Energy Markets: Factors Contributing to Higher Gasoline Prices	 
(01-FEB-06, GAO-06-412T).					 
                                                                 
Soaring retail gasoline prices, increased oil company profits,	 
and mergers of large oil companies have garnered extensive media 
attention and generated considerable public concern. Gasoline	 
prices impact the economy because of our heavy reliance on motor 
vehicles. According to the Department of Energy's Energy	 
Information Administration (EIA), each additional ten cents per  
gallon of gasoline adds about $14 billion to America's annual	 
gasoline bill. Given the importance of gasoline for the nation's 
economy, it is essential to understand the market for gasoline	 
and how prices are determined. In this context, this testimony	 
addresses the following questions: (1) What factors affect	 
gasoline prices? (2) What has been the pattern of oil company	 
mergers in the United States in recent years? (3) What effects	 
have mergers had on market concentration and wholesale gasoline  
prices? To address these questions, GAO relied on previous	 
reports, including (1) a 2005 GAO primer on gasoline prices, (2) 
a 2005 GAO report on the proliferation of special gasoline	 
blends, and (3) a 2004 GAO report on mergers in the U.S.	 
petroleum industry. GAO also collected updated data from a number
of sources that we deemed reliable. This work was performed in	 
accordance with generally accepted government auditing standards.
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-412T					        
    ACCNO:   A46178						        
  TITLE:     Energy Markets: Factors Contributing to Higher Gasoline  
Prices								 
     DATE:   02/01/2006 
  SUBJECT:   Corporate mergers					 
	     Cost analysis					 
	     Crude oil						 
	     Fuel gas industry					 
	     Fuel prices					 
	     Gasoline						 
	     Petroleum industry 				 
	     Petroleum prices					 
	     Petroleum products 				 
	     Prices and pricing 				 

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GAO-06-412T

     

     * Crude Oil Prices and Other Factors Affect Gasoline Prices
     * Mergers Occurred in All Segments of the U.S. Petroleum Indus
     * Mergers in the 1990s Increased Market Concentration and Led
     * Concluding Observations
     * GAO Contacts and Staff Acknowledgments
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Testimony

Before the Committee on the Judiciary, United States Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 9:30 a.m. EST

Wednesday, February 1, 2006

ENERGY MARKETS

Factors Contributing to Higher Gasoline Prices

Statement of Jim Wells, Director Natural Resources and Environment

Energy Markets Energy Markets Energy Markets Energy Markets Energy Markets
Energy Markets Energy Markets Energy Markets Energy Markets

GAO-06-412T

Mr. Chairman and Members of the Committee:

I am pleased to participate in the Committee's hearing to discuss the
factors that influence gasoline prices, including oil company mergers.
Soaring retail gasoline prices, increased oil company profits, and mergers
of large oil companies have garnered extensive media attention and
generated considerable public concern, particularly in the immediate
aftermath of hurricanes Katrina and Rita. More recently, retail gasoline
prices have fallen from those extremes but remain considerably higher than
they were for much of the past decade. In 2004, the United States consumed
about 20.5 million barrels per day of crude oil accounting for roughly 25
percent of world oil production. About half of the crude oil consumed in
this country goes into production of gasoline. High gasoline prices impact
the economy because of our heavy reliance on motor vehicles-the United
States consumes roughly 45 percent of all gasoline consumed in the world.
To put this in context, according to the Department of Energy's Energy
Information Administration (EIA), nationally, each additional ten cents
per gallon of gasoline adds about $14 billion to America's annual gasoline
bill.

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. Demand for
petroleum products has been rising at a faster rate than domestic refining
capacity and the difference has come from imports, including gasoline from
Europe. Although refining capacity has risen gradually since the mid 1980s
as refineries are upgraded, no new major refinery has been built on the
U.S. mainland in the last 25 years. Looking forward, domestic demand for
petroleum products is projected to increase by about 20 percent by 2020,
raising concerns about our ability to satisfy growing demand for gasoline
and other petroleum products without increasingly relying on imports.

Given the importance of gasoline for our economy, it is essential to
understand the market for gasoline and how prices are determined. In this
context, this testimony addresses the following questions: (1) What
factors affect gasoline prices? (2) What has been the pattern of oil
company mergers in the United States in recent years? (3) What effects
have mergers had on market concentration and wholesale gasoline prices?

To address these questions, we relied on previous GAO reports on gasoline
prices and other aspects of the petroleum industry, including (1) a 2005
GAO primer on gasoline prices, (2) a 2005 GAO report on the proliferation
of special gasoline blends, and (3) a 2004 GAO report on mergers in the
U.S. petroleum industry.1 We also collected updated data from a number of
sources that we deemed reliable. This work was performed in accordance
with generally accepted government auditing standards.

In summary we found the following:

           o  Crude oil prices are the fundamental determinant of gasoline
           prices. A number of other factors also affect gasoline prices
           including (1) refinery capacity in the United States, which has
           not expanded at the same pace as demand for gasoline in recent
           years; (2) gasoline inventories maintained by refiners or
           marketers of gasoline, which have seen a general downward trend in
           recent years; and (3) 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, the structure of the gasoline market can play a
           role in determining 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 prices above competitive
           levels.

           o  The 1990s saw a wave of merger activity in which over 2600
           mergers occurred 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 about 2 percent. Since 2000, we found that at least
           8 additional mergers have occurred, involving different segments
           of the industry.

           o  This wave of 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 that occurred in the 1990s showed that the majority
           resulted in small wholesale gasoline price increases-changes were
           generally between about 1 and 7 cents per gallon. The 8 additional
           mergers since 2000 did increase the level of industry
           concentration. However, because we have not performed modeling on
           these mergers, we cannot comment on any potential additional
           effect on wholesale gasoline prices.

           Crude oil prices are the fundamental 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.

           Figure 1: Gasoline and Crude Oil Prices-1976-2005 (Not adjusted
           for inflation)

           Source: GAO analysis of data from the Energy Information
           Administration, Department of Energy, Monthly Energy Review,
           Monthly Refiner Acquisition Cost of Crude Oil, Composite and
           Monthly Motor Gasoline Prices, U.S. City Averages, Regular
           Unleaded Gasoline.

           Refining capacity also plays a role in determining how gasoline
           prices vary across different locations and over time. Refinery
           capacity in the United States has not expanded at the same pace as
           demand for gasoline and other petroleum products in recent years.
           The American Petroleum Institute recently reported that U.S.
           average refinery capacity utilization has increased to 92 percent.
           As a result, domestic refineries have little room to expand
           production in the event of a temporary supply shortfall.
           Furthermore, the fact that imported gasoline comes from farther
           away than domestically produced gasoline means that when supply
           disruptions occur in the United States it might take longer to get
           replacement gasoline than if we had excess refining capacity in
           the United States. This could cause gasoline prices to rise and
           stay high until the imported supplies can reach the market.

           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 products 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 private
           companies held stocks of gasoline in excess of 35 days of average
           U.S. consumption, while in 2004 these stocks were equivalent to
           less than 25 days 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 also play a role. 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.

           Finally, the structure of the gasoline market can play a role in
           determining 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 prices above competitive levels.2 On the
           other hand, mergers could also yield cost savings and efficiency
           gains, which may be passed on to consumers through lower prices.
           Ultimately, the impact depends on whether market power or
           efficiency dominates.

           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.3 More than 2,600 merger
           transactions have occurred since 1991 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 about 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 since the second half of the 1990s,
           including those involving large partially or fully vertically
           integrated companies. For example, 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. 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.

           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.

           Mergers in the 1990s contributed to increases in market
           concentration in the refining and marketing segments of the U.S.
           petroleum industry, while the exploration and production segment
           experienced little change in concentration. Econometric modeling
           we performed of eight mergers that occurred in the 1990s showed
           that the majority resulted in small wholesale gasoline price
           increases. 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 additional effect on wholesale gasoline
           prices, these mergers would further increase market concentration
           nationwide since there are now fewer oil companies.

           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.

           While market concentration is important, other aspects of the
           market 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. Mergers may
           have also contributed to changes in these aspects. However, we
           could not quantify the extent of these changes because of a lack
           of relevant data.

           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.

           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 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.

           Our past work has shown that, crude oil price is the fundamental
           determinant of gasoline prices. Refinery capacity, gasoline
           inventory levels and regulatory factors 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 this change 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
           additional effect on wholesale gasoline prices, these mergers
           would further increase market concentration nationwide since there
           are now fewer oil companies.

           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. Going forward, we believe that, in light of our findings,
           both forward looking and retrospective analysis 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 important issue. 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.

           Regardless of the causes, high gasoline prices specifically, and
           high energy prices in general are a challenge for the nation.
           Rising demand for energy in the United States and across the world
           will put upward pressure on prices with potentially adverse
           economic impacts. Clearly none of the options for meeting the
           nation's energy needs are without tradeoffs. Current U.S. energy
           supplies remain highly dependent on fossil energy sources that are
           costly, imported, potentially harmful to the environment, or some
           combination of these three, while many renewable energy options
           are currently more costly than traditional options. Striking a
           balance between efforts to boost supplies from alternative energy
           sources and policies and technologies focused on improved
           efficiency of petroleum burning vehicles or on overall energy
           conservation present challenges as well as opportunities. How we
           choose to meet the challenges and seize the opportunities will
           help determine our quality of life and economic prosperity in the
           future.

           We are currently studying gasoline prices in particular, and the
           petroleum industry more generally, including an analysis of the
           viability of the Strategic Petroleum Reserve, an evaluation of
           world oil reserves, and an assessment of U.S. contingency plans
           should oil imports from a major oil producing country, such as
           Venezuela, be disrupted. With this body of work, we will continue
           to provide Congress and the American people the information needed
           to make informed decisions on energy that will have far-reaching
           effects on our economy and our way of life.

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

           For further information about this testimony, please contact me at
           (202) 512-3841 (or at [email protected] ). Godwin Agbara, Samantha
           Gross, John Karikari, and Frank Rusco made key contributions to
           this testimony.

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1See U.S. GAO, Energy Markets: Effects of Mergers and Market Concentration
in the U.S. Petroleum Industry, GAO-04-96 (Washington, D.C.: May 17,
2004); U.S. GAO, Motor Fuels: Understanding the Factors That Influence the
Retail Price of Gasoline, GAO-05-525SP (Washington, D.C.: May 2, 2005);
and U.S. GAO, "Gasoline Markets: Special Gasoline Blends Reduce Emissions
and Improve Air Quality, but Complicate Supply and Contribute to Higher
Prices," GAO-05-421 , (Washington, D.C.: June 17, 2005).

           Crude Oil Prices and Other Factors Affect Gasoline Prices

2Federal 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 Occurred in All Segments of the U.S. Petroleum Industry in Recent Years
                              for Several Reasons

3We refer to all of these transactions as mergers.

 Mergers in the 1990s Increased Market Concentration and Led to Small Increases
 in Wholesale Gasoline Prices, but the Impact of More Recent Mergers is Unknown

                            Concluding Observations

                     GAO Contacts and Staff Acknowledgments

(360669)

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To view the full product, including the scope

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For more information, contact Jim Wells at (202) 512-3841 or
[email protected]..

Highlights of GAO-06-412T, a report to the Committee on the Judiciary,
United States Senate

February 1, 2006

ENERGY MARKETS

Factors Contributing to Higher Gasoline Prices

Soaring retail gasoline prices, increased oil company profits, and mergers
of large oil companies have garnered extensive media attention and
generated considerable public concern. Gasoline prices impact the economy
because of our heavy reliance on motor vehicles. According to the
Department of Energy's Energy Information Administration (EIA), each
additional ten cents per gallon of gasoline adds about $14 billion to
America's annual gasoline bill.

Given the importance of gasoline for the nation's economy, it is essential
to understand the market for gasoline and how prices are determined. In
this context, this testimony addresses the following questions: (1) What
factors affect gasoline prices? (2) What has been the pattern of oil
company mergers in the United States in recent years? (3) What effects
have mergers had on market concentration and wholesale gasoline prices?

To address these questions, GAO relied on previous reports, including (1)
a 2005 GAO primer on gasoline prices, (2) a 2005 GAO report on the
proliferation of special gasoline blends, and (3) a 2004 GAO report on
mergers in the U.S. petroleum industry. GAO also collected updated data
from a number of sources that we deemed reliable. This work was performed
in accordance with generally accepted government auditing standards.

Crude oil prices are the major determinant of gasoline prices. A number of
other factors also affect gasoline prices including (1) refinery capacity
in the United States, which has not expanded at the same pace as demand
for gasoline and other petroleum products in recent years; (2) gasoline
inventories maintained by refiners or marketers of gasoline, which as with
trends in a number of other industries, have seen a general downward trend
in recent years; and (3) 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, the
structure of the gasoline market can play a role in determining 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 prices above
competitive levels.

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. During this period, more than 2,600 merger
transactions occurred-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 about 2
percent. Since 2000, we found that at least 8 additional mergers have
occurred, involving different segments of the industry. 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.

Mergers in the 1990s contributed to increases in market concentration in
the refining and marketing segments of the U.S. petroleum industry, while
the exploration and production segment experienced little change in
concentration. GAO evaluated eight mergers that occurred in the 1990s
after they had been reviewed by the FTC-the FTC generally reviews proposed
mergers involving the petroleum industry and only approves such mergers if
they are deemed not to have anticompetitive effects. GAO's econometric
modeling of these mergers showed that the majority resulted in small
wholesale gasoline price increases. While mergers since 2000 also
increased market concentration, we have not performed modeling on more
recent mergers and thus cannot comment on any potential additional effect
on wholesale gasoline prices.
*** End of document. ***