Energy Markets: Mergers and Other Factors that Affect the U.S.	 
Refining Industry (15-JUL-04, GAO-04-982T).			 
                                                                 
Gasoline is subject to dramatic price swings. A multitude of	 
factors affect U.S. gasoline markets, including world crude oil  
costs and limited refining capacity. Since the 1990s, another	 
factor affecting U.S. gasoline markets has been a wave of mergers
in the petroleum industry, several between large oil companies	 
that had previously competed with each other. For example, in	 
1999, Exxon, the largest U.S. oil company, merged with Mobil, the
second largest. This testimony is based primarily on Energy	 
Markets: Effects of Mergers and Market Concentration in the U.S. 
Petroleum Industry (GAO-04-96, May 17, 2004). This report	 
examined mergers in the industry from the 1990s through 2000, the
changes in market concentration (the distribution of market	 
shares among competing firms) and other factors affecting	 
competition in the industry, how U.S. gasoline marketing has	 
changed since the 1990s, and how mergers and market concentration
in the industry have affected U.S. gasoline prices at the	 
wholesale level. To address these issues, GAO purchased and	 
analyzed a large body of data and developed state-of-the art	 
econometric models for isolating the effects of eight specific	 
mergers and increased market concentration on wholesale gasoline 
prices. Experts peer-reviewed GAO's analysis.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-982T					        
    ACCNO:   A10954						        
  TITLE:     Energy Markets: Mergers and Other Factors that Affect the
U.S. Refining Industry						 
     DATE:   07/15/2004 
  SUBJECT:   Competition					 
	     Corporate mergers					 
	     Cost analysis					 
	     Gasoline						 
	     Petroleum industry 				 
	     Petroleum prices					 
	     Price regulation					 
	     Prices and pricing 				 
	     Energy marketing					 
	     Joint ventures					 
	     Petroleum products 				 

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GAO-04-982T

United States Government Accountability Office

GAO Testimony

Before the Subcommittee on Energy and Air Quality, Committee on Energy and
Commerce, House of Representatives

For Release on Delivery

Expected at 11:00 a.m. EDT ENERGY MARKETS

Thursday, July 15, 2004

        Mergers and Other Factors that Affect the U.S. Refining Industry

Statement of Jim Wells, Director Natural Resources and Environment

GAO-04-982T

Highlights of GAO-04-982T, a report to Subcommittee on Energy and Air
Quality, Committee on Energy and Commerce, House of Representatives

Gasoline is subject to dramatic price swings. A multitude of factors
affect U.S. gasoline markets, including world crude oil costs and limited
refining capacity. Since the 1990s, another factor affecting U.S. gasoline
markets has been a wave of mergers in the petroleum industry, several
between large oil companies that had previously competed with each other.
For example, in 1999, Exxon, the largest U.S. oil company, merged with
Mobil, the second largest.

This testimony is based primarily on Energy Markets: Effects of Mergers
and Market Concentration in the U.S. Petroleum Industry (GAO-04-96, May
17, 2004). This report examined mergers in the industry from the 1990s
through 2000, the changes in market concentration (the distribution of
market shares among competing firms) and other factors affecting
competition in the industry, how U.S. gasoline marketing has changed since
the 1990s, and how mergers and market concentration in the industry have
affected U.S. gasoline prices at the wholesale level.

To address these issues, GAO purchased and analyzed a large body of data
and developed stateof-the art econometric models for isolating the effects
of eight specific mergers and increased market concentration on wholesale
gasoline prices. Experts peerreviewed GAO's analysis.

www.gao.gov/cgi-bin/getrpt?GAO-04-982T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202) 512-3841
or [email protected].

July 15, 2004

ENERGY MARKETS

Mergers and Other Factors that Affect the U.S. Refining Industry

Mergers have altered the structure of the U.S. petroleum industry,
including the refining market. Over 2,600 mergers have occurred in the
U.S. petroleum industry since the 1990s, mostly later in the period.
Industry officials cited various reasons for the mergers, particularly the
need for increased efficiency and cost savings. Economic literature also
suggests that firms sometimes merge to enhance their ability to control
prices.

Partly because of the mergers, market concentration has increased in the
industry, mostly in the downstream (refining and marketing) segment. For
example, market concentration in refining increased from moderately to
highly concentrated in the East Coast and from unconcentrated to
moderately concentrated in the West Coast. Concentration in the wholesale
gasoline market increased substantially from the mid-1990s so that by
2002, most states had either moderately or highly concentrated wholesale
gasoline markets. Anecdotal evidence suggests that mergers also have
changed other factors affecting competition, such as the ability of new
firms to enter the market.

Two major changes have occurred in U.S. gasoline marketing related to
mergers, according to industry officials. First, the availability of
generic gasoline, which is generally priced lower than branded gasoline,
has decreased substantially. Second, refiners now prefer to deal with
large distributors and retailers, which has motivated further
consolidation in distributor and retail markets.

Based on data from the mid-1990s through 2000, GAO's econometric analyses
indicate that mergers and increased market concentration generally led to
higher wholesale gasoline prices in the United States. Six of the eight
mergers GAO modeled led to price increases, averaging about 1 cent to 2
cents per gallon. Increased market concentration, which reflects the
cumulative effects of mergers and other competitive factors, also led to
increased prices in most cases. For example, wholesale prices for boutique
fuels sold in the East and Gulf Coasts-fuels supplied by fewer refiners
than conventional gasoline-increased by about 1 cent per gallon, while
prices for boutique fuels sold in California increased by over 7 cents per
gallon. GAO also identified price increases of one-tenth of a cent to 7
cents that were caused by other factors included in the models,
particularly low gasoline inventories relative to demand, supply
disruptions in some regions, and high refinery capacity utilization rates.
For example, we found that a 1 percent increase in refinery capacity
utilization rates resulted in price increases of one-tenth to two-tenths
of a cent per gallon.

FTC disagreed with GAO's methodology and findings. However, GAO believes
its analyses are sound.

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to participate in discussing issues
related to the "Status of the U.S. Refining Industry." Refining transforms
crude oil into a wide range of petroleum products, with gasoline
accounting for about half of U.S. refinery output.

Data from the Energy Information Administration (EIA) indicate that there
are currently 149 refineries in the United States with a total crude oil
distillation capacity of about 16.9 million barrels per day. As we
testified in 2001, each day vehicles in the United States consume about 10
million barrels of petroleum fuels, primarily gasoline and diesel, and
according to projections, the figure will rise to about 15 million barrels
per day by 2010, raising concerns about our ability to satisfy this
growing demand. According to the United States Energy Association, no new
major refinery has been built on the U.S. mainland in the last 25 years,
and the nation's overall distillation capacity has declined more than 10
percent since the peak in 1981.

Concerns have also been raised about recent price increases for gasoline.
EIA data show that the average retail price for regular gasoline (the type
of gasoline used most in the United States) recently hit a nationwide high
of $2.06 cents/gallon by the end of May 2004, an increase of about 58
cents/gallon or 39 percent over the same time last year. In some parts of
the country, such as the West Coast, gasoline prices reached an average of
$2.34 cents/gallon by the end of May 2004, an increase of about 65
cents/gallon or 38 percent over the same time last year. Although prices
have recently begun to fall, elevated gasoline prices can be an economic
burden to American consumers and the economy.

A broad range of factors affects gasoline prices and its volatility. These
factors typically include changes in crude oil costs, refinery capacity,
inventory levels relative to demand, supply disruptions, and regulatory
factors-such as many different gasoline formulations that are required to
meet varying federal and state environmental laws. Federal and state taxes
are also a component of U.S. gasoline prices, but these do not fluctuate
often. We have addressed many of these issues in several studies on energy
markets. Among other things, our past studies showed that

o  	the U.S. economy is vulnerable to oil supply disruptions and options
were identified to mitigate their effects;

o  	the Clean Air Act specifically requires refiners to produce
reformulated gasoline, and the requirement to provide a specific blend for
a specific area can present challenges to refiners and other suppliers if
there are supply disruptions;

o  	most spikes in gasoline prices appear to result from such factors as
increases in world crude oil prices, unexpected refinery outages, or
largerthan-expected increase in demand; and

o  	gasoline price spikes were generally higher in California from January
1995 through December 1999 than in the rest of the nation, partly because
there were unplanned refinery outages and it was difficult to substitute
for the loss of supply of CARB, the special reformulated gasoline used in
California.

Market consolidation is another factor that can affect the price of
gasoline. Our testimony today will focus on our recent study that examined
the effects of market consolidation-including increased market
concentration in refining-and other factors related to the U. S. petroleum
industry.1

Since the 1990s, the U.S. petroleum industry has 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.2 A few examples include the merger between British
Petroleum (BP) and Amoco in 1998 to form BPAmoco, which later merged with
ARCO, and the merger in 1999 between Exxon, the largest U.S. oil company,
and Mobil, the second largest. In general, mergers raise concerns about
potential anticompetitive effects on the U.S. petroleum industry and
ultimately on gasoline prices because mergers could result in greater
market power for the merged companies, potentially allowing

1See U.S. General Accounting Office, Energy Markets: Effects of Mergers
and Market Concentration in the U.S. Petroleum Industry, GAO-04-96
(Washington, D.C., May 17, 2004). Additional related GAO studies include
U.S. Ethanol Market: MTBE Ban in California, GAO-02-440R (Washington,
D.C., Feb. 27, 2002); Alternative Motor Fuels and Vehicles: Impact on the
Transportation Sector, GAO-01-957T (Washington, D.C., July 10, 2001);
Motor Fuels: California Gasoline Price Behavior, GAO/RCED-96-121
(Washington, D.C., Apr. 28, 2000); International Energy Agency: How the
Agency Prepares Its World Market Statistics, GAO/RCED-99-142 (Washington,
D.C., May 7, 1999); and Energy Security: Evaluating U.S. Vulnerability to
Oil Supply Disruptions and Options for Mitigating Their Effects,
GAO/RCED-97-6 (Washington, D.C., Dec. 12, 1996).

2We refer to all of these transactions as mergers.

them to increase prices above competitive levels.3 On the other hand,
mergers could also yield cost savings and efficiency gains, which may be
passed on to consumers in lower prices. Ultimately, the impact depends on
whether market power or efficiency dominates.

Our report examined mergers in the U.S. petroleum industry from the 1990s
through 2000; the changes in market concentration (the distribution of
market shares among competing firms) in the different segments, including
refining, and other factors affecting competition in the U.S. petroleum
industry; how U.S. gasoline marketing has changed since the 1990s; and how
mergers and market concentration in the U.S. petroleum industry have
affected U.S. gasoline prices at the wholesale level.

To address these issues, we purchased and analyzed a large body of data on
mergers and wholesale gasoline prices, as well as data on other relevant
economic factors, including refinery capacity. We also developed
econometric models for examining the effects of eight specific mergers and
increased market concentration on U.S. wholesale gasoline prices
nationwide. It is noteworthy that using econometric models allowed us to
measure the effects of mergers and market concentration while isolating
the effects of several other factors that could influence wholesale
gasoline prices, such as world crude oil costs, limited refining capacity,
or low inventories relative to demand. For our market concentration model,
we used concentration data measured at the refining level. We believe that
the source of potential market power in the wholesale gasoline market is
at the refining level because the refinery market is imperfectly
competitive and refiners essentially control gasoline sales at the
wholesale level.

In the course of our work, we consulted with Dr. Severin Borenstein,4 a
recognized expert in the modeling of gasoline markets; interviewed
officials across the industry spectrum; and reviewed relevant economic
literature and numerous related studies. We also used an extensive peer
review process to obtain comments from experts in academia and relevant

3Federal 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.

4Dr. Borenstein is E.T. Grether Professor of Business Administration and
Public Policy at the Haas School of Business, University of California,
Berkeley. He is also the Director of the University of California Energy
Institute.

government agencies. We conducted our work in accordance with generally
accepted government auditing standards.

In summary, we found the following:

o  	Over 2,600 mergers occurred in the petroleum industry from 1991
through 2000, mostly during the second half of the decade. Petroleum
industry officials cited various reasons for this wave of mergers,
particularly the need for increased efficiency and cost savings. Economic
literature suggests that firms also sometimes use mergers to enhance their
market power. Ultimately, the reasons cited by both sources generally
relate to the merging companies' desire to maximize profit or shareholder
wealth.

o  	Market concentration, which is commonly measured by the
Herfindahl-Hirschman Index (HHI), has increased in the downstream
(refining and marketing) segment of the U.S. petroleum industry since the
1990s, partly as a result of merger activities, while changing very little
in the upstream (exploration and production) segment. Of particular
interest to this subcommittee, market concentration in refining increased,
although the levels as well as the changes varied geographically. For
example, market concentration in refining increased from moderately to
highly concentrated in the East Coast and from unconcentrated to
moderately concentrated in the West Coast; it increased but remained
moderately concentrated in the Rocky Mountain region. Concentration in the
wholesale gasoline market increased substantially from the mid-1990s so
that by 2002, most states had either moderately or highly concentrated
wholesale gasoline markets. Anecdotal evidence suggests that mergers may
also have affected other factors that impact competition, such as the
ability of new firms to enter the market.

o  	According to industry officials, two major changes have occurred in
U.S. gasoline marketing since the 1990s, partly related to mergers. First,
the availability of unbranded (generic) gasoline has decreased
substantially. Unbranded gasoline is generally priced lower than branded
gasoline, which is marketed under the refiner's trademark. Industry
officials generally attributed the decreased availability of unbranded
gasoline to, among other factors, a reduction in the number of independent
refiners that typically supply unbranded gasoline. Second, industry
officials said that refiners now prefer dealing with large distributors
and retailers. This preference, according to the officials, has motivated
further consolidation in both the distributor and retail markets,
including the rise of hypermarkets-a relatively new breed of gasoline
market participants that includes such large retail warehouses as Wal-Mart
and Costco.

o  	Our econometric analyses, using data from the mid-1990s through 2000,
show that oil industry mergers generally led to higher wholesale gasoline
prices (measured in our report as wholesale prices less crude oil prices),
although prices sometimes decreased. Six of the eight specific mergers we
modeled-which mostly involved large, fully vertically integrated
companies-generally resulted in increases in wholesale prices for branded
and/or unbranded gasoline of about 2 cents per gallon, on average. Two of
the mergers generally led to price decreases averaging about 1 cent per
gallon. The preponderance of price increases over decreases indicates that
the market power effects, which tend to increase prices, for the most part
outweighed the efficiency effects, which tend to decrease prices.

o  	Our econometric analyses also show that increased market
concentration, which captures the cumulative effects of mergers as well as
other market structure factors, also generally led to higher prices for
conventional gasoline and for boutique fuels-gasoline that has been
reformulated for certain areas in the East Coast and Gulf Coast regions
and in California to lower pollution. The price increases were
particularly large in California, where they averaged about 7 cents per
gallon.

o  	Higher wholesale gasoline prices were also a result of other factors:
high refinery capacity utilization rate; low gasoline inventories, which
typically occur in the summer driving months; and supply disruptions,
which occurred in the Midwest and on the West Coast. We identified price
increases of one-tenth of 1 cent to 7 cents per gallon that were caused by
other factors included in our models-particularly low gasoline inventories
relative to demand, high refinery capacity utilization rates, and supply
disruptions that occurred in some regions. For example, we found that a 1
percent increase in refinery capacity utilization rates resulted in price
increases of one-tenth to two-tenths of a cent per gallon. We found that
prices were higher because higher refinery capacity utilization rates
leave little room for error in predicting short-run demand. During the
period of our study, refinery capacity utilization rates at the national
level averaged about 94 percent per week. Just last week, DOE testified
that U.S. refineries are running at near total capacity of about 96
percent.

As I noted earlier, we used extensive peer review to obtain comments from
outside experts, including FTC and EIA, and we incorporated those comments
as appropriate. FTC disagreed with our methodology and findings and
provided extensive comments, which we have addressed in our report. Our
findings are generally consistent with previous studies of the effects of
specific oil mergers and of market concentration on gasoline prices. We
believe, however, that ours is the first comprehensive study to

model the impact of the industry's 1990s wave of mergers on wholesale
gasoline prices for the entire United States, an effort that required us
to acquire large datasets and perform complex analyses.

Background 	Many firms of varying sizes make up the U.S. petroleum
industry. While some firms engage in only limited activities within the
industry, such as exploration for and production of crude oil and natural
gas or refining crude oil and marketing petroleum products, fully
vertically integrated oil companies participate in all aspects of the
industry. Before the 1970s, major oil companies that were fully vertically
integrated controlled the global network for supplying, pricing, and
marketing crude oil. However, the structure of the world crude oil market
has dramatically changed as a result of such factors as the
nationalization of oil fields by oil-producing countries, the emergence of
independent oil companies, and the evolution of futures and spot markets
in the 1970s and 1980s. Since U.S. oil prices were deregulated in 1981,
the price paid for crude oil in the United Stated has been largely
determined in the world oil market, which is mostly influenced by global
factors, especially supply decisions of the Organization of Petroleum
Exporting Countries (OPEC) and world economic and political conditions.

The United States currently imports over 60 percent of its crude oil
supply. In contrast, the bulk of the gasoline used in the United States is
produced domestically. In 2001, for example, gasoline refined in the
United States accounted for over 90 percent of the total domestic gasoline
consumption. Companies that supply gasoline to U.S. markets also post the
domestic gasoline prices. Historically, the domestic petroleum market has
been divided into five regions: the East Coast region, the Midwest region,
the Gulf Coast region, the Rocky Mountain region, and the West Coast
region. (See fig. 1.) These regions are known as Petroleum Administration
for Defense Districts (PADDs).

Figure 1: Petroleum Administration for Defense Districts

Proposed mergers in all industries, including the petroleum industry, 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. According to FTC officials, FTC
generally reviews proposed mergers involving the petroleum industry
because of the agency's expertise in that industry. FTC analyzes these
mergers to determine if they would likely diminish competition in the

relevant markets and result in harm, such as increased prices. To
determine the potential effect of a merger on market competition, FTC
evaluates how the merger would change the level of market concentration,
among other things. Conceptually, the higher the concentration, the less
competitive the market is and the more likely that firms can exert control
over prices. The ability to maintain prices above competitive levels for a
significant period of time is known as market power.

According to the merger guidelines jointly issued by DOJ and FTC, market
concentration as measured by HHI is ranked into three separate categories:
a market with an HHI under 1,000 is considered to be unconcentrated; if
HHI is between 1,000 and 1,800 the market is considered moderately
concentrated; and if HHI is above 1,800, the market is considered highly
concentrated.5

While concentration is an important aspect of market structure-the
underlying economic and technical characteristics of an industry-other
aspects of market structure that may be affected by mergers also play an
important role in determining the level of competition in a market. These
aspects include barriers to entry, which are market conditions that
provide established sellers an advantage over potential new entrants in an
industry, and vertical integration.

Over 2,600 merger transactions occurred from 1991 through 2000 involving
all three 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 about 13 percent, and the midstream segment (transportation)
accounted for over 2 percent. The vast majority of the mergers-about 80
percent-involved one company's purchase of a segment or asset of another
company, while about 20 percent involved the acquisition of a company's
total assets by another so that the two became one company. Most of the
mergers occurred in the second half of the decade, including those
involving large partially or fully vertically integrated companies.

5HHI is calculated by summing the squares of the market shares of all the
firms within a given market.

  Mergers Occurred in All Segments of the U.S. Petroleum Industry in the 1990s
  for Several Reasons

  Mergers Contributed to Increases in Market Concentration and to Other Changes
  That Affect Competition

Petroleum industry officials and experts we contacted cited several
reasons for the industry's wave of mergers in the 1990s, including
achieving synergies, increasing growth and diversifying assets, and
reducing costs. Economic literature indicates that enhancing market power
is also sometimes a motive for mergers. Ultimately, these reasons mostly
relate to companies' desire to maximize profit or stock values.

Mergers in the 1990s contributed to increases in market concentration in
the downstream (refining and marketing) segment of the U.S. petroleum
industry, while the upstream segment experienced little change.

Overall, the refining market experienced increasing levels of market
concentration (based on refinery capacity) in all five PADDs during the
1990s, especially during the latter part of the decade, but the levels as
well as the changes of concentration varied geographically.

In PADD I-the East Coast-the HHI for the refining market increased from
1136 in 1990 to 1819 in 2000, an increase of 683 (see fig. 2).
Consequently, this market went from moderately concentrated to highly
concentrated. Compared to other U.S. PADDs, a greater share of the
gasoline consumed in PADD I comes from other supply sources-mostly from
PADD III and imports-than within the PADD. Consequently, some industry
officials and experts believe that the competitive impact of increased
refiner concentration within the PADD could be mitigated.6

6However, if the same PADD I refiners are also mostly responsible for
importing gasoline into the PADD, it could have implications for the
PADD's wholesale gasoline market concentration. In addition, the extent to
which these companies control vital infrastructure, such as terminals and
pipelines, within the region could impact competitive conditions.

Figure 2: Refining Market Concentration for PADD I Based on Crude Oil
Distillation Capacity (1990-2000)

Note: Data for 1996 and 1998 were unavailable.

For PADD II (the Midwest), the refinery market concentration increased
from 699 to 980 -an increase of 281-between 1990 and 2000. However, as
figure 3 shows, this PADD's refining market remained unconcentrated at the
end of the decade. According to EIA's data, as of 2001, the quantity of
gasoline refined in PADD II was slightly less than the quantity consumed
within the PADD.

Figure 3: Refining Market Concentration for PADD II Based on Crude Oil
Distillation Capacity (1990-2000)

Note: Data for 1996 and 1998 were unavailable.

The refining market in PADD III (the Gulf Coast), like PADD II, was
unconcentrated as of the end of 2000, although its HHI increased by 170-
from 534 in 1990 to 704 in 2000 (see fig. 4). According to EIA's data,
much more gasoline is refined in PADD III than is consumed within the
PADD, making PADD III the largest net exporter of gasoline to other parts
of the United States.

Figure 4: Refining Market Concentration for PADD III Based on Crude Oil
Distillation Capacity (1990-2000)

Note: Data for 1996 and 1998 were unavailable.

The HHI for the refining market in PADD IV-the Rocky Mountain region-where
gasoline production and consumption are almost balanced-increased by 95
between 1990 and 2000. This increase changed the PADD's refining market
from 1029 in 1990 to 1124 in 2000, within the moderate level of market
concentration (see fig. 5).

Figure 5: Refining Market Concentration for PADD IV Based on Crude Oil
Distillation Capacity (1990-2000)

Note: Data for 1996 and 1998 were unavailable.

The refining market's HHI for PADD V-the West Coast-increased from 937 to
1267, an increase of 330, between 1990 and 2000 and changed the West Coast
refining market, which produces most of the gasoline it consumes, from
unconcentrated to moderately concentrated by the end of the decade (see
fig. 6).7

7Some industry officials and experts believe that the California refining
market, which is a part of PADD V, is more concentrated than the PADD as a
whole because a unique (CARB) gasoline consumed in the state and the
production of the gasoline is dominated by a few large refiners.

Figure 6: Refining Market Concentration for PADD V Based on Crude Oil
Distillation Capacity (1990-2000)

Note: Data for 1996 and 1998 were unavailable.

We estimated a high and statistically significant degree of correlation
between merger activity and the HHIs for refining in PADDs I, II, and V
for 1991 through 2000. Specifically, the corresponding correlation numbers
are 91 percent for PADD V (West Coast), 93 percent for PADD II (Midwest),
and 80 percent for PADD I (East Coast). While mergers were positively
correlated with refining HHIs in PADDs III and IV-the Gulf Coast and the
Rocky Mountains-the estimated correlations were not statistically
significant.

In wholesale gasoline markets, market concentration increased broadly
throughout the United States between 1994 and 2002. Specifically, we found
that 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.

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.

Concerning barriers to entry, our interviews with petroleum industry
officials and experts provide 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.

According to some petroleum industry officials that we interviewed,
gasoline marketing in the United States has changed in two major ways
since the 1990s. First, the availability of unbranded gasoline has
decreased, partly due to mergers. Officials noted that unbranded gasoline
is generally priced lower than branded. They generally attributed the
decreased availability of unbranded gasoline to one or more of the
following factors:

o  	There are now fewer independent refiners, who typically supply mostly
unbranded gasoline. These refiners have been acquired by branded
companies, have grown large enough to be considered a brand, or have
simply closed down.

o  	Partially or fully vertically integrated oil companies have sold or
mothballed some refineries. As a result, some of these companies now have
only enough refinery capacity to supply their own branded needs, with
little or no excess to sell as unbranded.

  U.S. Gasoline Marketing Has Changed in Two Major Ways

o  	Major branded refiners are managing their inventory more efficiently,
ensuring that they produce only enough gasoline to meet their current
branded needs. We could not quantify the extent of the decrease in the
unbranded gasoline supply because the data required for such analyses do
not exist.

The second change identified by these officials is that refiners now
prefer dealing with large distributors and retailers because they present
a lower credit risk and because it is more efficient to sell a larger
volume through fewer entities. Refiners manifest this preference by
setting minimum volume requirements for gasoline purchases. These
requirements have motivated further consolidation in the distributor and
retail sectors, including the rise of hypermarkets.

Mergers and Our econometric modeling shows that the mergers we examined
mostly

led to higher wholesale gasoline prices in the second half of the 1990s.
The Increased Market majority of the eight specific mergers we
examined-Ultramar Diamond Concentration Shamrock (UDS)-Total,
Tosco-Unocal, Marathon-Ashland, Shell-Texaco I

(Equilon), Shell-Texaco II (Motiva), BP-Amoco, Exxon-Mobil, andGenerally
Led to Marathon Ashland Petroleum (MAP)-UDS-resulted in higher prices of
Higher U.S. Wholesale wholesale gasoline in the cities where the merging
companies supplied

gasoline before they merged. The effects of some of the mergers
wereGasoline Prices inconclusive, especially for boutique fuels sold in
the East Coast and Gulf Coast regions and in California.

o  	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.

o  	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.

o  	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 exceeded 6
cents per gallon, on average.

For market concentration, which captures the cumulative effects of mergers
as well as other competitive factors, our econometric analysis shows that
increased market concentration resulted in higher wholesale gasoline
prices.

o  	Prices for conventional (non-boutique) gasoline, the dominant type of
gasoline sold nationwide from 1994 through 2000, increased by less than
one-half cent per gallon, on average, for branded and unbranded gasoline.
The increases were larger in the West than in the East-the increases were
between one-half cent and one cent per gallon in the West, and about
onequarter cent in the East (for branded gasoline only), on average.

o  	Price increases for boutique fuels sold in some parts of the East
Coast and Gulf Coast regions and in California were larger compared to the
increases for conventional gasoline. The wholesale prices increased by an
average of about 1 cent per gallon for boutique fuel sold in the East
Coast and Gulf Coast regions between 1995 and 2000, and by an average of
over 7 cents per gallon in California between 1996 and 2000.

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. For
refinery capacity utilization rates, we found that prices were higher by
about an average of one-tenth to two-tenths of 1 cent per gallon when
utilization rates increased by 1 percent. We found that prices were higher
because higher refinery capacity utilization rates leave little room for
error in predicting short-run demand. During the period of our study,
refinery capacity utilization rates at the national level averaged about
94 percent per week.

Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Subcommittee may
have.

GAO Contacts and For further information about this testimony, please
contact me at (202) 512-3841. Key contributors to this testimony included
Godwin Agbara,Staff John A. Karikari, and Cynthia Norris.

  Acknowledgments

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