus fare and paying for the gasoline in their 
cars. That's one way to provide some relief at this time.
    Secondly, and this probably has even broader support, is to 
repeal a lot of the royalty giveaways and tax breaks and 
credits, really, that were embedded into the 2005 Energy Policy 
Act, which I think even of themselves didn't make a lot of 
sense; but now they add up to billions of dollars, if not tens 
of billions, which I think should be dedicated to a separate 
fund for research and development.
    So that's the bill, and I think it's an affirmative way to 
deal with this. But let me ask you a couple of basic questions. 
One is--and I don't know if the staff can get the chart--I know 
Senator Schumer may have referred to this earlier--but this is 
the pie chart. I don't know if you guys have that there. I have 
a darker copy.
    This will not be a very complicated question, but I just 
think graphically this chart really tells a story. When you go 
from 1993, 10 companies holding 56 percent of refining market 
share; now to 2005, 10 companies holding 81 percent of the 
share.
    Just in a very broad way, I realize we've got to stock 
within the confines of your report; you've got responsibilities 
to the FTC, you can't expound and give personal opinions. We're 
frustrated by that at this hearing, but we understand your 
restrictions.
    Which chart is preferable to the American consumer and to 
the American economy?
    Dr. Salinger. This pie chart that you have here, 
representing the structure of the industry now, that implies a 
degree of concentration which, under the DOJ-FCC guidelines, 
remains unconcentrated.
    The increase in concentration we're finding that, as 
there's been technical change in the industry that has made it 
desirable to have larger refiners than used to be the case.
    So the answer to your question is, the second; this one on 
the right, in my view, is preferable today.
    Senator Casey. Dr. McCool?
    Dr. McCool. Senator Casey, again it comes back to this, to 
me this question about the fact that it is probably true that 
the second, this chart on the right, reflects a lot of 
economies of scale and potentially lower cost, than this chart 
on the left for refining, but it's also potentially reflective 
of an increase in market power. These are the kind of 
offsetting effects that need to be analyzed, and that's my 
answer.
    Senator Casey. And I realize, you guys have to deal with 
your own limitations here, but in the real world when someone 
opens up the newspaper and they see Exxon-Mobile with more than 
$9 billion profit in one quarter, and you heard the aggregate 
numbers for all the companies; and then they go to fill up 
their gas tank--we've all done it. I've been driving, too. It 
takes a lot longer to fill your tank when you're watching the 
number go up.
    People just see a real--they see a connect and a 
disconnect. A disconnect from what you just said but a connect 
in the sense, a nexus between what's happening in this market 
with concentration, what's happening when we see these tax 
breaks and big profits, and what they see at the gas pump.
    So they are frustrated, they want us to do something about 
it. I hope this hearing does that. I have to run. But I would 
urge, Dr. Salinger I'd urge you, and I'd urge the FTC, if you 
have the, not just the opportunity, but if you take the 
initiative to do further work in this area, and I realize that 
you've outlined a lot of the work that you've done already; but 
I would hope that if you delve into this in the next couple of 
weeks or months that you expedite the process so that American 
consumers can have the benefit from each and any FTC 
investigation or review; because this reality for people is 
stark, and it's profound, and it doesn't help any of us just to 
be able to say ``Well, there's nothing we can do, and this 
degree of concentration doesn't rise to some threshold level.''
    So if there's any way the FTC can not only take a harder 
look at this but expedite the conclusions that you reach, I 
think that would help the American people.
    Chairman Schumer. Thank you, Senator Casey.
    And thank you both, Dr. McCool and Dr. Salinger, and we may 
have some written questions to submit to you, which we'd 
appreciate your responding to.
    And now we'll call up our second panel. Would they please 
come forward.
    Welcome, everybody. I guess this is not the order that I 
have.
    Dr. Diana Moss is the vice president of the American 
Antitrust Institute. She's an economist, has expertise in 
antitrust issues across a wide range of industries including: 
electricity, oil and gas, appliances, and agricultural 
biotechnology.
    Mr. Dennis DeCota is the executive director of the 
California Service Station and Automotive Repair Association. 
In addition, he himself is a service station owner.
    Ms. Samantha Slater is director of the Congressional and 
Regulatory Affairs at the Renewable Fuels Association.
    Dr. James Smith is chair of Oil and Gas Management at 
Southern Methodist University in Dallas, specializes in both 
economics and energy.
    And Red Cavaney is the president and CEO of the American 
Petroleum Institute.
    We're going to ask each witness to submit their entire 
statement for the record, because this is a large panel, and 
we're going to ask that you limit your testimony to 5 minutes.
    Thank you. Dr. Moss, you may begin.

   STATEMENT OF DR. DIANA L. MOSS, VICE PRESIDENT AND SENIOR 
         RESEARCH FELLOW, AMERICAN ANTITRUST INSTITUTE

    Dr. Moss. Thank you, Chairman Schumer and the Members of 
the Committee for holding this hearing. I appreciate the 
opportunity to appear here today.
    The American Antitrust Institute is a nonprofit education, 
research, and advocacy organization. Our mission is to increase 
the role of competition in the economy, assure that competition 
works in the interests of consumers, and to sustain the 
vitality of the antitrust laws.
    The response to high gasoline prices has been a number of 
policy initiatives, including State anti-price gouging laws, 
divorcement statutes to limit integrated ownership, a 
Government-owned and operated strategic refinery reserve, and 
unbundling of gasoline from branded outlets.
    I hope to shed some light on questions associated with the 
underlying determinants of high gasoline prices. Undoubtedly, 
conservation and adoption of alternative fuels can best deal 
with price effects relating to depletion, environmental 
restrictions, low sensitivity of demand, and supply shocks. But 
I believe it is also appropriate to look to the changed 
structure of the downstream industry for behavioral incentives 
that can produce anti-competitive product.
    Let me highlight some of these changes. The FTC reports 
over 1,000 mergers in the U.S. industry between 1985 and 2003. 
The average size of a petroleum merger was three times larger 
than the average plain vanilla merger.
    Billion-dollar mergers accounted for about 86 percent of 
all large transactions; and while only 13 percent of 
transactions involved downstream refining and marketing, most 
of the billion dollar deals were in these markets.
    Moreover, while the share of refining capacity owned by the 
majors fell by 18 percent over the 1990s, the independents 
tripled their share of capacity, largely by buying up what the 
majors divested. The independents, therefore, are now 
significantly vertically integrated in downstream markets.
    It's true that consolidation in refining and marketing has 
generated a relatively higher level of scrutiny by the 
antitrust agencies. On average, about 13 percent of petroleum 
and marketing transactions were challenged by the antitrust 
agencies, compared to roughly 2 percent of all transactions. 
However, in most cases the FTC put forward a horizontal theory 
of harm, and in very few cases a vertical theory of harm. Data 
show that refining concentration in most U.S. PADDs has 
increased over the last 20 years; but data from FTC enforcement 
actions also indicates that two-thirds of refining markets were 
highly concentrated, with HHIs ranging from 1,800 to almost 
7,000.
    High levels of concentration in refining raise concerns 
because it is a production bottleneck; the number of operating 
refineries has declined by 44 percent; no new refineries have 
been added since 1975. Refiners have developed high capacity, 
technologically advanced facilities that account for a good 
portion of U.S. refining capacity, and utilization rates are at 
an all-time high.
    Like the structure of refining markets, wholesale markets 
have also changed; the number of terminals has decreased by 50 
percent over the eighties and nineties, and PADD-based 
concentration has increased. Again, merger enforcement data 
indicates that concentration in terminalling and marketing is 
also high, with HHIs ranging from 1,600 to almost 5,000.
    Brand concentration in retail markets has increased over 
time. Sales of generic gasoline have decreased, and there are a 
smaller number of retail outlets operating today.
    I think it is reasonable, against this backdrop, to expect 
that the foregoing developments raise questions regarding the 
availability of competitive alternatives available to jobbers 
and distributors that purchase at the rack, independent 
gasoline retailers that potentially face the prospect of 
dealing more and more with integrated refiner-marketers, and 
ultimately consumers in obtaining supplies of competitively-
priced gasoline.
    Economic research has attempted to answer many of these 
questions by evaluating whether there is oligopolistic 
coordination at the retail level, explained by price asymmetry 
between crude oil and retail prices, by looking at the price 
cost effects of divorcement policies in various states, and by 
evaluating the price effects of mergers.
    The merger research appears to support the notion that 
merger activity in the 1990s involving refiner-marketers has 
increased prices; but at the same time this research has been 
met by resistance and controversy, largely over the validity of 
assumptions underlying methodologies for estimating price 
increase.
    In conclusion, there are two major implications of the 
foregoing: One is that policymakers should pay very close 
attention to: (a) the bottleneck nature of the refining 
industry; and (b) incentives to restrict capacity additions. 
They should find policies that fix that problem.
    Fewer high capacity refineries operating at high 
utilization rates mean that the strategic manipulation of even 
small amounts of refining capacity can produce sizeable 
increases. We need not look far to find a good analogy, in the 
electric power industry, where transmission has been a long-
recognized bottleneck, and policies that have been long pursued 
to incent the construction of new transmission need to de-
bottleneck and reduce market power.
    The second implication of the foregoing is the importance 
of rigorous scrutiny of the incremental accretion of market 
power. Theories of harm should consider traditional horizontal 
problems, but merger investigations should also focus closely 
on how vertical integration can create powerful incentives and 
abilities for integrated foreign firms to foreclose rivals.
    I think it's safe to say that antitrust enforcement in the 
U.S. has given a good deal of deference to vertical 
efficiencies that flow from integration. Perhaps it is time to 
rebalance this equation, and to scrutinize vertical 
integration.
    That concludes my testimony. Thank you again, and I look 
forward to questions.
    [The prepared statement of Dr. Diana L. Moss appears in the 
Submissions for the Record on page 64.]
    Chairman Schumer. Thank you, Dr. Moss.
    Mr. DeCota.

  STATEMENT OF DENNIS DeCOTA, EXECUTIVE DIRECTOR, CALIFORNIA 
       SERVICE STATION AND AUTOMOTIVE REPAIR ASSOCIATION

    Mr. DeCota. Chairman Schumer and Honorable Members, it's a 
privilege to be here today to testify before you.
    The question at hand is, is market concentration in the 
U.S. petroleum industry harming consumers? As a petroleum 
retailer for the past 28 years, I can assure you that it is. I 
counsel service station dealers throughout the State of 
California on these issues all the time.
    My name is Dennis DeCota. I am the executive director of 
the California Service Station and Automotive Repair 
Association, a 34-year-old trade association; at one time the 
largest in the United States. Today we boast a membership of 
200 members. We had 2,200 15 years ago.
    I'm currently a ConocoPhillips dealer, although at one time 
in the same station I was a Union Oil Company dealer, and 
franchisee, and then a Tosco franchisee, then a Phillips 
franchisee, and now a ConocoPhillips franchisee.
    We have seen the mergers and acquisitions that have 
occurred over the many years condense and basically consolidate 
our industry to a point to where there is very little 
competition.
    The manipulation and lack of consumer choice has all but 
wiped out any competitive ability for the consumer to seek 
independent branded supply of gasoline.
    Industry consolidation, again, mostly throughout the 
nineties, the major oil companies have merged and consolidated 
to a point where they no longer compete against one another for 
volume or market share. When I was a young retail rep with the 
oil company, I would go in and I would solicit a competitive 
account of another brand, and have to submit it to the home 
office to see if I could get approval in order to meet the 
demand and the price that I was competing against.
    That's not done anymore. The oil companies pool their 
product together and then only brand it once they sell it to 
the retail branded station. So you have to understand, ever 
since they started pooling product, they don't really compete 
with one another for market share. It stopped. And I think 
that's very important to understand; it stifled competition.
    The oil companies' retail competition, the independent 
refiners, due to mergers and acquisitions plus environmental 
compliance requirements, have all been wiped out in California. 
The competition between branded stations and independent 
stations is all but gone. They stopped franchising newly 
constructed stations back in the mid-nineties.
    One of the most glaring examples is the recent acquisition 
of the Exxon-Mobile refinery by Valero, and Valero's later 
acquisition of United Diamond Shamrock. That combination of 
acquisitions and mergers destroyed the independent market in 
California. Now we experience a situation where branded 
refiners supply over 98 percent of all produced gasoline. In 
the second largest gasoline market in the world, only second to 
the U.S. as a whole.
    Valero, once one of the largest independent refiners is now 
a major oil company, pricing like a major oil company. My 
recent letter to the Federal Trade Commission--by the way, 
their answers are much the same as they gave to you today--
CSSARA informed the FTC, opposing the sale of Shell's southern 
California refinery to Tesoro, and Tesoro's planned acquisition 
of the State's largest independent--that being USA Petroleum, 
who is the only large independent left--will further reduce 
competition in our State, and the last low price leader will be 
gone in the same manor that Valero/UDS has done.
    Gas price manipulation. Dealers must compete with 
proprietary company-operated stations at margins that simply 
won't sustain their economic viability. As dealers are forced 
out of their stations and replaced by company operations or 
commissioned agents who simply raise the price in that 
community, once the competition, the retailer is gone.
    A lack of consumer choice due to major oil companies' 
ability to drive out competition and control retail pricing, 
consumers are put at a tremendous disadvantage when it comes to 
their ability to find competitively priced fuel. The majors 
further reduce the free market by insisting that their 
franchise dealers, who excise rights under the PMPA--the 
Petroleum Marketing Practices Act--which are the statutes that 
created us to be captives in our relationship with the oil 
companies are governed by--simply we are forced into signing 
supply agreements and contracts of adhesion--2 weeks ago today, 
my company, ConocoPhillips, invited me to a marketing meeting 
where they told me, after 28 years, and investing over $500,000 
in my station, I must pay $1.6 million for the land and 
improvements my station sits on or they would then put it up 
for bid. If I don't buy, I also forfeit my business value.
    These are the type of problems they are exerting today to 
control the marketplace. And that's what we don't understand. 
Our antitrust laws are not being enforced as intended, and they 
are insufficient as far as protection. We need your help 
drastically.
    The majors are in lock step with one another as it relates 
to wholesale pricing, with the exception of ARCO/BP in our 
State. The industry is so controlled that any unplanned glitch 
such as, believe it or not, a raccoon chewing on a wire, raises 
the price in California 7 cents a gallon. That is the honest to 
God truth.
    When you look at this and you say, what's that constitute? 
Multiply a billion and a half gallons of retail gas sales a 
month, times 7 cents. You can do the math.
    In conclusion, I thank you, and I would be more than happy 
to answer questions.
    I did have two attachments. One is my price today. My price 
today, my margin, my profit margin at $3.39 a gallon--this was 
on the 18th, was 0.0707 a gallon; not even 8 cents a gallon.
    If I made 30 percent gross profit, which my supplier is 
currently making in just the refining margin alone--but if I 
made 30 percent gross profit, as most retailers do today, I 
would be making $1.17 a gallon, and you would be paying $4.589 
cents per gallon.
    [The prepared statement of Dennis DeCota (with attachments) 
appears in the Submissions for the Record on page 69.]
    Chairman Schumer. Thank you.
    Ms. Slater.

   STATEMENT OF SAMANTHA SLATER, DIRECTOR, CONGRESSIONAL AND 
        REGULATORY AFFAIRS, RENEWABLE FUELS ASSOCIATION

    Ms. Slater. Thank you. Good morning, Chairman Schumer and 
Members of the Committee. My name is Samantha Slater and I am 
director of Congressional and Regulatory Affairs for the 
Renewable Fuels Association, which is the national trade 
association representing the U.S. ethanol industry.
    I'm pleased to be here today to discuss the ethanol 
industry's perspective on the effects the increased 
concentration in the petroleum industry has had on the 
availability of E-85 at the pump.
    Ethanol today is largely a blend component of gasoline. Of 
the 5.4 billion gallons of ethanol blended in the U.S. last 
year, only about 15 million gallons were used for E-85. But the 
time when ethanol will saturate the blend market is on the 
horizon and the industry is looking forward to new market 
opportunities, including E-85.
    Today there are approximately E-85 pumps at service 
stations across the country. That number has more than doubled 
since the passage of the Energy Policy Act of 2005. However, 
that number remains insignificant considering the 170,000 
service stations nationwide. The majority of these stations are 
not owned by the major oil companies; but they are franchised 
from those same companies.
    The Gasohol Competition Act of 1980 put the day's 
discrimination against and unreasonable limitations on the sale 
of gasohol behind us. However, in recent years, the efforts of 
many gasoline retailers to sell E-85 with their stations have 
been thwarted by the major suppliers. Since E-85 has reached 
the same level of quality and acceptability as gasohol had in 
1980, such actions are plainly illegal under the Gasohol 
Competition Act, and yet the interference still occurs.
    Oil companies today do not generally sell E-85, so they 
lose a sale when a driver pulls into a service station bearing 
their name and purchases E-85 instead of the gasoline the oil 
companies supply to the service station. It is not in their 
best interest financially, then, to permit E-85 to be sold at 
these service stations.
    ConocoPhillips, in a letter to Senators Harkin and Lugar on 
February 14, 2006 plainly stated that E-85 ``is not currently 
sold as a ConocoPhillips branded product.'' And one of the key 
reasons is that ``E-85 predominantly originates and is 
manufactured by other producers.'' I would note that there are 
no restrictions in place today that would prohibit oil 
companies from selling their own brand of biofuels.
    If an oil company, however, was to grant an exemption and 
allow a franchise service station to buy E-85 from an outside 
supplier, the service station would then be required to follow 
restrictive rules put in place by the oil companies. It is not 
unusual to find clauses in oil company contracts with 
franchisees that require service stations to dispense E-85 from 
its own unit and not as part of the existing multi-hose 
dispenser, as service stations are required to sell all three 
grades of the supplier's gasoline. This necessitates station 
owners to install new pumps and tanks at their own expense. It 
is also common practice for oil companies to disallow the sale 
of E-85 on the primary island, under its canopy; and 
franchisees must therefore find another location on the 
property to install a new pump--and then, even if the 
franchisee is able to jump through all of those hoops, it is 
likely that the oil companies would prohibit the service 
station from advertising the availability and price of E-85 on 
their primary signs listing fuel prices.
    How can these service station owners hope to recoup their 
expenses if they can't advertise? The reason this interference 
continues is simple. Enforcement of the Gasohol Competition Act 
relies primarily on the willingness of marketers to face 
economic ruin. To bring a private action under the Gasohol 
Competition Act the plaintiff must have suffered antitrust 
injuries. For a marketer, that would mean that he could not sue 
unless his contract with the supplier has been terminated. 
Short of that, the marketer would be unable to demonstrate any 
antitrust injuries, so there would be no remedy available for 
the wrongful conduct of the supplier.
    In the face of these barriers, many retailers are taking 
action to bring fuel choice to their customers. Regional chains 
like Kroger have taken the initiative to install E-85 pumps at 
their stores, and national chains like Wal-Mart are also 
showing an interest in installing E-85 pumps at their stations. 
Even State legislatures are taking steps to end the restrictive 
policies put in place by the oil companies.
    In 2006, New York State enacted legislation that bars oil 
companies from requiring stations to buy all their fuel from 
those oil companies, and now two E-85 pumps are now in 
operation in Albany.
    RFA urges Congress to consider augmenting the existing 
enforcement mechanisms under the Gasohol Competition Act 
through the creation of a regulatory enforcement regime. 
Assigning responsibility to an appropriate regulatory agency 
would ensure that marketers eager to give their customers the 
option of using home grown, American made renewable fuels in 
place of imported oil have a realistic opportunity to do so.
    RFA looks forward to working with on these important 
issues, and thank you.
    [The prepared statement of Samantha Slater appears in the 
Submissions for the Record on page 110.]
    Chairman Schumer. Thank you, Ms. Slater.
    Mr. Cavaney.

STATEMENT OF RED CAVANEY, PRESIDENT AND CEO, AMERICAN PETROLEUM 
                           INSTITUTE

    Mr. Cavaney. Thank you, Mr. Chairman and Members of the 
Committee. I appreciate the opportunity, and request your 
permission to submit a more detailed statement following 
today's hearing.
    Chairman Schumer. Without objection.
    Mr. Cavaney. Industry mergers are not a cause of higher 
gasoline prices. In fact, mergers contribute to production 
efficiencies that benefit consumers. As with all industries, 
mergers have occurred only after careful Federal Trade 
Commission scrutiny to ensure the competitiveness of markets. 
The FTC reviews all proposed mergers and acquisitions in the 
oil and natural gas industry. It has required divestitures, 
challenged mergers in the industry at lower levels of 
concentration than in any other industry and has stated that, 
and I quote: ``despite some increases over time, concentrations 
for most levels of the petroleum industry has remained low to 
moderate.''
    Those who allege that mergers cause gasoline price 
increases fail to recognize that there is no shortage of 
competitors today, and market power is not concentrated. The 
eight largest refiners in the United States account for 66 
percent of the market, a level of concentration that is 
exceeded by 15 other consumer product industries. In fact, in 
eight other major industries, the top eight companies, on 
average, account for 85 percent or more of their respective 
markets, according to U.S. Department of Commerce 2006 data.
    In the United States there are 55 refining companies, 142 
operating refineries, and a few more than 165,000 retail motor 
fuel outlets. In the case of the latter, as was said before, 
all but a small percentage are owned and operated by 
independent businessmen and women, not refiners.
    According to the FTC, the share of U.S. refining capacity 
owned by independent refiners with no production or exploration 
operations, rose from 8 percent in 1990 to over 25 percent in 
2006.
    In part, as a result of the mergers, the industry has 
become more efficient and has reduced costs to consumers, with 
gasoline prices dropping to all-time record lows in the late 
1990s. Sharp increases in crude oil prices and costly 
investments made to reduce emissions have masked this benefit, 
obviously, in later years.
    Recent price increases reflect supply and demand. The same 
is true for past price increases, which have been thoroughly 
investigated by Government agencies who would have taken the 
industry to task if illegal or improper activity had been 
found. Invariably, these agencies have explained price spikes 
by supply and demand conditions that had nothing to do with 
manipulation of supplies or illegal agreements among companies.
    Moreover, a 2006 investigation by the U.S. Federal Trade 
Commission found, and I quote: ``no evidence indicating that 
refiners make market output decisions to affect the market 
price of gasoline. Instead, the evidence indicated that 
refiners responded to market prices by trying to produce as 
much higher-valued products as possible . . . The evidence 
collected in this investigation indicated that firms behave 
competitively.'' Unquote.
    Those who persist in suspecting that the industry is 
holding back supplies overlook the fact that over the past 10 
years, existing refineries have expanded capacity equivalent to 
building 10 new refineries and, based on public announcements 
of current refinery expansions, projected to add the capacity 
equivalent of an additional eight new refineries through 2011.
    We recognize that today's higher prices are a burden to 
people and a threat to the economy. The cause of higher prices 
is an imbalance between supply and demand, worsened in part by 
policy shortcomings.
    So far in 2007, total U.S. gasoline demand has set a 
record. Total production and total demand, both. However, 
because of maintenance at European refineries, where we import 
a significant amount of our product, an extended port workers 
strike in France, refinery problems in Venezuela and refining 
disruptions in Nigeria, less imported gasoline has been 
available to contribute to the traditional seasonal build in 
inventories.
    Oil company mergers and acquisitions have, in of 
themselves, not caused higher gasoline prices. The consumer 
would be best served if we focus on the factors shaping higher 
prices, and not be misled by claims that have been repeatedly 
disproved, have no basis in fact, and mask root causes.
    Thank you very much. I look forward to your questions.
    [The prepared statement of Red Cavaney (with attachments) 
appears in the Submissions for the Record on page 113.]
    Chairman Schumer. Thank you, Mr. Cavaney.
    Dr. Smith.

STATEMENT OF DR. JAMES L. SMITH, CARY M. MAGUIRE CHAIR IN OIL & 
   GAS MANAGEMENT, EDWIN L. COX SCHOOL OF BUSINESS, SOUTHERN 
                      METHODIST UNIVERSITY

    Dr. Smith. Thank you, Mr. Chairman, and distinguished 
Members. It's a pleasure to be here today.
    Many factors contribute to the high level of gasoline 
prices that we currently see, and to the continuing volatility 
in prices keeps us wondering what to expect next. The No. 1 
factor is the tight link that connects crude oil prices to 
gasoline prices, crude oil feedstock and gasoline.
    Over the past 15 years, 95 percent of month-to-month 
gasoline price fluctuations we've seen are directly accounted 
for by changes in the cost of the crude oil feedstock. We've 
heard a reference to a previous FTC study that found 85 
percent--I've updated that work, and in recent years, it's 
climbed to 95 percent.
    Dependence on the cost of crude oil feedstock is not the 
only factor responsible for changes in the price of gasoline, I 
know that; but its impact is so predominant that it usually 
overwhelms all other factors. We cannot easily attain any 
desirable outcomes for American motorists without keeping this 
dependence on crude oil prices in clear focus.
    Crude oil prices themselves are not determined within a 
U.S. market. Rather, crude prices are determined in a global 
market, one that's dominated by non-U.S. players. The models 
and assumptions of the world oil market that we might have 
relied on 40 years ago, indeed the market that we all grew up 
with, those are no longer relevant. The structure of the world 
oil market has changed in fundamental ways. The biggest change, 
one that we are still learning to grapple with, is the 
replacement of multinational oil companies, the so-called Seven 
Sisters, by national oil companies which are quasi-political 
and economic organizations that control access to the resource 
base and determine the supply of oil in most major oil 
producing countries of the world.
    The Seven Sisters, or what remains of them, provide only 
about one-sixth of the world's supply of crude oil. The 
national oil companies provide more than half the total supply, 
and that's after having shut in some production to support 
prices.
    The crude oil market is not competitive, and this is no 
secret. The members of OPEC, which now number 12 countries, 
deliberately attempt to manipulate the price of crude oil for 
their benefit, not ours. And sometimes they succeed. The 
national oil companies of those countries are the instruments 
by which control is exercised.
    OPEC members do not share with or cede control of the price 
mechanism to the multinational oil companies. The 
multinationals themselves do not have enough crude oil reserves 
or production to influence the market price.
    If you wish to deal with gasoline prices in a manner that 
addresses the long-run interests of American motorists, then 
you need to deal with OPEC. OPEC is the problem.
    What are the options for dealing with OPEC? Precious few. 
First, legal challenges have been discussed here today, and 
previously; you can try to win in court. Personally, I believe 
that's a tough road. The OPEC members are sovereign nations, in 
the first instance, so you have fewer tools on your side. On 
the other hand, they also have economies that are highly 
specialized; keyed and dependent upon oil. They have even more 
at stake than we do to win that battle.
    Second, you can encourage the development in growth of 
alternative supplies of oil and other forms of energy. This 
will directly diminish OPEC's ability to control oil prices, 
and it would instill greater competition.
    Finally, you can discourage oil consumption. However, the 
impact on OPEC of reduced consumption is less direct, and 
probably less potent than developing alternate supplies. That's 
because OPEC reserves are low-cost reserves of oil. When demand 
slackens and prices fall, it's the high-cost producers, the 
high-cost production flows, that are backed out of the market, 
not OPEC. OPEC is the last man standing.
    We could actually see our dependence on OPEC rise as 
consumption falls, unless other concurrent changes are not made 
to stimulate alternative supplies of oil and energy.
    In summary, gasoline prices are driven by crude oil prices. 
The volatility we see at the gas pump is a mere reflection of 
the underlying volatility that characterizes the world crude 
oil market. Any new policy initiative, to be effective and 
sustainable must be framed in the context of the world oil 
market and judged by its ability to tame the factors that are 
driving that market. Thank you.
    [The prepared statement of Dr. James L. Smith appears in 
the Submissions for the Record on page 129.]
    Chairman Schumer. Thank you, Dr. Smith.
    I want to thank all five of you for your testimony, and 
again we have votes coming up, so I'll get right to the 
questions.
    First, just a contrast. When I hear Mr. DeCota and Ms. 
Slater talk, they're in the real world, trying to get things 
done. They see competition squeezing off.
    You hear the two economists, and they're talking at a very 
rarefied level in terms of ``Oh, there's, you know, plenty of 
competition going on,'' the people we heard in the previous 
panel.
    But Mr. DeCota, you've been doing it for 30 years and you 
see less competition, less unbranded gasoline, fewer 
independents, and the price goes up. Is that a fair statement?
    Mr. DeCota. It is.
    Chairman Schumer. And Ms. Slater, you see that it's not 
just the market at work, it's a real attempt by those who have 
dominant power, to prevent a competitive fuel to get on the 
market. Is that true?
    Ms. Slater. That's absolutely true.
    Chairman Schumer. So do the two of you see any--what do you 
think when you hear these economists, particularly previously 
Dr. Salinger, the FTC, who should have more say over this than 
anyone say ``Well, there's plenty of competition, and the chart 
with 81 percent''--and do you agree with that, Dr. Moss, this 
chart on the right is best for America, having fewer refiners?
    That's what the previous panel had----
    Dr. Moss. No, I disagree with that.
    Chairman Schumer. Yes. I would think so.
    So how do you feel about that? Just re-face a dichotomy 
here: What seems to be plain common sense, less competition 
means higher prices.
    There is OPEC. I know my colleague has talked about it; so 
has Dr. Smith. But first of all, my guess is that the Big Oil 
companies are very happy with OPEC because they just add their 
profit margin on top of it. They haven't suffered since OPEC 
has started; they've actually gained.
    And so somebody who wants to find a way around OPEC, which 
is in the national interest, which might be with an alternative 
fuel, which might be maybe encouraging more production in non-
OPEC places, is not going to be one of the big oil companies, 
because they're tied into OPEC and they do very well.
    So would Ms. Slater and Mr. DeCota comment on just the 
dichotomy we seem to see here from the people on the ground, 
who are there day-to-day and minute-to-minute, and the 
theorists who seem to be quite up there in the stratosphere.
    Ms. Slater. The ethanol industry is in a bit of an 
interesting situation in that our biggest customer, certainly 
as a blend component, is also our biggest competitor; as an 
alternative fuel. So it puts the ethanol producers, and 
certainly those who are trying to market E-85, in a very 
interesting position as they try and move forward and increase 
the availability of E-85 nationwide.
    And it is a very big difference between what's happening at 
the high level and what's happening on the ground. If you have 
an opportunity to go out to the real world with E-85 marketers 
and travel around the highways as they look for appropriate 
spots to place their E-85 pumps, and I'm just talking about the 
competition issue and looking at those figures. I just wanted 
to note as well that for the ethanol industry, the top eight 
companies represent about 50 percent of our market share.
    Chairman Schumer. Thank you.
    Mr. DeCota?
    You were quite lucid in your testimony, in terms of how 
competition has decreased and prices go up--your price that you 
pay for gasoline goes up. You see a direct correlation.
    Mr. DeCota. I do. Let me give you one example. It's fresh, 
it's one of my members.
    He sold--at his service station, a van came in, the van 
filled up, the credit card, as mandated by the oil company, 
pays at the pump, it shuts off at $75. He has to re-do that 
sale. The total sale was $150 for this van. My dealer lost $3 
on the sale.
    The reason is zone pricing. In San Francisco as it is 
throughout the U.S., these oil companies strategically plan out 
how they're going to compete with one another to the tune of 
these zones. Where there's a non-growth community, they rip 
them--I'm sorry, I mean, that's the truth.
    Chairman Schumer. Understood.
    Just a question for Mr. Cavaney and Dr. Smith. How in God's 
name does having $60 billion, or whatever the number is, of 
buyback of stock from these companies making record profits, 
serve our national interest, rather than them putting that 
money into increasing--building new refineries, increasing 
refinery capacity, finding new oil--even assuming that so many 
of the leaders of the oil industry say they don't believe in 
alternative fuels.
    That's what Mr. Tillerson told us in the Judiciary 
Committee a year ago. He said, ``We don't believe in 
alternative fuels.''
    How does buying back the stock, how is that a preferential 
outcome for national happiness, security in every way?
    Mr. Cavaney.
    Mr. Cavaney. I'd like to comment that it's well known to 
anybody who reads the literature, on major construction 
projects worldwide, there is a shortage of engineering talent, 
companies to handle it, and people to do them. We are 
committing, as an industry, indefinite numbers--in the hundreds 
of billions of dollars, which exceed anything we've ever done 
before--but at some point you can't get people to do the work; 
so you're either left with sitting on the dollars or returning 
them to shareholders in the interim--giving them back.
    And that's the method that's used not just by the oil 
industry; huge companies like Microsoft, GE and others, do the 
very same thing. It's a way to enhance the shareholders, and 
therefore keep the investment going.
    Chairman Schumer. Dr. Smith.
    Dr. Smith. Well, I think it's a good question and a fair 
question. Let me just add two points that haven't been raised. 
One of course is that the oil companies would love to invest in 
any number of basins around the world, outside of the U.S. and 
inside of the U.S.; that's where the most productive 
exploration investments are being made, in new provinces.
    Unfortunately, a lot of those are closed, either under the 
influence of the nationalized oil companies or governmental 
controls of some sort.
    The second issue really is what the companies may view as 
the sustainable long run oil price. I don't know of any company 
now that's budgeting capital expenditures on the presumption 
that $60 oil is going to be prevailing in 5 years. I do know 
companies that expect it to be $30, $35. So they're gauging 
their investments relative to a standard that might look low 
compared to the current market, but it's a very long-lived 
investment, and that's their decision.
    Chairman Schumer. Thank you.
    Congressman Saxton.
    Representative Saxton. Thank you. I'd like to also thank 
each of you for being here to share your information with us, 
and Ms. Slater, I'd particularly like to thank you for coming 
to shine light on E-85; it's a project that I've been involved 
in for some years, and I didn't realize until I heard you say 
the problems that the dealers have instituting E-85, or 
including E-85 pumps at their stations, and we thank you for 
that.
    Dr. Smith, thank you for being here, too. You are a 
professor at Southern Methodist University, Cox School of 
Business, where you specialize in oil and gas management. Is 
that correct?
    Dr. Smith. Yes, it is.
    Representative Saxton. So you come from the world of 
academia.
    Dr. Smith. I do.
    Representative Saxton. So I would just like to think that 
perhaps you have an objective view of this; and I guess I've 
made the point several times, as the Chairman has pointed out, 
that you believe that OPEC is a major player, and it's left to 
us to determine--what the significance is of the role that OPEC 
plays in creating the problem that we're here to face.
    I want to ask you several questions, Dr. Smith. Would you 
agree that the cost of producing a barrel of oil in the Persian 
Gulf can be as little as $5?
    Dr. Smith. A little less than $5 in some cases, yes.
    Representative Saxton. Less than $5.
    Dr. Smith. Yes.
    Representative Saxton. In your testimony you noted that 
OPEC has attempted to manipulate world oil prices during the 
last 35 years. Do you have much doubt that OPEC's activities 
would be subject to antitrust laws if they were subject to--
they would be in violation of antitrust laws if they were 
subject to U.S. antitrust laws?
    Dr. Smith. They would be in clear violation if they were 
U.S. corporate entities.
    Representative Saxton. You also note that when oil prices 
rise, the impact of oil production from non-OPEC sources is 
limited. Can you please expand on this point?
    Dr. Smith. Well, it goes back to the point of not having 
geologically prospective areas. There's only so much more oil, 
even at high cost, that we can find in the mature basins of the 
U.S. and some of these other producing areas.
    The real expansion potential is in the Middle East; it's in 
the Persian Gulf. It's in Russia, it's in places where we have 
limited access.
    Representative Saxton. In coming decades, unless current 
trends change, will world energy demand become more dependent 
on oil produced by OPEC?
    Dr. Smith. Seems likely, yes.
    Representative Saxton. How do trends in OPEC oil production 
over the last 30 years or so contrast with the amount of OPEC 
oil reserves? Doesn't the discrepancy between the OPEC oil 
production and growing reserves indicate, as you suggest, that 
OPEC has been up to something; namely, underproduction of oil?
    Dr. Smith. Clearly that's so. During the 1980s when OPEC 
oil reserves were growing very rapidly, OPEC production was 
actually decreased. Only in the last year has OPEC production 
level regained the level of the 1970s. So they were suppressing 
production while shoring up their own reserves.
    Representative Saxton. And isn't it true that in 2004 and 
2005--I believe those were the years when the price of oil 
dropped to around $50 a barrel, that OPEC curtailed production, 
on two occasions?
    Dr. Smith. I believe that's correct. They deliberately 
reduced the quota production levels for the members.
    Representative Saxton. And didn't that more recently 
increase the cost of oil per barrel to over $60? In fact I 
believe today it's $67 a barrel.
    Dr. Smith. It's very close to that, yes.
    Representative Saxton. And would you attribute that to the 
underproduction of oil, deliberately brought about by OPEC 
decisionmaking?
    Dr. Smith. Yes, I do.
    Representative Saxton. The old OPEC price band was $22 to 
$28 per barrel. That was up until early 2005. Now with oil at 
roughly twice that price, OPEC doesn't seem interested in the 
old price band, but seems quite comfortable with oil over $60 a 
barrel. Has OPEC effectively changed its price band but is 
failing to acknowledge this?
    Dr. Smith. I don't know that there's a consensus on a new 
price band, as there was an explicit agreement on the old one; 
but a number of OPEC ministers have personally indicated 
support for a much higher price band. I don't think there's 
been an official adoption of one.
    Representative Saxton. My train of thought was interrupted 
by my Blackberry.
    Dr. Smith. That's the problem with those things.
    Representative Saxton. In any event, a little while ago 
somebody said to me--a little while ago here on this panel 
somebody said to me, one of my colleagues said to me, ``You're 
right, Jim, but we can't do anything about OPEC.''
    I would just suggest that through our diplomatic sources 
and through other leverages that we may have at our disposal, 
if OPEC is in fact the problem, then we have to find a way to 
deal with it. And you pointed out that increasing product 
availability, of different types of product, as Ms. Slater 
suggested, would be one of the things that we could do to 
affect petroleum prices.
    Is that correct?
    Dr. Smith. Yes. Additional oil supplies and alternatives to 
oil supplies.
    Representative Saxton. OK, my time has expired, but I want 
to thank all of you for being here today. I know the American 
public as well as Members of Congress are vitally interested in 
this subject and perhaps I, even for a different reason than 
most have realized at this point, sometime ago I took part in a 
press conference on the other side of the Capitol where my 
colleagues and I described oil as a potential weapon against 
our economy. And I believe that is true, and I believe that 
people all around the world recognize that that is true.
    So thank you all for being here to discuss this important 
issue.
    Representative Maloney. Thank you. And I thank all the 
panelists and my colleagues.
    I'd like to ask Mr. Cavaney: This year we heard repeatedly 
about the impact of refinery outages on the price of gasoline. 
In other words, gas prices are going up because refineries 
require maintenance or have accidents.
    Just yesterday BP reported that they're reducing production 
at an Alaskan refinery by 100,000 barrels because of a water 
pipeline leak. How, in an industry where they are making so 
much profit, $120 billion last year, are there so many 
maintenance problems that Mr. DeCota explained earlier are 
driving up prices dramatically for consumers. Why are there so 
many maintenance problems?
    Mr. Cavaney. Well, there's a number of things that have 
gone on and are going on that relate to this. First of all, in 
the Katrina and Rita period, when we lost 30 percent of our 
production, as soon as we could bring those refineries back on, 
they were brought back on and ran hard.
    We also were able, as a result of the price increase, to 
attract production from elsewhere in the world, to bring it in 
to make up that gap until the refineries got going.
    Once they got going, we had to keep them going, oftentimes 
at periods longer than might otherwise have been the case, 
because we were still short fuel for the American consumer, and 
yet we continued to provide that to them.
    You can't run refineries unlimited amounts of time; you 
have to take downtime, both for preventive maintenance, for 
safety, and also for what we call turnarounds; we change the 
fuel to go to winter fuel or you change it to go to summer 
grade fuel.
    There are also incidents that occur; for example, as 
mentioned earlier, the squirrel that chewed into the wire. 
Well, it chewed into the wire that provided the electricity to 
the refinery; and a refinery can't run without electricity.
    So there's a whole series of things. Right now, just this 
morning, for the third week in a row, the key factors that have 
made the market really tight, which is reduced imports coming 
in, production being able to increase a fair amount and 
inventories being up, have all headed in the right direction; 
and just before I stepped up here, the futures market is 
reacting with decreased prices.
    So what we're seeing now is regular market forces coming 
back; and if these patterns continue as they have historically, 
what you'll see after that is more supplies available, and 
you'll likely see relief on prices.
    Representative Maloney. Well, instead of using the $120 
billion in profits to expand refining capacity or make 
investments in renewable energy, I'd say investing in 
maintaining the pipelines and maintaining the access--they're 
using that money to buy back their own stock to enhance profits 
for their shareholders.
    Now I can see that they're under pressure by their 
shareholders to make profits. So do you think it might be a 
good idea if the Government required that a certain percentage 
of these profits go back into maintaining the distribution to 
consumers so the prices don't go back up dramatically? That's 
one thing we could do that would help the country; or maybe 
Government should require that they invest in some new 
refineries in our country? Instead of just taking all of this 
profit out.
    I know that in my district there was an electricity outage 
last year; there are six electricity plants in my district. And 
it was out for 10 days. People died; they were not without 
electricity, but they were not maintaining what they had.
    So we have suggested that they invest in maintaining the 
production, the distribution--and I think maybe we should do 
the same thing with the oil companies; require them to maintain 
their distribution rights better.
    I tell you, there is something wrong when the prices are 
going up so dramatically. We saw it with the oil that was being 
extracted from federally-owned land, this Government was giving 
them subsidies. That's just plain wrong, and we are trying to 
stop that.
    But I'd like to ask Mr. DeCota and Ms. Slater, who are out 
in the field working with this problem: What can Government do? 
You mentioned earlier, Ms. Slater, that the E-85, the ethanol, 
is not even available at branded sites. Here these companies 
are in many cases subsidized by billions of dollars. Should 
Government require that they allow other alternatives to be 
sold at these sites? What can we do to help address this in our 
own country?
    Ms. Slater. Absolutely. And as I mentioned in my concluding 
remarks, that we have the Gasohol Competition Act of 1980 in 
place, and we need a regulatory agency to enforce it, and to 
make sure that regime is in place so that the law that is 
already on the books can be enforced; and essentially, it's 
that simple, to enforce the regulation as it is supposed to be.
    Representative Maloney. What would you say, Mr. DeCota? 
What could we do?
    Mr. DeCota. Let's look at the issues of these contracts of 
adhesion that are entered into. You know, me as a retailer, I 
cannot sell E-85 in my service station; my contract will 
prohibit. I will have to buy that station within the next 60 
days, without an improvement. I have to sign a supply agreement 
that's between 13 and 20 years in length.
    I still will not have the right to do that. Not only that, 
the major oil company will put a penalty on me if I don't hit 
my demanded annual volume on the sale of their product. So 
what's going to happen here, Congresswoman, is they're going to 
take--and if E-85 catches hold, they're going to raise the cost 
of E-85 to the consumer by raising my cost, on my cost of fuel, 
petroleum product.
    We need to interject oversight by Government on contracts 
of adhesion that don't make sense. And that zone pricing, and 
their ability to take and set prices by zone have completely 
wiped out competition in the retail marketplace, and it's going 
to stymie the growth of our alternative fuels if we don't get 
Government engaged. Because no one can stand up to the strength 
of a major oil company; their legal power.
    Representative Maloney. Well, I thank everybody for their 
testimony; and my time is up, and thank you, and we will be 
following up.
    [Whereupon, at 12:20 p.m., Wednesday, May 23, 2007, the 
hearing adjourned.]
                       Submissions for the Record

=======================================================================

[GRAPHIC] [TIFF OMITTED] 37461.001

       Prepared Statement of Senator Charles E. Schumer, Chairman

Should We Begin To Examine the Rash of Oil Company Mergers in the Last 
 20 Years? Consolidation Raises Serious Economic, Consumer, and Energy 
                           Security Questions

    has u.s. policy on oil company mergers hurt refining capacity, 
  alternative energy development and raised gas prices for consumers?
Congressional Joint Economic Committee Begins Overdue Debate on 
        Consolidation in U.S. Oil Industry and its Impact on Consumers 
        and Energy Security
    Thank you all for coming to today's critical hearing on the state 
of competition in the market for U.S. petroleum. We have a lot of 
business to cover today, so I am going to ask that Ranking Member 
Saxton and Vice Chairman Maloney offer their opening statements, and 
our fellow Members to please submit their opening statements for the 
record so we can get right to it.
    After a wave of mergers in the industry over the past two decades, 
we have an elite group of five very large, integrated oil companies 
dominating our domestic petroleum market, and there has been very 
little analysis on the impact of those mergers.
    The looming question hanging over us that we will strive to answer 
today is whether the lack of competition in this market is harming 
consumers: Should we begin a serious exploration of whether or not to 
undo some of these mergers?
    To answer this question, we need to explore three areas--price-
manipulation, refining capacity, and barriers to entry for renewable 
energy alternatives:

    1. PRICES: Are oil companies exploiting their market control 
prices? If this market is, as some say it is, an oligopoly, then the 
oil companies don't have to meet behind closed doors to set the price 
of oil--one company can take the lead, and the rest can all wink at 
each other. Economists call this ``price leadership,'' and the more 
concentrated the oligopoly, the more market power they have to set 
prices above competitive levels.
    2. REFINING CAPACITY: Are oil companies strategically under-
investing in refinery capacity and maintenance in order to constrict 
supply, drive up prices and maximize profits?
    3. BARRIERS FOR RENEWABLES: And third, are oil companies using 
their market power to block the availability of alternative energy 
choices, such as E-85, at the pump?

    The goal of this hearing is to examine in depth whether the oil 
industry's market structure is to blame for the sky-high gas prices, 
lack of adequate refining capacity, and lack of alternative fuels at 
the pump that are harming consumers today.
    And frankly, I can't imagine a more appropriate time to have this 
hearing--the national average gasoline price reached $3.22 a gallon 
last week--the highest level on record.
    We are here today because the American people suspect that the high 
prices they are paying at the pump go straight to oil companies' 
profits. They're concerned that these profits are not going toward 
renewable energy alternatives or curbing the cost of gasoline at the 
pump.
    We are here today because, in the words of Teddy Roosevelt, ``We 
demand that big business give people a square deal.'' A square deal 
means passing along efficiencies achieved through mergers to consumers, 
investing in new production and refinery capacity, and ensuring 
reliability of supply so that gas prices don't shoot up by over $1 a 
gallon in a matter of months. Today, American families are getting a 
raw deal, while oil companies make out like the robber barons of 
Roosevelt's time.
    And finally, we are here today because competition in the petroleum 
industry is critically important to the health of the economy of this 
nation--an economy that has been dragging its feet in recent months. 
And the Federal Government has an important role to play in ensuring 
that this market is competitive.
    Scanning the landscape of the U.S. petroleum market, it isn't clear 
that we have anything that can remotely be called competition:
    Since the late 1990s--mergers between the giant oil companies, like 
Exxon and Mobil in 1999, Chevron and Texaco in 2001 and Conoco and 
Phillips in 2002--have left us with only five major domestic oil 
companies controlling the majority of our domestic refining capacity.
    In 1993, the largest five oil refiners controlled one-third of the 
U.S. market, while the largest 10 had 56 percent. By 2005, the largest 
five controlled 55 percent of the market, and the largest 10 refiners 
dominate the market with over 80 percent market share.
    Despite ever-increasing petroleum prices, our major oil companies 
don't feel they need to compete to create new domestic gasoline supply. 
All things being equal, high gas prices should be an incentive for 
increased refining capacity. But we haven't had a new refinery built in 
30 years, forcing refineries to operate longer and harder, and at 
capacity levels that are overtaxing the system.
    The oil companies tell us that instead of building new refineries, 
they are focused on upgrading existing refineries to keep up with 
increasing demand. Yet it isn't clear how much they are really 
investing in their existing refining plants when ``unexpected'' 
refinery accidents and unplanned maintenance closings have become a 
regular occurrence, choking off supply and causing steep price surges 
at the pump in recent months.
    The rust and neglect has crept into the pipelines as well. Just 
yesterday, BP announced that it would shut down 100,000 barrels a day 
in capacity ``for a few days'' because of a pipeline leak. Just the 
latest in a series of missteps for BP in their production and 
distribution systems.
    Meanwhile, even as oil prices are dropping, gas prices are going 
through the roof! Right now, crude oil prices are lower than they were 
last year at the onset of the summer driving season. But gas prices 
this morning, at $3.21 a gallon, are 34 cents higher than they were a 
year ago. The Department of Energy is predicting that crude oil prices 
will average about $66 a barrel this summer, versus $70 a barrel last 
summer. But the agency is predicting that gasoline will average about 
$2.95 a gallon this summer, up from an average of $2.84 last summer.
    As a result, with capacity as tight as it is, and the spread 
between oil and gas prices widening, refining profit margins are at 
historical highs--ConocoPhillips, the largest U.S. oil refiner, posted 
its biggest quarterly profit since its merger in 2002. ExxonMobil, the 
second-largest U.S. refiner, just reported its highest first-quarter 
refining earnings in 13 years, and Valero, #3, nearly tripled its 
profits during the first quarter of this year.
    I don't understand how an industry that makes tens of billions per 
year can still have rusty refining plants that constantly break down. I 
don't know of any other business where the ratio of profits to 
infrastructure breakdowns is as high. And I don't know any other 
industry where an equipment break down in one company benefits every 
other company by raising prices.
    On the surface, it seems that Big Oil is pumping cash rather than 
petrol, strengthening profits rather than fixing rusty pipes, and 
they're using their dominant market positions to buy back their own 
stock rather than meet the growing demand for fuel in this country.
    Here's just one example. ExxonMobil--the world's most profitable 
company--dolled out $29 billion (or 60 percent of its cash-flow)--on 
stock buybacks last year alone. This was more than any other company in 
the S&P 500. And this was $9 billion much more than Exxon invested back 
into its business. Meanwhile, according to news reports, Exxon's 
overall production as ``barely budged'' since its 1999 merger.
    ExxonMobil is not alone. Overall, the oil industry spent $52.4 
billion on buybacks last year, nearly double the amount in 2005. And 
like ExxonMobil, production levels at the rest of the Big 5 have been 
flat.
    If there was more competition in this market, wouldn't these 
companies be investing in new production rather than sending their 
oligopolistic profits back to shareholders? Wouldn't they have the 
incentive to take more risks in and innovate to get ahead on the 
renewable energy curve?
    This is a long overdue debate, and my instinct tells me that a 
reconsideration of oil company mergers in the last two decades may be 
in order.
    When markets have been distorted from lack of competition in the 
past, the Federal Government has taken action. Standard Oil, U.S. 
Steel, and AT&T come to mind.
    It's no coincidence that I again quote Teddy Roosevelt, a great New 
Yorker, who had a lot to do with restoring competition in markets that 
had been lost, once said ``Rhetoric is a poor substitute for action, 
and we have trusted only to rhetoric. If we are really to be a great 
Nation, we must not merely talk; we must act big.''
    It's time to consider acting big.
    We're looking forward to learning from our witnesses today more 
about what is going on in the market so we can best figure out how to 
proceed from here. I will first introduce our witnesses before we 
proceed to my colleagues opening statements.
    On our first panel we welcome:
    Mr. Thomas McCool from the Government Accountability Office, who is 
the Director of their Center for Economics in the Applied Research and 
Methods Group. He has been at GAO for 20 years.
    Dr. Michael Salinger is the Director of the Federal Trade 
Commission's Bureau of Economics. He previously taught at the business 
schools at Columbia and MIT, and is currently on leave from Boston 
University.
    On our second panel we today we will have:
    Dr. Diana Moss who is the Vice President of the American Antitrust 
Institute. She is an economist, and has expertise in antitrust issues 
across a wide range of industries, including: electricity, oil and gas, 
appliances, and agricultural biotechnology.
    Mr. Dennis DeCota, who is the Executive Director of the California 
Service Station and Automotive Repair Association. In addition, Mr. 
DeCota is himself a service-station owner.
    Ms. Samantha Slater is the Director of Congressional and Regulatory 
Affairs at the Renewable Fuels Association.
    Dr. James Smith is the Chair of Oil and Gas Management at Southern 
Methodist University in Dallas, Texas, and specializes in both 
economics and energy. Dr. Smith is an expert energy economics and 
policy.
    Now let's get down to business.
    [GRAPHIC] [TIFF OMITTED] 37461.060
    
    [GRAPHIC] [TIFF OMITTED] 37461.061
    
    [GRAPHIC] [TIFF OMITTED] 37461.002
    
  Prepared Statement of Representative Carolyn B. Maloney, Vice Chair
    Thank you, Chairman Schumer. This is a very timely hearing because 
the price of gasoline is rising precipitously just as the summer travel 
season upon us. Is it coincidence or corruption? Either way, it's a 
hard blow to American consumers.
    The average weekly price of gasoline hit $3.22 a gallon this week, 
the highest price on record. That means families are spending about 
$55, on average, every time they fill up their car--an astonishing $30 
more per tank since the President took office. Rising gas prices are 
forcing American families to cut back on other spending, putting our 
economic growth at risk.
    The current run-up in gas prices underscores the urgent need for a 
better national energy policy, but instead we see stubborn inaction and 
complicity on the part of the Administration.
    The President's priority has been to give tax breaks to oil and gas 
companies even as their profits have soared to new heights. The Big 5 
oil companies enjoyed eye-popping profits of $120 billion last year. 
Instead of using those profits to expand refining capacity or make 
serious investments in renewable energy, the big oil companies are 
buying back their own stock to enhance prices for their shareholders. 
Moreover, oil companies seem to be working hard to prevent gasoline 
alternatives, such as ethanol-based products, from being pumped at 
their branded gas stations.
    The Administration has also turned a blind eye to oversight of the 
oil and gas industry in general, but especially mergers. The President 
has approved mergers at such a break neck speed that by 2005 the top 10 
refiners controlled 81 percent of the market, up from 56 percent since 
1993. This concentration of refiners has restricted production 
capacity, causing American consumers to pay more at the pump than they 
would with more market competition. The lack of competition is hurting 
consumers now and will hurt our economy in the future.
    But elsewhere at home and around the globe, leaders are recognizing 
the need to invest in clean, renewable energy sources and technologies.
    Just yesterday it was announced in my home district that New York 
City cabs are going green, as the Mayor plans to replace the city's 
fleet with hybrid cars by 2012.
    And Democrats in Congress are working on legislation to protect 
consumers, increase our energy independence by investing in renewable 
energy sources, reduce global warming emissions, and strengthen the 
economy.
    Mr. Chairman, thank you for holding this important hearing and I 
look forward to the testimony of our witnesses.
                               __________
                               [GRAPHIC] [TIFF OMITTED] 37461.003
                               
                             [News Release]

    Brownback: The Government Takes More in Gas Taxes Than the Oil 
                       Companies Make in Profits

  a windfall profit tax on oil companies would raise prices and hurt 
                               consumers
    Washington, D.C.--U.S. Senator Sam Brownback today argued that 
windfall profit and price-gouging taxes on oil companies are based on a 
deeply flawed understanding of the factors that determine gas prices 
and would harm consumers by increasing prices.
    ``The government already makes more off gas prices than the oil 
companies,'' said Brownback. ``In the past 30 years, Federal and state 
governments have collected more than twice as much in gasoline taxes as 
the major American oil companies have earned in profits. Politicians 
looking at high gas prices might be tempted to punish oil companies, 
but this approach is out of sync with economic reality. A windfall 
profit tax on oil companies would hurt consumers by raising prices, 
limiting supply and discouraging investment in new technology.''
    At a hearing of the Joint Economic Committee, Brownback cast doubt 
on the premise that high gas prices result from price gouging and 
argued that a windfall profit tax would worsen the very problem it 
intends to solve. Key points included:
Oil Companies Have Little Control Over Gas Prices
    Crude oil prices, as determined by worldwide energy markets, play 
the largest role by far in determining the price of gas at the pump.
A Windfall Profit Tax Would Raise Consumer Prices by Limiting Supply
    A windfall profit tax on oil companies would remove much of their 
profit motive and likely lead to supply reductions by making it less 
profitable to look for oil in locations with higher extraction costs.
    Unless the government resorted to Soviet-style price controls, by 
simply raising prices, the oil companies could recoup some of the 
revenue they would lose to a windfall profit tax.
    The net effect would increase costs for consumers while 
discouraging further U.S. exploration, production and investment in new 
technologies and energy sources.
                      brownback on high gas prices
Gas Prices Have Declined as a Share of Consumption and GDP
    The relative cost of a gallon of gasoline, as a portion of 
household consumption, declined 38 percent between 1981 and 2005.
    As a portion of per capita GDP (a good proxy for average income), 
the relative cost of gasoline declined 45 percent from 1981 to 2005.
Price Increases Result from Worldwide Changes, Not Oil Company Greed
    Rising demand, especially from China and India, is a driving force 
behind the recent rise in crude oil prices.
    Additional factors include limited refining capacity in the U.S. 
and the requirement of a diverse mix of fuel blends to meet air 
pollution standards.
Oil Companies Experience Frequent Downturns
    A comparison of the difference between return on investment for 
U.S. oil companies and all other manufacturing companies reveals that 
oil companies have experienced inferior returns almost as frequently as 
they have experienced above-average returns.
Mergers Help Consumers by Increasing Efficiency and Capacity
    Consolidation and mergers in the oil industry have led to larger 
refineries and improved innovation and efficiency, which benefits 
consumers through increased supply and lower production costs.
    It is remarkable that despite growing demand, and the fact that no 
new refineries have been built in the U.S. since 1976, gas prices have 
actually decreased as a portion of household consumption and per capita 
GDP.
    Brownback is the Senior Republican Senator on the Joint Economic 
Committee.
                               __________
  Prepared Statement of Thomas McCool, Director, Applied Research and 
                              Methods, GAO

   Energy Markets: Mergers and Other Factors That Influence Gasoline 
                                 Prices

    Mr. Chairman and Members of the Committee:
    We are pleased to participate in the Joint Economic Committee's 
hearing to discuss the factors that influence the price of gasoline, 
including oil industry mergers. Few issues generate more attention and 
anxiety among American consumers than the price of gasoline. Periods of 
price increases are accompanied by high levels of media attention and 
consumers questioning the causes of higher prices. The most current 
upsurge in prices is no exception. Anybody who has filled up lately has 
felt the pinch of rising gasoline prices. Over the last few years, our 
Nation has seen a significant run up in the prices that consumers pay 
for gasoline. According to data from the Energy Information 
Administration (EIA), the average retail price of regular unleaded 
gasoline in the United States reached $3.21 per gallon the week of May 
21, 2007, breaking the previous record of $3.06 in September of 2005 
following Hurricane Katrina. This year, from January 29th to the 
present, gasoline prices have increased almost every week, and during 
this time the average U.S. price for regular unleaded gasoline jumped 
$1.05 per gallon, adding about $23 billion to consumers' total gasoline 
bill, or about $167 for each passenger car in the United States. 
Spending billions more on gasoline constrains consumers' budgets, 
leaving less money available for other purchases.
    However, for the average person understanding the complex 
interactions of the oil industry, consumers and the government can be 
daunting. For example, gasoline prices are affected by the decisions of 
the industry regarding refining capacity and utilization, gasoline 
inventories, as well as changes in industry structure such as 
consolidations; by consumers' decisions regarding the kinds of 
automobiles they purchase; and by government's regulatory standards. 
These are some of the key factors affecting gasoline prices that we 
will discuss today.
    Given the importance of gasoline for our economy, it is essential 
to understand the market for gasoline and what factors influence the 
prices that consumers pay. You expressed particular interest in the 
role consolidation in the U.S. petroleum industry may have played. In 
this context, this testimony addresses the following questions: (1) 
What key factors affect the prices of gasoline? (2) What effects have 
mergers had on market concentration and wholesale gasoline prices?
    To address these questions, we relied on information developed for 
a previous GAO report on mergers in the U.S. petroleum industry, the 
GAO primer on gasoline markets, and a previous testimony on gasoline 
prices and other aspects of the petroleum industry.\1\ We also reviewed 
reports and other documents by the Federal Trade Commission (FTC) on 
the U.S. petroleum industry.\2\ In addition, we obtained updated data 
from EIA. This work was performed in accordance with generally accepted 
government auditing standards.
---------------------------------------------------------------------------
    \1\ GAO, Energy Markets: Effects of Mergers and Market 
Concentration in the U.S. Petroleum Industry, GAO-04-96 (Washington, 
D.C.: May 17, 2004); GAO, Motor Fuels: Understanding the Factors That 
Influence the Retail Price of Gasoline, GAO-05-525SP (Washington, D.C.: 
May 2005); GAO, Energy Markets: Factors Contributing to Higher Gasoline 
Prices, GAO-06-412T (Washington D.C.: February 1, 2006).
    \2\ See, for example, FTC, The Petroleum Industry: Mergers, 
Structural Change, and Antitrust Enforcement, An FTC Staff Study, 
August 2004.
---------------------------------------------------------------------------
    In summary, we make the following observations:
     The price of crude oil is a major determinant of gasoline prices. 
A number of other factors also affect gasoline prices including (1) 
increasing demand for gasoline; (2) refinery capacity in the United 
States that has not expanded at the same pace as demand for gasoline in 
recent years, which coupled with high refinery capacity utilization 
rates, reduces refiners' ability to sufficiently respond to supply 
disruptions; (3) gasoline inventories maintained by refiners or 
marketers of gasoline that have seen a general downward trend in recent 
years; and (4) regulatory factors, such as national air quality 
standards, that have induced some states to switch to special gasoline 
blends that have been linked to higher gasoline prices. Finally, 
consolidation in the petroleum industry plays a role in determining 
gasoline prices. For example, mergers raise concerns about potential 
anticompetitive effects because mergers could result in greater market 
power for the merged companies, potentially allowing them to increase 
and sustain prices above competitive levels; on the other hand, these 
mergers could lead to efficiency effects enabling the merged companies 
to lower prices.
     The 1990s saw a wave of merger activity in which over 2,600 
mergers occurred in all segments of the U.S. petroleum industry. Almost 
85 percent of the mergers occurred in the upstream segment (exploration 
and production), while the downstream segment (refining and marketing 
of petroleum) accounted for 13 percent, and the midstream 
(transportation) accounted for about 2 percent. This wave of mergers 
contributed to increases in market concentration in the refining and 
marketing segments of the U.S. petroleum industry. Anecdotal evidence 
suggests that mergers may also have affected other factors that impact 
competition, such as vertical integration and barriers to entry. 
Econometric modeling we performed of eight mergers involving major 
integrated oil companies that occurred in the 1990s showed that, after 
controlling for other factors including crude oil prices, the majority 
resulted in wholesale gasoline price increases--generally between about 
1 and 7 cents per gallon. While these price increases seem small, they 
are not trivial because according to FTC's standards for merger review 
in the petroleum industry, a 1-cent increase is considered to be 
significant. Additional mergers since 2000 are expected to increase the 
level of industry concentration. However, because we have not performed 
modeling on these mergers, we cannot comment on any potential effect on 
gasoline prices at this time.
       crude oil prices and other factors affect gasoline prices
    Crude oil prices are a major determinant of gasoline prices. As 
figure 1 shows, crude oil and gasoline prices have generally followed a 
similar path over the past three decades and have risen considerably 
over the past few years.
[GRAPHIC] [TIFF OMITTED] 37461.005


    Also, as is the case for most goods and services, changes in the 
demand for gasoline relative to changes in supply affect the price that 
consumers pay. In other words, if the demand for gasoline increases 
faster than the ability to supply it, the price of gasoline will most 
likely increase. In 2006, the United States consumed an average of 387 
million gallons of gasoline per day. This consumption is 59 percent 
more than the 1970 average per day consumption of 243 million gallons--
an average increase of about 1.6 percent per year for the last 36 
years. As we have shown in a previous GAO report, most of the increased 
U.S. gasoline consumption over the last two decades has been due to 
consumer preference for larger, less-fuel efficient vehicles such as 
vans, pickups, and SUVs, which have become a growing part of the 
automotive fleet.\3\
---------------------------------------------------------------------------
    \3\ GAO, Motor Fuels: Understanding the Factors That Influence the 
Retail Price of Gasoline, GAO-05-525SP, (Washington, D.C.: May 2005).
---------------------------------------------------------------------------
    Refining capacity and utilization rates also play a role in 
determining gasoline prices. Refinery capacity in the United States has 
not expanded at the same pace as demand for gasoline and other 
petroleum products in recent years. U.S. refineries have been running 
at very high rates of utilization averaging 92 percent since the 1990s, 
compared to about an average of 78 percent in the 1980s.\4\ Figure 2 
shows that since 1970 utilization has been approaching the limits of 
U.S. refining capacity. Although the average capacity of existing 
refineries has increased, refiners have limited ability to increase 
production as demand increases. While the lack of spare refinery 
capacity may contribute to higher refinery margins, it also increases 
the vulnerability of gasoline markets to short-term supply disruptions 
that could result in price spikes for consumers at the pump. Although 
imported gasoline could mitigate short-term disruptions in domestic 
supply, the fact that imported gasoline comes from farther away than 
domestic supply means that when supply disruptions occur in the United 
States it might take longer to get replacement gasoline than if we had 
spare refining capacity in the United States. This could mean that 
gasoline prices remain high until the imported supplies can reach the 
market.
---------------------------------------------------------------------------
    \4\ The ratio of input to capacity measures the rate of 
utilization.
[GRAPHIC] [TIFF OMITTED] 37461.006


    Further, gasoline inventories maintained by refiners or marketers 
of gasoline can also have an impact on prices. As have a number of 
other industries, the petroleum industry has adopted so-called ``just-
in-time'' delivery processes to reduce costs leading to a downward 
trend in the level of gasoline inventories in the United States. For 
example, in the early 1980s U.S. oil companies held stocks of gasoline 
of about 40 days of average U.S. consumption, while in 2006 these 
stocks had decreased to 23 days of consumption. While lower costs of 
holding inventories may reduce gasoline prices, lower levels of 
inventories may also cause prices to be more volatile because when a 
supply disruption occurs, there are fewer stocks of readily available 
gasoline to draw from, putting upward pressure on prices.
    Regulatory factors play a role as well. For example, in order to 
meet national air quality standards under the Clean Air Act, as 
amended, many states have adopted the use of special gasoline blends--
so-called ``boutique fuels.'' As we reported in a recent study, there 
is a general consensus that higher costs associated with supplying 
special gasoline blends contribute to higher gasoline prices, either 
because of more frequent or more severe supply disruptions, or because 
higher costs are likely passed on, at least in part, to consumers. 
Furthermore, changes in regulatory standards generally make it 
difficult for firms to arbitrage across markets because gasoline 
produced according to one set of specifications may not meet another 
area's specifications.
    Finally, market consolidation in the U.S. petroleum industry 
through mergers can influence the prices of gasoline. Mergers raise 
concerns about potential anticompetitive effects because mergers could 
result in greater market power for the merged companies, either through 
unilateral actions of the merged companies or coordinated interaction 
with other companies, potentially allowing them to increase and 
maintain prices above competitive levels.\5\ On the other hand, mergers 
could also yield cost savings and efficiency gains, which could be 
passed on to consumers through lower prices. Ultimately, the impact 
depends on whether the market power or the efficiency effects dominate.
---------------------------------------------------------------------------
    \5\ Federal Trade Commission and Department of Justice have defined 
market power for a seller as the ability profitably to maintain prices 
above competitive levels for a significant period of time.
---------------------------------------------------------------------------
 mergers in the 1990s increased market concentration and led to small 
  but significant increases in wholesale gasoline prices; however the 
                impact of more recent mergers is unknown
    During the 1990s, the U.S. petroleum industry experienced a wave of 
mergers, acquisitions, and joint ventures, several of them between 
large oil companies that had previously competed with each other for 
the sale of petroleum products.\6\ More than 2,600 merger transactions 
occurred from 1991 to 2000 involving all segments of the U.S. petroleum 
industry. These mergers contributed to increases in market 
concentration in the refining and marketing segments of the U.S. 
petroleum industry. Econometric modeling we performed of eight mergers 
involving major integrated oil companies that occurred in the 1990s 
showed that the majority resulted in small but significant increases in 
wholesale gasoline prices. The effects of some of the mergers were 
inconclusive, especially for boutique fuels sold in the East Coast and 
Gulf Coast regions and in California. While we have not performed 
modeling on mergers that occurred since 2000, and thus cannot comment 
on any potential effect on wholesale gasoline prices at this time, 
these mergers would further increase market concentration nationwide 
since there are now fewer oil companies.
---------------------------------------------------------------------------
    \6\ We refer to all of these transactions as mergers.
---------------------------------------------------------------------------
    Some of the mergers involved large partially or fully vertically 
integrated companies that previously competed with each other. For 
example, as shown in figure 3, in 1998 British Petroleum (BP) and Amoco 
merged to form BPAmoco, which later merged with ARCO, and in 1999 
Exxon, the largest U.S. oil company merged with Mobil, the second 
largest. Since 2000, we found that at least 8 large mergers have 
occurred. Some of these mergers have involved major integrated oil 
companies, such as the Chevron-Texaco merger, announced in 2000, to 
form ChevronTexaco, which went on to acquire Unocal in 2005. In 
addition, Phillips and Tosco announced a merger in 2001 and the 
resulting company, Phillips, then merged with Conoco to become 
ConocoPhillips. To illustrate the extent of consolidations in the U.S. 
oil industry, figure 3 shows that there were 12 integrated and 9 non-
integrated oil companies, but these companies have dwindled to only 8.

[GRAPHIC] [TIFF OMITTED] 37461.007

    \7\ See footnotes a-e.
---------------------------------------------------------------------------
    \7\ a. Marathon and Ashland formed a joint venture called Marathon 
Ashland Petroleum that was primarily owned by Marathon Oil (62 
percent), which was a wholly owned affiliate of USX Corporation at the 
time the joint venture was created. Ashland sold its 38 percent 
ownership of the joint venture to Marathon on June 30, 2005.
    b. Equilon Enterprises was a 56/44 venture between Shell Oil and 
Texaco, respectively, that sold motor gasoline and petroleum products 
under both the Shell Texaco brand names. Although not depicted in the 
graphic, Motiva Enterprises was a joint venture between Star Enterprise 
and Shell Oil that sold gasoline and petroleum products under both the 
Shell and Texaco brand names. Motiva is now a 50/50 joint venture 
between Saudi Refining and Shell Oil after Texaco sold its ownership to 
its partners as a precondition of the U.S. Federal Trade Commission 
approving the merger of Chevron and Texaco.
    c. El Paso Corporation sold its 16,700-barrels-per-day Chickasaw, 
Alabama refinery to Trigeant EP Ltd, in August 2003. El Paso's 
remaining refineries were sold to publicly traded companies at the 
times indicated (Sun Company on 01/04 and Valero on 03/04).
    d. Clark Refining divested its marketing operations (including the 
``Clark'' brandname) and renamed itself Premcor in July 1999.
    e. Williams Companies sold its Memphis, Tennessee 180,000-barrels-
per-day refinery to Premcor in March 2003.
---------------------------------------------------------------------------
    Independent oil companies have also been involved in mergers. For 
example, Devon Energy and Ocean Energy, two independent oil producers, 
announced a merger in 2003 to become the largest independent oil and 
gas producer in the United States at that time. Petroleum industry 
officials and experts we contacted cited several reasons for the 
industry's wave of mergers since the 1990s, including increasing 
growth, diversifying assets, and reducing costs. Economic literature 
indicates that enhancing market power is also sometimes a motive for 
mergers, which could reduce competition and lead to higher prices. 
Ultimately, these reasons mostly relate to companies' desire to 
maximize profits or stock values.
    Proposed mergers in all industries are generally reviewed by 
Federal antitrust authorities--including the Federal Trade Commission 
(FTC) and the Department of Justice (DOJ)--to assess the potential 
impact on market competition and consumer prices. According to FTC 
officials, FTC generally reviews proposed mergers involving the 
petroleum industry because of the agency's expertise in that industry. 
To help determine the potential effect of a merger on market 
competition, FTC evaluates, among other factors, how the merger would 
change the level of market concentration. Conceptually, when market 
concentration is higher, the market is less competitive and it is more 
likely that firms can exert control over prices.
    DOJ and FTC have jointly issued guidelines to measure market 
concentration. The scale is divided into three separate categories: 
unconcentrated, moderately concentrated, and highly concentrated. The 
index of market concentration in refining increased all over the 
country during the 1990s, and changed from moderately to highly 
concentrated on the East Coast. In wholesale gasoline markets, market 
concentration increased throughout the United States between 1994 and 
2002. Specifically, 46 states and the District of Columbia had 
moderately or highly concentrated markets by 2002, compared to 27 in 
1994.
    Evidence from various sources indicates that, in addition to 
increasing market concentration, mergers also contributed to changes in 
other aspects of market structure in the U.S. petroleum industry that 
affect competition--specifically, vertical integration and barriers to 
entry. However, we could not quantify the extent of these changes 
because of a lack of relevant data and lack of consensus on how to 
appropriately measure them.
    Vertical integration can conceptually have both pro- and 
anticompetitive effects. Based on anecdotal evidence and economic 
analyses by some industry experts, we determined that a number of 
mergers that have occurred since the 1990s have led to greater vertical 
integration in the U.S. petroleum industry, especially in the refining 
and marketing segment. For example, we identified eight mergers that 
occurred between 1995 and 2001 that might have enhanced the degree of 
vertical integration, particularly in the downstream segment. 
Furthermore, mergers involving integrated companies are likely to 
result in increased vertical integration because FTC review, which is 
based on horizontal merger guidelines, does not focus on vertical 
integration.
    Concerning barriers to entry, our interviews with petroleum 
industry officials and experts at the time we did our study provided 
evidence that mergers had some impact on the U.S. petroleum industry. 
Barriers to entry could have implications for market competition 
because companies that operate in concentrated industries with high 
barriers to entry are more likely to possess market power. Industry 
officials pointed out that large capital requirements and environmental 
regulations constitute barriers for potential new entrants into the 
U.S. refining business. For example, the officials indicated that a 
typical refinery could cost billions of dollars to build and that it 
may be difficult to obtain the necessary permits from the relevant 
state or local authorities. Furthermore, the FTC has recently indicated 
that barriers to entry in the form of high sunk costs and environmental 
regulations have become more formidable since the 1980s, as refineries 
have become more capital-intensive and the regulations more 
restrictive. According to FTC, no new refinery still in operation has 
been built in the U.S. since 1976.
    To estimate the effect of mergers on wholesale gasoline prices, we 
performed econometric modeling on eight mergers that occurred during 
the 1990s: Ultramar Diamond Shamrock (UDS)-Total, Tosco-Unocal, 
Marathon-Ashland, Shell-Texaco I (Equilon), Shell-Texaco II (Motiva), 
BP-Amoco, Exxon-Mobil, and Marathon Ashland Petroleum (MAP)-UDS.
     For the seven mergers that we modeled for conventional gasoline, 
five led to increased prices, especially the MAP-UDS and Exxon-Mobil 
mergers, where the increases generally exceeded 2 cents per gallon, on 
average.
     For the four mergers that we modeled for reformulated gasoline, 
two--Exxon-Mobil and Marathon-Ashland--led to increased prices of about 
1 cent per gallon, on average. In contrast, the Shell-Texaco II 
(Motiva) merger led to price decreases of less than one-half cent per 
gallon, on average, for branded gasoline only.\8\
---------------------------------------------------------------------------
    \8\ Unbranded (generic) gasoline is generally priced lower than 
branded gasoline, which is marketed under the refiner's trademark.
---------------------------------------------------------------------------
     For the two mergers--Tosco-Unocal and Shell-Texaco I (Equilon)--
that we modeled for gasoline used in California, known as California 
Air Resources Board (CARB) gasoline, only the Tosco-Unocal merger led 
to price increases. The increases were for branded gasoline only and 
were about 7 cents per gallon, on average.
    Our analysis shows that wholesale gasoline prices were also 
affected by other factors included in the econometric models, including 
gasoline inventories relative to demand, supply disruptions in some 
parts of the Midwest and the West Coast, and refinery capacity 
utilization rates.
                        concluding observations
    Our past work has shown that, the price of crude oil is a major 
determinant of gasoline prices along with changes in demand for 
gasoline. Limited refinery capacity and the lack of spare capacity due 
to high refinery capacity utilization rates, decreasing gasoline 
inventory levels and the high cost and changes in regulatory standards 
also play important roles. In addition, merger activity can influence 
gasoline prices. During the 1990s, mergers decreased the number of oil 
companies and refiners and our findings suggest that these changes in 
the state of competition in the industry caused wholesale prices to 
rise. The impact of more recent mergers is unknown. While we have not 
performed modeling on mergers that occurred since 2000, and thus cannot 
comment on any potential effect on wholesale gasoline prices at this 
time, these mergers would further increase market concentration 
nationwide since there are now fewer oil companies.
    We are currently in the process of studying the effects of the 
mergers that have occurred since 2000 on gasoline prices as a follow up 
to our previous report on mergers in the 1990s. Also, we are working on 
a separate study on issues related to petroleum inventories, refining, 
and fuel prices. With these and other related work, we will continue to 
provide Congress the information needed to make informed decisions on 
gasoline prices that will have far-reaching effects on our economy and 
our way of life.
    Our analysis of mergers during the 1990s differs from the approach 
taken by the FTC in reviewing potential mergers because our analysis 
was retrospective in nature--looking at actual prices and estimating 
the impacts of individual mergers on those prices--while FTC's review 
of mergers takes place necessarily before the mergers, which is 
prospective. Going forward, we believe that, in light of our findings, 
both prospective and retrospective analyses of the effects of mergers 
on gasoline prices are necessary to ensure that consumers are protected 
from anticompetitive forces. In addition, we welcome this hearing as an 
opportunity for continuing public scrutiny and discourse on this and 
the other issues that we have raised here today. We encourage future 
independent analysis by the FTC or other parties, and see value in 
oversight of the regulatory agencies in carrying out their 
responsibilities.
    Mr. Chairman, this completes my prepared statement. I would be 
happy to respond to any questions you or the other Members of the 
Committee may have at this time.
                               __________
  Prepared Statement of Dr. Michael A. Salinger, Director, Bureau of 
                  Economics, Federal Trade Commission

                    Petroleum Industry Consolidation

                            i. introduction
    Mr. Chairman and members of the Committee, I am Michael A. 
Salinger, Director of the Bureau of Economics of the Federal Trade 
Commission. I am pleased to appear before you to present the 
Commission's testimony on FTC initiatives to protect competitive 
markets in the production, distribution, and sale of gasoline through 
our vigilant and comprehensive merger program.\1\
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    \1\ This written statement represents the views of the Federal 
Trade Commission. My oral presentation and responses to questions are 
my own and do not necessarily represent the views of the Commission or 
any Commissioner.
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    The petroleum industry plays a crucial role in our economy. Indeed, 
few issues are more important to American consumers and businesses than 
the decisions being made about current and future energy production and 
use. Not only do changes in gasoline prices affect consumers directly, 
but the price and availability of gasoline also influence many other 
economic sectors. No other industry's performance is more deeply felt, 
and no other industry is more carefully scrutinized by the FTC. For 
example, just last month the Commission challenged a merger between 
Western Refining and Giant Industries because it believes the merger 
will lead to the reduced supply of bulk light petroleum products in 
Northern New Mexico.
    Although the FTC does not regulate energy market sectors, the 
agency plays a key role in maintaining competition and protecting 
consumers in energy markets. The Commission has been particularly 
vigilant regarding mergers in the oil industry that could harm 
competition. It examines any merger and any course of conduct in the 
industry that has the potential to decrease competition and thus harm 
consumers of gasoline and other petroleum products. A review released 
in January of this year of horizontal merger investigations and 
enforcement actions from fiscal year 1996 to fiscal year 2005 shows 
that the Commission has brought more merger cases at lower levels of 
market concentration in the petroleum industry than in any other 
industry.\2\ Unlike in other industries, the Commission has brought 
enforcement actions (and obtained merger relief in many cases) in 
petroleum markets that are only moderately concentrated.\3\
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    \2\ The Horizontal Merger Guidelines that serve as a guide to 
merger enforcement by the FTC and the Department of Justice categorize 
market concentration, as measured by the Herfindahl-Hirschman Index 
(``HHI''), into three concentration zones. (The HHI is computed by 
squaring each firm's market share and summing the squares.) A market 
with an HHI below 1,000 is considered ``unconcentrated.'' A market with 
an HHI between 1,000 and 1,800 is ``moderately concentrated,'' while a 
market with an HHI over 1,800 is classified as ``highly concentrated.'' 
The likelihood of enforcement agency interest in a merger or 
acquisition generally increases as HHI levels rise, although 
concentration levels are only a starting point for the searching 
analysis of potential competitive effects that is necessary to 
understand a transaction's potential effects. U.S. Dep't of Justice and 
Fed. Trade Comm'n, 1992 Horizontal Merger Guidelines (Section 4 on 
Efficiencies revised April 8, 1997), reprinted in 4 Trade Reg. Rep. 
(CCH) Paragraph 13,104 (``Merger Guidelines'').
    \3\ Federal Trade Commission Horizontal Merger Investigation Data, 
Fiscal Years 1996-2005 (Jan. 25, 2007), Table 3.1, et seq., available 
at http://www.ftc.gov/os/2007/01/
P035603horizmergerinvestigationdata1996-2005.pdf; FTC Horizontal Merger 
Investigations Post-Merger HHI and Change in HHI for Oil Markets, FY 
1996 through FY 2003 (May 27, 2004), available at http://www.ftc.gov/
opa/2004/05/040527petrolactionsHHIdeltachart.pdf.
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    Although we analyze each petroleum merger according to numerous 
market facts surrounding the transaction, an overall analysis of merger 
policy in the petroleum industry necessarily takes a longer and broader 
view. Over the past 20 years, the Commission's merger policy has been 
consistent across administrations. Applying sound principles of law and 
of economics, this policy has been designed and focused to prevent the 
accumulation and use of market power to the detriment of consumers.
    Over the past two decades, the petroleum industry has undergone a 
structural upheaval, punctuated by a burst of large mergers in the late 
1990s. A number of other industries also saw a large number of mergers 
in that time frame. Certain forces unique to producing and distributing 
petroleum products, however, have spurred the transformation of that 
industry. Technological, economic, and regulatory factors have led 
toward reliance on a smaller number of larger, more sophisticated 
refineries that can process different kinds of crude oil more 
efficiently. The development of crude oil spot and futures markets has 
reduced the risks of acquiring crude oil through market transactions--
as opposed to owning crude oil extraction and production assets--thus 
contributing to a decline in vertical integration between crude oil 
production and refining among the major oil companies. A number of 
major integrated firms have restructured to concentrate on one or more 
segments of the industry, and a number of unintegrated refiners or 
retailers have entered. Domestic crude oil production has fallen, and 
foreign sources have supplied an increasing share of the crude oil 
refined in the United States, thus enhancing the importance of 
competition in the world market for crude oil. That competition has 
intensified over the last decade with the dramatic increase in crude 
oil demand from newly industrializing countries.
           ii. the ftc's expertise in the petroleum industry
    Since the early 1980s, the FTC has been the Federal antitrust 
agency primarily responsible for addressing petroleum industry 
competition issues. The Commission has closely scrutinized prices and 
examined any merger and nonmerger activity in the gasoline industry 
that had the potential to decrease competition and thus harm consumers. 
The Commission and its staff have developed expertise in the industry 
through years of investigation and research, pursuant to our primary 
function as a law enforcement agency tasked with preventing ``unfair 
methods of competition,'' \4\ as well as mergers or acquisitions whose 
effect ``may be substantially to lessen competition, or tend to create 
a monopoly.'' \5\ Under Section 5 of the FTC Act and Section 7 of the 
Clayton Act, the agency has carefully examined proposed mergers and has 
blocked or required revisions\6\ of any that have threatened to harm 
consumers by reducing competition.
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    \4\ Section 5 of the Federal Trade Commission Act, 15 U.S.C.  45.
    \5\ Section 7 of the Clayton Act, 15 U.S.C.  18.
    \6\ FTC enforcement action has played an important role in the 
restructuring of the petroleum industry over the past 20 years. The 
Commission has not challenged mergers when the overall transaction was 
efficient and procompetitive but has required divestitures to remedy 
the anticompetitive effects that might have arisen in particular 
relevant markets. These FTC orders permitted the merging firms to 
achieve the economic benefits of the transaction while curing the 
potential anticompetitive effects through divestiture to a third party.
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    The FTC has challenged, or obtained modifications of, numerous 
other mergers and acquisitions. Indeed, statistics on FTC merger 
enforcement in the petroleum industry show that, from 1981 to 2007, the 
agency filed complaints against 21 petroleum mergers. In 13 of these 
cases, the FTC obtained significant divestitures.\7\ Of the eight other 
matters, the parties in four cases abandoned the transactions 
altogether after agency antitrust challenges; one case resulted in a 
remedy requiring the acquiring firm to provide the Commission with 
advance notice of its intent to acquire or merge with another entity; 
another case (Aloha/Trustreet) was resolved with the announcement of a 
throughput agreement to preserve competition;\8\ yet another case 
(Chevron/Unocal) was resolved with the parties' agreement not to 
enforce certain patents on California's CARB gasoline; and the order in 
a final case (Carlyle/Riverstone) required certain ownership interests 
to be made passive and prohibited exchanges of competitively sensitive 
information.
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    \7\ See, e.g., Chevron Corp., FTC Docket No. C-4023 (Jan. 2, 2002) 
(consent order), at http://www.ftc.gov/os/2002/01/chevronorder.pdf; 
Valero Energy Corp., FTC Docket No. C-4031 (Feb. 19, 2002) (consent 
order), at http://www.ftc.gov/os/2002/02/valerodo.pdf; Conoco Inc. and 
Phillips Petroleum Corp., FTC Docket No. C-4058 (Aug. 30, 2002) 
(Analysis of Proposed Consent Order to Aid Public Comment), at http://
www.ftc.gov/os/2002/08/conocophillipsan.htm. Not all oil industry 
merger activity raises competitive concerns, however. In 2003, the 
Commission closed its investigation of Sunoco's acquisition of the 
Coastal Eagle Point refinery in the Philadelphia area without requiring 
relief. The Commission noted that the acquisition would have no 
anticompetitive effects and seemed likely to yield substantial 
efficiencies that would benefit consumers. Sunoco Inc./Coastal Eagle 
Point Oil Co., FTC File No. 031 0139 (Dec. 29, 2003) (Statement of the 
Commission), at http://www.ftc.gov/os/caselist/0310139/
031229stmt0310139.pdf. The FTC also considered the likely competitive 
effects of Phillips Petroleum's proposed acquisition of Tosco. After 
careful scrutiny, the Commission declined to challenge the acquisition. 
A statement issued in connection with the closing of the investigation 
set forth the FTC's reasoning in detail. Phillips Petroleum Corp., FTC 
File No. 011 0095 (Sept. 17, 2001) (Statement of the Commission), at 
http://www.ftc.gov/os/2001/09/phillipstoscostmt.htm.
    \8\ BUREAU OF ECONOMICS, FEDERAL TRADE COMMISSION, THE PETROLEUM 
INDUSTRY: MERGERS, STRUCTURAL CHANGE, AND ANTITRUST ENFORCEMENT (2004), 
available at http://www.ftc.gov/os/2004/08/
040813mergersinpetrolberpt.pdf.
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    In 2004, the FTC staff also published a study reviewing the 
petroleum industry's mergers and structural changes as well as the 
antitrust enforcement actions that the agency has taken in the industry 
over the past 20 years.\9\ This was the Commission's third such report 
since 1982.\10\ Like its predecessors, the 2004 report had two basic 
goals: to inform public policy concerning competition in the petroleum 
industry, and to make more transparent how the Commission analyzes 
mergers and other competitive phenomena in this sector.
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    \9\ BUREAU OF ECONOMICS, FEDERAL TRADE COMMISSION, THE PETROLEUM 
INDUSTRY: MERGERS, STRUCTURAL CHANGE, AND ANTITRUST ENFORCEMENT (2004), 
available at http://www.ftc.gov/os/2004/08/
040813mergersinpetrolberpt.pdf.
    \10\ See Federal Trade Commission, Mergers in the Petroleum 
Industry (Sept. 1982), available at http://www.ftc.gov/os/2004/08/
040813mergersinpetro182.pdf; Staff Report of the Bureau of Economics, 
Federal Trade Commission, Mergers in the U.S. Petroleum Industry 1971-
1984: An Updated Comparative Analysis (May 1989), available at http://
www.ftc.gov/os/2004/08/040813mergersinpetrol84.pdf.
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    Several themes emerged from the Commission's study of changes in 
the petroleum industry over the past two decades:

     Mergers of private oil companies have not significantly affected 
worldwide concentration in crude oil. This fact is important, because 
crude oil prices historically have been the chief determinant of 
gasoline prices.
     Despite some increases over time, concentration for most levels 
of the United States petroleum industry has remained low to moderate.
     Intensive, thorough FTC merger investigations and enforcement 
have helped prevent further increases in petroleum industry 
concentration and avoid potentially anticompetitive problems and higher 
prices for consumers.
     Economies of scale have become increasingly significant in 
shaping the petroleum industry. The United States has fewer refineries 
than it had 20 years ago, but the average size and efficiency of 
refineries have increased, along with the total output of refined 
products.
     Industry developments have lessened the incentive to vertically 
integrate throughout all or most levels of production, distribution, 
and marketing. Several significant refiners have no crude oil 
production, and integrated petroleum companies today tend to depend 
less on their own crude oil production. In addition, a number of 
independent retailers purchase refined products on the open market.
     Some significant independent refiners have built market share by 
acquiring refineries that were divested from integrated majors pursuant 
to FTC enforcement orders.\11\
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    \11\ In 2005, the Commission issued a report on the various factors 
that influence the price of gasoline and other refined petroleum 
products. See Federal Trade Commission, Gasoline Price Changes: The 
Dynamic of Supply, Demand, and Competition (2005), available at http://
www.ftc.gov/reports/gasprices05/050705gaspricesrpt.pdf. A key lesson of 
this report is that worldwide supply, demand, and competition for crude 
oil are the most important factors in the national average price of 
gasoline in the United States. Other important factors affecting retail 
gasoline prices include retail station density, new retail formats, 
environmental factors, state and local tax rates, and state and local 
regulations.
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           iii. merger enforcement in the petroleum industry
    The Commission has gained much of its antitrust enforcement 
experience in the petroleum industry by analyzing proposed mergers and 
challenging transactions that likely would reduce competition, thus 
resulting in higher prices. For more than 20 years, the FTC has been 
the Federal antitrust agency primarily responsible for reviewing 
conduct in the petroleum industry to assess whether it is likely to 
reduce competition and harm consumer welfare. In this role, the FTC has 
devoted substantial resources to investigating and studying the 
industry. For example, during the period of large oil industry mergers 
in the late 1990s, the Bureau of Competition spent almost one-fourth of 
its enforcement budget on investigations in energy industries.
    The Commission investigates every substantial petroleum industry 
merger. Many transactions, particularly smaller ones, raised no 
competitive concerns and required no enforcement intervention. A case-
by-case analysis is necessary to find the relevant markets in which 
competition might be lessened, to assess the likelihood and 
significance of possible competitive harm, and to fashion remedies to 
ensure that competition is not reduced in those relevant markets and 
consumers consequently are not harmed.\12\ It is important to note that 
mergers can be, and often are, efficiency-enhancing and procompetitive.
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    \12\ In May 2004, the Government Accountability Office released a 
report that purported to analyze how eight petroleum industry mergers 
or joint ventures carried out during the late 1990s affected gasoline 
prices. GAO, Energy Markets: Effects of Mergers and Market 
Concentration in the U.S. Petroleum Industry (May 2004). The Commission 
regards evaluations of past enforcement decisions as valuable elements 
of responsible antitrust policymaking, and is supportive of the goal of 
the GAO inquiry--to evaluate the consequences of past decisions by the 
Federal antitrust agencies. The Commission believes, however, that the 
GAO report suffered from a number of significant deficiencies. See 
Prepared Statement of the Federal Trade Commission Before the Committee 
on Energy and Commerce, Subcommittee on Energy and Air Quality, U.S. 
House of Representatives, Market Forces, Anticompetitive Activity and 
Gasoline Prices--FTC Initiatives to Protect Competitive Markets (July 
15, 2004), available at http://www.ftc.gov/os/2004/07/
040715gaspricetestimony.pdf.
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    The FTC's analysis of petroleum mergers follows the same Department 
of Justice/Federal Trade Commission Horizontal Merger Guidelines that 
the agencies use to analyze mergers in other industries. Although 
merger analysis begins with concentration data, the Commission analyzes 
qualitative factors--consistent with advances in economic learning and 
case law developments--that indicate whether a merger will increase the 
ability of the merging parties to exercise market power in one or more 
properly defined relevant markets\13\ by curbing output unilaterally or 
by coordinating their behavior with rival suppliers.
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    \13\ The correct definition of a market in merger review is a 
detailed, fact-intensive inquiry that involves both product and 
geographic components. We must ascertain for which product (or 
products) the transaction may harm competition, and we also must 
determine the geographic area over which any anticompetitive effects 
will be felt. In our analysis of petroleum mergers, national, state, or 
PADD-wide ``markets'' rarely correspond to properly defined geographic 
markets. (``PADD'' stands for ``Petroleum Administration for Defense 
District.'' PADD I consists of the East Coast. PADD II consists of the 
Midwest. PADD III includes the Gulf Coast. PADD IV consists of the 
Rocky Mountain region. PADD V is made up of the West Coast plus Alaska 
and Hawaii.)
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    Despite increases in concentration at some production levels over 
the last two decades, particularly since the mid-1990s, most sectors of 
the petroleum industry generally remain unconcentrated or moderately 
concentrated. In addition, the growth of independent marketers and 
hypermarkets has increased competition at the wholesale and retail 
levels in many areas.
    Some mergers have led to increased concentration. An increase in 
concentration from a merger, however, is not by itself a sufficient 
basis for finding that a merger is anticompetitive. Where concentration 
changes raise concerns about potential competitive harm, the FTC 
conducts a more detailed investigation. When it has concluded that a 
merger is likely to reduce competition, the FTC has required 
divestitures or sought preliminary injunctions. Many of the mergers the 
FTC challenged would have lessened competition significantly if they 
had proceeded as originally planned. Our antitrust remedies prevented 
those increases: through carefully crafted divestitures and other 
remedial provisions, the Commission has mandated the elimination of 
competitively problematic overlaps between the merging parties while 
allowing the competitively unobjectionable--or even efficiency-
enhancing--portion of a transaction to proceed.
    Collectively, mergers have raised competitive concerns at all of 
the various levels of the petroleum industry, but the majority of FTC 
actions have targeted downstream activities, i.e., refining, refined 
products pipelines, terminals, and marketing. The competitive concern 
generally has been that the merger would enable the merged firm to 
raise prices in a market for products that it sells to the next level 
of the industry (e.g., refined products sold to wholesalers, or 
wholesale products sold to retailers) through either unilateral or 
coordinated behavior. A key element in assessing the potential for 
adverse competitive effects is to determine the alternatives available 
to customers, including whether more distant suppliers are viable 
options. Some enforcement actions have been based on a potential 
competition theory; some on competitive problems involving market power 
held by a buyer or a group of buyers; and some on vertical concerns 
relating to the ability of a single firm or a coordinating group of 
firms to raise the costs of other firms in the industry, to the injury 
of consumers.
    Most recently, the Commission filed for a preliminary injunction in 
Federal court and issued an administrative complaint against a 
petroleum industry transaction--Western Refining's proposed acquisition 
of Giant Industries. On April 12, 2007, the Commission filed its 
complaint in the U.S. District Court for the District of New Mexico, 
alleging that the proposed acquisition would lead to reduced 
competition for the bulk supply of light petroleum products to northern 
New Mexico.\14\ In the complaint, as amended, we allege that Western 
and Giant are two of only a small number of firms capable of responding 
to higher prices or quantity decreases in the bulk supply of gasoline 
to northern New Mexico, and that Giant would have increased its supply 
of gasoline to that area absent its acquisition by Western.\15\ 
Following the district court's April 13, 2007, issuance of a temporary 
restraining order against consummation of the transaction, the trial of 
the preliminary injunction action took place last week, and the court 
is expected to rule soon on the Commission's request for an injunction. 
The FTC issued an administrative complaint against the merger on May 3, 
2007.\16\
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    \14\ Federal Trade Commission v. Paul L. Foster, Western Refining, 
Inc., and Giant Industries, Inc., Civil Action No. 07cv352 JH/ACT 
(D.N.M. Apr. 12, 2007), available at http://www.ftc.gov/os/caselist/
0610259/index.shtm.
    \15\ See http://www.ftc.gov/os/caselist/0610259/
070430weterngiantfirstamndcmplt.pdf.
    \16\ Two other recent FTC law enforcement actions also involve the 
energy sector, although not the petroleum industry. The Commission 
issued an administrative complaint on March 14, 2007, challenging 
Equitable Resources' proposed acquisition of The Peoples Natural Gas 
Company from Dominion Resources. According to the FTC's complaint, the 
acquisition would result in a monopoly in the distribution of natural 
gas to nonresidential customers in certain areas of Allegheny County, 
Pennsylvania, including Pittsburgh. See http://www.ftc.gov/os/adjpro/
d9322/0703admincmp.pdf. Following the Pennsylvania Public Utility 
Commission's approval of the merger, the FTC also filed an action in 
the Federal district court in Pittsburgh, seeking a preliminary 
injunction against the transaction. On May 14, 2007, the court granted 
defendants' motion to dismiss on state action grounds; the Commission 
has requested an injunction pending appeal.
    In addition, in November 2006, the FTC challenged EPCO's proposed 
$1.1 billion acquisition of TEPPCO's natural gas liquids storage 
businesses. The FTC approved a consent order that allowed the 
acquisition to be completed only if TEPPCO first divested its interests 
in the world's largest natural gas liquids storage facility in Mont 
Belvieu, Texas, to an FTC-approved buyer. EPCO, Inc., and TEPPCO 
Partners, L.P., FTC Docket No. C-4173 (Oct. 31, 2006) (consent order), 
available at http://www.ftc.gov/os/caselist/0510108/
0510108c4173do061103.pdf.
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    Also, on March 14, 2007, the FTC challenged the acquisition of 
energy transportation, storage, and distribution firm Kinder Morgan by 
Kinder Morgan management and a group of investment firms, including 
private equity funds managed and controlled by The Carlyle Group and 
Riverstone Holdings. Because the proposed transaction threatened 
competition between Kinder Morgan and Magellan Midstream--a major 
competitor of Kinder Morgan in terminalling and distributing gasoline 
and other light petroleum products in the southeastern United States--
the Commission ordered the parties in effect to turn Carlyle's and 
Riverstone's interest in Magellan Midstream into a passive 
investment.\17\
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    \17\ TC Group L.L.C., et al., FTC Docket No. C-4183 (Mar. 14, 2007) 
(consent order), available at http://www.ftc.gov/os/caselist/0610197/
index.shtm.
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    In November 2006, Chevron and USA Petroleum abandoned a transaction 
in which Chevron would have acquired most of the retail gasoline 
stations owned by USA Petroleum, the largest remaining chain of service 
stations in California not controlled by a refiner. USA Petroleum's 
president acknowledged that the parties abandoned the transaction 
because of resistance from the FTC.\18\
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    \18\ See Elizabeth Douglass, Chevron Ends Bid to Buy Stations, L.A. 
TIMES, Nov. 18, 2006, available at http://www.latimes.com/business/la-
fichevron18nov18,1,7256145.story?coll=la-headlines-
business&ctrack=l&cset=true.
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    The Commission filed a complaint on July 27, 2005, in Federal 
district court in Hawaii, alleging that Aloha Petroleum's proposed 
acquisition of Trustreet Properties' half interest in an import-capable 
terminal and retail gasoline assets on the island of Oahu would reduce 
the number of gasoline marketers from 5 to 4 and could lead to higher 
gasoline prices for Hawaii consumers.\19\ The case was resolved through 
the parties' execution of a 20-year throughput agreement that will 
preserve the competition that we believe was threatened by the 
acquisition.\20\
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    \19\ Aloha Petroleum Ltd., FTC File No. 051 0131 (July 27, 2005) 
(complaint), at http://www.ftc.gov/os/caselist/1510131/
050728comp1510131.pdf.
    \20\ FTC Press Release, FTC Resolves Aloha Petroleum Litigation 
(Sept. 6, 2005), available at http://www.ftc.gov/opa/2005/09/
alohapetrol.htm.
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    In June 2005, the FTC challenged the acquisition of Kaneb Services 
and Kaneb Pipe Line Partners--companies that engaged in petroleum 
transportation and terminalling in a number of markets--by Valero L.P., 
the largest petroleum terminal operator and second largest operator of 
liquid petroleum pipelines in the United States.\21\ The complaint 
alleged that the acquisition had the potential to increase prices in 
bulk gasoline and diesel markets.\22\ The FTC's consent order required 
the parties to divest assets sufficient to maintain premerger 
competition, including certain Kaneb Philadelphia-area terminals, 
Kaneb's West pipeline system in Colorado's Front Range, and Kaneb's 
Martinez and Richmond terminals in Northern California.\23\ In 
addition, the order forbids Valero L.P. from discriminating in favor of 
or otherwise preferring its Valero Energy affiliate in bulk ethanol 
terminalling services, and requires Valero to maintain customer 
confidentiality at the Selby and Stockton terminals in Northern 
California. The order succeeds in maintaining import possibilities for 
wholesale customers in Northern California, Denver, and greater 
Philadelphia and precludes the merging parties from undertaking an 
anticompetitive price increase.
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    \21\ Valero L.P., FTC Docket No. C-4141 (June 14, 2005) 
(complaint), at http://www.ftc.gov/os/caselist/0510022/
050615comp0510022.pdf.
    \22\ Id.
    \23\ Valero L.P., FTC Docket No. C-4141 (July 22, 2005) (consent 
order), at http://www.ftc.gov/os/caselist/0510022/050726do0510022.pdf.
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    In the past few years, the Commission has brought a number of other 
important merger cases. One of these challenged the merger of Chevron 
and Texaco,\24\ which combined assets located throughout the United 
States. Following an investigation in which 12 states participated, the 
Commission issued a consent order against the merging parties requiring 
numerous divestitures to maintain competition in particular relevant 
markets, primarily in the western and southern United States.
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    \24\ Chevron Corp., FTC Docket No. C-4023 (Jan. 2, 2002) (consent 
order), at http://www.ftc.gov/os/2002/01/chevronorder.pdf.
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    Another petroleum industry transaction that the Commission 
challenged successfully was the $6 billion merger between Valero Energy 
Corp. (``Valero'') and Ultramar Diamond Shamrock Corp. 
(``Ultramar'').\25\ Both Valero and Ultramar were leading refiners and 
marketers of gasoline that met the specifications of the California Air 
Resources Board (``CARB''), and they were the only significant 
suppliers to independent stations in California. The Commission's 
complaint alleged competitive concerns in both the refining and the 
bulk supply of CARB gasoline in two separate geographic markets--
Northern California and the entire state of California--and the 
Commission contended that the merger could raise the cost to California 
consumers by at least $150 million annually for every 1-cent-per-gallon 
price increase at retail.\26\ To remedy the alleged violations, the 
consent order settling the case required Valero to divest (1) an 
Ultramar refinery in Avon, California; (2) all bulk gasoline supply 
contracts associated with that refinery; and (3) 70 Ultramar retail 
stations in Northern California.\27\
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    \25\ Valero Energy Corp., FTC Docket No. C-4031 (Feb. 19, 2002) 
(consent order), at http://www.ftc.gov/os/2002/02/valerodo.pdf.
    \26\ Valero Energy Corp., FTC Docket No. C-4031 (Dec. 18, 2001) 
(complaint), at http://www.ftc.gov/os/2001/12/valerocmp.pdf.
    \27\ Valero Energy Corp., supra note 25.
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    An additional example is the Commission's 2002 challenge to the 
merger of Phillips Petroleum Company and Conoco Inc., alleging that the 
transaction would harm competition in the Midwest and Rocky Mountain 
regions of the United States. To resolve that challenge, the Commission 
required the divestiture of (1) the Phillips refinery in Woods Cross, 
Utah, and all of the Phillips-related marketing assets served by that 
refinery; (2) Conoco's refinery in Commerce City, Colorado (near 
Denver), and all of the Phillips marketing assets in Eastern Colorado; 
and (3) the Phillips light petroleum products terminal in Spokane, 
Washington.\28\ The Commission's order ensured that competition would 
not be lost and that gasoline prices would not increase as a result of 
the merger.
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    \28\ Conoco Inc. and Phillips Petroleum Corp., FTC Docket No. C-
4058 (Aug. 30, 2002) (Analysis of Proposed Consent Order to Aid Public 
Comment), at http://www.ftc.gov/os/2002/08/conocophillipsan.htm. Not 
all oil industry merger activity raises competitive concerns. For 
example, in 2003, the Commission closed its investigation of Sunoco's 
acquisition of the Coastal Eagle Point refinery in the Philadelphia 
area without requiring relief. The Commission noted that the 
acquisition would have no anticompetitive effects and seemed likely to 
yield substantial efficiencies that would benefit consumers. Sunoco 
Inc./Coastal Eagle Point Oil Co., FTC File No. 031 0139 (Dec. 29, 2003) 
(Statement of the Commission), at http://www.ftc.gov/os/caselist/
0310139/031229stmt0310139.pdf. The FTC also considered the likely 
competitive effects of Phillips Petroleum's proposed acquisition of 
Tosco. After careful scrutiny, the Commission declined to challenge the 
acquisition. A statement issued in connection with the closing of the 
investigation set forth the FTC's reasoning in detail. Phillips 
Petroleum Corp., FTC File No. 011 0095 (Sept. 17, 2001) (Statement of 
the Commission), at http://www.ftc.gov/os/2001/09/
phillipstoscostmt.htm.
    Acquisitions of firms operating mainly in oil or natural gas 
exploration and production are unlikely to raise antitrust concerns, 
because that segment of the industry is generally unconcentrated. 
Acquisitions involving firms with de minimis market shares, or with 
production capacity or operations that do not overlap geographically, 
also are unlikely to raise antitrust concerns.
---------------------------------------------------------------------------
    To sum up structural changes and merger enforcement policy in the 
last two decades, mergers have contributed to the restructuring of the 
petroleum industry but have had only a limited impact on industry 
concentration. The FTC has investigated all major petroleum mergers and 
required relief when it had reason to believe that a merger was likely 
to lead to competitive harm. The FTC has required divestitures in 
moderately concentrated markets as well as in highly concentrated 
markets.
           iv. other ftc activities in the petroleum industry
    In addition, beyond investigating mergers and acquisitions, the FTC 
also is very active in other antitrust enforcement work in this 
industry. For example, in a program unique to the petroleum industry, 
the Commission actively and continuously monitors retail and wholesale 
prices of gasoline and diesel fuel.\29\ FTC staff monitors gasoline and 
diesel prices to identify ``unusual'' price movements\30\ and then 
examines whether any such movements might result from anticompetitive 
conduct that violates Section 5 of the FTC Act. FTC economists 
developed a statistical model for identifying such movements. The 
agency's economists regularly scrutinize price movements in 20 
wholesale regions and approximately 360 retail areas across the 
country. In no other industry does the Commission so closely monitor 
prices.
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    \29\ See FTC, Oil and Gas Industry Initiatives, at http://
www.ftc.gov/ftc/oilgas/index.html.
    \30\ An ``unusual'' price movement in a given area is a price that 
is significantly out of line with the historical relationship between 
the price of gasoline in that area and the gasoline prices prevailing 
in other areas.
---------------------------------------------------------------------------
    The staff reviews daily data from the Oil Price Information 
Service, a private data collection agency, and receives information 
weekly from the public gasoline price hotline maintained by the U.S. 
Department of Energy (``DOE''). The staff monitoring team uses an 
econometric model to determine whether current retail and wholesale 
prices are anomalous in comparison to the historical price 
relationships among cities. When there are unusual changes in gasoline 
or diesel prices, the project alerts the staff to those anomalies so 
that we can make further inquiries into the situation.
    This gasoline and diesel monitoring and investigation initiative, 
which focuses on the timely identification of unusual movements in 
prices (compared to historical trends), is one of the tools that the 
FTC uses to determine whether a law enforcement investigation is 
warranted. If the FTC staff detects unusual price movements in an area, 
it researches the possible causes, including, where appropriate, 
through consultation with the state attorneys general, state energy 
agencies, and the EIA. In addition to monitoring DOE's gasoline price 
hotline complaints and the OPIS data, this project includes scrutiny of 
gasoline price complaints received by the Commission's Consumer 
Response Center and of any similar information provided to the FTC by 
state and local officials. If the staff concludes that an unusual price 
movement likely results from a business-related cause (i.e., a cause 
unrelated to anticompetitive conduct), it continues to monitor but--
absent indications of potentially anticompetitive conduct--it does not 
investigate further.\31\ The Commission's experience from its past 
investigations and from the current monitoring program indicates that 
unusual movements in gasoline prices typically have a business-related 
cause. FTC staff further investigates unusual price movements that do 
not appear to be explained by business-related causes to determine 
whether anticompetitive conduct may underlie the pricing anomaly.\32\ 
Cooperation with state law enforcement officials is an important 
element of such investigations.
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    \31\ Business-related causes include movements in crude oil prices, 
supply outages (e.g., from refinery fires or pipeline disruptions), or 
changes in and/or transitions to new fuel requirements imposed by air 
quality standards.
    \32\ For example, following up on observations of anomalous pricing 
patterns affecting multiple cities over the past year, staff currently 
is examining bulk supply and demand conditions and practices for 
gasoline and diesel in the Pacific Northwest.
---------------------------------------------------------------------------
    In addition to its law enforcement investigations and its price 
monitoring project, the Commission spends significant resources 
examining and analyzing issues of importance to consumers in the 
petroleum industry. An important recent development in this regard was 
the public conference on ``Energy Markets in the 21st Century: 
Competition Policy in Perspective'' that the FTC hosted for 3 days last 
month. The conference brought together leading experts from the 
government, industries in the energy sector, consumer groups, and 
academia to exchange information and ideas about critical issues 
related to energy development, transportation, marketing, and use. 
Speakers at the conference addressed such topics as ``Savvy Consumers 
in the Energy Marketplace,'' ``New Frontiers of Energy,'' ``The Current 
Implications of the World Energy Situation for United States Energy 
Supplies,'' and ``How Do Energy Markets Work Within the Framework of 
Government Policy Choices?'' The conference website contains numerous 
presentations by the panelists and a number of informative background 
papers.\33\ The Commission expects to release a written report 
presenting findings from the conference.
---------------------------------------------------------------------------
    \33\ See http://www.ftc.gov/bcp/workshops/energymarkets/
index.shtml.
---------------------------------------------------------------------------
    In May 2006, the Commission completed an extensive, 
Congressionally-mandated investigation\34\ to determine whether 
gasoline prices were being affected by manipulation\35\ and to 
determine whether ``price gouging'' occurred following Hurricane 
Katrina.\36\ The investigation included the full-time commitment of a 
significant number of attorneys, economists, financial analysts, and 
other personnel with specialized expertise in the petroleum industry. 
Based on our knowledge and expertise from previous investigations and 
studies, and the concerns raised by knowledgeable observers and market 
participants about competition in this industry, the Commission and its 
staff focused substantially on levels of the industry and parts of the 
country where problematic behavior was most likely to have occurred and 
to have had an effect on consumers.\37\
---------------------------------------------------------------------------
    \34\ FEDERAL TRADE COMMISSION, INVESTIGATION OF GASOLINE PRICE 
MANIPULATION AND POST-KATRINA GASOLINE PRICE INCREASES (Spring 2006), 
available at http://www.ftc.gov/reports/
060518PublicGasolinePricesInvestigationReportFinal.pdf.
    \35\ ``Price manipulation'' is not a defined legal or economic 
term. As used in the Commission's report, the term ``price 
manipulation'' included (1) all transactions and practices that are 
prohibited by the antitrust laws (including the Federal Trade 
Commission Act) and (2) all other transactions and practices, 
irrespective of their legality under the antitrust laws, that tend to 
increase prices relative to costs and to reduce output.
    \36\ No Federal statute identifies a legal violation of ``price 
gouging,'' and state laws prohibiting price gouging have not adopted a 
common definition or standard to describe the practice. The statute 
mandating the post-Katrina pricing investigation effectively defined 
price gouging, for purposes of the investigation, as an average price 
of gasoline available for sale to the public following the hurricane 
that exceeded its average price in the area for the month before the 
hurricane, unless the increase was substantially attributable to 
additional costs in connection with the production, transportation, 
delivery, and sale of gasoline in that area or to national or 
international market trends. Accordingly, for the report we analyzed 
whether specific post-Katrina price increases were attributable either 
to increased costs or to national or international trends.
    \37\ The FTC undertook another major nonmerger investigation during 
1998-2001, examining the major oil refiners' marketing and distribution 
practices in Arizona, California, Nevada, Oregon, and Washington (the 
``Western States'' investigation). FTC Press Release, FTC Closes 
Western States Gasoline Investigation (May 7, 2001), available at 
http://www.ftc.gov/opa/2001/05/westerngas.htm. The agency initiated the 
Western States investigation out of concern that differences in 
gasoline prices in Los Angeles, San Francisco, and San Diego might be 
due partly to anticompetitive activities. The investigation uncovered 
no basis to allege an antitrust violation, and the Commission closed 
the investigation in May 2001.
    In addition, the Commission conducted a 9-month investigation into 
the causes of gasoline price spikes in local markets in the Midwest in 
the spring and early summer of 2000. As explained in a 2001 report, the 
Commission found that a variety of factors contributed in different 
degrees to the price spikes. Midwest Gasoline Price Investigation, 
Final Report of the Federal Trade Commission (Mar. 29, 2001), available 
at http://www.ftc.gov/os/2001/03/mwgasrpt.htm; see also Remarks of 
Jeremy Bulow, Director, Bureau of Economics, Federal Trade Commission, 
The Midwest Gasoline Investigation, available at http://www.ftc.gov/
speeches/other/midwestgas.htm. Primary factors included refinery 
production problems (e.g., refinery breakdowns and unexpected 
difficulties in producing the new summer-grade RFG gasoline required 
for use in Chicago and Milwaukee), pipeline disruptions, and low 
inventories. Secondary factors included high crude oil prices that 
contributed to low inventory levels, the unavailability of substitutes 
for certain environmentally required gasoline formulations, increased 
demand for gasoline in the Midwest, and ad valorem taxes in certain 
states. The industry responded quickly to the price spike. Within 3 or 
4 weeks, an increased supply of product had been delivered to the 
Midwest areas suffering from the supply disruption. By mid-July 2000, 
prices had receded to pre-spike or even lower levels.
---------------------------------------------------------------------------
    The Commission's investigation did not uncover any evidence of 
manipulation to increase prices aside from limited instances of price 
gouging as defined by the statute mandating the post-Katrina pricing 
investigation.\38\ Evidence indicated that the price of crude oil, the 
largest cost component of gasoline, contributed to most of the gasoline 
price increases that occurred from early 2002 until just before 
Hurricane Katrina struck the United States. Higher refining margins 
caused some of the remaining increase.\39\
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    \38\ But see Concurring Statement of Commissioner Jon Leibowitz 
(concluding that the behavior of many market participants leaves much 
to be desired and that price gouging statutes, which almost invariably 
require a declared state of emergency or other triggering event, may 
serve a salutary purpose of discouraging profiteering in the aftermath 
of a disaster), available at http://www.ftc.gov/speeches/leibowitz/
060518LeibowitzStatementReGasolinelnvestigation.pdf.
    \39\ Margins in any competitive market can be expected to increase, 
at least in the short run, during periods of strong demand.
---------------------------------------------------------------------------
    The Commission analyzed various aspects of refinery operations to 
determine whether refiners manipulated, or tried to manipulate, 
gasoline prices. Staff investigated whether refiners manipulate prices 
in the short run by operating their refineries below full productive 
capacity in order to restrict supply, by altering their product output 
to produce less gasoline, or by diverting gasoline from markets in the 
United States to less lucrative foreign markets. Staff also 
investigated allegations that companies refused to invest sufficiently 
in new refineries for the purpose of tightening supply and raising 
prices in the long run. Staff found no evidence to suggest that 
refiners manipulated prices through any of these means. Instead, the 
evidence indicated that refiners responded to market prices by trying 
to produce as much higher-valued products as possible, taking into 
account crude oil costs and physical characteristics. The evidence also 
indicated that refiners did not reject profitable capacity expansion 
opportunities in order to raise prices.
    The Commission also examined the extent to which infrastructure 
constraints gave pipelines the ability or incentive to manipulate 
gasoline prices, or limited the ability of marketers to move additional 
supply to specific markets when an unexpected need arose. The evidence 
obtained during that investigation did not suggest that pipeline 
companies made rate or expansion decisions to manipulate gasoline 
prices. Similarly, the Commission found no evidence suggesting 
anticompetitive activity involving refined product terminals.
    Inventory levels have declined since at least the early 1980s, 
covering periods when the real price of gasoline was declining and 
increasing. The investigation, however, did not produce evidence that 
oil companies reduced inventory in order to manipulate prices or 
exacerbate the effects of price spikes due to supply disruptions. 
Maintaining inventories is costly, both in terms of the value of assets 
held and in terms of the actual costs of storing the product. The 
decline in inventory levels reflects a trend that is not limited to the 
petroleum industry. As in many other major industries, lower inventory 
holdings likely allowed oil companies to free up capital to invest in 
other areas and save storage costs. Low inventories, however, provide 
little cushion for gasoline supplies when there is an unexpected 
disruption.
    Hurricanes Katrina and Rita caused substantial damage to the 
Nation's petroleum infrastructure. In the week after Hurricane 
Katrina--which caused the immediate loss of 27 percent of the Nation's 
crude oil production and 13 percent of national refining capacity--the 
average price of gasoline increased by about 50 cents per gallon in six 
representative cities. About 35 cents per gallon of the post-Katrina 
price increase dissipated by the time Hurricane Rita hit. Rita damaged 
another 8 percent of crude production and, even accounting for the 
refineries affected by Katrina and back online, 14 percent of domestic 
refining capacity was lost.
    In light of the amount of crude oil production and refining 
capacity knocked out by Katrina and Rita, the sizes of the post-
hurricane price increases were approximately what would be predicted by 
the standard supply and demand paradigm that presumes a market is 
performing competitively. Thus the regions of the country that 
experienced the largest price increases were those that normally 
receive supply from areas affected by the hurricanes.
    Evidence gathered during our investigation indicated that the 
conduct of firms in response to the supply shocks caused by the 
hurricanes was consistent with competition. After both hurricanes, 
companies with unaffected assets increased output and diverted supplies 
to high-priced areas. This is what we would expect in competitive 
markets and what the affected consumers needed. Refiners deferred 
scheduled maintenance in order to keep refineries operating. Imports 
increased and companies drew down existing inventories to help meet the 
shortfall in supply.
    The Commission's assessment of potential price gouging as defined 
in the relevant legislation revealed that the average gasoline price 
charged by 8 of 30 refiners analyzed increased 5 or more cents per 
gallon more than the national average price trend for this period. Once 
geographic locations of sales and channels of distribution were taken 
into account, however, individual refiners' price increases appeared 
comparable to local market trends in almost every instance.\40\
---------------------------------------------------------------------------
    \40\ But see Concurring Statement of Commissioner Jon Leibowitz at 
1-2, available at http://www.ftc.gov/speeches/leibowitz/
060518LeibowitzStatementReGasolinelnvestigation.pdf.
---------------------------------------------------------------------------
    Based on an analysis of retail pricing data and retailer 
interviews, the Commission concluded that some ``price gouging'' by 
individual retailers, as defined by the relevant statute, did occur to 
a limited extent. Local or regional market trends, however, explained 
the price increases in all but one case. Exceptionally high prices on 
the part of individual retailers generally were very short-lived. 
Interviews with retailers that charged exceptionally high prices 
indicated that at least some were responding to station-level supply 
shortages and to imprecise and changing perceptions of market 
conditions.
    The Commission's spring 2006 report to Congress, as well as 
testimony delivered to the Senate Commerce Committee the day after we 
released the report, addressed a number of important policy issues 
arising from the investigation, including the important role of prices 
in a market-based economy and the misallocation of resources that can 
stem from attempts to cap or control prices. Underscoring the crucial 
role of the antitrust laws in ensuring that consumers are offered 
competitive market prices for gasoline, the report and testimony 
pointed out the problems that price gouging legislation can engender, 
including interference with the market's pricing mechanism that is 
likely to lead to even worse shortages and more harm to consumers. The 
Commission advised Congress that if it enacts a price gouging statute 
despite these considerations, it will be important to make the law as 
clear to businesses and easy to enforce as possible. In addition, the 
Commission urged Congress to include important mitigating factors in 
any price gouging statute, including allowance for market factors of 
supply and demand and the maintenance of incentives for firms to 
increase supply into a disaster-affected area.
                             v. conclusion
    The Federal Trade Commission has an aggressive program to enforce 
the antitrust laws in the petroleum industry. The agency has taken 
action whenever a merger or nonmerger conduct has violated the law and 
threatened the welfare of consumers or competition in the industry. The 
Commission continues to search for appropriate targets of antitrust law 
enforcement, to analyze and bring cases against any merger that is 
potentially anticompetitive, and to study this industry in detail.
    Thank you for this opportunity to present the FTC's views on this 
important topic. I look forward to answering your questions.
                               __________
  Prepared Statement of Dr. Diana L. Moss, Vice President and Senior 
                          Research Fellow, AAI
                            i. introduction
    I would like to thank Chairman Schumer, Ranking Member Saxton, and 
the members of the Senate Joint Economic Committee for holding this 
hearing on concentration in the U.S. petroleum industry and its affects 
on the American consumer. I appreciate the opportunity to appear here 
today.\1\ The American Antitrust Institute is a non-profit education, 
research, and advocacy organization. Our mission is to increase the 
role of competition in the economy, assure that competition works in 
the interests of consumers, and sustain the vitality of the antitrust 
laws.
---------------------------------------------------------------------------
    \1\ Diana Moss is Vice President and Senior Fellow, American 
Antitrust Institute (www.antitrustinstitute.org).
---------------------------------------------------------------------------
                             ii. background
    ``High'' petroleum product prices continue to raise public policy 
concerns in the U.S. A number of factors have attracted particular 
attention to current gasoline price levels. Retail prices are 
approaching 25-year highs. The intensity of the most recent price run-
up rivals that experienced during the energy crisis of the late 1970s. 
And while real gasoline prices have actually declined slightly since 
the early part of the 1900s, the rate of that decrease has fallen off. 
Together, these factors compound fears that the long-predicted effects 
of depletion on global supply sources are at last being felt or that 
other forces such as market power are at work.
    The response to high petroleum product prices includes a number of 
disparate initiatives that directly target high prices or address the 
underlying structure of the domestic downstream industry that could be 
driving them. For example, there have been proposals to variously 
enact, authorize, or implement:

     the U.S. Department of Justice (DOJ) to enforce the Sherman Act 
against OPEC
     state anti-price gouging laws
     divorcement statutes to limit integrated ownership
     ``open supply'' regulations enabling lessee-dealer gasoline 
retailers to purchase supplies from sources other than the lessor-
refiner
     unbundling the sale of gasoline at wholesale from the marketing 
of branded products, thus allowing retailers to ``shop'' for the 
commodity
     petroleum-specific extensions or amendments to state and Federal 
antitrust statutes, including merger enforcement
     creation of a government-owned and operated strategic refinery 
reserve

    Most initiatives that target high gasoline prices implicitly 
acknowledge that crude oil prices, which made up just over 50 percent 
of retail gasoline prices in 2006, are determined by OPEC--outside the 
scope of the domestic industry. Thus, most proposals are directed at 
the downstream segment of the industry controlled by domestic firms. 
This includes refining, distribution of refined products to storage 
terminals, and wholesale and retail marketing. These activities 
collectively make up 30 percent of the retail gasoline price while 
taxes account for the remaining 20 percent. The forgoing proposals 
raise a number of important questions.
    First, each policy approach purports to have identified the 
appropriate policy response but it is not clear that there is any 
consensus on the underlying determinants of high gasoline prices. For 
example, petroleum commodity prices reflect, to some extent, the 
effects of resource depletion, technological advances, environmental 
restrictions (e.g., requirements for reformulated gasoline), low demand 
and income elasticities, and natural disasters that can result in 
adverse supply shocks. These factors comprise market forces that can 
drive price dynamics.
    At the same time, however, it is appropriate to look to the 
structure of downstream petroleum markets for changes in behavioral 
incentives that could produce anticompetitive conduct resulting in 
higher prices. For almost 60 years, economists have probed into this 
possibility. For example, Alfred Kahn and Joel Dirlam in 1952 noted the 
antitrust agencies' concern over potentially exclusionary conduct in 
gasoline marketing. The concept of ``conscious parallelism'' was also 
applied to gasoline pricing in the 1950s to encourage the Federal Trade 
Commission (FTC) to recognize that anticompetitive coordination did not 
necessarily take the form of a conspiracy. The price run-ups of the 
1970s generated significant debate on the merits of vertical and/or 
horizontal divestiture. Finally, refusals to deal and the potential 
incentives to foreclose rivals associated with integrated refining-
marketing have been the subject of earlier analysis, as have entry 
barriers at the refining level.\2\
---------------------------------------------------------------------------
    \2\ See, e.g., for discussion of various competitive issues: J. B. 
Dirlam and A. E. Kahn, ``Leadership and Conflict in the Pricing of 
Gasoline,'' Yale L. J. 61, 1952, pp. 818-855; B. Turner, ``Conscious 
Parallelism in the Pricing of Gasoline,'' Rocky Mntn. L. Rev. 32, 1959-
1960, pp. 206-222. W. Adams, ``Vertical Divestiture of the Petroleum 
Majors: An Affirmative Case,'' Vand. L. Rev. 30(6), 1977. pp. 1115-
1147; J. W. Markham and A. Hourihan, ``Horizontal Divestiture in the 
Petroleum Industry,'' Vand. L. Rev. 31(2), 1978, pp. 237-247; W. L. 
Novotny, ``The Gasoline Marketing Structure and Refusals to Deal with 
Independent Dealers: A Sherman Act Approach,'' Ariz. L. Rev. 16, 1974, 
pp. 465-488; and E. V. Rostow and A. S. Sachs, ``Entry into the Oil 
Refining Business: Vertical Integration Re-examined,'' Yale L. J. 61, 
1952, pp. 856-914.
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    Second, policy proposals highlight the tension between competition 
policy and broader-based public policy. Competition policy would view 
domestic petroleum refining and marketing much like any other commodity 
markets. Antitrust analysis would therefore use accepted methodologies 
and economic tools to evaluate whether mergers or firm conduct are 
likely to harm (or harmed) competition and/or consumers. Public policy, 
on the other hand, is more likely to view high gasoline prices as a 
societal problem. In addition to traditional consumer welfare and 
economic efficiency concerns, public policy would also consider quality 
of life, equity, economic growth, and national security as key factors 
in crafting approaches. Given these concerns, public policy could view 
petroleum markets as candidates for special rules or treatment that 
would not be considered in the realm of competition policy.
    Third, if implemented together or in a haphazard manner, various 
proposals targeting the domestic petroleum industry could open a 
``Pandora's Box'' of competing and potentially conflicting objectives, 
stakeholder agendas, and effects on economic efficiency and consumer 
welfare. It is thus important that approaches attempt to identify the 
underlying source(s) of high petroleum product prices and chose the 
appropriate policy instruments for dealing with them. Consolidation and 
concentration in the domestic petroleum refining and marketing industry 
should receive a good deal of scrutiny in making this assessment.
    iii. concentration in domestic petroleum refining and marketing
    One of the most important features of the domestic petroleum 
industry has been the significant level of consolidation at the 
refining and marketing level over the last 20 years. The FTC reports 
1,165 mergers in the domestic petroleum industry between 1985 and 2003, 
at an estimated total value (for transactions of $10 million or more) 
of about $500 billion dollars.\3\ The Government Accountability Office 
(GAO), however, cites a much higher figure over a shorter period of 
time--2,600 transactions from 1991 to 2000.\4\
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    \3\ Federal Trade Commission (August 2004). The Petroleum Industry: 
Mergers, Structural Change, and Antitrust Enforcement, Tables 4-6 and 
4-11.
    \4\ Government Accountability Office (July 15, 2004). Mergers and 
Other Factors That Affect the U.S. Refining Industry, p. 0.
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    A number of features of recent petroleum merger activity stand out. 
First, this activity has shadowed the wave-like, economy-wide pattern 
in consolidation over the last two decades. Second, the average size of 
a petroleum merger was three times larger than the average merger deal. 
Moreover, billion-dollar mergers accounted for about 86 percent of the 
total $500 billion in larger transactions.
    Third, merger transactions have been disproportionately allocated 
over various segments of the industry. For example, GAO estimates that 
85 percent of mergers proposed during the 1990s were in upstream 
exploration and production. Two percent of mergers occurred in 
midstream pipeline transportation and 13 percent of transactions 
involved downstream refining and markets.\5\ Despite the intensity of 
merger activity in the upstream segment of the industry, about two-
thirds of billion-dollar petroleum mergers in the U.S. involved 
downstream, integrated assets. Data on mergers enforced by the FTC 
confirm this observation. For example, of the 72 relevant markets 
defined by the agency in 15 petroleum merger enforcement actions in the 
1980s and 1990s, 36 percent were related to refining and 33 percent 
involved marketing.\6\ Several transactions (beginning in the mid-
1990s) were sizable combinations involving integrated ``majors'' such 
as BP-Amoco and Exxon-Mobil and the unintegrated ``independents'' such 
as Ultramar Diamond Shamrock-Total.
---------------------------------------------------------------------------
    \5\ Jim Wells (September 21, 2005). Factors Contributing to Higher 
Gasoline Prices, Testimony of the Director, Natural Resources and 
Environment, Government Accountability Office, p. 2.
    \6\ Data are for the 1980s and 1990s. Enforcement actions are those 
cases in which the FTC required divestiture or other remedial 
conditions to address competitive concerns. See Federal Trade 
Commission (undated). ``FTC Enforcement Actions in the Petroleum 
Industry, 1981-2002.''
---------------------------------------------------------------------------
    Third, consolidation in refining and marketing generated a 
relatively higher level of antitrust scrutiny. On average, about 13 
percent of petroleum and marketing transactions that were cleared for 
investigation by either FTC or DOJ were challenged, as compared to 
roughly 2 percent of all transactions. These challenges include 
transactions in which one of the agencies filed a complaint, requested 
injunctive relief, or settled the case through consent decree. In the 
majority of merger enforcement actions in downstream petroleum, the FTC 
has posited horizontal theories of harm in which the merged firm could 
unilaterally withhold capacity to drive up price or achieve the same 
result through coordinated interaction. It is not clear, however, if 
vertical theories of harm have played a substantive role in petroleum 
merger analysis. These include, for example, the foreclosure of rival 
gasoline retailers by vertically integrated refiner-marketers in order 
to increase profits in retail markets. Enforcement statistics for all 
industries indicate that in only about 9 percent of merger cases did 
the agencies propose a vertical theory of harm.\7\
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    \7\ FTC, Horizontal Merger Investigation Data, Fiscal Years 1996-
2005, Table 1.
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                        iv. the role of refining
    Refining is a major feature that defines the landscape of the 
domestic downstream petroleum industry. Much like electricity 
transmission, refining is arguably a production ``bottleneck,'' or a 
level through which all inputs produced in complementary markets must 
flow to ultimately reach the consumer. Control of bottleneck 
facilities--particularly with integrated ownership--has long raised 
concerns over market power, via: (1) unilateral withholding of output 
or restricted investment in capacity; (2) leverage of market power from 
the bottleneck level to a complementary level; or (3) the possibility 
of oligopolistic coordination involving production or capacity 
investment decisions.
    Several major features of refining highlight its bottleneck 
characteristics. For example, the number of operating refineries 
declined by 44 percent from the mid-1970s through early 2000s with no 
new refinery additions. This apparent tightening of refining capacity 
in the U.S. should be considered in light of several developments. The 
phase-out of crude oil price controls in 1981 reduced incentives to 
operate small, inefficient facilities so the decline in refinery 
numbers over time may reflect the work-off of obsolete inefficient 
capacity. Since the early 1980s, refiners have also developed higher 
capacity and more technologically advanced facilities through increased 
computerization, employment of advanced catalysts, additional 
processing units at existing facilities, networking of refinery 
facilities, and other improvements that allow refiners (among other 
things) to process more sulfurous crudes as inputs and net greater 
volumes of more valuable refined products. A 15 percent increase in 
crude oil distillation capacity at U.S. refineries over the last 20 
years, however, should considered with care.\8\ For example, the 
majority of refining capacity resides in large facilities that account 
for the bulk of operating distillation capacity.\9\ Utilization rates 
at this smaller number of larger refineries have also increased over 
time\10\ rising from a low of almost 70 percent in 1981 to around 95 
percent in the late 1990s and early 2000s.
---------------------------------------------------------------------------
    \8\ See http://tonto.eia.doe.gov/dnav/pet/hist/mocggu2A.htm.
    \9\ FTC (2004), Table 7-4.
    \10\ Among other things, higher utilization minimizes the 
opportunity cost of holding excess capacity. See FTC (2004) at 7.
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    Concentration in U.S. refining markets should carefully scrutinized 
against the backdrop of fewer, larger and more sophisticated refineries 
operating at very high utilization rates. At the broadest level, 
refining markets have become more concentrated over the last 20 
years.\11\ Concentration in most PADD districts has increased since 
1985, in some cases by over 100 percent. By the DOJ/FTC Horizontal 
Merger Guidelines (Guidelines) standards, concentration in PADD II, 
III, IV, and V was moderate (between around 1,000 and 1,200 HHI) and 
high in PADD I (around 1,900 HHI) by the early 2000s.
---------------------------------------------------------------------------
    \11\ How refining capacity is measured raises a number of important 
issues. Most quoted figures use distillation capacity, but alternative 
measures could be based on type of refined product and sources of crude 
inputs.
---------------------------------------------------------------------------
    PADD-based refining concentration statistics, however, do not 
reflect the actual geographic dimensions of markets. For example, PADD 
boundaries are likely to encompass far broader areas than what 
consumers would consider in searching out alternative sources of 
supplies. Those areas--determined by pipeline constraints and 
production cost differentials--are likely to be much smaller and more 
concentrated than PADD-based markets.
    Data on relevant antitrust markets is helpful for developing a more 
accurate picture of refining concentration. For example, concentration 
statistics are available for about 20 relevant downstream petroleum 
markets defined by the FTC in 15 enforcement actions in the 1980s and 
1990s. About two-thirds of these markets would be considered highly 
concentrated on a pre-merger basis, with HHIs ranging from 1,800 to as 
high as 6,700.\12\ The remaining one-third of relevant markets are 
unconcentrated to moderately concentrated. These statistics are 
significantly higher than PADD-based concentration figures.
---------------------------------------------------------------------------
    \12\ Merger-related increases in concentration in many of these 
markets are as high as 1,600 HHI points.
---------------------------------------------------------------------------
                        v. the role of marketing
    Another important feature of the domestic petroleum industry is how 
refined products--particularly gasoline--are marketed. Much like 
refining, the structure of wholesale markets has changed significantly. 
For example the number of terminals in the U.S. decreased by almost 50 
percent over the 1980s to 1990s.\13\ By the late 1990s, PADD V was 
highly concentrated (around 2,000 HHI) and the remaining PADDS were 
moderately concentrated (between around 1,100 and 1,600 HHI). Increases 
in concentration are the most pronounced in PADDs I, II and III.
---------------------------------------------------------------------------
    \13\ FTC (2004), Table 9-1.
---------------------------------------------------------------------------
    Much like refining, broad regional concentration statistics may not 
accurately reflect wholesale market structures. Terminal networks are 
likely to be defined around smaller, metropolitan areas which encompass 
a consumer's universe of economic alternatives. We turn again to merger 
data to sharpen the picture. For example, about eight relevant markets 
identified by the FTC in the 15 enforcement actions discussed earlier 
involve terminalling and marketing. Over one-half of these markets are 
highly concentrated (1,565 to 4,600 HHI) and the remaining are 
moderately concentrated. As in the case of refining, merger-specific 
wholesale concentration statistics are significantly higher than 
regional PADD-based statistics.
    Brand concentration in retail markets has also increased over time. 
The GAO observes, for example, that one of the major changes in 
gasoline marketing has been a decrease in sales of unbranded (generic) 
gasoline relative to branded gasoline. For example, brand concentration 
increased by 25 percent and 36 percent in PADD III and PADD IV, 
respectively, during the 1990s to early 2000s.\14\ Accompanying an 
increase in brand concentration is a smaller number of retail outlets 
(e.g., a 16 percent decrease overall and a 63 percent decrease in 
outlets owned by the majors).\15\ Some of the decrease in numbers of 
retail outlets is likely due to the increasing capital intensity of 
gasoline marketing. Growth of the convenience store/gasoline 
distribution channel reflects the rise of higher-volume outlets owned 
by independents such as Sheetz and RaceTrac. Hypermarkets such as 
Costco, Wal-Mart, and club warehouses are also accounting for an 
increasing percentage of retail outlet share.\16\
---------------------------------------------------------------------------
    \14\ FTC (2004), Table 9-7.
    \15\ See EIA (August 19, 2004) and FTC (2004), Table 9-3.
    \16\ FTC (2004) at 11. The GAO reports (July 2004 at 0) that 
refiners deal more with large distributors and retailers than in the 
past.
---------------------------------------------------------------------------
                  vi. what economic analysis tells us
    There is a sizable body of research on competitive issues involving 
the domestic downstream petroleum industry, much of which has arisen 
from the debate over high and/or volatile gasoline prices. The research 
addresses three major topics that relate to the competitive 
implications of downstream petroleum market structures and behavioral 
incentives facing firms: (1) ``asymmetry'' between upstream and 
downstream petroleum prices; (2) effects of divorcement and open supply 
regulation; and (3) merger-related price effects.
    The first type of analysis attempts to determine the statistical 
significance of the tendency for downstream petroleum prices to 
increase faster than upstream prices when upstream prices are on the 
rise, but to fall more slowly when upstream prices are on the decline. 
Such ``asymmetry'' or the so-called ``rockets and feathers'' effect 
occurs most often between wholesale and retail gasoline prices, 
followed by crude oil-retail gasoline prices and spot gasoline-crude 
oil prices. There are various theories that could explain asymmetry, 
including oligopolistic coordination (e.g., signaling adherence to a 
collusive agreement at the refining or retail levels), consumer search 
costs, and inventory adjustment costs. However, no single theory 
emerges as a prevailing explanation.
    A second category of analysis responds to various proposals to 
limit integration between refiners and gasoline retailers (i.e., 
``divorcement'' legislation). Other proposals would allow lessee-dealer 
retailers to purchase gasoline supplies from sources other than the 
lessor-refiner--otherwise know as ``open supply'' regulation. Here, the 
research appears to show that forced deintegration of refiners and 
retailers is associated with higher costs and/or consumer prices. Such 
policies are therefore not likely to be the most effective in dealing 
with vertical competitive concerns unless it can be determined that 
such integration creates incentives for anticompetitive conduct.
    A third class of studies evaluates the effect of mergers on 
wholesale and retail gasoline prices. These assessments range over the 
price effects of increased market concentration, to the role of 
independent gasoline retailers in disciplining retail gasoline prices, 
to incentives for exclusionary conduct associated with vertical 
integration. The research appears to at least support the notion that 
merger activity in the U.S. since the mid-1990s involving refiner-
marketer combinations has increased wholesale and, sometimes, retail 
prices. However, petroleum merger studies have generated a good deal of 
technical controversy inside the economic community.
                   vii. synthesis and recommendations
    The industry trends discussed above sketch out a picture of an 
industry that has undergone significant change in the last decade. A 
number of observations are worth making. First, the bulk of merger 
activity has been concentrated in very large transactions that involve 
downstream, integrated refining and marketing assets. Moreover, while 
the share of refining capacity owned by the majors fell from 72 percent 
in 1990 to 54 percent in 1998, the independents (e.g., Citgo/PDV 
America, Ultramar Diamond Shamrock, and Valero Energy) tripled their 
share of capacity from 8 to 23 percent--largely by buying the divested 
assets of the majors.\17\ These independents are now vertically 
integrated downstream to a significant degree.
---------------------------------------------------------------------------
    \17\ EIA (August 19, 2004). All other domestic refiners maintained 
stable market shares from 1990 to 1998.
---------------------------------------------------------------------------
    Higher levels of concentration in refining, at wholesale, and at 
the retail level, are not particularly surprising in light of this 
activity. Indeed, it should raise significant questions regarding the 
availability of competitive alternatives available to: (1) jobbers and 
other distributors that purchase at the rack, (2) independent gasoline 
retailers that potentially face the prospect of dealing more and more 
with integrated refiner-markets, and (4) consumers in obtaining 
supplies of competitively priced gasoline.
    Second, the transformation of the U.S. refining industry emphasizes 
the increasingly bottlenecked nature of the segment. High sunk costs, 
environmental regulations, and the declining availability of domestic 
crude inputs collectively act to discourage new entry that could inject 
additional competition into refining. Moreover, technological change 
and the phase-out of price controls have driven the movement to fewer, 
higher-capacity refineries that operate at high utilization rates. And 
while efficiency in the refining sector has likely increased, it is 
also the case that operation of bottlenecks at high utilization levels 
can create unique opportunities for the exercise of market power.
    Third, economists have made valiant attempts to estimate the price 
effects of both horizontal and vertical domestic petroleum mergers. At 
the same time, this research has been met with considerable resistance, 
largely over the robustness of findings to different econometric 
specifications. For example, the FTC--in critiquing the GAO's studies--
convened a panel of experts that called for additional research in 
order to ``test the validity of assumptions that underlie existing 
methodologies used to estimate merger price effects.'' \18\ This debate 
reveals an often observed tension in economic analysis involving 
controversial policy issues. Thus, the results of petroleum merger 
studies (which appear to show, on balance, merger-induced increases in 
wholesale and retail prices) should probably motivate even more 
rigorous antitrust scrutiny.\19\
---------------------------------------------------------------------------
    \18\ FTC Staff Technical Report (December 21, 2004). ``Robustness 
of the Results in GAO's 2004 Report Concerning Price Effects of Mergers 
and Concentration Changes in the Petroleum Industry,'' p. 2. L. M. 
Froeb, et all, (2005). ``Economics at the FTC: Cases and Research, with 
a Focus on Petroleum'' Review of Industrial Organization 27, pp. 237.
    \19\ Not all studies evaluate the net effect of mergers on retail 
prices, which would provide some sense of the consumer welfare impact 
of mergers. While the magnitude of estimated price increases described 
by various studies may seem small, they can translate into a 
significant loss of welfare in a market that amounts to billions of 
dollars in annual retail gasoline sales.
---------------------------------------------------------------------------
    Merger review could probably be improved within the existing 
framework of the antitrust agency Guidelines. Rigorous approaches to 
market definition should clearly identify refining bottlenecks. 
Theories of competitive harm should consider how a merger affects the 
firm's ability and incentive to adversely affect prices or output. 
Here, it is particularly important to consider not only horizontal 
theories of harm, but vertical ones, including the possibility of 
vertical foreclosure. It may be the case--as in electricity markets--
for example, that manipulation of even small amounts of strategic 
refining capacity may result in very profitable anticompetitive price 
increases. Thus, small market shares may not necessarily mean small 
market power. Simulation models are also useful for evaluating 
unilateral price effects under alternative scenarios. Finally, 
evaluation of joint ventures and alliances should focus on the ways 
that such coordination may reduce the intensity of competition without 
necessarily being reflected in concentration statistics.\20\
---------------------------------------------------------------------------
    \20\ See, e.g., threshold issues litigated in Texaco v. Dagher, 126 
S. Ct. 1276 (2006).
---------------------------------------------------------------------------
                               __________
   Prepared Statement of Dennis C. DeCota, Executive Director, CSSARA
    Chairman Schumer and honorable members it is a privilege to be here 
to give testimony before you today. I and the thousands of other 
petroleum retailers across our Nation thank you for your attention to 
this very serious issue: ``Is market concentration in the U.S. 
petroleum industry harming consumers?'' As a petroleum retailer, I 
assure you that it has.
    My name is Dennis DeCota. I am the Executive Director of the 
California Service Station and Automotive Repair Association (CSSARA).
    CSSARA is a 34-year-old trade association representing both branded 
and unbranded service station dealers throughout the state of 
California. I have been the Executive Director for the past 16 years 
and in that position I have had the privilege of consulting with 
dealers of all major brands on issues related to petroleum retailing.
    I am currently a ConocoPhillips dealer and have been in my station 
the past 28-plus years and have operated seven other branded locations. 
I have also served two terms as vice president of Service Station 
Dealers of America, our national trade association during the mid-
1980s. I have been designated as an expert witness in several different 
petroleum related litigation suits.
    My testimony will focus on the following topics: industry 
consolidation, retail competition, gas price manipulation, lack of 
consumer choice and, last but not least, today's collective price 
gouging.
                         industry consolidation
    Mostly throughout the nineties the major oil companies merged and 
consolidated to a point where they no longer compete against one 
another for volume or market share. In other words, through these 
mergers and acquisitions they eliminated their competition while at the 
same time they grew their own proprietary gasoline volume sales through 
key locations that became company operated stations. In the case of 
Shell, this was done through multiple site operators, known as MSO 
franchise dealers, which are nothing more than commissioned agents for 
Shell. MSO operators operate under a non-petroleum marketing practices 
act (PMPA) franchise. PMPA is Federal statute that deals with issues 
relating to a franchisee and franchisor's relationship. The PMPA's main 
purpose is to address protection for dealers as it relates to 
termination or non-renewal of their franchise agreement. Shell controls 
the retail price at the MSO stations. This would not be the case if 
these MSO dealers were governed by a PMPA lease agreement. As the oil 
companies consolidated they closed or sold off most of their less 
desirable locations, reducing competition amongst branded and unbranded 
stations, gaining a stronger grip over the retail market place. 
Collectively, they also implemented zone pricing throughout the Nation. 
This one tactic allowed the majors to control the retail street price 
of gasoline more then any other strategy. It stymied true competition 
and allowed the majors to gain market power. This along with their 
increase of proprietary gallons and the simple fact they stopped 
franchising newly constructed stations in the mid-nineties, has all but 
wiped out competition at the retail level.
                           retail competition
    Independent refiners due to mergers and acquisitions plus 
environmental compliance requirements have all but been wiped out in 
California. The competition between branded stations and independent 
stations is all but gone. They stopped franchising newly constructed 
stations. One of the most glaring examples is the recent acquisition of 
the Exxon-Mobil refinery in California by Valero, and Valero's later 
acquisition of United Diamond Shamrock. The combination of these 
acquisition and merger destroyed the independent market in California. 
Now we experience a situation where branded product is frequently 
cheaper than unbranded product at wholesale rack pricing.
    Valero, once one of the largest independent refiners is now a major 
oil company pricing like a major. My recent letter to the FTC opposing 
the sale of Shell's southern California refinery to Tesoro and Tesoro's 
planned acquisition of the state's last large independent USA Petroleum 
will only further reduce competition in our state. I believe that 
Tesoro will emulate what Valero has already done.
                         gas price manipulation
    Dealers must compete with proprietary company operated stations at 
margins that simply won't sustain there economic viability. As dealers 
are forced out of their stations they are replaced by company 
operations and or commissioned agents who simply raise the price to 
that community once the competition is gone so they can obtain their 
desired profit goals.
                        lack of consumer choice
    Due to the major oil companies' ability to drive out competition 
and control retail pricing, consumers are put at a tremendous 
disadvantage when it comes to their ability to find competitively 
priced fuel. The majors further reduce the free market by insisting 
that their franchise dealers who exercise their right under the PMPA to 
purchase their land and improvements are forced into entering long term 
supply agreements. This impedes station owners from seeking a more 
competitively priced supplier.
                    today's collective price gouging
    In California the majors are in lock step with one another as it 
relates to wholesale pricing, with the exception of ARCO/BP. The 
industry is so controlled that any unplanned refinery glitch or supply 
issue impacts the entire state's retail pricing as all majors increase 
price to curtail volume demand. The pooling of refined product by the 
majors has created a noncompetitive market place and consumers are 
paying the price.
    In conclusion, the only power that can stop the oil companies from 
harming the consumers of the United States is our government. 
Government must realize the control big oil has over the consuming 
public. To reinstate competition in the market place, government needs 
to stop zone pricing, curtail the ability of the majors to demand long 
term supply agreements and force them out of company operations.
    Attachments are as follows:

    1. Break down of cost and margins of 87 grade regular at my station 
in San Anselmo, CA on May 18, 2007.
    2. The second attachment is a hypothetical description of what a 
gallon of gas at my station would cost if I was to make a 30 percent 
gross profit.
    3. Why Californians Pay More at the Pump.
                                 ______
                                 
                              Attachment 1

           California Regular Grade 87 ETH. 5.7 Percent BRD.

                retail price per gallon as of 5/18/2007
                               cash price
                                 $3.399

 
------------------------------------------------------------------------
 
------------------------------------------------------------------------
 Cost per gallon..........................................    $2.731600
 Dealers profit p/g.......................................      .070715
 Fed oil spill fee........................................      .001130
 Fed excise tax...........................................      .184000
 Fed tax credit (ethanol).................................    (.029070)
 CA state fuel tax........................................      .180000
 CA environ. fee..........................................      .000960
 CA oil fee reimbursement.................................      .001190
 CA UST fee...............................................      .014000
 CA state sales tax @ retail price........................      .244475
                                                            ------------
                                                                 $ 3.399
------------------------------------------------------------------------

                    dealers gross profit per gallon
              0.0258 percent not even 3 percent per gallon
    The majors control retail margins through three forms of price 
controls, zone pricing, long term supply agreements, and propriety 
company operations!
                                 ______
                                 
                              Attachment 2

           California Regular Grade 87 ETH. 5.7 Percent BRD.

                retail price per gallon as of 5/18/2007
                               cash price
                                 $4.589
    If I was to make 30 percent gross profit, this would be how it 
would breakout.

 
------------------------------------------------------------------------
 
------------------------------------------------------------------------
 Cost per gallon..........................................    $2.731600
 Dealers profit p/g.......................................     1.174588
 Fed oil spill fee........................................      .001130
 Fed excise tax...........................................      .184000
 Fed tax credit (ethanol).................................    (.029070)
 CA state fuel tax........................................      .180000
 CA environ. fee..........................................      .000960
 CA oil fee reimbursement.................................      .001190
 CA UST fee...............................................      .014000
 CA state sales tax @ retail price........................      .330067
                                                            ------------
                                                                  $4.589
------------------------------------------------------------------------

             hypothetically dealers gross profit per gallon
    Today the major oil companies refining margins are at an all time 
high arguable they are realizing more then 30 percent gross profit 
return on just the refinery margins. This example exemplifies the major 
gouging that is currently taking place as the majors tighten their grip 
on their ability to exert market power.
                              Attachment 3
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  Prepared Statement of Samantha Slater, Director, Congressional and 
            Regulatory Affairs, Renewable Fuels Association
    Good morning Chairman Schumer and Members of the Committee. My name 
is Samantha Slater and I am Director of Congressional and Regulatory 
Affairs for the Renewable Fuels Association (RFA), the national trade 
association representing the U.S. ethanol industry.
    This is an important and timely hearing, and I am pleased to be 
here to discuss the ethanol industry's perspective of the effects that 
increased concentration of the petroleum industry has had on 
availability of E-85 at the pump. When consumers drive into service 
stations, they should have the option of choosing renewable fuels. The 
increased availability of E-85 at service stations nationwide would 
give consumers the opportunity to choose a high-octane fuel that 
provides superior engine performance, reduces harmful tailpipe and 
greenhouse gas emissions that contribute to global warming, reduces our 
dependence on foreign oil, and enhances our energy and economic 
security.
                               background
    Today's ethanol industry consists of 119 biorefineries located in 
19 different states with the capacity to process more than 2 billion 
bushels of grain into 6.1 billion gallons of high octane, low carbon, 
clean burning motor fuel, and more than 12 million metric tons of 
livestock and poultry feed. It is a dynamic and growing industry that 
is revitalizing rural America, reducing emissions in our Nation's 
cities, and lowering our dependence on imported petroleum.
    Ethanol has become an essential component of the U.S. motor fuel 
market. Today, ethanol is blended in 50 percent of the Nation's fuel, 
and is sold virtually from coast to coast and border to border. The 
almost 5 billion gallons of ethanol produced and sold in the U.S. last 
year contributed significantly to the Nation's economic, environmental 
and energy security. According to an analysis completed for the RFA\1\, 
the approximately 5 billion gallons of ethanol produced in 2006 
resulted in the following impacts:
---------------------------------------------------------------------------
    \1\ Contribution of the Ethanol In States, Dr. John Urbanchuk, 
Director, LECG, LLC, December, 2006.

     Added $41.1 billion to gross output;
     Created 160,231 jobs in all sectors of the economy;
     Increased economic activity and new jobs from ethanol increased 
household income by $6.7 billion, money that flows directly into 
consumers' pockets;
     Contributed $2.7 billion of tax revenue for the Federal 
Government and $2.3 billion for State and Local governments; and,
     Reduced oil imports by 170 million barrels of oil, valued at 
$11.2 billion.

    There are currently 79 biorefineries under construction. With eight 
existing biorefineries expanding, the industry expects more than 6.4 
billion gallons of new production capacity to be in operation by the 
end of 2009. The following is our best estimate of when this new 
production will come online.
[GRAPHIC] [TIFF OMITTED] 37461.046

    Ethanol today is largely a blend component with gasoline, adding 
octane, displacing toxics and helping refiners meet Clean Air Act 
specifications. Of the 5.4 billion gallons of ethanol blended in the 
U.S. last year, only about 50 million gallons were used for E-85. But 
the time when ethanol will saturate the blend market is on the horizon, 
and the industry is looking forward to new market opportunities. As 
rapidly as ethanol production is expanding, it is likely the industry 
will saturate the existing blend market before a meaningful E-85 market 
develops.
    Today there are more than 230 million cars on American roads today 
capable of running on an up to 10 percent blend of ethanol. Of these, 
only 6 million are flexible fuel vehicles (FFV), capable of using up to 
an 85 percent blend of ethanol. America's automakers have realized the 
benefits of ethanol, particularly E-85, and have joined with the 
ethanol industry to aggressively develop the infrastructure and provide 
the vehicle fleet necessary to grow the E-85 market. Ford, General 
Motors and DaimlerChrysler pledged to increase production of FFVs to 
half of all new vehicles by 2012, or about 4 million new FFVs a year. 
General Motors has been a leader in promoting the use of ethanol. Its 
campaign, ``Live Green, Go Yellow,'' which focuses on the yellow gas 
caps that now come standard with all GM flex-fuel vehicles, has helped 
to raise public awareness of ethanol and especially E-85.
    Enhancing incentives to gasoline marketers to install E-85 
refueling pumps at service stations will continue to be essential. 
There are now more than 1,200 E-85 pumps at service stations across the 
country, more than doubling in number since the passage of the Energy 
Policy Act of 2005. However, that number remains insignificant 
considering the 170,000 service stations nationwide. The majority of 
those service stations are not owned by the major oil companies, but 
franchised from those same companies, or independent.
          barriers to the increased use of renewable fuel use
    The greatest challenge the ethanol industry faces to increasing E-
85 refueling pumps nationwide remains the resistance from the major oil 
companies to allow service stations to sell E-85. In 1980, the U.S. 
Congress amended the Clayton Act through enactment of the Gasohol 
Competition Act, to make it unlawful for any person ``to impose any 
condition [or] restriction . . . that . . . unreasonably discriminates 
against or unreasonably limits the sale, resale, or transfer of gasohol 
or other synthetic motor fuel of equivalent usability . . . .'' 
Congress decided to take this action when several major suppliers 
refused to permit their pumps and tanks to be used for the sale of 
gasohol, threatening to terminate their franchisees' contracts if they 
did so. The Senate Report language on the legislation that became the 
Gasohol Competition Act noted that the statute was intended ``to remove 
any potential obstacles that may be raised by the major oil companies 
to dealers who desire to market gasohol and other synthetic fuels . . . 
.''
    The Gasohol Competition Act put the days of discrimination against 
and unreasonable limitations on the sale of gasohol behind us; however, 
in recent years the efforts of many independent retailers to begin to 
sell E-85 at their stations have been thwarted by the major suppliers. 
Since E-85 has certainly reached the same level of quality and 
acceptability as gasohol had in 1980, such actions are plainly illegal 
under the Gasohol Competition Act, and yet the interference still 
occurs.
    Oil companies today do not generally sell E-85, so they lose a sale 
when a driver pulls into a service station bearing their name and 
purchases E-85 instead of the gasoline the oil companies supply to the 
service station. It is not in their best interest financially, then, to 
permit E-85 to be sold at these service stations. ConocoPhillips, in a 
letter (attached) to Senators Tom Harkin and Richard Lugar on February 
14, 2006, plainly stated that E-85 ``is not currently sold as a 
ConocoPhillips Branded product,'' and one of the key reasons is that 
``E-85 fuel predominately originates and is manufactured by other 
producers.''
    [The letter from ConocoPhillips, as referenced above, is not 
attached.]
    If an oil company, however, were to grant an exemption and allow a 
franchise service station to buy E-85 from an outside supplier, the 
service station would then be required to follow restrictive rules the 
oil companies say are in place to protect customers, as well as their 
brand. It is not unusual to find clauses in oil company contracts with 
franchisees that require service stations to dispense E-85 from its own 
unit, and not part of the existing multi-hose dispenser, necessitating 
service station owners to install new pumps and tanks at their own 
expense. It is common practice for oil companies to disallow the sale 
of E-85 on the primary island--under its canopy--and franchisees must 
therefore find another location on the property to install a new pump. 
And then, even if the franchisee is able to jump through all of those 
hoops, it is likely that the oil companies would prohibit the service 
station from advertising the availability and price of E-85 on their 
primary signs listing fuel prices.
    The reason this interference continues is simple--enforcement of 
the Gasohol Competition Act relies primarily on the willingness of 
marketers to face economic ruin. To bring a private action under the 
Gasohol Competition Act, the plaintiff must have suffered ``antitrust 
injuries,'' according the United States Court of Appeals for the 
Seventh Circuit. For a marketer, that would mean that he could not sue 
unless his contract with the supplier has been terminated. Short of 
that, the marketer would be unable to demonstrate any antitrust 
injuries, and so there would be no remedy available for the wrongful 
conduct of the supplier. Faced with the possibility of termination of 
the contract with the supplier, and consequent economic ruin, the 
marketer will simply have to capitulate to the demands of the supplier 
to not sell E-85. An ethanol producer could bring an action against 
suppliers who interfere with the sale of E-85, but under current market 
conditions the producers are selling all the ethanol they can make 
already, and so they too would be unable to show any antitrust 
injuries. Further, any such litigation would be extremely costly, 
further discouraging the use of the Gasohol Competition Act.
    In the faces of these barriers, many retailers are taking action to 
bring fuel choice to their customers. Recently, regional chains like 
Kroger and Meijer Inc. have taken the initiative to install E-85 pumps 
at their stores in Ohio and Texas, and Michigan and Indiana, 
respectively. National chains, like Wal-Mart, have also shown an 
interest in installing E-85 pumps at their 388 company-owned stations 
across the country. Even state legislatures are taking steps to end the 
restrictive policies put in place by the oil companies. In 2006, New 
York State enacted legislation that barred oil companies from requiring 
stations to buy all of their fuel from the companies, and the first E-
85 pump is now in operation in Albany.
    The goal of the Gasohol Competition Act was to integrate the sale 
of synthetic fuels into the existing distribution system, and Congress 
observed that the longer it takes to do so, ``the longer we will be 
subjected to the vagaries of the international petroleum markets and 
the harshness of cartel price actions.'' That was true then, and it is 
just as true now. The need for opening up the gasoline supply 
infrastructure to E-85, to allow the millions of flex-fuel cars that 
the auto companies have manufactured over the last several years and 
will manufacture in increased numbers over the years to come, is 
critical to the achievement of the our national goal of reducing our 
dependence on imported oil. It is also critical to reducing our 
emissions of greenhouse gases, through the increased use of biofuels, 
like ethanol.
                               conclusion
    The RFA urges this Congress to consider augmenting the existing 
enforcement mechanisms under the Gasohol Competition Act through the 
creation of a regulatory enforcement regime. Assigning responsibility 
to an appropriate regulatory agency to ensure that marketers eager to 
give their customers the option of using home grown and American made 
fuels in place of imported oil have the realistic opportunity to do so 
would make a major contribution to opening up the market for E-85, and 
to helping alleviate our Nation's addition to oil. The continued 
commitment of the 110th Congress and this Committee to further expand 
the rapidly growing domestic biofuels industry will contribute to 
ensuring America's future energy security. The RFA looks forward to 
working with you on these important issues.
    Thank you.
                               __________
       Prepared Statement of Red Cavaney, President and CEO, API
    I am Red Cavaney, President and CEO of API, which is the national 
trade association of the U.S. oil and natural gas industry. API 
represents nearly 400 companies involved in all aspects of the oil and 
natural gas industry, including exploration and production, refining, 
marketing and transportation, as well as the service companies that 
support our industry. We welcome this opportunity to present our 
industry's views on mergers and acquisitions, gasoline prices, and 
related issues to the Joint Economic Committee.
       industry mergers are not a cause of higher gasoline prices
    Industry mergers have not caused today's higher gasoline prices. In 
fact, mergers contribute to production efficiencies that benefit 
consumers. As with all industries, mergers have occurred only after 
careful Federal Trade Commission (FTC) scrutiny to ensure the 
competitiveness of markets. The FTC reviews all proposed mergers and 
acquisitions in the oil and natural gas industry. It has required 
divestitures, or challenged mergers in the industry, at lower levels of 
concentration than in any other industry and has stated that ``despite 
some increases over time, concentration for most levels of the 
petroleum industry has remained low to moderate.''
    Those who allege that mergers cause gasoline price increases fail 
to recognize that there is no shortage of competitors today in the 
industry, and market power is not heavily concentrated. The eight 
largest refiners in the U.S. account for 66 percent of the market, a 
level of concentration that is exceeded by 15 other consumer product 
industries. In fact, in eight other major industries, the top eight 
companies, on average, account for 85 percent or more of their 
respective markets, according to U.S. Department of Commerce 2003-2006 
data.
    There are 55 refining companies, 142 operating refineries, and 
approximately 165,000 motor fuel outlets. In the case of the latter, 
all but a small percentage are owned and operated by small businessmen 
and women, not refiners. According to the FTC, the share of U.S. 
refining capacity owned by independent refiners with no production/
exploration operations rose from 8 percent in 1990 to over 25 percent 
in 2006.
    While a 2003 GAO report alleged that mergers affected prices by 
less than one half of 1 cent per gallon at the wholesale level, the FTC 
dismissed the report as ``fundamentally flawed'' and full of ``major 
methodological mistakes that make its quantitative analyses wholly 
unreliable.'' Beyond this suspect GAO report, we are unaware of 
anything in the professional literature tying higher prices to mergers. 
(See attachment to this statement for a detailed analysis of the 2003 
GAO report.)
    In part, as a result of the mergers, the industry has become more 
efficient, which has reduced costs to consumers, with gasoline prices 
dropping to all-time record lows in the late 1990s. Sharp increases in 
crude oil prices and costly investments made to reduce emissions have 
masked this benefit in later years.
    Attached to this statement is a time chronology showing that all 
significant oil and natural gas industry mergers occurred before 2001.
    Industry challenges, economic pressures, and changing regulatory 
requirements were some of the factors behind the oil company mergers of 
the 1990s.
    During the 1990s, the oil and natural gas industry earned 
relatively poor rates of return on their investments. This was 
especially true in the refining sector, which was hard hit with the 
need for new investment in technology and equipment to produce cleaner-
burning fuels to meet clean air standards set by the Clean Air Act of 
1990. This law had a major impact on the operation of refineries in the 
United States and the return on investment realized at the time. (See 
Figures 1-3.)
    Technological advancements have helped refineries produce more fuel 
from existing facilities than they did in the past. In addition, the 
elimination of subsidies under government regulations after 1981 led to 
the closure of many smaller, less-efficient refineries throughout the 
1980s and 1990s. Those refineries left standing did a better job of 
bringing product to market for less. The massive restructuring that 
occurred in the 1990s cut costs, increased economies of scale and 
improved utilization rates.
    The consolidation in the refining sector has increased measurements 
of industry concentration, but according to the FTC, ``despite some 
increases over time, concentration for most levels of the petroleum 
industry has remained low to moderate.'' (August 2004, p.3) Even though 
concentration in the refining sector has increased since 1997, the 
concentration ratio is still less than it is for many other industries.
                 refiners are not withholding supplies
    Recent gasoline price increases reflect the forces of supply and 
demand. The same is true for past price increases that have been 
thoroughly investigated by government agencies who would have taken the 
industry to task, if illegal or improper activity had been discovered. 
Over the past couple of decades, there have been more than 30 state and 
Federal investigations of the industry. Invariably, these 
investigations have explained price spikes by supply/demand conditions 
that had nothing to do with manipulation of supplies or illegal 
agreements among companies.
    Here, for example, is what the FTC said in May 2006 as a result of 
an investigation:\1\
---------------------------------------------------------------------------
    \1\ ``Investigation of Gasoline Price Manipulation and Post-Katrina 
Gasoline Price Increases,'' U.S. Federal Trade Commission, May 22, 
2006.

        .  .  . the best evidence available through our investigation 
        indicated that companies operated their refineries at full 
        sustainable utilization rates. Companies scheduled maintenance 
        downtime in periods when demand was lowest in order to minimize 
        the costs they incur in lost production. Internal company 
        documents suggested that refinery downtime is costly, 
        particularly when demand and prices are high. Companies track 
        these costs, and their documents reflected efforts to minimize 
        unplanned downtime resulting from weather or other unforeseen 
        calamities. Our investigation uncovered no evidence indicating 
        that refiners make product output decisions to affect the 
        market price of gasoline. Instead, the evidence indicated that 
        refiners responded to market prices by trying to produce as 
        much higher-valued products as possible, taking into account 
        crude oil costs and other physical characteristics. The 
        evidence collected in this investigation indicated that firms 
---------------------------------------------------------------------------
        behave competitively.

    Moreover, the current FTC Chairman, Deborah Platt Majoras, has said 
of the oil and natural gas industry: ``No other industry's performance 
is more deeply felt, and no other industry is more carefully 
scrutinized by the FTC.''
    Those who persist in suspecting, despite the massive evidence to 
the contrary, that the industry is holding back supplies often cite the 
lack of new refinery construction. While it is true that no new 
refinery has been built since the 1970s, companies have steadily 
increased the capacity of existing refineries and continue to do so. 
Over the past 10 years, existing refineries have expanded capacity 
equivalent to building 10 new refineries and, based on public 
announcements of refinery expansions, are projected to add capacity 
equivalent to an additional eight new refineries through 2011.
                    causes of higher gasoline prices
    We recognize that today's higher prices are a burden to consumers 
and a threat to the economy. The cause of the higher prices is an 
imbalance between supply and demand, worsened by policy shortcomings.
    U.S. oil companies are working extremely hard to provide Americans 
with the fuels they need and demand. The industry has been making 
record amounts of gasoline, about 8.75 million barrels per day to date 
this year (see Figure 4). However, because of maintenance at European 
refineries, an extended port-workers' strike in France, refinery 
problems in Venezuela and refining disruptions in Nigeria, less 
imported gasoline has been available to contribute to the traditional 
seasonal build in inventories. Typically, imports make up about 12 
percent of gasoline supply. As a result, though gasoline production has 
been at record highs, total U.S. gasoline supplies have struggled to 
keep up with demand, which has been extremely strong. So far in 2007, 
total U.S. gasoline demand has set a record, averaging over 9 million 
barrels a day.
    As noted by the FTC in their August 2004 report on oil industry 
mergers, ``The world price of crude oil is the most important factor in 
the price of gasoline. Over the last 20 years, changes in crude oil 
prices have explained 85 percent of the changes in the price of 
gasoline in the U.S.'' (p.1)
    More than half the cost of gasoline is attributable to the cost of 
crude oil. Crude oil prices have fluctuated significantly, driven by 
lingering geopolitical tensions, OPEC's continuing production controls, 
and worldwide demand growth. Oil companies do not set the price of 
crude. It is bought and sold in international markets, with the price 
for a barrel of crude reflecting the market conditions at the time of 
purchase. It is well recognized that the market for crude oil has 
tightened. World oil demand reached unprecedented levels in 2006 and 
continues to grow due to strong economic growth, particularly in China 
and the United States. World oil spare production capacity--crude that 
can be brought online quickly during a supply emergency or during 
surges in demand--is near its lowest level in 30 years.
    No one company or group of companies has control over global crude 
oil prices. In terms of market power, investor-owned oil companies own 
only 6 percent of the world's proven crude oil reserves. Almost 80 
percent is exclusively controlled by the foreign government-owned 
national oil companies.
    In addition, the annual switchover to ``summer blend'' gasoline 
required by EPA has occurred, and this warm-weather gasoline is more 
expensive to produce. The switchover lowers yields per barrel of oil 
and requires a large supply drawdown to meet regulations, which reduces 
inventories.
    Finally, despite record U.S. gasoline production, regularly 
scheduled refinery maintenance and unexpected problems relating to 
extreme weather, external power outages and other incidents have 
prevented the industry from making even more gasoline. Refinery 
maintenance is a normal procedure, though it has been delayed, in some 
cases, by damage suffered from the catastrophic hurricanes in 2005. 
While maintenance curtails refining operations temporarily, it helps 
ensure the long-term viability of the refinery and protects the health 
and safety of workers.
          higher gasoline prices cannot be viewed in isolation
    Rising gasoline prices are a burden on U.S. consumers--but they 
cannot be viewed in isolation from the overall U.S. energy situation. 
If we are to avoid price volatility and tight supplies and ensure that 
the fuel needs of U.S. consumers are met, we must focus on three areas: 
efficiency, technology, and diversity.

     First, America's energy companies must continue to improve our 
own energy efficiency, and encourage energy efficiency in other 
industries and by the American people;
     Second, we must increase the use of advanced energy technologies 
that allow us to develop our resources cleanly and responsibly; and
     Third, we must increase the diversity of our oil and natural gas 
supplies, both here at home and from around the world.

    One of the first steps toward increasing our energy security is 
making the most of what we already have. We all need to become more 
energy efficient. API member companies pledged to improve aggregate 
energy efficiency at refineries between 2002 and 2012, in response to 
the President's Climate Action Challenge, and we are on track to 
meeting that goal.
    Our efforts go beyond just our operations. Last summer, our 
refineries began to deliver an impressive, new fuel that significantly 
reduces emissions and allows the increased use of energy-efficient 
diesel engines. It's called Ultra Low Sulfur Diesel and it's the 
cleanest diesel fuel supplied in the world today--with a 97 percent 
reduction in sulfur content.
    In addition to energy efficiency, our industry has researched and 
developed breakthrough technologies to help us find, develop and 
deliver energy. For example, we now have 4-Dimensional Imaging, which 
helps us better locate oil underground. Imagine a geoscientist watching 
multiple data screens of 3D visuals revealing exactly what exists below 
the surface--like stepping into the earth and seeing specific rock 
strata: sandstone, limestone, and salt domes, along with oil. Time 
being the fourth dimension, we can take snapshots of those underground 
reservoirs over time and overlay the pictures to see in which direction 
the oil is moving. That's how we find oil today. It's non-invasive and 
more environmentally compatible than ever.
    We also use what's called multi-directional drilling. We can drill 
down at one site, then turn left or right and drill for more than five 
miles, and then go further down or back up--whatever is needed to 
encounter the oil. Advanced techniques like this have dramatically 
reduced our environmental footprint. Today it's possible to develop 
nearly 80 square miles of area below the surface from a single two-acre 
site on the surface. These technological innovations are making a 
difference.
    Just as we need to diversify the kinds of energy we use, we also 
need to acknowledge that a diversity of sources is the best way to 
ensure energy security and meet growing demand. Our country should be 
doing all it can to increase the amount of energy produced in the 
United States. We should encourage the development of alternative and 
renewable sources of energy, which are growing at a rate faster than 
traditional sources.
    However, it's important to place U.S. energy sources in the proper 
perspective. According to the Energy Information Administration (EIA), 
renewable energy presently accounts for about 6 percent of our Nation's 
energy use. And, this EIA figure is projected to climb to 7 percent 
over the next 25 years. Concurrently, the Department of Energy 
estimates that oil, natural gas, and coal will continue to meet 
approximately 86 percent of U.S. energy demand for at least the next 
two decades.
    We have abundant volumes of oil and natural gas resources beneath 
Federal lands and coastal waters. According to Federal Government 
estimates, there is enough oil in these areas to power more than 60 
million cars for 60 years and heat more than 25 million homes for 60 
years. And there is enough natural gas to heat an additional 160 
million homes for another 60 years. However, more than 85 percent of 
coastal waters in the lower-48 states that are up to 200 miles from our 
shores are off-limits to oil and natural gas exploration and 75 percent 
of the most prospective, technically available U.S. onshore areas are 
off-limits or accessible only with significant restrictions.
    If our Nation is to continue to have access to secure, affordable 
energy from today's global marketplace, U.S. oil and natural gas 
companies must be able to successfully compete.
     We need companies that have the scale to manage a large and 
diverse portfolio of global projects and to compete with large foreign 
and government-owned companies.
     Our companies also must have the financial strength to undertake 
the risk involved to make the enormous investments required to develop 
future energy supplies.
     In addition, we need companies committed to developing and 
utilizing leading-edge technologies to enable them to bring harder-to-
reach resources to market.
     Furthermore, competitive companies must have the financial 
resources to make significant investments over time in research and 
development of new technologies to meet ever-changing environmental 
expectations.
                               conclusion
    Oil company mergers and acquisitions have not caused higher 
gasoline prices. We need to focus on the factors shaping higher prices 
and not be misled by claims that have been repeatedly disproved, have 
no basis in fact, and mask root causes.
    The U.S. oil and natural gas industry is doing everything it can to 
produce the fuel supply needed to meet consumer energy needs. However, 
the industry cannot meet U.S. energy challenges alone. Our Nation's 
energy policy needs to focus on increasing supplies; encouraging energy 
efficiency in all sectors of the economy, including transportation; and 
promoting responsible development of alternative and non-conventional 
sources of energy.
 Appendix 1: Genealogy of Major U.S. Oil and Gas Producers and Refiners
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 Appendix 2: U.S. Oil and Natural Gas Industry Earnings and Investments
    There is considerable misunderstanding about U.S. oil and natural 
gas industry earnings. Companies' earnings are typically in line with 
other industries and often lower. For 2006, the industry's annual 
earnings averaged 9.5 cents on each dollar of sales. The average for 
all manufacturing industries was 8.2 cents or about a penny lower. From 
2002 to 2006, average earnings for the industry stood at approximately 
7.4 cents on each dollar of sales--a penny above the 5-year average for 
all U.S. manufacturing industries.
    The oil and natural gas industry is one of the world's largest 
industries. Its revenues are large, but so are its costs of providing 
consumers with the energy they need. Among those are the cost of 
finding and producing oil and natural gas and the costs of refining, 
distributing and marketing it. These costs remain huge, regardless of 
whether earnings are high or low--as was the case throughout most of 
the 1990s and during other industry ``bust'' periods. It is only in 
recent years that the return on investment (net income/net investment 
in place) for the industry has matched or exceeded the returns for the 
S&P industrials. Over the 10-year period 1996-2005, for example, the 
return on investment for the refining sector was 10 percent, or about 
4.7 percent less than the returns realized by the S&P Industrials. Over 
the same period the returns for the more profitable upstream oil and 
gas production sector averaged 13.5 percent. In 2005, the return for 
all three were very close with the S&P Industrials realizing 21 
percent, and refining and marketing 23.5 percent and oil and gas 
production 22.5 percent. (See Figures 1-3.)
    It should not be forgotten that the energy Americans consume today 
is brought to us by investments made years or even decades ago. Today's 
oil and natural gas industry earnings are invested in new technology, 
new production, and environmental and product quality improvements to 
meet tomorrow's energy needs. Between 1992 and 2006, the industry 
invested more than $1.25 trillion in a range of long-term energy 
initiatives: from new exploration and expanding production and refining 
capacity to applying industry leading technology. In fact, over this 
period, our cumulative capital and exploration expenditures exceeded 
our cumulative earnings of $900 billion. New investment in 2006 by 
leading U.S. oil companies reached more than $174 billion, a 29 percent 
increase from 2005.
    Furthermore, the industry's future investments are not focused 
solely on oil and natural gas projects. For example, one oil company is 
among the world's largest producers of photovoltaic solar cells; 
another oil company is the world's largest developer of geothermal 
energy; and the oil and gas industry is the largest producer and user 
of hydrogen. Over the period from 2000 to 2005 in North America alone, 
the industry invested $12 billion in renewable, alternative and 
advanced non-hydrocarbon technologies. In fact, when you add up all of 
the various types of emerging energy technologies, our industry, over 
the 5 years, has invested almost $100 billion--more than two and half 
times as much as the Federal Government and all other U.S. companies 
combined.
    It also requires billions more dollars to maintain the delivery 
system necessary to ensure a reliable supply of energy and to make sure 
it gets where it needs to go: to industry customers. According to the 
Energy Information Administration (EIA), U.S. consumers will need 28 
percent more oil and 19 percent more natural gas in 2030 than in 2005. 
The industry is committed to making the reinvestments that are critical 
to ensuring our Nation has a stable and reliable supply of energy today 
and tomorrow.
    It is also important to understand that those benefiting from 
healthy oil and natural gas industry earnings include numerous private 
and government pension plans, including 401K plans, as well as many 
millions of individual American investors. While shares are owned by 
individual investors, firms, and mutual funds, pension plans own 41 
percent of oil and natural gas company stock. To protect the interest 
of their shareholders and help meet future energy demand, companies are 
investing heavily in finding and producing new supplies.
                                 ______
                                 
            Appendix 3: API Analysis of the 2003 GAO Report
    GAO, in 2003, was asked to examine the price effect of the wave of 
mergers that occurred in the U.S. oil and natural gas industry in the 
1990s. It found that ``increased market concentration generally led to 
higher whole gasoline prices in the U.S. from the mid-1990s through 
2000.''
    GAO's results are measured to within fractions of a cent. It found, 
for example, that wholesale prices for ``conventional gasoline 
increased by less than one-half cent per gallon, on average from 1994 
through 2000. The increases were larger in the West than in the East--
the increases were between one-half cent and 1 cent per gallon in the 
West, and about one-quarter cent in the East (for branded gasoline 
only) on average.'' (p.11). Given the number of mergers GAO attempted 
to analyze at once, and the limitations of the data available to it, as 
well as the approach it used in its analysis, there is simply no way it 
could trace price effects with sufficient credibility.
    The FTC, in a statement issued by Chair Timothy J. Muris shortly 
after its release, had this to say about the GAO report:

        In 30 years as an antitrust enforcer, academic, and consultant 
        on antitrust issues, I have rarely seen a report so 
        fundamentally flawed as the GAO study of several oil mergers 
        that the Federal Trade Commission investigated under my 
        predecessor, Robert Pitofsky. As the Commission unanimously 
        said in its August 2003 letter to the GAO, this report has 
        major methodological mistakes that make its quantitative 
        analyses wholly unreliable; relies on critical factual 
        assumptions that are both unstated and unjustified; and 
        presents conclusions that lack any quantitative foundation. As 
        a result, the report does not meet GAO's own high standards of 
        `accountability, integrity, and reliability' that one expects 
        from its reports and publications.

    At the heart of the problem with the GAO's approach was the idea of 
causality. Essentially, GAO arrived at its conclusion that the mergers 
that occurred during the 1990s increased the wholesale price of 
gasoline by measuring the difference between the price a refiner pays 
for crude oil and the price of the gasoline sold at the refiners rack. 
It measured this price for a period before the mergers took place and 
for a period after the mergers, and saw an increase after the merger 
and concluded the merger was the cause.
    This approach is surprisingly simplistic and misguided. It only 
accounts for a refiner's crude costs; it leaves out all the costs 
incurred by a refinery, such as capital costs, energy costs, and labor 
costs. And it does this at a critical juncture in the history of U.S. 
refineries--just when massive investments in capital expenditures were 
being made by refineries to comply with the 1990 Clean Air Act. Between 
1994 and 2003, for example, the refining sector spent $47 billion on 
environmental expenditures alone. Furthermore, GAO dismissed the need 
to examine these other costs because, it said, ``these inputs comprise 
a small share of the inputs used to produce gasoline'' since ``crude 
oil costs constitute about 66 percent of total refining costs.'' (GAO, 
p.115). When results are measured in pennies and fractions of pennies, 
as GAO's are, leaving out 34 percent of the equation is a stunning 
omission.
    The GAO also completely ignored the introduction of new types of 
gasoline. Over the period studied, the first two phases of the Clean 
Air Act provisions were introduced that required two new more costly 
blends of reformulated gasoline. Also, over the period several new 
higher-cost ``boutique'' blends of gasoline were introduced. GAO 
ignored this cost increase and simply attributed the rise in price due 
to the mergers.
    In addition, the cost of crude oil will vary as a share of the cost 
to refiners. It is not always 66 percent. It depends, in large measure, 
on the price of the crude, as well as capital costs, energy costs and 
labor costs. This can and does vary quite a bit. There was considerable 
volatility in the price of crude oil at exactly the time of the 
mergers. In 1998, for example, the price of crude dropped to just $10 a 
barrel, from around $20 a barrel. Anytime you have sharp changes in 
crude prices, you'll see price adjustments being made at varying speeds 
and heights throughout the wholesale and retail market.
    Also, there are a number of different kinds of crude oil and 
different prices for these crudes. The GAO used the price of West Texas 
Intermediate crude for its analysis. This is a reference spot market 
price. A better measure of what U.S. refiners actually pay for their 
crude oil is to use the refiner's composite acquisition cost. This is a 
volume-weighted average of the price of domestic crude oil and imported 
crude oil. Domestic crude oil is more expensive, on average, than the 
heavier imported crudes. That differential was growing in the 1990s. At 
the same time, refineries were becoming more technologically 
sophisticated in order to produce cleaner-burning fuels. The most 
advanced of them were able to take advantage of the growing difference 
in price between the lighter crude and the heavier imports and process 
more of the heavier cheaper imports. If we are measuring changes in the 
difference between a refiner's rack and the WTI price, we'll get a 
different answer than if we use one of the other crude prices. The 
results vary by several cents per gallon. This is important to note 
because the GAO's results are measured to within fractions of a cent. 
This kind of precision, given the variables the GAO measured, is simply 
not credible.
                       refinery utilization rates
    GAO's interpretation of inventory information and refinery 
utilization rates is also uninformed. For example, it correlates 
national refinery utilization rates with city rack prices. GAO does 
this because it said that regional data was not available. This is 
inaccurate. The national utilization rate is an inadequate choice for 
studying local markets. GAO was apparently unaware that weekly regional 
utilization rates are available for the 12 refining districts from both 
API and the Energy Information Administration.
    Refinery utilization rates are high. Typically, they average over 
90 percent of their capacity. For most industries, utilization rates 
are in the 80 percentile. Refinery utilization rates peaked in the late 
1990s because capacity additions and imports took some pressure off the 
need to run refineries so hard.
    Refinery utilization rates will fluctuate widely during the year 
and in different parts of the country for different reasons. In a 
typical year, refineries shut down for routine maintenance before they 
gear up to produce a new slate of products. So, for example, refiners 
will shut their operations down in the fall in advance of the winter 
season and will start producing more distillate for heating oil and 
less gasoline than they will in the spring and summer months when the 
demand for gasoline is at its peak. This process became increasingly 
complicated during the 1990s because of the number and variety of new 
fuel specifications being introduced during that time in response to 
the Clean Air Act. Different cities, counties, and states adopted 
different fuel specifications with different implementation dates. This 
added to the volatility of gasoline prices during that time. It truly 
complicates the job of discerning merger price impacts from fuel 
specification impacts.
    Even if the GAO had used the refining districts for its analysis, 
rather than national averages, its analysis would not account for such 
things as ``formulation changes, supply disruptions, refinery outages, 
and changes in imports'' (FTC to GAO, p.178). It is not enough to have 
a utilization rate and a price and from that infer some relationship. 
We really need to know the information behind that rate or the 
correlation is meaningless.
                              inventories
    Another variable that GAO relied on to explain the availability and 
price of gasoline at the wholesale level is an inventory ratio, which 
the GAO defined as ``the ratio of gasoline inventories to expected 
demand'' (p.115). GAO apparently intended inventory levels as a proxy 
for ``supply'' or the supply curve, but in reality the supply curve 
includes not just the potential to draw from inventories, but the 
potential for refineries to produce gasoline and the potential for 
imports.
    The ratio does not account for something as simple as the summer/
winter blend difference for gasoline. Summer blends tend to be more 
costly to produce because evaporation must be reduced, which leads to 
more costly inputs to keep octane levels up. That doesn't have anything 
to do with the inventory ratio used by GAO, and strongly suggests there 
may be a type of seasonal price variation that would not be captured by 
that variable.
    In addition, changes in inventory holding costs can affect 
inventory levels. For example, when oil prices are high, a refiner 
might decide to hold a smaller inventory and rely more on producing 
gasoline when needed. This might be more a reflection of the prices and 
not have any direct relationship to the tightness or slackness in the 
gasoline market. Also, there has been a steady decline in privately 
held inventories for many years, reflecting growing efficiencies of 
operations and the steady decline in the market share of several 
products with high seasonal fluctuation (residual fuel for electricity 
generation and distillate for home heating, for example). In short, 
GAO's simplistic assumption that ``prices will increase if inventories 
are low relative to demand and decrease if inventories are high 
relative to demand'' (p.115) does not sufficiently capture the reasons 
for changes in inventories and has the causality of the relationship 
backward.
             gao silent on retail price effects of mergers
    Finally, we find it surprising that GAO never once mentions the 
retail price of gasoline in the areas it measured wholesale prices. 
That would be one of the first things most analysts would check 
wholesale price results against. GAO's silence on this is telling. No 
doubt a spot check would show results all over the board.
    This is a seriously flawed report and ought not be used as the 
basis for public policy decisions.
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Prepared Statement of Dr. James L. Smith, Cary M. Maguire Chair in Oil 
     and Gas Management, Department of Finance, Southern Methodist 
                               University

                The Role of OPEC in the World Oil Market

    The Organization of the Petroleum Exporting Countries (OPEC) is an 
international cartel of oil-producing states that has attempted with 
varied success to manipulate world oil prices during the past 35 years. 
OPEC was founded in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and 
Venezuela, a group of major oil producing countries who wished to 
coordinate national petroleum policies and forge a more united front in 
dealings with the multinational oil companies who were licensed to 
produce and export petroleum from their lands. Within the next dozen 
years, eight additional members (Algeria, Ecuador, Gabon, Indonesia, 
Libya, Nigeria, Qatar, and the United Arab Emirates) joined in, which 
brought the total membership of OPEC to 13 by 1973. At that time, the 
combined membership of OPEC accounted for over half of worldwide crude 
oil production. Two small producers (Gabon and Ecuador) withdrew during 
the 1990s, and in 2007 Angola joined OPEC, bringing current membership 
to 12 nations.
    As with any cartel, OPEC's ability to hold the price of oil above 
the competitive level is dependent upon barriers to entry, which in 
this case hinge upon OPEC's dominant ownership and control of low-cost 
oil reserves. By accident of nature, some 75 percent of the world's 
proved reserves of crude oil are located in OPEC nations. Proved 
reserves constitute that portion of the ultimate resource base that has 
already been discovered and is commercially producible. Additional 
reserves can and will be developed through exploration, discovery, and 
development of new fields, but this process has become increasingly 
difficult and expensive--even more so outside the OPEC nations than 
within. Thus, while production of crude oil from non-OPEC sources does 
expand in response to the higher prices that result when cartel members 
restrict output, the scope for this is limited and will remain so. 
Moreover, OPEC's coordinated efforts to manipulate the price of oil are 
protected from anti-trust enforcement and legal intervention by the 
sovereign rights of its members.
    Economists have debated and tested various theories about how OPEC 
actually goes about exerting its influence on the market, whether 
through the independent initiatives of individual members, via actions 
and strategies undertaken by semi-autonomous coalitions working within 
the larger organization, or through concerted plans embraced and 
executed by the organization as a whole. Some researchers might 
question whether OPEC has ever managed to operate successfully in the 
manner of a classic cartel. Whatever are one's opinions on those 
matters, there is no question that OPEC members have restricted 
production in ways that are unrelated to the inherent scarcity of crude 
oil. Although OPEC's proved oil reserves were steadily rising during 
1973-1985, production was cut by nearly half during that 12-year 
interval, falling from 31 million barrels per day (mbpd) in 1973 to an 
all-time low of 16 mbpd in 1985. Today, OPEC continues to hold 
production below the 1973 level, although the proved oil reserves of 
OPEC members have doubled in volume since then and total worldwide 
consumption of crude oil has grown by roughly 50 percent. It does 
appear that OPEC members have been up to something.
                           evolution of opec
    To better understand OPEC, its history and development can be 
viewed in three phases. During the first phase (1960-1970), OPEC's 
primary objective was to win for its members a larger share of the oil 
profits that private companies generated within their territory. The 
stated goal of increasing government take from 50 percent to 80 percent 
of total profits was pursued largely through the imposition of tax and 
administrative reforms by individual OPEC members, including the 
introduction of fictional ``tax reference prices'' that boosted the tax 
base, and therefore government take, without altering the stated tax 
rate and without much impact on the market price of oil. During this 
phase, there was no direct attempt by OPEC to raise the overall level 
of world oil prices, and perhaps there was not even the realization 
that such a feat would be possible. In those early years, OPEC was 
concerned with winning for itself a bigger share of the pie, rather 
than growing the size of the pie.
    The second phase (1970-1982) saw greater reliance on collective 
deliberations and coordinated actions designed to reverse a long period 
of decline in world oil prices (and therefore tax revenues) that had 
set in after World War II. These efforts began with a series of 
dictated agreements (the so-called Teheran-Tripoli agreements of 1970-
71) by which the OPEC members unilaterally raised posted tax reference 
prices by 21 percent. The members also announced that further increases 
could and would be imposed as they saw fit under the doctrine of 
``changing circumstances,'' one of which was the declining exchange 
value of the dollar, the currency in which oil prices were denominated. 
Indeed, it was during a special OPEC conference convened to review 
these matters that the October 1973 Arab-Israeli war broke out, which 
prompted the Arab members of OPEC to declare an embargo on sales to 
Israel's allies (the United States and the Netherlands). Although the 
embargo did not have much effect on actual deliveries of oil to those 
countries, and was soon rescinded, this bold move panicked the markets 
and fueled a speculative demand for oil inventories, which ultimately 
drove prices in the spot market to unprecedented levels and taught OPEC 
ministers something about the value of their oil. By 1974, the 
``official'' OPEC price had reached $11.25 per barrel, a startling 
increase from the $2.18 price level that had been established just 2 
years before. By 1975, the posted price was no longer merely a 
fictional ``tax reference'' price used by OPEC members to compute their 
share of company profits. Indeed, the multinational companies were 
mostly removed from the equation by a wave of nationalizations that 
began in earnest in 1974, after which OPEC members sold their oil 
outright to whichever customers were willing to pay the official price. 
The posted price was successively increased during the 1970s by 
collective agreement of the OPEC ministers, but the real price of oil 
actually declined as the decade progressed since the posted price 
failed to keep pace with accelerating inflation. Such was the state of 
affairs at the onset of the Iranian Revolution, when the expulsion of 
foreign oil field service firms and a series of labor strikes in 1978 
and 1979 disrupted Iranian output. Disruptions spread to Iraq in 1980 
with the outbreak of the Iran-Iraq war. Again the market panicked, and 
again the OPEC members were taught something about the value of their 
oil. By October, 1981, the posted price of OPEC oil reached $34 per 
barrel (which in real terms still represents the all-time high).
    A sharp downturn in the oil market led to the third (and current) 
phase in OPEC's evolution. Already by 1982, individual OPEC members 
were offering customers large discounts below the ``official'' OPEC 
price in order to maintain or even increase their share of what had 
become a dwindling market. Sluggish OPEC sales and falling prices were 
the product of reduced consumption and rising non-OPEC oil supplies, 
both spurred by the price shocks of the 1970s. To deal with the growing 
surplus of oil in the marketplace, OPEC adopted in March 1983 a formal 
system of production allocations that imposed--for the first time--
individual ceilings on the output of each member. During this third 
phase of OPEC's development, which continues today, OPEC members meet 
at regular intervals (and sometimes more frequently on an emergency 
basis) to review market conditions and adjust members' quotas as needed 
to support or ``defend'' the market price within a desired range. This 
phase of OPEC's history is the one that most resembles the textbook 
example of a cartel, at least outwardly.
                        opec's future prospects
    When judging OPEC's past success or contemplating its future course 
of action, several things must be kept in mind. Foremost is the fact 
that any system of output restraint is vulnerable to the classic free-
rider problem. OPEC as a whole may be made better off by reducing total 
output, but each member has an incentive to produce beyond its assigned 
quota. From the individual member's point of view, marginal revenue 
from incremental sales exceeds the marginal cost of extraction, which 
creates the temptation to cheat. Cartel membership is most beneficial 
to a producer when other members are doing the hard work. But if they 
won't, who will? Without a system to detect and punish cheating, the 
cartel is hampered by a prisoner's dilemma in which the dominant 
strategy for most, if not all, members is to ignore their assigned 
production quotas.
    In fact, OPEC lacks an effective means to monitor, detect, and 
punish members who exceed their quotas. A monthly chart of OPEC's 
combined crude oil production level relative to the agreed ceiling 
indicates the scope and persistence of this problem (see Figure 1). 
Compliance has been sporadic. Since the inception of the quota system, 
total OPEC production of crude oil has exceeded the ceiling by 4 
percent on average, but on numerous occasions the excess has run to 15 
percent or more. For the most part, compliance has been achieved only 
during episodes (like 2005-2006) when the production ceiling itself 
pushed the limits of each member's available production capacity.
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    A second factor that confounds OPEC's attempt to manage the market 
price is the lack of timely and accurate information about changes in 
the level of demand for oil and the availability of non-OPEC oil 
supplies. Several forecasts of demand and supply are available at any 
given time (including those prepared by the U.S. Energy Information 
Administration, the International Energy Agency, and by the OPEC 
Secretariat itself), but the precision of these forecasts is low and 
surprises are frequent. For example, none anticipated the surge in 
Asian demand that triggered the sudden tightening of oil markets in 
2005. OPEC's forecasting problem is compounded by the fact that several 
years may elapse, due to rigidities in both supply and demand, before 
the full impact of a price change can be observed--so if a mistake is 
made, it may go undetected for several years and then take several 
years more to rectify.
    Even if perfect information about future market conditions were 
available, there is no assurance that the interests of individual OPEC 
members could be easily aligned around a single ``correct'' price or 
production target. In part, this is due to the fact that OPEC has very 
limited means by which to redistribute earnings among members. 
Therefore, any given set of quotas determines not only the overall 
profit of OPEC, but also the individual revenues that accrue to each 
member.
    If the members were more homogeneous demographically and 
economically, the problem of misaligned interests would be less severe. 
As things happen, however, large volumes of low-cost reserves are 
concentrated in certain countries with small populations and relatively 
high incomes (e.g., Kuwait, Saudi Arabia, and the United Arab 
Emirates), while smaller volumes of higher-cost reserves are found in 
populous and relatively poor countries (e.g., Nigeria, Indonesia, and 
Venezuela). Table 1 sets forth some of the more salient differences 
among the members of OPEC. The potential for conflicting interests 
involves not only the question of which members ``deserve'' larger 
quotas, but what is the preferred market price level for OPEC oil. What 
price would the respective members of the cartel like to see? Members 
with low-cost, long-lived reserves will take a long view of the future 
and may be reluctant to push prices too high given the fear of induced 
technological innovations that would usher in new forms of energy (or 
energy conservation) that eventually compete against OPEC. Members 
holding fewer reserves and shorter horizons are less vulnerable to this 
type of risk and therefore perhaps less averse to high prices. Internal 
divisions between ``price hawks'' and ``price doves'' have been 
observed previously and will likely surface within OPEC again.

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    A final factor that looms large in the future of OPEC is the role 
to be played by serendipitous events and geopolitical tensions. A large 
portion of OPEC's apparent historical impact on the price of oil has 
come about not as the result of deliberate plans crafted by a 
purposeful cartel, but as the by-product of clashing national agendas 
that encompass far more than the petroleum sector. During the past 35 
years, most of the idle capacity held by OPEC members has been 
involuntary--taken out of production due to military conflict. Much of 
the hard work that any cartel has to do--commanding the determination 
and discipline to restrict output--has in OPEC's case been provided 
fortuitously. For that reason, the ultimate strength and cohesion of 
OPEC has perhaps not yet been tested.
    The value of crude oil produced and sold on the world market 
exceeds $1 billion each day. Even a relatively small impact on the unit 
price of oil represents an enormous transfer of wealth between 
consumers and producers. Moreover, the disruptive impact of sudden 
price ``shocks'' and heightened volatility threatens the goal of 
sustained and steady global economic growth. As consumers, investors, 
and government officials continue to wrestle with these problems, it is 
no exaggeration to say that OPEC has left an indelible imprint on the 
world economy through its impact on the price of oil.
  

                                  
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